Business Overview The following Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to help the reader understand our results of operations and financial condition. The MD&A is provided as a supplement to, and should be read in conjunction with, our consolidated financial statements and notes thereto included in Item 8 - Financial Statements and Supplementary Data. The MD&A generally discusses 2019 and 2018 items and year-to-year comparisons between 2019 and 2018. Discussions of 2017 items and year-to-year comparisons between 2018 and 2017 that are not included in this Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results or Operations" in the Company's Annual Report on Form 10-K for the fiscal year endedDecember 31, 2018 filed with theSEC onFebruary 8, 2019 . We are a global security and aerospace company principally engaged in the research, design, development, manufacture, integration and sustainment of advanced technology systems, products and services. We also provide a broad range of management, engineering, technical, scientific, logistics, system integration and cybersecurity services. We serve bothU.S. and international customers with products and services that have defense, civil and commercial applications, with our principal customers being agencies of theU.S. Government . In 2019, 71% of our$59.8 billion in net sales were from theU.S. Government , either as a prime contractor or as a subcontractor (including 61% from theDepartment of Defense (DoD )), 28% were from international customers (including foreign military sales (FMS) contracted through theU.S. Government ) and 1% were fromU.S. commercial and other customers. Our main areas of focus are in defense, space, intelligence, homeland security and information technology, including cybersecurity. We operate in four business segments: Aeronautics, Missiles and Fire Control (MFC),Rotary and Mission Systems (RMS) and Space. We organize our business segments based on the nature of the products and services offered. We operate in an environment characterized by both complexity in global security and continuing economic pressures in theU.S. and globally. A significant component of our strategy in this environment is to focus on program execution, improving the quality and predictability of the delivery of our products and services, and placing security capability quickly into the hands of ourU.S. and international customers at affordable prices. Recognizing that our customers are resource constrained, we are endeavoring to develop and extend our portfolio domestically in a disciplined manner with a focus on adjacent markets close to our core capabilities, as well as growing our international sales. We continue to focus on affordability initiatives. We also expect to continue to innovate and invest in technologies to fulfill new mission requirements for our customers and invest in our people so that we have the technical skills necessary to succeed without limiting our ability to return a substantial portion of our free cash flow to our investors in the form of dividends and share repurchases. We define free cash flow as cash from operations as determined underU.S. generally accepted accounting principles (GAAP), less capital expenditures as presented on our consolidated statements of cash flows. 2020 Financial Trends We expect our 2020 net sales to increase in the mid-single digit range from 2019 levels. The projected growth is driven by increased volume at all four business areas. Specifically, the increased growth is driven by the F-35 program at Aeronautics, increased volume in the tactical and strike missiles and air and missile defense businesses at MFC, Sikorsky volume at RMS, and hypersonics volume at Space. Total business segment operating profit margin in 2020 is expected to be approximately 10.8%; and cash from operations is expected to be greater than or equal to$7.6 billion . The preliminary outlook for 2020 assumes theU.S. Government continues to support and fund our key programs. Changes in circumstances may require us to revise our assumptions, which could materially change our current estimate of 2020 net sales, operating margin and cash flows. We expect a net FAS/CAS pension benefit of approximately$2.1 billion in 2020 based on a 3.25% discount rate (a 100 basis point decrease from the end of 2018), an approximate 21% return on plan assets in 2019, a 7.00% expected long-term rate of return on plan assets in future years, and the revised longevity assumptions released during the fourth quarter of 2019 by theSociety of Actuaries . We do not expect to make any contributions to our qualified defined benefit pension plans in 2020 and anticipate recovering approximately$2.0 billion of CAS pension cost. As previously announced onJuly 1, 2014 , we completed the final step of the planned freeze of our qualified and nonqualified defined benefit pension plans for salaried employees effectiveJanuary 1, 2020 . The service-based component of the formula used to determine retirement benefits is frozen such that participants are no longer earning further credited service for any period afterDecember 31, 2019 . As a result of these changes, the plans are fully frozen effectiveJanuary 1, 2020 . Retirees already collecting 27
--------------------------------------------------------------------------------
Table of Contents
benefits and former employees with a vested benefit were not affected by the change. Current employees also will retain all benefits already earned in their pension plan to date. Portfolio Shaping Activities We continuously strive to strengthen our portfolio of products and services to meet the current and future needs of our customers. We accomplish this in part by our independent research and development activities and through acquisition, divestiture and internal realignment activities. We selectively pursue the acquisition of businesses and investments at attractive valuations that will expand or complement our current portfolio and allow access to new customers or technologies. We also may explore the divestiture of businesses that no longer meet our needs or strategy or that could perform better outside of our organization. In pursuing our business strategy, we routinely conduct discussions, evaluate targets and enter into agreements regarding possible acquisitions, divestitures, joint ventures and equity investments. Divestiture of Distributed Energy Solutions OnNovember 18, 2019 , we completed the sale of our Distributed Energy Solutions (DES) business, a commercial energy service provider that was part of our MFC business segment. We received$225 million in cash from the sale and recognized a gain of$34 million (approximately$0 after-tax) for the sale. Amounts related to this divestiture were not significant to the corporation and the sale did not represent a strategic shift, and accordingly, the operating results, financial position and cash flows for the DES business have not been reclassified to discontinued operations. Industry ConsiderationsU.S. Government Funding OnDecember 20, 2019 , the President signed the annual fiscal year (FY) 2020 appropriations, funding theDoD and other government agencies (aU.S. Government fiscal year starts onOctober 1 and ends onSeptember 30 ). The appropriations provide$738 billion in discretionary funding for national defense, including$667 billion in base funding and$71 billion in Overseas Contingency Operations (OCO)/emergency funding (OCO and emergency supplemental funding do not count toward discretionary spending caps). Of the$738 billion , theDoD is allocated$709 billion ; composed of$637 billion in base funding and$72 billion in OCO and emergency funding. The approved funding is in accordance with the Bipartisan Budget Act of 2019 (BBA-19), which was enacted onAugust 2, 2019 . The BBA-19 increased the spending limits for both defense and non-defense discretionary funding for theU.S. Government FY 2020 and 2021 set under the Budget Control Act of 2011 (BCA). The defense spending limits were increased by$90 billion to$667 billion for FY 2020 and by$81 billion to$672 billion for FY 2021. When combined with approved OCO/emergency funding, the agreement raised top-line spending for national defense to the$738 billion enacted in FY 2020 and$741 billion in FY 2021. By raising the spending limits, the BBA-19 essentially ended the budgetary constraints implemented by the 2011 BCA. Additionally, the BBA-19 also suspended the debt ceiling throughJuly 31, 2021 , at which time the debt limit will be increased to the amount ofU.S. Government debt outstanding on that date. International Business A key component of our strategic plan is to grow our international sales. To accomplish this growth, we continue to focus on strengthening our relationships internationally through partnerships and joint technology efforts. We conduct business with international customers through each of our business segments through either FMS or direct sales to international customers. See Item 1A - Risk Factors for a discussion of risks related to international sales. International customers accounted for 37% of Aeronautics' 2019 net sales. There continues to be strong international interest in the F-35 program, which includes commitments from theU.S. Government and eight international partner countries and four international customers, as well as expressions of interest from other countries. TheU.S. Government and the partner countries continue to work together on the design, testing, production, and sustainment of the F-35 program. While, inJuly 2019 , theDoD announced plans to removeTurkey , who had previously committed to purchase up to 100 F-35 aircraft, from the F-35 program, we received congressional notification of approval of the proposed sale of 32 F-35A aircraft toPoland in the third quarter of 2019. Additionally, inJanuary 2019 ,Singapore announced its selection of the F-35 as their next generation fighter.Singapore's initial request is for four F-35s, with the option of eight additional aircraft. Other areas of international expansion at our Aeronautics business segment include the F-16 program. InAugust 2019 , the Bulgarian government and theU.S. Government signed a letter of offer and acceptance worth$1.26 billion regardingBulgaria's planned procurement of eight new production F-16 Block 70 aircraft for theBulgarian Air Force . 28
--------------------------------------------------------------------------------
Table of Contents
In 2019, international customers accounted for 24% of MFC's net sales. Our MFC business segment continues to generate significant international interest, most notably in the air and missile defense product line, which produces the Patriot Advanced Capability-3 (PAC-3) and Terminal High Altitude Area Defense (THAAD) systems. The PAC-3 is an advanced missile defense system designed to intercept incoming airborne threats. We have ongoing PAC-3 programs for production and sustainment activities inQatar , theKingdom of Saudi Arabia ,UAE ,Japan , theRepublic of Korea ,Poland andTaiwan . THAAD is an integrated system designed to protect against high altitude ballistic missile threats.UAE and theKingdom of Saudi Arabia are international customers for THAAD, and other countries in theMiddle East ,Europe and theAsia-Pacific region have also expressed interest in our air and missile defense systems. Additionally, we continue to see international demand for our tactical missile and fire control products, where we received orders for Apache and Low Altitude Navigation and Targeting Infrared for Night (LANTIRN®) systems forQatar , and precision fires systems fromPoland andRomania . Other MFC international customers include theUnited Kingdom ,Germany ,India ,Kuwait andBahrain . In 2019, international customers accounted for 25% of RMS' net sales. Our RMS business segment continues to experience international interest in the Aegis Ballistic Missile Defense System (Aegis). We perform activities in the development, production, modernization, ship integration, test and lifetime support for ships of international customers such asJapan ,Spain ,Republic of Korea , andAustralia . We have ongoing programs inCanada andChile for combat systems equipment upgrades on Halifax-class and Type 23 frigates. Our Multi-Mission Surface Combatant (MMSC) program provides surface combatant ships for international customers, such as theKingdom of Saudi Arabia , designed to operate in shallow waters and the open ocean. In our training and logistics solutions portfolio, we have active programs and pursuits in theUnited Kingdom , theKingdom of Saudi Arabia ,Canada ,Egypt ,Singapore , andAustralia . We have active development, production, and sustainment support of the S-70i Black Hawk® and MH-60 Seahawk® aircraft to foreign military customers, includingChile ,Australia ,Denmark ,Taiwan , theKingdom of Saudi Arabia andColombia . Commercial aircraft are sold to customers in the oil and gas industry, emergency medical evacuation, search and rescue fleets, and VIP customers in over 30 countries. International customers accounted for 14% of Space's 2019 net sales. Our Space business segment includes the operations ofAWE Management Limited (AWE), which operates theUnited Kingdom's nuclear deterrent program. The work at AWE covers the entire life cycle, from initial concept, assessment and design, through component manufacture and assembly, in-service support and decommissioning, and disposal. In addition, Space has an international contract withJapan to design and manufacture geostationary communication satellites using the LM2100 satellite platform. Status of the F-35 Program The F-35 program primarily consists of production contracts, sustainment activities, and new development efforts. Production of the aircraft is expected to continue for many years given theU.S. Government's current inventory objective of 2,456 aircraft for theU.S. Air Force ,U.S. Marine Corps , andU.S. Navy ; commitments from our eight international partner countries and four international customers; as well as expressions of interest from other countries. During 2019, the F-35 program completed several milestones both domestically and internationally. TheU.S. Government continued testing the aircraft, including ship trials, mission and weapons systems evaluations, and the F-35 fleet recently surpassed 240,000 flight hours. During 2019, multiple customers declared Initial Operating Capability including theU.S. Navy for its F-35C variant, theUnited Kingdom for its F-35B variant,Japan for its F-35A variant, andNorway for its F-35A variant. Since program inception, we have delivered 491 production F-35 aircraft, demonstrating the F-35 program's continued progress and longevity. The first 491 F-35 aircraft delivered toU.S. and international customers include 347 F-35A variants, 108 F-35B variants, and 36 F-35C variants. The full-rate production decision, also known formally as Milestone C, is expected to be delayed by theDoD until Initial Operational Test and Evaluation (IOT&E) activities are complete in the Naval Air Systems Command (NAVAIR)-led Joint Simulation Environment (JSE). The JSE is used to conduct simulated evaluations of the F-35 in a range of high-threat scenarios. Testing is expected to be completed by the end of 2020. The data will be utilized by theU.S. Government as part of their evaluation to transition the F-35 program from Low Rate Initial Production (LRIP) into full-rate production. During the fourth quarter of 2019, theU.S. Government andLockheed Martin finalized aBlock Buy agreement for the production and delivery of F-35s in Lots 12, 13 and 14 at the lowest aircraft price in the history of the program. This includes amounts previously awarded by theU.S. Government inNovember 2018 for the production of 252 Block Buy F-35 aircraft. As part of the fourth quarter 2019 agreement, theU.S. Government awarded the production of an additional 112 F-35 Block Buy Aircraft. We delivered 134 production aircraft in 2019 to ourU.S. and international partner countries, and we have 374 production aircraft in backlog, including orders from our international partner countries. OnJuly 17, 2019 , theU.S. Government suspendedTurkey's participation in the F-35 program and initiated the process to formally removeTurkey from the program as a result ofTurkey accepting delivery of the Russian S-400 air and missile defense system. To date, the Administration has not imposed sanctions on Turkish entities involved in the S-400 procurement, although sanctions under the Countering America's Adversaries Through Sanctions Act (CAATSA) remain a risk. Additionally, sanctions 29
--------------------------------------------------------------------------------
Table of Contents
