LMT

Business Context and Reporting Period

Company: Lockheed Martin Corporation
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Three months ended March 31, 2005
Business Overview: Lockheed Martin is a leading systems integrator providing advanced technology systems, products, and services to domestic and international defense, civil, and homeland security markets. Approximately 80% of sales are to U.S. Government agencies. The company operates through five segments: Aeronautics, Electronic Systems, Space Systems, Integrated Systems & Solutions (IS&S), and Information & Technology Services (I&TS).

Key Financial Metrics

Margins: Operating margin was approximately 7.4% in Q1 2005 compared to 6.4% in Q1 2004. The effective income tax rate was 31.7% in Q1 2005 versus 32.0% in Q1 2004.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 2% year-over-year, driven by growth in Electronic Systems (+6%), Space Systems (+5%), and IS&S (+6%), which offset slight declines in Aeronautics (-4%) and I&TS (-1%).
• Profitability: Operating profit rose 18% to $630 million. All five business segments reported increased operating profits compared to the prior year.
• Cash Flow: Net cash provided by operating activities increased significantly to $1.5 billion from $1.1 billion, aided by working capital management and earnings growth.
• Balance Sheet: Cash and cash equivalents increased by $1.6 billion to $2.7 billion. Long-term debt remained stable at $5.1 billion.
• Unusual Items:
  • Gain on Sale: Recorded a $47 million gain (net of tax) from the sale of a 25% interest in Intelsat, Ltd., increasing net earnings by $31 million.
  • Impairment Charge: Recorded a $30 million charge (net of tax) for the impairment of a telecommunications satellite, reducing net earnings by $19 million.

Guidance, Outlook, and Risks

Management Commentary: Management attributes strong cash flow to disciplined management of the cash conversion cycle, including progress payments and inventory management. The company expects higher capital expenditures in 2005 and 2006 compared to 2004 to support business growth.

Acquisitions and Divestitures:

• Completed the acquisition of The SYTEX Group, Inc. for approximately $480 million to expand IT solutions for the Department of Defense.
• Completed the acquisition of STASYS Limited (not material to consolidated results).
• Received $762 million in proceeds from divestitures, primarily the Intelsat sale.

Risks and Contingencies:

• Legal Proceedings: The company is involved in various litigation, including environmental remediation (Redlands, Burbank, Glendale, Great Neck), a patent infringement suit by Space Systems Loral (remanded to District Court), and lawsuits related to a 2003 incident in Meridian, Mississippi. Management believes the probability of a material adverse effect is remote.
• Environmental Liabilities: Recorded liabilities for environmental matters were approximately $420 million as of March 31, 2005.
• Advances to Russian Manufacturers: $321 million in advances to Khrunichev State Research and Production Space Center are included in inventories. Realization of these amounts depends on Khrunichev's ability to provide launch services and the political environment in Russia.
• Accounting Changes: The company intends to adopt FAS 123(R) in Q1 2006, which will impact net earnings and EPS by requiring fair value accounting for stock-based compensation.

Investor Verification Checklist

• Segment Performance: Verify the sustainability of operating profit growth across all five segments, particularly the offsetting declines in Aeronautics sales.
• Unusual Items Impact: Assess the net impact of the Intelsat gain and satellite impairment charge on core operating performance.
• Environmental Exposure: Review the $420 million environmental liability and the status of the Redlands groundwater contamination litigation and remediation plans.
• Russian Launch Services: Monitor the $321 million advance to Khrunichev and potential risks related to political stability or service delivery failures in Russia.
• Share Repurchases: Confirm the remaining capacity under the share repurchase program (approx. 16 million shares available as of March 31, 2005).
• Accounting Adoption: Evaluate the potential future impact of FAS 123(R) adoption on 2006 earnings per share.