Northrop Grumman 2013 Annual Report Download - page 23

NORTHROP GRUMMAN CORPORATION
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Our risk varies with the type of contract. Due to their nature, fixed-price contracts inherently have more risk than
cost type contracts. In 2013, approximately 47 percent of our annual revenues were derived from fixed-price
contracts. We typically enter into fixed-price contracts where costs can be more reasonably estimated based on
experience. In addition, our contracts contain provisions relating to cost controls and audit rights. If the terms
specified in our contracts are not met, our profitability may be reduced and we may incur a loss. Fixed-price
development work comprises a small portion of our fixed-price contracts. This type of work is inherently more
uncertain as to future events than production contracts, and, as a result, there is typically more variability in
estimates of the costs to complete the development stage. As work progresses through the development stage into
production, the risks associated with estimating the total costs of the contract are typically reduced. While
management uses its best judgment to estimate costs associated with fixed-price development contracts, future
events could result in either upward or downward adjustments to those estimates.
Other contracts are also subject to risk, for example, under a fixed-price incentive contract, the allowable costs
incurred by the contractor are paid up to a ceiling, which can affect profitability. Further, under a cost type contract,
the allowable costs incurred by the contractor are also subject to reimbursement plus a fee. We often enter into cost
type contracts for development programs with complex design and technical challenges. These cost type programs
typically have award or incentive fees that are subject to uncertainty and may be earned over extended periods or
towards the end of the contract. In these cases, the associated financial risks are primarily in recognizing profit,
which ultimately may not be earned, or program cancellation if cost, schedule, or technical performance issues arise.
We use estimates when accounting for contracts. Changes in estimates could affect our profitability and our
overall financial position.
When agreeing to contractual terms, we make assumptions and projections about future conditions and events, many
of which extend over long periods. These assumptions and projections assess the cost, productivity and availability
of labor, future levels of business base, complexity of the work to be performed, cost and availability of materials
and components, impact of potential delays in performance and timing of product deliveries. Contract accounting
requires judgment relative to assessing risks, estimating contract revenues and costs, and making assumptions for
schedule and technical issues. Due to the size and nature of many of our contracts, the estimation of total revenues
and costs at completion is complicated and subject to many variables. Incentives, awards or penalties related to
performance on contracts are considered in estimating revenue and profit rates when there is sufficient information
to assess anticipated performance. Suppliers’ assertions are also assessed and considered in estimating costs and
profitability.
Because of the significance of the judgment and estimation processes described above, it is possible that materially
different amounts could be obtained if different assumptions were used or if the underlying circumstances were to
change. Changes in underlying assumptions, circumstances or estimates could have a material adverse effect upon
the profitability of one or more of the affected contracts and on our overall financial position, results of operations
and/or cash flows. See Critical Accounting Policies, Estimates, and Judgments in Part II, Item 7.
Our business could be negatively impacted by security threats, including physical and cybersecurity threats, and
other disruptions.
As a defense contractor, we face various cyber and other security threats, including attempts to gain unauthorized
access to sensitive information and networks; threats to the safety of our directors, officers and employees; threats to
the security of our facilities and infrastructure; and threats from terrorist acts. Although we utilize various
procedures and controls to monitor and mitigate the risk of these threats, there can be no assurance that these
procedures and controls will be sufficient. These threats could lead to losses of sensitive information or capabilities,
harm to personnel or infrastructure, and/or damage to our reputation. They could have a material adverse effect on
our financial position, results of operations and/or cash flows.
Cybersecurity threats are evolving and include, but are not limited to, malicious software, attempts to gain
unauthorized access to data, disruption or denial of service attacks, and other electronic security breaches that could
lead to disruptions in mission critical systems, unauthorized release of confidential or otherwise protected
information (ours or that of our customers or partners), and corruption of data, networks or systems. These events, if
not prevented or effectively mitigated, could damage our reputation and lead to financial losses from remedial
actions, loss of business or potential liability. They could have a material adverse effect on our financial position,
results of operations and/or cash flows.
We provide cyber and information technology systems, products and services to various customers (government and
commercial) and other third parties who also face these types of cybersecurity threats. Our systems, products and