could be imposed againstTurkey as a result of future legislation, including the "Promoting American National Security and Preventing the Resurgence of ISIS Act of 2019" that was passed out of theSenate Foreign Relations Committee onDecember 11, 2019 . The bill includes significant new sanction provisions targeted atTurkey that, if enacted, would directly affectLockheed Martin programs inTurkey .Turkey could implement retaliatory sanctions if the bill moves forward inCongress in 2020.We are monitoring these developments and the potential impacts of any sanctions and other actions regardingTurkey on the F-35 program and on our other programs involvingTurkey . Depending on the scope and applicability of any sanctions or other actions, the impact could be material to our operations, operating results, financial position or cash flows.Turkey is one of eight international partner countries on the F-35 program and previously committed to purchase up to 100 F-35 aircraft, of which six have completed production. Turkish suppliers also produce component parts for the F-35 program, many of which are single-sourced. To minimize the risks of disruption of our supply chain and ensure continuity of F-35 production, we have been working closely with theDoD and supporting activities to identify and engage alternate suppliers for the component parts produced by Turkish suppliers. We have made significant progress toward this end but due to the procedure to qualify new parts and suppliers, this collaborative process betweenDoD andLockheed Martin is ongoing. We are in discussions with theU.S. Government with respect to the timeline for the transition of Turkish sources. While the transition timeline is an important first step, it is equally important that our replacement capacity is re-established so that production is not impacted. Efforts to date have significantly reduced our risk but final resolution on a limited number of remaining components could affect F-35 deliveries, including in 2020, and any accelerated work stoppage would impact cost. International sales of the F-35 are negotiated between theU.S. Government and international governments and the process to formally removeTurkey from the F-35 program is a government-to-government matter. We will continue to follow officialU.S. Government guidance as it relates to delivery of F-35 aircraft toTurkey and the export and import of component parts from the Turkish supply chain. The full effects of potentialU.S. Government sanctions onTurkey andTurkey's removal from the F-35 program cannot be determined at this time. However, these actions could impact the timing of orders, disrupt the production of aircraft, delay delivery of aircraft, disrupt delivery of sustainment components produced inTurkey and impact funding on the F-35 program to include the result of any reprogramming of funds that may be necessary to mitigate the impact of alternate sources for component parts made inTurkey . While, in the case of the F-35 program, we expect that these costs ultimately would be recovered from theU.S. Government , the availability or timing of any recovery could adversely affect our cash flows and results of operations. For additional discussion, including the risk of sanctions on other programs involving sales toTurkey or work with Turkish industry, see Item 1A - Risk Factors. Given the size and complexity of the F-35 program, we anticipate that there will be continual reviews related to aircraft performance, program schedule, cost, and requirements as part of theDoD , Congressional, and international partner countries' oversight and budgeting processes. Current program challenges include, but are not limited to, supplier and partner performance, software development, level of cost associated with life cycle operations and sustainment and warranties, receiving funding for production contracts on a timely basis, executing future flight tests, findings resulting from testing and operating the aircraft. 30
--------------------------------------------------------------------------------
Table of Contents
Consolidated Results of Operations Our operating cycle is primarily long term and involves many types of contracts for the design, development and manufacture of products and related activities with varying delivery schedules. Consequently, the results of operations of a particular year, or year-to-year comparisons of sales and profits, may not be indicative of future operating results. The following discussions of comparative results among years should be reviewed in this context. All per share amounts cited in these discussions are presented on a "per diluted share" basis, unless otherwise noted. Our consolidated results of operations were as follows (in millions, except per share data): 2019 2018 2017 Net sales$ 59,812 $ 53,762 $ 49,960 Cost of sales (51,445 ) (46,488 ) (43,589 ) Gross profit 8,367 7,274 6,371 Other income, net 178 60 373 Operating profit (a)(b)(c)(d) 8,545 7,334 6,744 Interest expense (653 ) (668 ) (651 ) Other non-operating expense, net (651 ) (828 ) (847 ) Earnings from continuing operations before income taxes 7,241 5,838 5,246 Income tax expense (e)(f) (1,011 ) (792 ) (3,356 ) Net earnings from continuing operations 6,230 5,046 1,890 Net earnings from discontinued operations - - 73 Net earnings$ 6,230 $ 5,046 $ 1,963 Diluted earnings per common share Continuing operations$ 21.95 $ 17.59 $ 6.50 Discontinued operations - - 0.25 Total diluted earnings per common share$ 21.95 $
17.59
(a) For the year ended
asset impairment charge of
investee,
(AMMROC). For the year ended
impairment charge recorded by AMMROC. See "Note 1 - Significant Accounting
Policies" included in our Notes to Consolidated Financial Statements for more information.
(b) For the year ended
of severance and restructuring charges. See "Note 15 - Severance and
Restructuring Charges" included in our Notes to Consolidated Financial
Statements for a discussion of 2018 severance and restructuring charges.
(c) For the years endedDecember 31, 2019 andDecember 31, 2017 , operating profit includes a previously deferred non-cash gain of approximately$51 million and$198 million related to properties sold in 2015. (d) For the year endedDecember 31, 2019 , operating profit includes a gain of$34 million for the sale of our Distributed Energy Solutions business. (e) In 2017, we recorded a net one-time tax charge of$2.0 billion ($6.77 per share), substantially all of which was non-cash, primarily related to the
estimated impact of the Tax Cuts and Jobs Act. See "Income Tax Expense"
section below and "Note 9 - Income Taxes" included in our Notes to
Consolidated Financial Statements for additional information.
(f) Net earnings for the year ended
million (
primarily attributable to foreign derived intangible income treatment based
on proposed tax regulations released on
accounting method. Net earnings for the year ended
benefits of
the prior year, primarily attributable to true-ups to the net one-time
charges related to the Tax Cuts and Jobs Act enacted on
and our change in tax accounting method. See "Income Tax Expense" section
below and "Note 9 - Income Taxes" included in our Notes to Consolidated
Financial Statements for additional information.
Certain amounts reported in other income, net, primarily our share of earnings or losses from equity method investees, are included in the operating profit of our business segments. Accordingly, such amounts are included in our discussion of our business segment results of operations. 31
--------------------------------------------------------------------------------
Table of Contents
Net Sales We generate sales from the delivery of products and services to our customers. Our consolidated net sales were as follows (in millions): 2019 2018 2017 Products$ 50,053 $ 45,005 $ 42,502 % of total net sales 83.7 % 83.7 % 85.1 % Services 9,759 8,757 7,458 % of total net sales 16.3 % 16.3 % 14.9 % Total net sales$ 59,812 $ 53,762 $ 49,960 Substantially all of our contracts are accounted for using the percentage-of-completion cost-to-cost method. Under the percentage-of-completion cost-to-cost method, we record net sales on contracts over time based upon our progress towards completion on a particular contract, as well as our estimate of the profit to be earned at completion. The following discussion of material changes in our consolidated net sales should be read in tandem with the subsequent discussion of changes in our consolidated cost of sales and our business segment results of operations because changes in our sales are typically accompanied by a corresponding change in our cost of sales due to the nature of the percentage-of-completion cost-to-cost method. Product Sales Product sales increased$5.0 billion , or 11%, in 2019 as compared to 2018, primarily due to higher product sales of$2.1 billion at Aeronautics,$1.5 billion at MFC and$965 million at Space. The increase in product sales at Aeronautics was primarily due to higher production volume for the F-35 program and higher volume on classified programs. The increase in product sales at MFC was primarily due to increased volume for tactical and strike missile programs (primarily precision fires, new hypersonic development programs, and classified programs), increased volume for integrated air and missile defense programs (primarily PAC-3 and THAAD), and increased volume for sensors and global sustainment programs (primarily Apache). The increase in product sales at Space was primarily due to higher volume for government satellite programs (primarily Next Generation Overhead Persistent Infrared (Next Gen OPIR) and Global Positioning System (GPS III)) and higher volume for strategic and missile defense programs (primarily new hypersonic development programs). Service Sales Service sales increased$1.0 billion , or 11%, in 2019 as compared to 2018, primarily due to an increase in service sales of about$385 million at RMS,$340 million at Aeronautics and$190 million at MFC. The increase in service sales at RMS was primarily due to higher volume of various training and logistics solutions programs (primarily an army sustainment program), and integrated warfare systems and sensors (IWSS) programs (primarily Aegis Combat System (Aegis)). Higher service sales at Aeronautics were primarily due to higher sustainment volume for the F-35 and F-22 programs. The increase in service sales at MFC was primarily attributable to increased volume for sensors and global sustainment programs (primarilySpecial Operations Forces Global Logistics Support Services (SOF GLSS)) and higher sustainment volume for the PAC-3 program. 32
--------------------------------------------------------------------------------
Table of Contents
Cost of Sales Cost of sales, for both products and services, consist of materials, labor, subcontracting costs, an allocation of indirect costs (overhead and general and administrative), as well as the costs to fulfill our industrial cooperation agreements, sometimes referred to as offset agreements, required under certain contracts with international customers. For each of our contracts, we monitor the nature and amount of costs at the contract level, which form the basis for estimating our total costs to complete the contract. Our consolidated cost of sales were as follows (in millions): 2019 2018 2017 Cost of sales - products$ (44,589 ) $ (40,293 ) $ (38,417 ) % of product sales 89.1 % 89.5 % 90.4 % Cost of sales - services (8,731 ) (7,738 ) (6,673 ) % of service sales 89.5 % 88.4 % 89.5 % Severance and restructuring charges - (96 ) - Other unallocated, net 1,875 1,639 1,501 Total cost of sales$ (51,445 ) $ (46,488 ) $ (43,589 ) The following discussion of material changes in our consolidated cost of sales for products and services should be read in tandem with the preceding discussion of changes in our consolidated net sales and our business segment results of operations. We have not identified any developing trends in cost of sales for products and services that would have a material impact on our future operations. Product Costs Product costs increased approximately$4.3 billion , or 11%, in 2019 as compared to 2018, primarily due to higher product costs of approximately$1.9 billion at Aeronautics,$1.3 billion at MFC and$750 million at Space. The increase in product costs at Aeronautics was primarily due to higher production volume for the F-35 program and higher volume on classified programs. The increase in product costs at MFC was primarily due to increased volume for tactical and strike missile programs (primarily precision fires, classified programs and new hypersonic missile programs), contract mix and increased volume for integrated air and missile defense programs (primarily PAC-3 and THAAD) and increased volume for sensors and global sustainment programs (primarily Apache). The increase in product costs at Space was primarily attributable to higher volume for government satellite programs (primarily Next Gen OPIR and GPS III) and strategic and missile defense programs (primarily new hypersonic development programs). Service Costs Service costs increased approximately$1.0 billion , or 13%, in 2019 compared to 2018, primarily due to higher service costs of approximately$385 million at RMS,$315 million at Aeronautics and$195 million at MFC. The increase in service costs at RMS was primarily due to increased volume for various training and logistics solutions programs and IWSS programs (primarily Aegis). Higher service costs at Aeronautics were primarily due to higher sustainment volume for the F-35 and F-22 programs. The increase in service costs at MFC was primarily attributable to increased volume for sensors and global sustainment programs (primarily SOF GLSS) and higher sustainment volume for the PAC-3 program. Restructuring Charges During 2018, we recorded charges totaling$96 million ($76 million , or$0.26 per share, after-tax) related to certain severance and restructuring actions at our RMS business segment. As ofDecember 31, 2019 , we have paid substantially all of the severance payments associated with these actions. In addition, we have recovered a significant portion of these payments through the pricing of our products and services to theU.S. Government and other customers, which are included in RMS' operating results. Other Unallocated, Net Other unallocated, net primarily includes the FAS/CAS operating adjustment as described in the "Business Segment Results of Operations" section below, stock-based compensation and other corporate costs. These items are not allocated to the business segments and, therefore, are excluded from the cost of sales for products and services. Other unallocated, net was a net reduction to expense of$1.9 billion in 2019 and$1.6 billion in 2018. The increase in net reduction in expense from 2019 to 2018 was primarily attributable to fluctuations in the FAS/CAS operating adjustment of$2.0 billion in 2019 and$1.8 billion in 2018, and fluctuations in other costs associated with various corporate items, 33
--------------------------------------------------------------------------------
Table of Contents
