Revenue Recognition

In the Company’s Aerospace and Defense segment, the majority of the Company’s revenue is earned from long-term contracts to design, develop, and manufacture aerospace and defense products, and provide related services, for the Company’s customers, including the U.S. government, major aerospace and defense prime contractors, and a portion of the commercial sector. Each customer contract defines the Company’s distinct performance obligations and the associated transaction price for each obligation. A contract may contain a single or multiple performance obligations. In certain circumstances, multiple contracts with a customer are required to be combined in determining the distinct performance obligations. For contracts with multiple performance obligations, the Company allocates the contracted transaction price to each performance obligation based upon the relative standalone selling price, which represents the price the Company would sell the promised good or service separately to the customer. The Company determines the standalone selling price based upon the facts and circumstances of each obligated good or service. The majority of the Company’s contracts have no observable standalone selling price since the associated products and service are customized to customer specifications. As such, the standalone selling price generally reflects the Company’s forecast of the total cost to satisfy the performance obligation plus an appropriate profit margin.

Contract modifications are routine in the performance of the Company's long-term contracts. Contracts are often modified to account for changes in contract specifications or requirements. In most instances, contract modifications are for goods or services that are not distinct, and, therefore, are accounted for as part of the existing contract.

The Company recognizes revenue as each performance obligation is satisfied. The majority of the Company’s aerospace and defense performance obligations are satisfied over time either as the service is provided, or as control transfers to the customer. Transfer of control is evidenced by the Company’s contractual right to payment for work performed to date plus a reasonable profit on highly customized products. The Company measures progress on substantially all its performance obligations using the cost-to-cost method, which the Company believes best depicts the transfer of control of goods and services to the customer. Under the cost-to-cost method, the Company records revenues based upon costs incurred to date relative to the total estimated cost at completion. Contract costs include labor, material, overhead, and general and administrative expenses, as appropriate.

Recognition of revenue and profit on long-term contracts requires the use of assumptions and estimates related to the total contract value, the total cost at completion, and the measurement of progress towards completion for each performance obligation. Due to the nature of the programs, developing the estimated total contract value and total cost at completion for each performance obligation requires the use of significant judgment.

The contract value of long-term contracts may include variable consideration, such as incentives, awards, or penalties. The value of variable consideration is generally determined by contracted performance metrics, which may include targets for cost, performance, quality, and schedule. The Company includes variable consideration in the transaction price for the respective performance obligation at either estimated value, or most likely amount to be earned, based upon the Company’s assessment of expected performance. The Company records these amounts only to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved.

The Company evaluates the contract value and cost estimates for performance obligations at least quarterly and more frequently when circumstances significantly change. Factors considered in estimating the work to be completed include, but are not limited to: labor productivity, the nature and technical complexity of the work to be performed, availability and cost volatility of materials, subcontractor and vendor performance, warranty costs, volume assumptions, anticipated labor agreements, inflationary trends, schedule and performance delays, availability of funding from the customer, and the recoverability of costs incurred outside the original contract included in any estimates to complete. When the Company’s estimate of total costs to be incurred to satisfy a performance obligation exceeds the expected revenue, the Company recognizes the loss immediately. When the Company determines that a change in estimates has an impact on the associated profit of a performance obligation, the Company records the cumulative positive or negative adjustment to the statement of operations. Changes in estimates and assumptions related to the status of certain long-term contracts may have a material effect on the Company’s operating results. The following table summarizes the impact of the changes in significant contract accounting estimates on the Company’s Aerospace and Defense segment operating results:



	Three months ended June 30,				Six months ended June 30,
	2018		2017		2018		2017
	(In millions, except per share amounts)
Net favorable effect of the changes in contract estimates on net sales	$	26.2	$	9.6	$	18.8	$	13.5
Net favorable effect of the changes in contract estimates on income before income taxes	22.0		10.3		14.1		13.7
Net favorable effect of the changes in contract estimates on net income	16.3		6.2		10.4		8.2
Net favorable effect of the changes in contract estimates on basic net income per share	0.22		0.08		0.14		0.11
Net favorable effect of the changes in contract estimates on diluted net income per share	0.21		0.08		0.14		0.11

The three and six months ended June 30, 2018, net favorable changes in contract estimates on income before income taxes were primarily driven by risk retirements on the Terminal High Altitude Area Defense (“THAAD”), RS-68, RS-25, and RL-10 programs and better than expected overhead rate performance, partially offset by cost growth and performance issues on the Commercial Crew Development program.

In the Company’s Aerospace and Defense segment, the timing of revenue recognition, customer invoicing, and collections produces accounts receivable, contract assets, and contract liabilities on the Company’s Consolidated Balance Sheet. The Company invoices in accordance with contract payment terms either based upon a recurring contract payment schedule, or as contract milestones are achieved. Customer invoices, net of reserves, represent an unconditional right of consideration. When revenue is recognized in advance of customer invoicing a contract asset is recorded. Conversely, when customers are invoiced in advance of revenue recognition, a contract liability is recorded. Unpaid customer invoices are reflected as accounts receivable. A summary of the contract assets and liabilities is as follows:



	June 30, 2018			December 31, 2017
	(In millions)
Contract assets	$	296.3		$	310.9
Reserve for overhead rate disallowance	(43.2		)	(42.8		)
Contract assets, net of reserve	253.1			268.1
Contract liabilities	185.3			276.8
Net contract assets (liabilities), net of reserve	$	67.8		$	(8.7	)

Net contract assets (liabilities) increased by $76.5 million, primarily due to a decrease in cash advances on long-term contracts as of June 30, 2018. During the three and six months ended June 30, 2018, the Company recognized sales of $68.0 million and $200.5 million, respectively, that were included in the Company’s contract liabilities as of January 1, 2018.

As of June 30, 2018, the Company’s total remaining performance obligations, also referred to as backlog, totaled $3.9 billion. The Company expects to recognize approximately 48%, or $1.9 billion, of the remaining performance obligations as sales over the next twelve months, an additional 28% the following twelve months, and 24% thereafter.

The Company's contracts are largely categorized as either “fixed-price” (largely used by the U.S. government for production-type contracts) or “cost-reimbursable” (largely used by the U.S. government for development-type contracts). Fixed-price contracts present the risk of unreimbursed cost overruns, potentially resulting in lower than expected contract profits and margins. This risk is generally lower for cost-reimbursable contracts which, as a result, generally have a lower margin. The following are percentages of net sales by contract type:



	Three months ended June 30,				Six months ended June 30,
	2018		2017		2018		2017
Fixed-price	58	%	58	%	59	%	57	%
Cost-reimbursable	39		37		38		39
Other	3		5		3		4

The following are percentages of net sales by customer type:



	Three months ended June 30,				Six months ended June 30,
	2018		2017		2018			2017
U.S. government	93	%	93	%	93	%		93	%
Non U.S. government customers	7		7		7		7	7

The Company's Real Estate segment represented less than 1% of the Company's net sales for the three and six months ended June 30, 2018 and 2017.