Lockheed Martin 2013 Annual Report Download - page 61

include a significant deterioration in overall economic conditions, changes in the business climate of our industry, a decline
in our market capitalization, operating performance indicators, competition, reorganizations of our business, or the disposal
of all or a portion of a reporting unit. Our goodwill has been allocated to and is tested for impairment at a level referred to as
the reporting unit, which is our business segment level or a level below the business segment. The level at which we test
goodwill for impairment requires us to determine whether the operations below the business segment constitute a self-
sustaining business for which discrete financial information is available and segment management regularly reviews the
operating results.
We initially test goodwill for impairment by comparing the fair value of each reporting unit with its carrying amount,
including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not
impaired. If the carrying amount of a reporting unit exceeds its fair value, we compare the implied value of the reporting
unit’s goodwill with the carrying amount of its goodwill. The implied value of the reporting unit’s goodwill is calculated by
creating a hypothetical balance sheet as if the reporting unit had just been acquired. This balance sheet contains all assets and
liabilities recorded at fair value (including any assumed intangible assets that may not have any corresponding carrying
amount in our balance sheet). The implied value of the reporting unit’s goodwill is calculated by subtracting the fair value of
the net assets from the fair value of the reporting unit. If the carrying amount of the reporting unit’s goodwill exceeds the
implied value of that goodwill, an impairment loss is recognized in an amount equal to that excess.
The carrying amount of each reporting unit includes the assets and liabilities employed in its operations, allocations of
amounts held at the business segment and corporate levels as well as goodwill. The corporate allocations include our
postretirement benefit plans liabilities, as determined in accordance with CAS, in order to align the basis of the carrying
amounts with the determination of the fair values of our reporting units, which are measured using CAS cost. CAS cost is
recovered through the pricing of our products and services on U.S. Government contracts and, therefore, affects the fair value
of each reporting unit. The discount rate used for CAS is currently higher than the discount rate used for GAAP but is
expected to trend downward over the next few years, which would increase the amount of CAS liabilities allocated to each
reporting unit, contributing to a reduction in the carrying amount of each reporting unit.
We estimate the fair value of each reporting unit using a combination of a discounted cash flow (DCF) analysis and market-
based valuation methodologies such as comparable public trading values and values observed in market transactions. Determining
fair value requires the exercise of significant judgments, including judgments about the amount and timing of expected future cash
flows, discount rates, perpetual growth rates, and relevant comparable company earnings multiples and transaction multiples. The
cash flows employed in the DCF analyses are based on our best estimate of future sales and operating costs, based primarily on
existing firm orders, expected future orders, contracts with suppliers, labor agreements, and general market conditions; changes in
working capital; most recent long-term business plans in place at the time of our testing date; and recent operating performance.
The discount rates utilized in the DCF analysis are based on the respective reporting unit’s weighted average cost of capital, which
takes into account the relative weights of each component of capital structure (equity and debt) and represents the expected cost of
new capital, adjusted as appropriate to consider the risk inherent in future cash flows of the respective reporting unit.
In the fourth quarter of 2013, we performed our annual goodwill impairment test for each of our reporting units. The
results of these tests indicated that the estimated fair values of our reporting units exceeded their carrying amounts, with the
exception of our Technical Services reporting unit within our MFC business segment. During the fourth quarter of 2013, the
continuing impact of defense budget reductions and related competitive pressures on the Technical Services business, which
typically has smaller customer contracts of a shorter duration, adversely impacted the fair value of this reporting unit. As a
result, we compared the implied value of that reporting unit’s goodwill with the carrying amount of its goodwill, and since
the carrying amount exceeded the implied value, we recorded a non-cash impairment charge of $195 million, net of state tax
benefits, in the fourth quarter of 2013 equal to that differential.
The fair value of each reporting unit was based on our best estimates and judgment, particularly assumptions regarding
the planned defense spending levels of the U.S. Government, our principal customer. If customer budget pressures continue,
these circumstances could eventually result in other impairments of goodwill in the future. Our reporting units in our IS&GS
business segment and our services businesses at our MFC and MST business segments have smaller customer contracts of
short duration and are most susceptible to the impacts of budget reductions. Following the goodwill impairment charge
described above, we currently do not believe that any of our reporting units are at risk of a goodwill impairment charge in the
near-term, as their fair values are significantly greater than their carrying amounts.
Impairment assessments inherently involve management judgments regarding assumptions about expected future sales,
profits, and cash flows and the impact of market conditions on those assumptions. Due to the many variables inherent in the
estimation of a reporting unit’s fair value and the relative size of our recorded goodwill, differences in assumptions could
have a material effect on the estimated fair value of one or more of our reporting units and could result in a goodwill
impairment charge in a future period.
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