none of which were individually significant. See "Business Segment Results of Operations" and "Critical Accounting Policies - Postretirement Benefit Plans" discussion below for more information on our pension cost. Other Income, Net Other income, net primarily includes our share of earnings or losses from equity method investees and gains or losses for acquisitions and divestitures. Other income, net in 2019 was$178 million , compared to$60 million in 2018. The increase in 2019 compared to 2018 was primarily attributable to the recognition in 2019 of a previously deferred non-cash gain of approximately$51 million ($38 million , or$0.13 per share, after-tax) related to properties sold in 2015 as a result of completing our remaining obligations, the recognition in 2019 of a$34 million gain (approximately$0 after-tax) for the sale of our Distributed Energy Solutions business, and the recognition in 2018 of a non-cash asset impairment charge of$110 million ($83 million , or$0.29 per share, after-tax) related to our equity method investee,Advanced Military Maintenance, Repair and Overhaul Center LLC (AMMROC). These increases were partially offset by lower earnings generated by equity method investees. As ofDecember 31, 2019 , our equity method investment in AMMROC totaled approximately$435 million . We are continuing to monitor this investment in light of ongoing performance, business base and economic issues, and we may have to record our portion of additional charges, or an impairment of our investment, or both, should the carrying value of our investment exceed its fair value. Substantially all of AMMROC's current business is dependent on one contract that is currently up for re-competition and if AMMROC is not successful in securing such business on favorable terms or at all, the carrying value of our investment would be adversely affected. These charges could adversely affect our results of operations. Interest Expense Interest expense in 2019 was$653 million , compared to$668 million in 2018. The decrease in interest expense in 2019 resulted primarily from our scheduled repayment of$750 million of debt during 2018. See "Capital Structure, Resources and Other" included within "Liquidity and Cash Flows" discussion below and "Note 10 - Debt" included in our Notes to Consolidated Financial Statements for a discussion of our debt. Other Non-Operating Expense, Net Other non-operating expense, net primarily includes the non-service cost components of FAS pension and other postretirement benefit plan expense (i.e., interest cost, expected return on plan assets, net actuarial gains or losses, and amortization of prior service cost or credits). Other non-operating expense, net in 2019 decreased compared to 2018 primarily due to a reduction in non-service FAS pension expense for our qualified defined benefit pension plans. Income Tax Expense Our effective income tax rate from continuing operations was 14.0% for 2019 and 13.6% for 2018. OnDecember 22, 2017 , the President signed the Tax Cuts and Jobs Act (the "Tax Act"). The Tax Act, among other things, lowered theU.S. corporate income tax rate from 35% to 21% effectiveJanuary 1, 2018 . We recognized a tax benefit of$220 million in 2019 and$61 million in 2018 related to the deduction for foreign derived intangible income enacted by the Tax Act, which reduced our effective income tax rate by 3.0 percentage points and 1.0 percentage points, respectively. The rate for 2019 benefited from$98 million in additional tax deductions for the prior year, primarily due to proposed tax regulations released onMarch 4, 2019 . We also recognized a tax benefit of$15 million in 2019 and$61 million in 2018, which reduced our effective income tax rate by 0.2 and 1.0 percentage points respectively, from our change in a tax accounting method reflecting a 2012Court of Federal Claims decision, which held that the tax basis in certain assets should be increased and realized upon the assets' disposition. The rates for 2019 and 2018 benefited from tax deductions for dividends paid to our defined contribution plans with an employee stock ownership plan feature, and theU.S. research and development (R&D) tax credit. The R&D tax credit reduced our effective tax rate by 2.0 percentage points in 2019 and 2.4 percentage points in 2018. In addition, the rates for 2019 and 2018 benefited from tax benefits related to employee share-based payment awards, which are recorded in earnings as income tax benefit or expense. Accordingly, we recognized additional income tax benefits of$63 million , and$55 million during the years endedDecember 31, 2019 and 2018, which reduced our effective income tax rate by 0.9 percentage points for both 2019 and 2018. Changes inU.S. federal or foreign tax laws and regulations, or their interpretation and application, including those with retroactive effect, including the amortization for research or experimental expenditures, could significantly impact our provision for income taxes, the amount of taxes payable, our deferred tax asset and liability balances, and stockholders' equity. The amount 34
--------------------------------------------------------------------------------
Table of Contents
of net deferred tax assets will change periodically based on several factors, including the measurement of our postretirement benefit plan obligations, actual cash contributions to our postretirement benefit plans, and future changes in tax laws. In addition, we are regularly under audit or examination by tax authorities, including foreign tax authorities. The final determination of tax audits and any related litigation could similarly result in unanticipated increases in our tax expense and affect profitability and cash flows. Net Earnings We reported net earnings of$6.2 billion ($21.95 per share) in 2019 and$5.0 billion ($17.59 per share) in 2018. Both net earnings and earnings per share were affected by the factors mentioned above. Earnings per share also benefited from a net decrease of approximately 1 million common shares outstanding fromDecember 31, 2018 toDecember 31, 2019 as a result of share repurchases, partially offset by share issuances under our stock-based awards and certain defined contribution plans. Business Segment Results of Operations We operate in four business segments: Aeronautics, MFC, RMS and Space. We organize our business segments based on the nature of products and services offered. Net sales and operating profit of our business segments exclude intersegment sales, cost of sales, and profit as these activities are eliminated in consolidation. Business segment operating profit includes our share of earnings or losses from equity method investees as the operating activities of the equity method investees are closely aligned with the operations of our business segments.United Launch Alliance (ULA), results of which are included in our Space business segment, is one of our largest equity method investees. Business segment operating profit also excludes the FAS/CAS operating adjustment described below, a portion of corporate costs not considered allowable or allocable to contracts under CAS or federal acquisition regulations (FAR), and other items not considered part of management's evaluation of segment operating performance such as a portion of management and administration costs, legal fees and settlements, environmental costs, stock-based compensation expense, retiree benefits, significant severance and restructuring actions (see "Note 15 - Severance and Restructuring Charges" included in our Notes to Consolidated Financial Statements), gains or losses from significant divestitures, and other miscellaneous corporate activities. Excluded items are included in the reconciling item "Unallocated items" between operating profit from our business segments and our consolidated operating profit. See "Note 1 - Significant Accounting Policies" included in our Notes to Consolidated Financial Statements for a discussion related to certain factors that may impact the comparability of net sales and operating profit of our business segments. Our business segments' results of operations include pension expense only as calculated under CAS pension cost. We recover CAS pension and other postretirement benefit plan cost through the pricing of our products and services onU.S. Government contracts and, therefore, recognize CAS cost in each of our business segment's net sales and cost of sales. Our consolidated financial statements must present FAS pension and other postretirement benefit plan expense calculated in accordance with FAS requirements underU.S. GAAP. The operating portion of the net FAS/CAS pension adjustment represents the difference between the service cost component of FAS pension expense and total CAS pension cost. The non-service FAS pension cost component is included in other non-operating expense, net in our consolidated statements of earnings. As a result, to the extent that CAS pension cost exceeds the service cost component of FAS pension expense, which occurred for 2019 and 2018, we have a favorable FAS/CAS operating adjustment. 35
--------------------------------------------------------------------------------
Table of Contents
Summary operating results for each of our business segments were as follows (in millions): 2019 2018 2017 Net sales Aeronautics$ 23,693 $ 21,242 $ 19,410 Missiles and Fire Control 10,131 8,462 7,282 Rotary and Mission Systems 15,128 14,250 13,663 Space 10,860 9,808 9,605 Total net sales$ 59,812 $ 53,762 $ 49,960 Operating profit Aeronautics$ 2,521 $ 2,272 $ 2,176 Missiles and Fire Control 1,441 1,248 1,034 Rotary and Mission Systems 1,421 1,302 902 Space 1,191 1,055 980 Total business segment operating profit 6,574 5,877 5,092 Unallocated items FAS/CAS operating adjustment (a) 2,049 1,803
1,613
Stock-based compensation (189 ) (173 ) (158 ) Severance and restructuring charges (b) - (96 ) - Other, net (c) 111 (77 ) 197 Total unallocated, net 1,971 1,457 1,652
Total consolidated operating profit
(a) The FAS/CAS operating adjustment represents the difference between the
service cost component of FAS pension expense and total pension costs
recoverable on
CAS. For a detail of the FAS/CAS operating adjustment and the total net
FAS/CAS pension adjustment, see the table below.
(b) See "Consolidated Results of Operations - Restructuring Charges" discussion
above for information on charges related to certain severance actions at our
business segments. Severance and restructuring charges for initiatives that
are not significant are included in business segment operating profit.
(c) Other, net in 2019 includes a previously deferred non-cash gain of
remaining obligations and a gain of
Distributed Energy Solutions business. Other, net in 2018 includes a
non-cash asset impairment charge of
method investee, AMMROC (see "Note 1 - Significant Accounting Policies"
included in our Notes to Consolidated Financial Statements for more
information). Other, net in 2017 includes a previously deferred non-cash
gain of$198 million related to properties sold in 2015 as a result of completing our remaining obligations and a$64 million charge, which represents our portion of a non-cash asset impairment charge recorded by
AMMROC (see "Note 1 - Significant Accounting Policies" included in our Notes
to Consolidated Financial Statements for more information).
Total net FAS/CAS pension adjustments, including the service and non-service cost components of FAS pension expense, were as follows (in millions):
2019 2018
2017
Total FAS expense and CAS costs FAS pension expense$ (1,093 ) $ (1,431 ) $ (1,372 ) Less: CAS pension cost 2,565 2,433
2,248
Net FAS/CAS pension adjustment$ 1,472 $ 1,002 $
876
Service and non-service cost reconciliation FAS pension service cost (516 ) (630 ) (635 ) Less: CAS pension cost 2,565 2,433 2,248 FAS/CAS operating adjustment 2,049 1,803 1,613 Non-operating FAS pension expense (a) (577 ) (801 ) (737 ) Net FAS/CAS pension adjustment$ 1,472 $ 1,002 $
876
(a) We record the non-service cost components of net periodic benefit cost as
part of other non-operating expense, net in the consolidated statement of
earnings. The non-service cost components in the table above relate only to
our qualified defined benefit pension plans. We incurred total non-service
costs for our qualified defined benefit pension plans in the table above,
along with similar costs for our other postretirement benefit plans of
million,
2017. 36
--------------------------------------------------------------------------------
Table of Contents
We recover CAS pension and other postretirement benefit plan cost through the pricing of our products and services onU.S. Government contracts and, therefore, recognize CAS cost in each of our business segment's net sales and cost of sales. Our consolidated financial statements must present FAS pension and other postretirement benefit plan expense calculated in accordance with FAS requirements underU.S. GAAP. The operating portion of the net FAS/CAS pension adjustment represents the difference between the service cost component of FAS pension expense and total CAS pension cost. The non-service FAS pension cost component is included in other non-operating expense, net in our consolidated statements of earnings. The net FAS/CAS pension adjustment increases or decreases CAS pension cost to equal total FAS pension expense (both service and non-service). The following segment discussions also include information relating to backlog for each segment. Backlog was approximately$144.0 billion and$130.5 billion atDecember 31, 2019 and 2018. These amounts included both funded backlog (firm orders for which funding has been both authorized and appropriated by the customer) and unfunded backlog (firm orders for which funding has not yet been appropriated). Backlog does not include unexercised options or task orders to be issued under indefinite-delivery, indefinite-quantity contracts. Funded backlog was approximately$94.5 billion atDecember 31, 2019 . Management evaluates performance on our contracts by focusing on net sales and operating profit and not by type or amount of operating expense. Consequently, our discussion of business segment performance focuses on net sales and operating profit, consistent with our approach for managing the business. This approach is consistent throughout the life cycle of our contracts, as management assesses the bidding of each contract by focusing on net sales and operating profit and monitors performance on our contracts in a similar manner through their completion. We regularly provide customers with reports of our costs as the contract progresses. The cost information in the reports is accumulated in a manner specified by the requirements of each contract. For example, cost data provided to a customer for a product would typically align to the subcomponents of that product (such as a wing-box on an aircraft) and for services would align to the type of work being performed (such as aircraft sustainment). Our contracts generally allow for the recovery of costs in the pricing of our products and services. Most of our contracts are bid and negotiated with our customers under circumstances in which we are required to disclose our estimated total costs to provide the product or service. This approach for negotiating contracts with ourU.S. Government customers generally allows for recovery of our actual costs plus a reasonable profit margin. We also may enter into long-term supply contracts for certain materials or components to coincide with the production schedule of certain products and to ensure their availability at known unit prices. Many of our contracts span several years and include highly complex technical requirements. At the outset of a contract, we identify and monitor risks to the achievement of the technical, schedule and cost aspects of the contract and assess the effects of those risks on our estimates of total costs to complete the contract. The estimates consider the technical requirements (e.g., a newly-developed product versus a mature product), the schedule and associated tasks (e.g., the number and type of milestone events) and costs (e.g., material, labor, subcontractor, overhead and the estimated costs to fulfill our industrial cooperation agreements, sometimes referred to as offset agreements, required under certain contracts with international customers). The initial profit booking rate of each contract considers risks surrounding the ability to achieve the technical requirements, schedule and costs in the initial estimated total costs to complete the contract. Profit booking rates may increase during the performance of the contract if we successfully retire risks surrounding the technical, schedule and cost aspects of the contract, which decreases the estimated total costs to complete the contract. Conversely, our profit booking rates may decrease if the estimated total costs to complete the contract increase. All of the estimates are subject to change during the performance of the contract and may affect the profit booking rate. We have a number of programs that are designated as classified by theU.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 theU.S. Government as well as FMS contracted through theU.S. Government . We recognize revenue as performance obligations are satisfied and the customer obtains control of the products and services. For performance obligations to deliver products with continuous transfer of control to the customer, revenue is recognized based on the extent of progress towards completion of the performance obligation, generally using the percentage-of-completion cost-to-cost measure of progress for our contracts because it best depicts the transfer of control to the customer as we incur costs on our contracts. For performance obligations in which control does not continuously transfer to the customer, we recognize revenue at the point in time in which each performance obligation is fully satisfied. 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. 37
--------------------------------------------------------------------------------
Table of Contents
