Lockheed Martin 2015 Annual Report Download - page 51

We have a number of programs that are designated as classified by the U.S. Government which cannot be specifically
described. The operating results of these classified programs are included in our consolidated and business segment results
and are subjected to the same oversight and internal controls as our other programs.
Our net sales are primarily derived from long-term contracts for products and services provided to the U.S. Government
as well as FMS contracted through the U.S. Government. We account for these contracts, as well as product contracts with
non-U.S. Government customers, using the percentage-of-completion method of accounting, which represent substantially all
of our net sales. We derive our remaining net sales from contracts to provide services to non-U.S. Government customers,
which we account for under the services method of accounting.
Under the percentage-of-completion method of accounting, we record sales on contracts based upon our progress
towards completion on a particular contract as well as our estimate of the profit to be earned at completion. Cost-
reimbursable contracts provide for the payment of allowable costs plus a fee. For fixed-priced contracts, net sales and cost of
sales are recognized as products are delivered or as costs are incurred. Due to the nature of the percentage-of-completion
method of accounting, changes in our cost of sales are typically accompanied by a related change in our net sales.
Changes in net sales and operating profit generally are expressed in terms of volume. Changes in volume refer to
increases or decreases in sales or operating profit resulting from varying production activity levels, deliveries or service
levels on individual contracts. Volume changes in segment operating profit are typically based on the current profit booking
rate for a particular contract.
In addition, comparability of our segment sales, operating profit and operating margins may be impacted favorably or
unfavorably by changes in profit booking rates on our contracts accounted for using the percentage-of-completion method of
accounting. Increases in the profit booking rates, typically referred to as risk retirements, usually relate to revisions in the
estimated total costs that reflect improved conditions on a particular contract. Conversely, conditions on a particular contract
may deteriorate resulting in an increase in the estimated total costs to complete and a reduction in the profit booking rate.
Increases or decreases in profit booking rates are recognized in the current period and reflect the inception-to-date effect of
such changes. Segment operating profit and margins may also be impacted favorably or unfavorably by other items.
Favorable items may include the positive resolution of contractual matters, cost recoveries on restructuring charges,
insurance recoveries and gains on sales of assets. Unfavorable items may include the adverse resolution of contractual
matters; restructuring charges, except for significant severance actions as mentioned above which are excluded from segment
operating results; reserves for disputes; asset impairments; and losses on sales of assets. Segment operating profit and items
such as risk retirements, reductions of profit booking rates or other matters are presented net of state income taxes.
Our consolidated net adjustments not related to volume, including net profit booking rate adjustments and other matters,
net of state income taxes, increased segment operating profit by approximately $1.9 billion, $1.8 billion and $2.1 billion for
2015, 2014 and 2013. The increase in our consolidated net adjustments in 2015 compared to 2014 was primarily due to an
increase in profit booking rate adjustments at our Space Systems, Aeronautics and IS&GS business segments, offset by a
decrease in profit booking rate adjustments at our MST and MFC business segments. The decrease in our consolidated net
adjustments in 2014 compared to 2013 was primarily due to a decrease in profit booking rate adjustments at our Aeronautics,
MFC and MST business segments. The consolidated net adjustments for 2015 are inclusive of approximately $645 million in
unfavorable items, which include reserves for performance matters on an international program at MST and on commercial
satellite programs at Space Systems. The consolidated net adjustments for 2014 are inclusive of approximately $650 million
in unfavorable items, which include reserves recorded on certain training and logistics solutions programs at MST and net
warranty reserve adjustments for various programs (including JASSM and GMLRS) at MFC as described in the respective
business segment’s results of operations below. The consolidated net adjustments for 2013 are inclusive of approximately
$600 million in unfavorable items, which include significant profit reductions on the F-35 development contract and on the
C-5 program.
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