LMT

Business Context and Reporting Period

Company: Lockheed Martin Corporation
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2007
Business Overview: Lockheed Martin is a global aerospace and defense company engaged in the research, design, development, manufacture, and sustainment of advanced technology systems. In 2007, the company realigned its operations into four principal segments: Aeronautics, Electronic Systems, Information Systems & Global Services (IS&GS), and Space Systems. The U.S. Government remains the primary customer, accounting for 84% of net sales in 2007.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 6% year-over-year, driven by growth across all four business segments. Aeronautics sales rose 1%, Electronic Systems 6%, IS&GS 14%, and Space Systems 4%.
• Profitability Expansion: Operating profit grew 20% to $4.5 billion. This was primarily due to improved performance on key programs (F-22, F-16, C-130J) and a significant reduction in the FAS/CAS pension adjustment expense, which decreased from $275 million in 2006 to $58 million in 2007.
• Segment Performance:
  • Aeronautics: Operating profit increased 21% due to improved performance on Combat Aircraft programs, offsetting declines in Air Mobility.
  • Electronic Systems: Operating profit rose 12% driven by volume and performance in Missiles & Fire Control and Maritime Systems.
  • IS&GS: Operating profit grew 18%, aided by the acquisition of Pacific Architects and Engineers (PAE) and Management Systems Designers (MSD).
  • Space Systems: Operating profit increased 15%, with growth in Satellites and Strategic & Defensive Missile Systems offsetting a decline in Space Transportation due to the formation of the United Launch Alliance (ULA) joint venture.
• Unusual Items: Net earnings included $71 million of pre-tax income from items not considered in segment operating performance, including gains on the sale of land and Comsat International interests, and a $59 million tax benefit from the closure of IRS examinations.

Guidance, Outlook, and Risks

• Outlook: Management expects capital expenditures to exceed 2007 levels over the next three years to support business growth. The company anticipates no required cash contributions to the pension trust in 2008 due to discretionary prepayments made in 2007.
• Key Programs: The F-35 Lightning II program is in the System Development and Demonstration phase with low-rate initial production. The F-22 Raptor achieved Full Operational Capability in December 2007. The C-130J and C-5M programs continue to receive strong support in the FY2009 DoD budget request.
• Risks and Contingencies:
  • Government Funding: 84% of sales are to the U.S. Government, making the company dependent on Congressional appropriations. Contracts are subject to termination for convenience.
  • Legal Proceedings: The company is subject to various investigations and litigation, including False Claims Act allegations and environmental remediation matters. Management believes the probability of a material adverse effect is remote.
  • Environmental Liabilities: Recorded liabilities for environmental matters totaled $572 million at year-end, with $480 million expected to be recovered through U.S. Government pricing.
  • Raw Materials: Supply risks exist for single-source materials like carbon fiber and aluminum lithium, which could impact program schedules and costs.

Investor Verification Checklist

• Pension Funding: Verify the impact of the FAS/CAS pension adjustment on future earnings and confirm the company's assertion of zero required cash contributions for 2008.
• Convertible Debentures: Review the terms of the $1.0 billion floating-rate convertible debentures, noting that holders may elect to convert in Q1 2008 if stock price conditions are met, potentially diluting earnings or requiring cash settlement.
• Backlog Composition: Analyze the funded vs. unfunded backlog ($42.3 billion funded vs. $34.4 billion unfunded) to assess revenue visibility and funding risks.
• Segment Realignment: Ensure comparability of segment data by noting the 2007 realignment that created the IS&GS segment and shifted certain activities between Aeronautics and Electronic Systems.
• Legal Exposure: Monitor the status of the Department of Justice interventions in False Claims Act lawsuits and the outcome of the SpaceX antitrust appeal.