In addition, comparability of our segment sales, operating profit and operating margin may be impacted favorably or unfavorably by changes in profit booking rates on our contracts for which we recognize revenue over time using the percentage-of-completion cost-to-cost method to measure progress towards completion. Increases in the profit booking rates, typically referred to as risk retirements, usually relate to revisions in the estimated total costs to fulfill the performance obligations 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 fulfill the performance obligations 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 margin may also be impacted favorably or unfavorably by other items, which may or may not impact sales. Favorable items may include the positive resolution of contractual matters, cost recoveries on severance and 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, which are excluded from segment operating results; reserves for disputes; certain asset impairments; and losses on sales of certain 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. As previously disclosed, we are responsible for a program to design, develop and construct a ground-based radar at our RMS business segment. The program has experienced performance issues for which we have periodically accrued reserves. In 2019, we revised our estimated costs to complete the program and recorded a charge of approximately$60 million ($47 million , or$0.17 per share, after-tax) at our RMS business segment, which resulted in cumulative losses of approximately$205 million on this program as ofDecember 31, 2019 . We may continue to experience issues related to customer requirements and our performance under this contract and have to record additional charges. However, based on the losses previously recorded and our current estimate of the sales and costs to complete the program, at this time we do not anticipate that additional losses, if any, would be material to our operating results or financial condition. As previously disclosed, we have a program, EADGE-T, to design, integrate, and install an air missile defense command, control, communications, computers - intelligence (C4I) system for an international customer that has experienced performance issues and for which we have periodically accrued reserves. In 2017, we revised our estimated costs to complete the EADGE-T contract as a consequence of ongoing performance matters and recorded an additional charge of$120 million ($74 million , or$0.25 per share, after-tax) at ourRotary and Mission Systems (RMS) business segment, which resulted in cumulative losses of approximately$260 million on this program. As ofDecember 31, 2019 , cumulative losses remained at approximately$260 million . We continue to monitor program requirements and our performance. At this time, we do not anticipate additional charges that would be material to our operating results or financial condition. As previously disclosed, we have two commercial satellite programs at our Space business segment for which we have experienced performance issues related to the development and integration of a modernized LM 2100 satellite platform. These programs are for the delivery of three satellites in total, including one that launched inFebruary 2019 and one that launched inApril 2019 . We have periodically revised our estimated costs to complete these developmental commercial programs. As ofDecember 31, 2019 , cumulative losses remained at approximately$410 million for these programs. While these losses reflect our estimated total losses on the programs, we will continue to incur unrecoverable general and administrative costs each period until we complete the contract for the third satellite. We have launched two satellites from one program, and the third satellite has completed development and has been shipped to the launch site for a planned launch in the first quarter of 2020. Any new satellite anomalies discovered during launch preparation requiring repair or rework, or prolonged on orbit testing prior to customer handover, could require that we record additional loss reserves, which could be material to our operating results. As previously disclosed, we are responsible for designing, developing and installing an upgraded turret for the Warrior Capability Sustainment Program. In 2018, we revised our estimated costs to complete the program as a consequence of performance issues, and recorded a charge of approximately$85 million ($64 million , or$0.22 per share, after-tax) at our MFC business segment, which resulted in cumulative losses of approximately$140 million on this program atDecember 31, 2019 . We may continue to experience issues related to customer requirements and our performance under this contract and have to record additional reserves. However, based on the losses already recorded and our current estimate of the sales and costs to complete the program, at this time we do not anticipate that additional losses, if any, would be material to our operating results or financial condition. Our consolidated net adjustments not related to volume, including net profit booking rate adjustments and other items, net of state income taxes, increased segment operating profit by approximately$1.9 billion in both 2019 and 2018. The consolidated net adjustments in 2019 compared to 2018 were comparable primarily due to an increase in profit booking rate adjustments at Space offset by decreases in the other three business segments. The consolidated net adjustments for 2019 are inclusive of approximately$930 million in unfavorable items, which include reserves for various programs at RMS, the F-16 program at Aeronautics, performance matters on a sensors and global sustainment international military program at MFC and government satellite programs at Space. The consolidated net adjustments for 2018 are inclusive of approximately$900 million in unfavorable items, which 38
--------------------------------------------------------------------------------
Table of Contents
include reserves for performance matters on the Warrior Capability Sustainment Program at MFC, various programs at RMS, and commercial satellite programs at Space. Aeronautics Our Aeronautics business segment is engaged in the research, design, development, manufacture, integration, sustainment, support and upgrade of advanced military aircraft, including combat and air mobility aircraft, unmanned air vehicles and related technologies. Aeronautics' major programs include the F-35 Lightning II Joint Strike Fighter, C130 Hercules, F-16 Fighting Falcon and F-22 Raptor. Aeronautics' operating results included the following (in millions): 2019 2018 2017 Net sales$ 23,693 $ 21,242 $ 19,410 Operating profit 2,521 2,272 2,176 Operating margin 10.6 % 10.7 % 11.2 % Backlog at year-end$ 55,636 $ 55,601 $ 35,692 Aeronautics' net sales in 2019 increased$2.5 billion , or 12%, compared to 2018. The increase was primarily attributable to higher net sales of approximately$2.0 billion for the F-35 program due to increased volume on production, sustainment and development contracts; and about$350 million for higher volume on classified programs. Aeronautics' operating profit in 2019 increased$249 million , or 11%, compared to 2018. Operating profit increased approximately$210 million for the F-35 program due to increased volume on production, sustainment and development contracts; and about$50 million for the F-16 program due to higher risk retirements on sustainment contracts. These increases were partially offset by a decrease of$20 million on the F-22 program due to lower risk retirements. Adjustments not related to volume, including net profit booking rate adjustments, were$25 million lower in 2019 compared to 2018. Backlog Backlog in 2019 was comparable to 2018. Trends We expect Aeronautics' 2020 net sales to increase in the high-single digit percentage range from 2019 levels driven by increased volume on the F-35 program. Operating profit is also expected to increase in the high-single digit percentage range above 2019 levels. Operating profit margin for 2020 is expected to be slightly higher than 2019 levels. Missiles and Fire Control Our MFC business segment provides air and missile defense systems; tactical missiles and air-to-ground precision strike weapon systems; logistics; fire control systems; mission operations support, readiness, engineering support and integration services; manned and unmanned ground vehicles; and energy management solutions. MFC's major programs include PAC3, THAAD, Multiple Launch Rocket System (MLRS), Hellfire,Joint Air -to-Surface Standoff Missile (JASSM), Javelin, Apache, SNIPER®, LANTIRN and SOF GLSS. MFC's operating results included the following (in millions): 2019 2018 2017 Net sales$ 10,131 $ 8,462 $ 7,282 Operating profit 1,441 1,248 1,034 Operating margin 14.2 % 14.7 % 14.2 % Backlog at year-end$ 25,796 $ 21,363 $ 17,729 MFC's net sales in 2019 increased$1.7 billion , or 20%, compared to the same period in 2018. The increase was primarily attributable to higher net sales of approximately$940 million for tactical and strike missile programs due to increased volume (primarily precision fires, new hypersonic development programs, and classified development programs); about$465 million for integrated air and missile defense programs due to increased volume (primarily PAC-3 and THAAD); and about$300 million for sensors and global sustainment programs due to increased volume (primarily SOF GLSS and Apache). MFC's operating profit in 2019 increased$193 million , or 15%, compared to 2018. Operating profit increased approximately$100 million for integrated air and missile defense programs due to higher volume and higher risk retirements (primarily PAC-3 and THAAD); and about$60 million for tactical and strike missile programs due to higher volume (primarily precision fires), 39
--------------------------------------------------------------------------------
Table of Contents
partially offset by lower risk retirements (primarily Hellfire and Javelin). Operating profit on sensors and global sustainment programs was comparable as higher volume (primarily Apache and SOF GLSS) was offset by lower risk retirements (primarily LANTIRN and SNIPER), after a net decrease in charges of$55 million on international military programs. Adjustments not related to volume, including net profit booking rate adjustments, were$30 million lower in 2019 compared to 2018. Backlog Backlog increased in 2019 compared to 2018 primarily due to higher orders on THAAD, PAC-3 and precision fires programs. Trends We expect MFC's 2020 net sales to increase in the low-double digit percentage range in 2020 as compared to 2019 driven by higher volume in the tactical and strike missiles and air and missile defense businesses, partially offset by a decrease in sales as a result of the divestiture of our Distributed Energy Solutions business. Operating profit is expected to increase in the mid-single digit percentage range in 2020 as compared to 2019 driven by the increase in sales volume. Operating profit margin for 2020 is expected to be slightly lower than 2019 levels.Rotary and Mission Systems Our RMS business segment provides design, manufacture, service and support for a variety of military and commercial helicopters; ship and submarine mission and combat systems; mission systems and sensors for rotary and fixed-wing aircraft; sea and land-based missile defense systems; radar systems; the Littoral Combat Ship (LCS); simulation and training services; and unmanned systems and technologies. In addition, RMS supports the needs of government customers in cybersecurity and delivers communication and command and control capabilities through complex mission solutions for defense applications. RMS' major programs include Black Hawk and Seahawk helicopters, Aegis, CH-53KKing Stallion helicopter, LCS, VH-92A helicopter program, and the C2BMC contract. RMS' operating results included the following (in millions): 2019 2018 2017 Net sales$ 15,128 $ 14,250 $ 13,663 Operating profit 1,421 1,302 902 Operating margin 9.4 % 9.1 % 6.6 % Backlog at year-end$ 34,296 $ 31,320 $ 30,030 RMS' net sales in 2019 increased$878 million , or 6%, compared to 2018. The increase was primarily attributable to higher net sales of approximately$535 million for IWSS programs due to higher volume (primarily LCS, radar surveillance systems programs, Multi Mission Surface Combatant (MMSC), and Aegis); about$290 million for various training and logistics (TLS) programs due to higher volume (primarily an army sustainment program); and about$200 million for various C6ISR (command, control, communications, computers, cyber, combat systems, intelligence, surveillance, and reconnaissance) programs due to higher volume (primarily undersea combat systems and cyber solutions programs). These increases were partially offset by a decrease of approximately$145 million for Sikorsky helicopter programs due to lower volume (primarily Black Hawk production, mission systems programs, and commercial aircraft). RMS' operating profit in 2019 increased$119 million , or 9%, compared to 2018. Operating profit increased approximately$105 million for Sikorsky helicopter programs primarily due to better cost performance across the portfolio, customer mix, and higher risk retirements; and about$55 million for IWSS programs due to higher volume (primarily radar surveillance systems programs, LCS, and Aegis), after$50 million in charges in the first quarter of 2019 for a ground-based radar program. These increases were partially offset by a decrease of$50 million for TLS programs due to$80 million in charges primarily recorded in the second quarter of 2019 for an army sustainment program partially offset by lower charges on various other programs. Adjustments not related to volume, including net profit booking rate adjustments, were$65 million lower in 2019 compared to 2018. Backlog Backlog increased in 2019 compared to 2018 primarily due to higher orders on IWSS programs. Trends We expect RMS' 2020 net sales to increase in the mid-single digit range above 2019 levels driven primarily by Sikorsky. Operating profit is also expected to increase in the mid-single digit range above 2019 levels driven by the increase in sales 40
--------------------------------------------------------------------------------
Table of Contents
volume. Operating profit margin for 2020 is expected to be slightly higher than 2019 levels. Space Our Space business segment is engaged in the research and development, design, engineering and production of satellites, strategic and defensive missile systems and space transportation systems. Space provides network-enabled situational awareness and integrates complex space and ground-based global systems to help our customers gather, analyze, and securely distribute critical intelligence data. Space is also responsible for various classified systems and services in support of vital national security systems. Space's major programs include the Trident II D5 Fleet Ballistic Missile (FBM), AWE, Orion Multi-Purpose Crew Vehicle (Orion), Space Based Infrared System (SBIRS) and Next Generation Overhead Persistent Infrared (Next Gen OPIR) system, Global Positioning System (GPS) III, Advanced Extremely High Frequency (AEHF), and hypersonics. Operating profit for our Space business segment includes our share of earnings for our investment in ULA, which provides expendable launch services to theU.S. Government . Space's operating results included the following (in millions): 2019 2018 2017 Net sales$ 10,860 $ 9,808 $ 9,605 Operating profit 1,191 1,055 980
Operating margin 11.0 % 10.8 % 10.2 %
Backlog at year-end
Space's net sales in 2019 increased$1.1 billion , or 11%, compared to 2018. The increase was primarily attributable to higher net sales of approximately$690 million for government satellite programs due to higher volume (primarily Next Gen OPIR, GPS III and government satellite services); and about$355 million for strategic and missile defense programs due to higher volume (primarily new hypersonic development programs). Space's operating profit in 2019 increased$136 million , or 13%, compared to 2018. Operating profit increased approximately$125 million for government satellite programs due to higher risk retirements (primarily AEHF) and higher volume (primarily GPS III and government satellite services); and about$45 million for commercial satellite programs, which reflect a lower amount of charges recorded for performance matters. These increases were partially offset by a decrease of approximately$65 million due to lower equity earnings for ULA. Operating profit on strategic and missile defense programs was comparable as higher volume (primarily hypersonic development programs) was offset by lower risk retirements (primarily missile defense programs). Adjustments not related to volume, including net profit booking rate adjustments, were$120 million higher in 2019 compared to 2018. Equity earnings Total equity earnings recognized by Space (primarily ULA) represented approximately$145 million and$210 million , or 12% and 20% of this business segment's operating profit during 2019 and 2018. Backlog Backlog increased in 2019 compared to 2018 primarily due to new orders in strategic and missile defense (hypersonic development programs and AWE) and space transportation (Orion). Trends We expect Space's 2020 net sales to increase in the mid-single digit percentage range from 2019 levels largely driven by hypersonics. Operating profit in 2020 is expected to decrease in the mid-single digit percentage range as compared to 2019 driven by lower profit rate adjustments in government satellites and lower equity earnings in 2020 compared to 2019. As a result, operating profit margin in 2020 is expected to decrease from 2019 levels. Liquidity and Cash Flows We have a balanced cash deployment strategy to enhance stockholder value and position ourselves to take advantage of new business opportunities when they arise. Consistent with that strategy, we have continued to invest in our business, including capital expenditures, independent research and development, and selective business acquisitions and investments; returned cash to stockholders through dividends and share repurchases; and actively managed our debt levels and maturities, interest rates, and pension obligations. 41
--------------------------------------------------------------------------------
Table of Contents
We have generated strong operating cash flows, which have been the primary source of funding for our operations, capital expenditures, debt service and repayments, dividends, share repurchases and postretirement benefit plan contributions. Our strong operating cash flows enabled our Board of Directors to approve two key cash deployment initiatives inSeptember 2019 . First, we increased our dividend rate in the fourth quarter by$0.20 to$2.40 per share. Second, the Board of Directors approved a$1.0 billion increase to our share repurchase program. Inclusive of this increase, the total remaining authorization for future common share repurchases under our program was$2.8 billion as ofDecember 31, 2019 . We expect our cash from operations will continue to be sufficient to support our operations and anticipated capital expenditures for the foreseeable future. We also have access to credit markets, if needed, for liquidity or general corporate purposes, and letters of credit to support customer advance payments and for other trade finance purposes such as guaranteeing our performance on particular contracts. See our "Capital Structure, Resources and Other" section below for a discussion on financial resources available to us, including the issuance of commercial paper. We made discretionary contributions of$1.0 billion to our qualified defined benefit pension plans in 2019 using cash on hand. We made contributions of$5.0 billion to our qualified defined benefit pension plans in 2018, including required and discretionary contributions. We do not expect to make contributions to our qualified defined benefit pension plans in 2020. Cash received from customers, either from the payment of invoices for work performed or for advances from non-U.S. Government customers in excess of costs incurred, is our primary source of cash. We generally do not begin work on contracts until funding is appropriated by the customer. However, we may determine to fund customer programs ourselves pending government appropriations. If we incur costs in excess of funds obligated on the contract, we may be at risk for reimbursement of the excess costs. Billing timetables and payment terms on our contracts vary based on a number of factors, including the contract type. We generally bill and collect cash more frequently under cost-reimbursable contracts, which represented approximately 39% of the sales we recorded in 2019, as we are authorized to bill as the costs are incurred. A number of our fixed-price contracts may provide for performance-based payments, which allow us to bill and collect cash as we perform on the contract. The amount of performance-based payments and the related milestones are encompassed in the negotiation of each contract. The timing of such payments may differ from our incurrence of costs related to our contract performance, thereby affecting our cash flows. TheU.S. Government has indicated that it would consider progress payments as the baseline for negotiating payment terms on fixed-price contracts, rather than performance-based payments. In contrast to negotiated performance-based payment terms, progress payment provisions correspond to a percentage of the amount of costs incurred during the performance of the contract. Our cash flows may be affected if theU.S. Government decides to withhold payments on our billings. While the impact of withholding payments delays the receipt of cash, the cumulative amount of cash collected during the life of the contract will not vary. The majority of our capital expenditures for 2019 and those planned for 2020 are for equipment, facilities infrastructure and information technology. Expenditures for equipment and facilities infrastructure are generally incurred to support new and existing programs across all of our business segments. For example, we have projects underway in our Aeronautics business segment for facilities and equipment to support higher production of the F-35 combat aircraft, and we have projects underway to modernize certain of our facilities. We also incur capital expenditures for information technology to support programs and general enterprise information technology infrastructure, inclusive of costs for the development or purchase of internal-use software.
The following table provides a summary of our cash flow information followed by a discussion of the key elements (in millions):
2019 2018
2017
Cash and cash equivalents at beginning of year$ 772 $ 2,861 $ 1,837 Operating activities Net earnings 6,230 5,046 1,963 Non-cash adjustments 1,549 1,186 4,530 Changes in working capital (672 ) (1,401 ) (427 ) Other, net 204 (1,693 ) 410
Net cash provided by operating activities 7,311 3,138 6,476 Net cash used for investing activities
(1,241 ) (1,075 ) (1,147 ) Net cash used for financing activities (5,328 ) (4,152 ) (4,305 ) Net change in cash and cash equivalents 742 (2,089 )
1,024
Cash and cash equivalents at end of year
42
--------------------------------------------------------------------------------
Table of Contents
Operating Activities Net cash provided by operating activities increased$4.2 billion in 2019 compared to 2018 primarily due to a reduction in cash contributions made to our qualified defined benefit pension plans and an improvement in cash used for working capital, partially offset by an increase in cash paid for income taxes. During 2019, we made cash contributions to our qualified defined benefit pension plans of$1.0 billion compared to$5.0 billion in 2018. The$729 million improvement in cash flows used for working capital (defined as receivables, contract assets, and inventories less accounts payable and contract liabilities) was primarily attributable to timing of production and billing cycles affecting contract assets (primarily the F-35 program) and contract liabilities (primarily C-130 program at Aeronautics and IWSS programs at RMS), partially offset by the timing of cash payments for accounts payable (primarily Aeronautics) and growth in inventories (primarily classified programs at Aeronautics and Sikorsky at RMS). We made net cash tax payments of approximately$940 million in 2019 compared to receiving net tax refunds of approximately$41 million in 2018. Investing Activities Net cash used for investing activities increased$166 million in 2019 compared to 2018, primarily due to an increase in capital expenditures, partially offset by net cash proceeds from various divestitures and acquisitions, and cash received for various other items, none of which were individually significant. Capital expenditures totaled$1.5 billion in 2019 and$1.3 billion in 2018. The majority of our capital expenditures were for equipment and facilities infrastructure that generally are incurred to support new and existing programs across all of our business segments. We also incur capital expenditures for information technology to support programs and general enterprise information technology infrastructure, inclusive of costs for the development or purchase of internal-use software. Financing Activities Net cash used for financing activities increased$1.2 billion in 2019 compared to 2018, primarily driven by net repayments of$600 million for commercial paper in 2019 compared to net proceeds received of$600 million of commercial paper in 2018. InNovember 2019 , we repaid$900 million of long-term notes with a fixed interest rate of 4.25% according to their scheduled maturities. InNovember 2018 , we repaid$750 million of long-term notes with a fixed interest rate of 1.85% according to their scheduled maturities. For additional information about our debt financing activities see the "Capital Structure, Resources and Other" discussion below and "Note 10 - Debt" included in our Notes to Consolidated Financial Statements. We paid dividends totaling$2.6 billion ($9.00 per share) in 2019 and$2.3 billion ($8.20 per share) in 2018.We paid quarterly dividends of$2.20 per share during each of the first three quarters of 2019 and$2.40 per share during the fourth quarter of 2019. We paid quarterly dividends of$2.00 per share during each of the first three quarters of 2018 and$2.20 per share during the fourth quarter of 2018. We paid$1.2 billion to repurchase 3.5 million shares of our common stock during 2019, which includes the$350 million paid to repurchase 916,249 shares pursuant to the accelerated share repurchase (ASR) agreement entered into during the fourth quarter. We paid$1.5 billion to repurchase 4.7 million shares of our common stock during 2018. See "Note 12 - Stockholders' Equity" included in our Notes to Consolidated Financial Statements for additional information about our repurchases of common stock. Capital Structure, Resources and Other AtDecember 31, 2019 , we held cash and cash equivalents of$1.5 billion that was generally available to fund ordinary business operations without significant legal, regulatory, or other restrictions. Our outstanding debt, net of unamortized discounts and issuance costs, amounted to$12.7 billion atDecember 31, 2019 and mainly is in the form of publicly-issued notes that bear interest at fixed rates. As ofDecember 31, 2019 , we had$1.3 billion of short-term borrowings due within one year, which are scheduled to mature inNovember 2020 . As ofDecember 31, 2018 , we had$1.5 billion of short-term borrowings due within one year, of which$900 million was composed of a scheduled debt maturity due inNovember 2019 and$600 million was composed of commercial paper with a weighted-average rate of 2.89% outstanding, all of which were repaid during 2019. As ofDecember 31, 2019 , we were in compliance with all covenants contained in our debt and credit agreements. We actively seek to finance our business in a manner that preserves financial flexibility while minimizing borrowing costs to the extent practicable. We review changes in financial market and economic conditions to manage the types, amounts and maturities 43
--------------------------------------------------------------------------------
Table of Contents
of our indebtedness. We may at times refinance existing indebtedness, vary our mix of variable-rate and fixed-rate debt or seek alternative financing sources for our cash and operational needs. On occasion, our customers may seek deferred payment terms to purchase our products. In connection with these transactions, we may, at our customer's request, enter into arrangements for the non-recourse sale of customer receivables to unrelated third-party financial institutions. For accounting purposes, these transactions are not discounted and are treated as a sale of receivables as we have no continuing involvement. The sale proceeds from the financial institutions are reflected in our operating cash flows on the statement of cash flows. We sold approximately$387 million in 2019 and$532 million in 2018 of customer receivables. There were no gains or losses related to sales of these receivables. Revolving Credit Facilities AtDecember 31, 2019 , we had a$2.5 billion revolving credit facility (the 5-year Facility) with various banks that is available for general corporate purposes. EffectiveAugust 24, 2019 , we extended the expiration date of the 5-year Facility fromAugust 24, 2023 toAugust 24, 2024 . The undrawn portion of the 5-year Facility also serves as a backup facility for the issuance of commercial paper. The total amount outstanding at any point in time under the combination of our commercial paper program and the credit facility cannot exceed the amount of the 5-year Facility. We may request and the banks may grant, at their discretion, an increase in the borrowing capacity under the 5-year Facility of up to an additional$500 million . There were no borrowings outstanding under the 5-year Facility as ofDecember 31, 2019 and 2018. Borrowings under the 5-year Facility are unsecured and bear interest at rates based, at our option, on a Eurodollar Rate or a Base Rate, as defined in the 5-year Facility's agreement. Each bank's obligation to make loans under the 5-year Facility is subject to, among other things, our compliance with various representations, warranties and covenants, including covenants limiting our ability and certain of our subsidiaries' ability to encumber assets and a covenant not to exceed a maximum leverage ratio, as defined in the 5year Facility agreement. Long-Term Debt InNovember 2019 , we repaid$900 million of long-term notes with a fixed interest rate of 4.25% according to their scheduled maturities. InNovember 2018 , we repaid$750 million of long-term notes with a fixed interest rate of 1.85% according to their scheduled maturities. InSeptember 2017 , we issued notes totaling approximately$1.6 billion with a fixed interest rate of 4.09% maturing inSeptember 2052 (the New Notes) in exchange for outstanding notes totaling approximately$1.4 billion with fixed interest rates ranging from 4.70% to 8.50% maturing 2029 to 2046 (the Old Notes). In connection with the exchange of principal, we paid a premium of$237 million , substantially all of which was in the form of New Notes. This premium will be amortized as additional interest expense over the term of the New Notes using the effective interest method. We may, at our option, redeem some or all of the New Notes at any time by paying the principal amount of notes being redeemed plus a make-whole premium and accrued and unpaid interest. Interest on the New Notes is payable onMarch 15 andSeptember 15 of each year and began onMarch 15, 2018 . The New Notes are unsecured senior obligations and rank equally in right of payment with all of our existing and future unsecured and unsubordinated indebtedness. We have an effective shelf registration statement on Form S-3 on file with theU.S. Securities and Exchange Commission to provide for the issuance of an indeterminate amount of debt securities. Total Equity Our total equity was$3.2 billion atDecember 31, 2019 , an increase of$1.7 billion fromDecember 31, 2018 . The increase was primarily attributable to net earnings of$6.2 billion , recognition of previously deferred postretirement benefit plan amounts of$908 million , and employee stock activity of$486 million (including the impacts of stock option exercises, issuances of shares under the employee stock ownership plan and stock-based compensation), partially offset by the annualDecember 31 re-measurement adjustment related to our postretirement benefit plans of$2.2 billion , the repurchase of 3.5 million common shares for$1.2 billion ; and dividends declared of$2.6 billion during the year. As we repurchase our common shares, we reduce common stock for the$1 of par value of the shares repurchased, with the excess purchase price over par value recorded as a reduction of additional paid-in capital. If additional paid-in capital is reduced to zero, we record the remainder of the excess purchase price over par value as a reduction of retained earnings. Due to the volume of repurchases made under our share repurchase program, additional paid-in capital was reduced to zero, with the remainder of the excess purchase price over par value of$713 million recorded as a reduction of retained earnings in 2019. 44
--------------------------------------------------------------------------------
Table of Contents
Contractual Commitments and Off-Balance Sheet Arrangements AtDecember 31, 2019 , we had contractual commitments to repay debt, make payments under operating leases, settle obligations related to agreements to purchase goods and services and settle tax and other liabilities. Financing lease obligations were not material. Payments due under these obligations and commitments are as follows (in millions): Payments Due By Period Less Than Years Years After Total 1 Year 2 and 3 4 and 5 5 Years Total debt (a)$ 13,799 $ 1,250 $ 906 $ 786 $ 10,857 Interest payments 9,277 571 1,048 979 6,679 Other liabilities 2,914 252 567 400 1,695 Operating lease obligations 1,287 280 344 217 446 Purchase obligations: Operating activities 55,491 28,564 22,528 3,483 916 Capital expenditures 839 446 309 84 - Total contractual cash obligations$ 83,607 $ 31,363 $ 25,702
(a) Total debt excludes approximately
consolidated joint venture as we do not guarantee the debt.
The table above excludes estimated minimum funding requirements for our qualified defined benefit pension plans. For additional information about our future minimum contributions for these plans, see "Note 11 - Postretirement Benefit Plans" included in our Notes to Consolidated Financial Statements. Amounts related to other liabilities represent the contractual obligations for certain long-term liabilities recorded as ofDecember 31, 2019 . Such amounts mainly include expected payments under non-qualified pension plans, environmental liabilities and deferred compensation plans. Purchase obligations related to operating activities include agreements and contracts that give the supplier recourse to us for cancellation or nonperformance under the contract or contain terms that would subject us to liquidated damages. Such agreements and contracts may, for example, be related to direct materials, obligations to subcontractors and outsourcing arrangements. Total purchase obligations for operating activities in the preceding table include approximately$49.9 billion related to contractual commitments entered into as a result of contracts we have with ourU.S. Government customers. TheU.S. Government generally would be required to pay us for any costs we incur relative to these commitments if they were to terminate the related contracts "for convenience" under the FAR, subject to available funding. This also would be true in cases where we perform subcontract work for a prime contractor under aU.S. Government contract. The termination for convenience language also may be included in contracts with foreign, state and local governments. We also have contracts with customers that do not include termination for convenience provisions, including contracts with commercial customers. Purchase obligations in the preceding table for capital expenditures generally include facilities infrastructure, equipment and information technology. We also may enter into industrial cooperation agreements, sometimes referred to as offset agreements, as a condition to obtaining orders for our products and services from certain customers in foreign countries. These agreements are designed to enhance the social and economic environment of the foreign country by requiring the contractor to promote investment in the country. Offset agreements may be satisfied through activities that do not require us to use cash, including transferring technology, providing manufacturing and other consulting support to in-country projects and the purchase by third parties (e.g., our vendors) of supplies from in-country vendors. These agreements also may be satisfied through our use of cash for such activities as purchasing supplies from in-country vendors, providing financial support for in-country projects, establishment of joint ventures with local companies and building or leasing facilities for in-country operations. We typically do not commit to offset agreements until orders for our products or services are definitive. The amounts ultimately applied against our offset agreements are based on negotiations with the customer and typically require cash outlays that represent only a fraction of the original amount in the offset agreement. Satisfaction of our offset obligations are included in the estimates of our total costs to complete the contract and may impact our sales, profitability and cash flows. Our ability to recover investments on our consolidated balance sheet that we make to satisfy offset obligations is generally dependent upon the successful operation of ventures that we do not control and may involve products and services that are dissimilar to our business activities. AtDecember 31, 2019 , the notional value of remaining obligations under our outstanding offset agreements totaled approximately$15.1 billion , which primarily relate to our Aeronautics, MFC and RMS business segments, most of which extend through 2049. To the extent we have entered into purchase or other obligations atDecember 31, 2019 that also satisfy offset agreements, those amounts are included in the preceding table. Offset programs usually extend over several years and may provide for penalties, estimated at approximately$1.9 billion atDecember 31, 2019 , in the 45
--------------------------------------------------------------------------------
Table of Contents
event we fail to perform in accordance with offset requirements. While historically we have not been required to pay material penalties, resolution of offset requirements are often the result of negotiations and subjective judgments. We have entered into standby letters of credit and surety bonds issued on our behalf by financial institutions, and we have directly issued guarantees to third parties primarily relating to advances received from customers and the guarantee of future performance on certain contracts. Letters of credit and surety bonds generally are available for draw down in the event we do not perform. In some cases, we may guarantee the contractual performance of third parties such as joint venture partners. AtDecember 31, 2019 , we had the following outstanding letters of credit, surety bonds and third-party guarantees (in millions): Commitment Expiration By Period Total Less Than Years Years After Commitment 1 Year 2 and 3 4 and 5 5 Years
Standby letters of credit (a)$ 2,233 $ 1,030 $ 779 $ 298 $ 126 Surety bonds 359 350 9 - - Third-party Guarantees 996 199 317 151 329 Total commitments$ 3,588 $ 1,579 $ 1,105 $ 449 $ 455
(a) Approximately
Year" category,
million in the "Years 4 and 5" category are expected to renew for additional
periods until completion of the contractual obligation.
AtDecember 31, 2019 , third-party guarantees totaled$996 million , of which approximately 76% related to guarantees of contractual performance of joint ventures to which we currently are or previously were a party. These amounts represent our estimate of the maximum amounts we would expect to incur upon the contractual non-performance of the joint venture, joint venture partners or divested businesses. Generally, we also have cross-indemnities in place that may enable us to recover amounts that may be paid on behalf of a joint venture partner. In determining our exposures, we evaluate the reputation, performance on contractual obligations, technical capabilities and credit quality of our current and former joint venture partners and the transferee under novation agreements all of which include a guarantee as required by the FAR. There were no material amounts recorded in our financial statements related to third-party guarantees or novation agreements. Critical Accounting Policies Contract Accounting / Sales Recognition The majority of our net sales are generated from long-term contracts with theU.S. Government and international customers (including FMS contracted through theU.S. Government ) for the research, design, development, manufacture, integration and sustainment of advanced technology systems, products and services. We account for a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable. For certain contracts that meet the foregoing requirements, primarily international direct commercial sale contracts, we are required to obtain certain regulatory approvals. In these cases, we recognize revenue based on the likelihood of obtaining regulatory approvals based upon all known facts and circumstances. We provide our products and services under fixed-price and cost-reimbursable contracts. Under fixed-price contracts, we agree to perform the specified work for a pre-determined price. To the extent our actual costs vary from the estimates upon which the price was negotiated, we will generate more or less profit or could incur a loss. Some fixed-price contracts have a performance-based component under which we may earn incentive payments or incur financial penalties based on our performance. Cost-reimbursable contracts provide for the payment of allowable costs incurred during performance of the contract plus a fee up to a ceiling based on the amount that has been funded. Typically, we enter into three types of cost-reimbursable contracts: cost-plus-award-fee, cost-plus-incentive-fee, and cost-plus-fixed-fee. Cost-plus-award-fee contracts provide for an award fee that varies within specified limits based on the customer's assessment of our performance against a predetermined set of criteria, such as targets based on cost, quality, technical and schedule criteria. Cost-plus-incentive-fee contracts provide for reimbursement of costs plus a fee, which is adjusted by a formula based on the relationship of total allowable costs to total target costs (i.e., incentive based on cost) or reimbursement of costs plus an incentive to exceed stated performance targets (i.e., incentive based on performance). The fixed-fee in a cost-plus-fixed-fee contract is negotiated at the inception of the contract and that fixed-fee does not vary with actual costs. 46
--------------------------------------------------------------------------------
Table of Contents
We account for a contract after it has been approved by all parties to the arrangement, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable. We assess each contract at its inception to determine whether it should be combined with other contracts. When making this determination, we consider factors such as whether two or more contracts were negotiated and executed at or near the same time or were negotiated with an overall profit objective. If combined, we treat the combined contracts as a single contract for revenue recognition purposes. We evaluate the products or services promised in each contract at inception to determine whether the contract should be accounted for as having one or more performance obligations. The products and services in our contracts are typically not distinct from one another due to their complex relationships and the significant contract management functions required to perform under the contract. Accordingly, our contracts are typically accounted for as one performance obligation. In limited cases, our contracts have more than one distinct performance obligation, which occurs when we perform activities that are not highly complex or interrelated or involve different product lifecycles. Significant judgment is required in determining performance obligations, and these decisions could change the amount of revenue and profit recorded in a given period. We classify net sales as products or services on our consolidated statements of earnings based on the predominant attributes of the performance obligations. We determine the transaction price for each contract based on the consideration we expect to receive for the products or services being provided under the contract. For contracts where a portion of the price may vary, we estimate variable consideration at the most likely amount, which is included in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur. We analyze the risk of a significant revenue reversal and if necessary constrain the amount of variable consideration recognized in order to mitigate this risk. At the inception of a contract we estimate the transaction price based on our current rights and do not contemplate future modifications (including unexercised options) or follow-on contracts until they become legally enforceable. Contracts are often subsequently modified to include changes in specifications, requirements or price, which may create new or change existing enforceable rights and obligations. Depending on the nature of the modification, we consider whether to account for the modification as an adjustment to the existing contract or as a separate contract. Generally, modifications to our contracts are not distinct from the existing contract due to the significant integration and interrelated tasks provided in the context of the contract. Therefore, such modifications are accounted for as if they were part of the existing contract and recognized as a cumulative adjustment to revenue. For contracts with multiple performance obligations, we allocate the transaction price to each performance obligation based on the estimated standalone selling price of the product or service underlying each performance obligation. The standalone selling price represents the amount we would sell the product or service to a customer on a standalone basis (i.e., not bundled with any other products or services). Our contracts with theU.S. Government , including FMS contracts, are subject to FAR and the price is typically based on estimated or actual costs plus a reasonable profit margin. As a result of these regulations, the standalone selling price of products or services in our contracts with theU.S. Government and FMS contracts are typically equal to the selling price stated in the contract. For non-U.S. Government contracts with multiple performance obligations, we evaluate whether the stated selling prices for the products or services represent their standalone selling prices. We primarily sell customized solutions unique to a customer's specifications. When it is necessary to allocate the transaction price to multiple performance obligations, we typically use the expected cost plus a reasonable profit margin to estimate the standalone selling price of each product or service. We occasionally sell standard products or services with observable standalone sales transactions. In these situations, the observable standalone sales transactions are used to determine the standalone selling price. We recognize revenue as performance obligations are satisfied and the customer obtains control of the products and services. In determining when performance obligations are satisfied, we consider factors such as contract terms, payment terms and whether there is an alternative future use of the product or service. Substantially all of our revenue is recognized over time as we perform under the contract because control of the work in process transfers continuously to the customer. For most contracts with theU.S. Government and FMS contracts, this continuous transfer of control of the work in process to the customer is supported by clauses in the contract that give the customer ownership of work in process and allow the customer to unilaterally terminate the contract for convenience and pay us for costs incurred plus a reasonable profit. For most non-U.S. Government contracts, primarily international direct commercial contracts, continuous transfer of control to our customer is supported because we deliver products that do not have an alternative use to us and if our customer were to terminate the contract for reasons other than our non-performance we would have the right to recover damages which would include, among other potential damages, the right to payment for our work performed to date plus a reasonable profit. 47
--------------------------------------------------------------------------------
Table of Contents
For performance obligations to deliver products with continuous transfer of control to the customer, revenue is recognized based on the extent of progress towards completion of the performance obligation, generally using the percentage-of-completion cost-to-cost measure of progress for our contracts because it best depicts the transfer of control to the customer as we incur costs on our contracts. Under the percentage-of-completion cost-to-cost measure of progress, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs to complete the performance obligation(s). For performance obligations to provide services to the customer, revenue is recognized over time based on costs incurred or the right to invoice method (in situations where the value transferred matches our billing rights) as our customer receives and consumes the benefits. For performance obligations in which control does not continuously transfer to the customer, we recognize revenue at the point in time in which each performance obligation is fully satisfied. This coincides with the point in time the customer obtains control of the product or service, which typically occurs upon customer acceptance or receipt of the product or service, given that we maintain control of the product or service until that point. Significant estimates and assumptions are made in estimating contract sales and costs, including the profit booking rate. At the outset of a long-term contract, we identify and monitor risks to the achievement of the technical, schedule and cost aspects of the contract, as well as variable consideration, and assess the effects of those risks on our estimates of sales and total costs to complete the contract. The estimates consider the technical requirements (e.g., a newly-developed product versus a mature product), the schedule and associated tasks (e.g., the number and type of milestone events) and costs (e.g., material, labor, subcontractor, overhead, general and administrative and the estimated costs to fulfill our industrial cooperation agreements, sometimes referred to as offset or localization agreements, required under certain contracts with international customers). The initial profit booking rate of each contract considers risks surrounding the ability to achieve the technical requirements, schedule and costs in the initial estimated total costs to complete the contract. Profit booking rates may increase during the performance of the contract if we successfully retire risks surrounding the technical, schedule and cost aspects of the contract, which decreases the estimated total costs to complete the contract or may increase the variable consideration we expect to receive on the contract. Conversely, our profit booking rates may decrease if the estimated total costs to complete the contract increase or our estimates of variable consideration we expect to receive decrease. All of the estimates are subject to change during the performance of the contract and may affect the profit booking rate. When estimates of total costs to be incurred on a contract exceed total estimates of the transaction price, a provision for the entire loss is determined at the contract level and is recorded in the period in which the loss is determined. Comparability of our segment sales, operating profit and operating margin may be impacted favorably or unfavorably by changes in profit booking rates on our contracts for which we recognize revenue over time using the percentage-of-completion cost-to-cost method to measure progress towards completion. Increases in the profit booking rates, typically referred to as risk retirements, usually relate to revisions in the estimated total costs to fulfill the performance obligations 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 fulfill the performance obligations 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 margin may also be impacted favorably or unfavorably by other items, which may or may not impact sales. Favorable items may include the positive resolution of contractual matters, cost recoveries on severance and 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, which are excluded from segment operating results; reserves for disputes; certain asset impairments; and losses on sales of certain assets. Other Contract Accounting Considerations The majority of our sales are driven by pricing based on costs incurred to produce products or perform services under contracts with theU.S. Government . Cost-based pricing is determined under the FAR. The FAR provides guidance on the types of costs that are allowable in establishing prices for goods and services underU.S. Government contracts. For example, costs such as those related to charitable contributions, interest expense and certain advertising and public relations activities are unallowable and, therefore, not recoverable through sales. In addition, we may enter into advance agreements with theU.S. Government that address the subjects of allowability and allocability of costs to contracts for specific matters. For example, most of the environmental costs we incur for environmental remediation related to sites operated in prior years are allocated to our current operations as general and administrative costs under FAR provisions and supporting advance agreements reached with theU.S. Government . We closely monitor compliance with and the consistent application of our critical accounting policies related to contract accounting. Costs incurred and allocated to contracts are reviewed for compliance withU.S. Government regulations by our personnel and are subject to audit by theDefense Contract Audit Agency . 48
--------------------------------------------------------------------------------
Table of Contents Postretirement Benefit Plans Overview Many of our employees and retirees participate in qualified and nonqualified defined benefit pension plans, retiree medical and life insurance plans and other postemployment plans (collectively, postretirement benefit plans - see "Note 11 - Postretirement Benefit Plans" included in our Notes to Consolidated Financial Statements). The majority of our accrued benefit obligations relate to our qualified defined benefit pension plans and retiree medical and life insurance plans. We recognize on a plan-by-plan basis the net funded status of these postretirement benefit plans under GAAP as either an asset or a liability on our consolidated balance sheets. The GAAP funded status represents the difference between the fair value of each plan's assets and the benefit obligation of the plan. The GAAP benefit obligation represents the present value of the estimated future benefits we currently expect to pay to plan participants based on past service. We completed the final step of the previously announced planned freeze of our qualified and nonqualified defined benefit pension plans for salaried employees effectiveJanuary 1, 2020 . The freeze took effect in two stages. EffectiveJanuary 1, 2016 , the pay-based component of the formula used to determine retirement benefits was frozen. EffectiveJanuary 1, 2020 , the service-based component of the formula was frozen. As a result of these changes, the qualified defined benefit pension plans for salaried employees are fully frozen effectiveJanuary 1, 2020 . With the freeze complete, the majority of our salaried employees participate in an enhanced defined contribution retirement savings plan. We may from time to time take actions to mitigate the effect of our defined benefit pension plans on our financial results by reducing the volatility of our pension obligations, including entering into additional transactions involving the purchase of a group annuity contract for a portion of our outstanding defined benefit pension obligations using assets from the pension trust. DuringDecember 2019 ,Lockheed Martin , through its master retirement trust, purchased an irrevocable group annuity contract from an insurance company (referred to as a buy-out contract) for$1.9 billion to transfer$1.9 billion of our outstanding defined benefit pension obligations related to certainU.S. retirees and beneficiaries. The group annuity contract was purchased using assets from the pension trust. As a result of this transaction, we were relieved of all responsibility for these pension obligations and the insurance company is now required to pay and administer the retirement benefits owed to approximately 20,000U.S. retirees and beneficiaries, with no change to the amount, timing or form of monthly retirement benefit payments. Although the transaction was treated as a settlement for accounting purposes, we did not recognize a loss on the settlement in earnings associated with the transaction because total settlements during 2019 for the affected pension plans were less than the plans' service and interest cost in 2019. Accordingly, the transaction had no impact on our 2019 FAS pension expense or CAS pension cost, and the difference of approximately$45 million between the amount paid to the insurance company and the amount of the pension obligations settled was recognized in other comprehensive income and will be amortized to FAS pension expense in future periods. We expect to continue to look for opportunities to manage our pension liabilities through additional buy out contracts in future years and the amounts involved could be material to a particular reporting period. Future transactions could result in a non-cash settlement charge to earnings, which could be material to a reporting period. Also, duringDecember 2018 ,Lockheed Martin , through its master retirement trust, purchased two contracts from insurance companies for$2.6 billion related to our outstanding defined benefit pension obligations. One of the contracts we purchased was an irrevocable group annuity contract from an insurance company (referred to as a buy-out contract), which relieved us of all responsibility for the pension obligations related to approximately 32,000U.S. retirees and beneficiaries. The second contract was structured as a buy-in contract (that will reimburse the pension plan for all future benefit payments related to defined benefit obligations for approximately 9,000U.S retirees and beneficiaries). The buy-in contract is accounted for at fair value as an investment of the trust. Notwithstanding these actions, the impact of these plans and benefits on our earnings may be volatile in that the amount of expense we record and the funded status for our postretirement benefit plans may materially change from year to year because those calculations are sensitive to funding levels as well as changes in several key economic assumptions, including interest rates, actual rates of return on plan assets and other actuarial assumptions including participant longevity and employee turnover, as well as the timing of cash funding. Actuarial Assumptions The plan assets and benefit obligations are measured at the end of each year or more frequently, upon the occurrence of certain events such as a significant plan amendment, settlement or curtailment. The amounts we record are measured using actuarial valuations, which are dependent upon key assumptions such as discount rates, the expected long-term rate of return on plan assets, participant longevity, employee turnover and the health care cost trend rates for our retiree medical plans. The assumptions we make affect both the calculation of the benefit obligations as of the measurement date and the calculation of net periodic benefit 49
--------------------------------------------------------------------------------
Table of Contents
cost in subsequent periods. When reassessing these assumptions we consider past and current market conditions and make judgments about future market trends. We also consider factors such as the timing and amounts of expected contributions to the plans and benefit payments to plan participants. We continue to use a single weighted average discount rate approach when calculating our consolidated benefit obligations related to our defined benefit pension plans resulting in 3.25% atDecember 31, 2019 , compared to 4.25% atDecember 31, 2018 . We utilized a single weighted average discount rate of 3.25% when calculating our benefit obligations related to our retiree medical and life insurance plans atDecember 31, 2019 , compared to 4.25% atDecember 31, 2018 . We evaluate several data points in order to arrive at an appropriate single weighted average discount rate, including results from cash flow models, quoted rates from long-term bond indices and changes in long-term bond rates over the past year. As part of our evaluation, we calculate the approximate average yields on corporate bonds rated AA or better selected to match our projected postretirement benefit plan cash flows. The decrease in the discount rate fromDecember 31, 2018 toDecember 31, 2019 resulted in an approximate$5.8 billion increase in the projected benefit obligations of our qualified defined benefit pension plans. We utilized an expected long-term rate of return on plan assets of 7.00% atDecember 31, 2019 compared to 7.00% forDecember 31, 2018 . The long-term rate of return assumption represents the expected long-term rate of return on the funds invested or to be invested, to provide for the benefits included in the benefit obligations. This assumption is based on several factors including historical market index returns, the anticipated long-term allocation of plan assets, the historical return data for the trust funds, plan expenses and the potential to outperform market index returns. The difference between the long-term rate of return on plan assets assumption we select and the actual return on plan assets in any given year affects both the funded status of our benefit plans and the calculation of FAS pension expense in subsequent periods. Although the actual return in any specific year likely will differ from the assumption, the average expected return over a long-term future horizon should be approximately equal to the assumption. Any variance in a given year should not, by itself, suggest that the assumption should be changed. Patterns of variances are reviewed over time, and then combined with expectations for the future. As a result, changes in this assumption are less frequent than changes in the discount rate. The actual investment return for our qualified defined benefit plans during 2019 of$6.7 billion based on an actual rate of approximately 21% improved plan assets more than the$2.3 billion expected return based on our 7.00% long-term rate of return assumption. InOctober 2019 , theSociety of Actuaries published revised longevity assumptions that refined its prior studies. We used the revised assumptions in ourDecember 31, 2019 re-measurement of benefit obligation. We reflected a longevity basis specific to the demographics of the underlying population (e.g., the nature of the work), versus the prior basis which was blended for all types of work, resulting in an approximate$860 million increase in the projected benefit obligations of our qualified defined benefit pension plans. Our stockholders' equity has been reduced cumulatively by$15.5 billion from the annual year-end measurements of the funded status of postretirement benefit plans. The cumulative non-cash, after-tax reduction primarily represents net actuarial losses resulting from declines in discount rates, investment losses and updated longevity. A market-related value of our plan assets, determined using actual asset gains or losses over the prior three year period, is used to calculate the amount of deferred asset gains or losses to be amortized. These cumulative actuarial losses will be amortized to expense using the corridor method, where gains and losses are recognized to the extent they exceed 10% of the greater of plan assets or benefit obligations, over an average period of approximately twenty years as ofDecember 31, 2019 . This amortization period extended (approximately doubled from the prior nine years) in 2020 due to the freeze of our salaried pension plans to use the average remaining life expectancy of the participants instead of average future service. During 2019,$908 million of these amounts were recognized as a component of postretirement benefit plans expense and about$441 million is expected to be recognized as expense in 2020. The discount rate and long-term rate of return on plan assets assumptions we select at the end of each year are based on our best estimates and judgment. A change of plus or minus 25 basis points in the 3.25% discount rate assumption atDecember 31, 2019 , with all other assumptions held constant, would have decreased or increased the amount of the qualified pension benefit obligation we recorded at the end of 2019 by approximately$1.5 billion , which would result in an after-tax increase or decrease in stockholders' equity at the end of the year of approximately$1.2 billion . If the 3.25% discount rate atDecember 31, 2019 that was used to compute the expected 2020 FAS pension expense for our qualified defined benefit pension plans had been 25 basis points higher or lower, with all other assumptions held constant, the amount of FAS pension expense projected for 2020 would be lower or higher by approximately$15 million . The impact of changes in the discount rate on FAS pension expense is significantly less than in prior years (i.e.,$15 million for 2020 compared to$120 million for 2019) due to the freeze of our salaried pension plans effectiveJanuary 1, 2020 , and resulting service cost reduction and extended loss amortization period discussed above. If the 7.00% expected long-term rate of return on plan assets assumption atDecember 31, 2019 that was used to compute the expected 2020 FAS pension expense for our qualified defined benefit pension plans had been 25 basis points higher or lower, with all other assumptions held constant, the amount of FAS pension expense projected for 2020 would be lower or higher by approximately$80 million . Each year, differences between the actual plan asset return and the expected long-term rate of return on plan assets 50
--------------------------------------------------------------------------------
Table of Contents
impacts the measurement of the following year's FAS expense. Every 100 basis points difference in return during 2019 between our actual rate of return of approximately 21% and our expected long-term rate of return of 7.00% impacted 2020 expected FAS pension expense by approximately$15 million . Funding Considerations We made contributions of$1.0 billion in 2019 and$5.0 billion in 2018 to our qualified defined benefit pension plans. Funding of our qualified defined benefit pension plans is determined in a manner consistent with CAS and in accordance with the Employee Retirement Income Security Act of 1974 (ERISA), as amended by the Pension Protection Act of 2006 (PPA). Our goal has been to fund the pension plans to a level of at least 80%, as determined under the PPA. The ERISA funded status of our qualified defined benefit pension plans was approximately 82% and 81% as ofDecember 31, 2019 and 2018; which is calculated on a different basis than under GAAP. Contributions to our defined benefit pension plans are recovered over time through the pricing of our products and services onU.S. Government contracts, including FMS, and are recognized in our cost of sales and net sales. CAS govern the extent to which our pension costs are allocable to and recoverable under contracts with theU.S. Government , including FMS. Pension cost recoveries under CAS occur in different periods from when pension contributions are made under the PPA. The CAS rules fully transitioned in 2017 to better align the recovery of pension costs with the minimum funding requirements of the PPA (referred to as CAS Harmonization). We recovered$2.6 billion in 2019 and$2.4 billion in 2018 as CAS pension costs. Amounts contributed in excess of the CAS pension costs recovered underU.S. Government contracts are considered to be prepayment credits under the CAS rules. Our prepayment credits were approximately$8.5 billion at bothDecember 31, 2019 and 2018. The prepayment credit balance will increase or decrease based on our actual investment return on plan assets. Trends We made contributions to our qualified defined benefit pension plans of$1.0 billion in 2019 and$5.0 billion in 2018, including required and discretionary contributions. As a result of these contributions, we do not expect to make contributions to our qualified defined benefit pension plans in 2020. We anticipate recovering approximately$2.0 billion of CAS pension cost in 2020 allowing us to recoup a portion of our CAS prepayment credits. We project FAS pension income of$115 million in 2020, compared to FAS pension expense of$1.1 billion in 2019, as a result of completing the planned freeze of our salaried pension plans effectiveJanuary 1, 2020 that was previously announced onJuly 1, 2014 . Our FAS pension expense is comprised of service cost, interest cost, expected return on plan assets, amortization of prior service cost or credit, and amortization of actuarial losses. The service cost and amortization of actuarial losses components of FAS pension expense are significantly lower due to the freeze. As a result, the expected return on plan assets and amortization of prior service credit exceed all other FAS pension expense components in 2020. Environmental Matters We are a party to various agreements, proceedings and potential proceedings for environmental remediation issues, including matters at various sites where we have been designated a potentially responsible party (PRP). AtDecember 31, 2019 and 2018, the total amount of liabilities recorded on our consolidated balance sheet for environmental matters was$810 million and$864 million . We have recorded assets totaling$703 million and$750 million atDecember 31, 2019 and 2018 for the portion of environmental costs that are probable of future recovery in pricing of our products and services for agencies of theU.S. Government , as discussed below. The amount that is expected to be allocated to our non-U.S. Government contracts or that is determined to not be recoverable underU.S. Government contracts has been expensed through cost of sales. We project costs and recovery of costs over approximately 20 years. We enter into agreements (e.g., administrative consent orders, consent decrees) that document the extent and timing of some of our environmental remediation obligations. We also are involved in environmental remediation activities at sites where formal agreements either do not exist or do not quantify the extent and timing of our obligations. Environmental remediation activities usually span many years, which makes estimating the costs more judgmental due to, for example, changing remediation technologies. To determine the costs related to clean up sites, we have to assess the extent of contamination, effects on natural resources, the appropriate technology to be used to accomplish the remediation and evolving environmental standards. We perform quarterly reviews of environmental remediation sites and record liabilities and receivables in the period it becomes probable that a liability has been incurred and the amounts can be reasonably estimated (see the discussion under "Environmental Matters" in "Note 1 - Significant Accounting Policies" and "Note 14 - Legal Proceedings, Commitments and Contingencies" 51
--------------------------------------------------------------------------------
Table of Contents
included in our Notes to Consolidated Financial Statements). We consider the above factors in our quarterly estimates of the timing and amount of any future costs that may be required for environmental remediation activities, which results in the calculation of a range of estimates for a particular environmental remediation site. We do not discount the recorded liabilities, as the amount and timing of future cash payments are not fixed or cannot be reliably determined. Given the required level of judgment and estimation, it is likely that materially different amounts could be recorded if different assumptions were used or if circumstances were to change (e.g., a change in environmental standards or a change in our estimate of the extent of contamination). Under agreements reached with theU.S. Government , most of the amounts we spend for environmental remediation are allocated to our operations as general and administrative costs. Under existingU.S. Government regulations, these and other environmental expenditures relating to ourU.S. Government business, after deducting any recoveries received from insurance or other PRPs, are allowable in establishing prices of our products and services. As a result, most of the expenditures we incur are included in our net sales and cost of sales according toU.S. Government agreement or regulation, regardless of the contract form (e.g. cost-reimbursable, fixed-price). We continually evaluate the recoverability of our assets for the portion of environmental costs that are probable of future recovery by assessing, among other factors,U.S. Government regulations, ourU.S. Government business base and contract mix, our history of receiving reimbursement of such costs, and efforts by someU.S. Government representatives to limit such reimbursement. In addition to the proceedings and potential proceedings discussed above,California previously established a maximum level of the contaminant hexavalent chromium in drinking water of 10 parts per billion (ppb). This standard was successfully challenged by theCalifornia Manufacturers and Technology Association (CMTA) for failure to conduct the required economic feasibility analysis. In response to the court's ruling, theState Water Resources Control Board (State Board ), a branch of theCalifornia Environmental Protection Agency , withdrew the hexavalent chromium standard from the published regulations, leaving only the 50 ppb standard for total chromium.The State Board has indicated it will work to re-establish a hexavalent chromium standard. Further, theU.S. Environmental Protection Agency (U.S. EPA ) is considering whether to regulate hexavalent chromium.California is also reevaluating its existing drinking water standard of 6 ppb for perchlorate, and theU.S. EPA is taking steps to regulate perchlorate in drinking water. If substantially lower standards are adopted, in eitherCalifornia or at the federal level for perchlorate or for hexavalent chromium, we expect a material increase in our estimates for environmental liabilities and the related assets for the portion of the increased costs that are probable of future recovery in the pricing of our products and services for theU.S. Government . The amount that would be allocable to our non-U.S. Government contracts or that is determined not to be recoverable underU.S. Government contracts would be expensed, which may have a material effect on our earnings in any particular interim reporting period. As disclosed above, we may record changes in the amount of environmental remediation liabilities as a result of our quarterly reviews of the status of our environmental remediation sites, which would result in a change to the corresponding amount that is probable of future recovery and a charge to earnings. For example, if we were to determine that the liabilities should be increased by$100 million , the corresponding amount that is probable of future recovery would be increased by approximately$87 million , with the remainder recorded as a charge to earnings. This allocation is determined annually, based upon our existing and projected business activities with theU.S. Government . We cannot reasonably determine the extent of our financial exposure at all environmental remediation sites with which we are involved. There are a number of former operating facilities we are monitoring or investigating for potential future environmental remediation. In some cases, although a loss may be probable, it is not possible at this time to reasonably estimate the amount of any obligation for remediation activities because of uncertainties (e.g., assessing the extent of the contamination). During any particular quarter, such uncertainties may be resolved, allowing us to estimate and recognize the initial liability to remediate a particular former operating site. The amount of the liability could be material. Upon recognition of the liability, a portion will be recognized as a receivable with the remainder charged to earnings, which may have a material effect in any particular interim reporting period. If we are ultimately found to have liability at those sites where we have been designated a PRP, we expect that the actual costs of environmental remediation will be shared with other liable PRPs. Generally, PRPs that are ultimately determined to be responsible parties are strictly liable for site remediation and usually agree among themselves to share, on an allocated basis, the costs and expenses for environmental investigation and remediation. Under existing environmental laws, responsible parties are jointly and severally liable and, therefore, we are potentially liable for the full cost of funding such remediation. In the unlikely event that we were required to fund the entire cost of such remediation, the statutory framework provides that we may pursue rights of cost recovery or contribution from the other PRPs. The amounts we record do not reflect the fact that we may recover some of the environmental costs we have incurred through insurance or from other PRPs, which we are required to pursue by agreement andU.S. Government regulation. 52
--------------------------------------------------------------------------------
Table of Contents
Goodwill and Intangible Assets The assets and liabilities of acquired businesses are recorded under the acquisition method of accounting at their estimated fair values at the date of acquisition.Goodwill represents costs in excess of fair values assigned to the underlying identifiable net assets of acquired businesses. Intangible assets from acquired businesses are recognized at fair value on the acquisition date and consist of customer programs, trademarks, customer relationships, technology and other intangible assets. Customer programs include values assigned to major programs of acquired businesses and represent the aggregate value associated with the customer relationships, contracts, technology and trademarks underlying the associated program and are amortized on a straight-line basis over a period of expected cash flows used to measure fair value, which ranges from nine to 20 years. Our goodwill balance was$10.6 billion atDecember 31, 2019 and$10.8 billion atDecember 31, 2018 . We perform an impairment test of our goodwill at least annually in the fourth quarter or more frequently whenever events or changes in circumstances indicate the carrying value of goodwill may be impaired. Such events or changes in circumstances may 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,U.S. Government budget restrictions 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 may use both qualitative and quantitative approaches when testing goodwill for impairment. For selected reporting units where we use the qualitative approach, we perform a qualitative evaluation of events and circumstances impacting the reporting unit to determine the likelihood of goodwill impairment. Based on that qualitative evaluation, if we determine it is more likely than not that the fair value of a reporting unit exceeds its carrying amount, no further evaluation is necessary. Otherwise we perform a quantitative impairment test. We perform quantitative tests for most reporting units at least once every three years. However, for certain reporting units we may perform a quantitative impairment test every year. To perform the quantitative impairment test, we compare the fair value of a reporting unit to its carrying value, including goodwill. If the fair value of a reporting unit exceeds its carrying value, goodwill of the reporting unit is not impaired. If the carrying value of the reporting unit, including goodwill, exceeds its fair value, a goodwill impairment loss is recognized in an amount equal to that excess. We generally 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 company trading values and values observed in recent business acquisitions. Determining fair value requires the exercise of significant judgments, including the amount and timing of expected future cash flows, long-term growth rates, discount rates and relevant comparable public company earnings multiples and relevant transaction multiples. The cash flows employed in the DCF analysis are based on our best estimate of future sales, earnings and cash flows after considering factors such as general market conditions,U.S. Government budgets, existing firm orders, expected future orders, contracts with suppliers, labor agreements, changes in working capital, long term business plans 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. The carrying value of each reporting unit includes the assets and liabilities employed in its operations, goodwill and allocations of amounts held at the business segment and corporate levels. In the fourth quarter of 2019, we performed our annual goodwill impairment test for each of our reporting units. The results of that test indicated that for each of our reporting units no impairment existed. As of the date of our annual impairment test, the fair value of our Sikorsky reporting unit exceeded its carrying value, which included goodwill of$2.7 billion , by a margin of approximately 40%. While the margin between the fair value and carrying value of our Sikorsky reporting unit improved since the prior year impairment test, the fair value of our Sikorsky reporting unit can be significantly impacted by changes in expected future orders, discount rates and long term growth rates, along with other significant judgments. Based on our assessment of these circumstances, we have determined that goodwill at our Sikorsky reporting unit is at risk for impairment should there be a deterioration of projected cash flows of the reporting unit. Impairment assessments inherently involve management judgments regarding a number of assumptions such as those described above. 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. Acquired intangible assets deemed to have indefinite lives are not amortized, but are subject to annual impairment testing. This testing compares carrying value to fair value and, when appropriate, the carrying value of these assets is reduced to fair value. 53
--------------------------------------------------------------------------------
Table of Contents
Finite-lived intangibles are amortized to expense over the applicable useful lives, ranging from three to 20 years, based on the nature of the asset and the underlying pattern of economic benefit as reflected by future net cash inflows. We perform an impairment test of finite-lived intangibles whenever events or changes in circumstances indicate their carrying value may be impaired. If events or changes in circumstances indicate the carrying value of a finite-lived intangible may be impaired, the sum of the undiscounted future cash flows expected to result from the use of the asset group would be compared to the asset group's carrying value. If the asset group's carrying amount exceed the sum of the undiscounted future cash flows, we would determine the fair value of the asset group and record an impairment loss in net earnings. The carrying value of our Sikorsky business includes an indefinite-lived trademark intangible asset of$887 million as ofDecember 31, 2019 . In the fourth quarter of 2019, we performed the annual impairment test for the Sikorsky indefinite-lived trademark intangible asset and the results indicated that no impairment existed. As of the date of our annual impairment test, the fair value of the Sikorsky trademark exceeded its carrying value by a margin of approximately 10%. Additionally, our Sikorsky business has finite-lived customer program intangible assets with carrying values of$2.2 billion as ofDecember 31, 2019 . Any business deterioration, contract cancellations or terminations, or negative changes in market factors could cause our sales to decline below current projections. Based on our assessment of these circumstances, we have determined that our Sikorsky intangible assets are at risk for impairment should there be any business deterioration, contract cancellations or terminations, or negative changes in market factors. Recent Accounting Pronouncements See "Note 1 - Significant Accounting Policies" included in our Notes to Consolidated Financial Statements (under the caption "Recent Accounting Pronouncements"). 54
--------------------------------------------------------------------------------
Table of Contents
© Edgar Online, source