LMT

Business Context and Reporting Period

Company: Lockheed Martin Corporation
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and six months ended June 30, 2007
Business Overview: Lockheed Martin is a global aerospace and defense company serving primarily U.S. Government agencies (84% of 2006 sales). Operations are organized into four segments: Aeronautics, Electronic Systems, Information Systems & Global Services (IS&GS), and Space Systems. In February 2007, the company realigned operations, merging IT&GS and IS&S into the new IS&GS segment.

Key Financial Metrics

Margins (6 Months 2007): Operating margin was approximately 11.3%; Net margin was approximately 7.4%.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 7% in Q2 and 4% for the six months ended June 30, 2007, compared to 2006. Growth was driven by Aeronautics, Electronic Systems, and IS&GS. Space Systems sales declined due to the divestiture of International Launch Services (ILS) and the formation of the United Launch Alliance (ULA) joint venture.
• Profitability: Operating profit rose 31% in Q2 and 18% for the six-month period. All four business segments reported increased operating profit.
• Unusual Items: Net earnings were boosted by discrete items, including a $25 million gain from the sale of the remaining interest in Comsat International (Q2) and a $25 million gain from surplus land sales (Q1). Additionally, the closure of IRS examinations for 2003-2004 reduced income tax expense by $59 million in Q1.
• Shareholder Returns: The company repurchased $1,394 million of common stock in the first six months of 2007. Dividends were increased to $0.35 per share per quarter from $0.30 in 2006.

Guidance, Outlook, and Risks

Outlook and Commentary:

• Capital Allocation: Management maintains a balanced strategy of investing in the business, acquisitions, share repurchases, and debt reduction. Capital expenditures are expected to exceed 2006 levels over the next three years.
• ULA Investment: Following an agreement with Boeing in July 2007, Lockheed Martin expects to contribute an additional $175 million to ULA in Q3 2007. The company anticipates recognizing approximately $395 million in income ratably over 10 years related to its 50% ownership share of ULA's net assets exceeding book value.
• Debt Management: The company amended its $1.5 billion revolving credit facility to extend the expiration to June 2012. The debt-to-total capital ratio improved to 38%.

Risks and Contingencies:

• Legal Proceedings: The company faces various investigations, including grand jury subpoenas regarding a National Archives contract and patent applications. Environmental remediation liabilities are recorded at $499 million.
• Government Funding: Results are heavily dependent on U.S. Government funding, which is subject to budgetary constraints, political cycles, and changes in defense priorities.
• Pension Obligations: Significant pension liabilities exist, though 2006 prepayments reduced 2007 funding requirements.

Investor Verification Checklist

• Discrete Earnings Impact: Verify the sustainability of earnings growth by excluding the $50 million in gains from asset sales (Comsat and land) and the $59 million tax benefit from IRS audit closures.
• ULA Financials: Monitor the $175 million additional capital contribution to ULA expected in Q3 and the long-term recognition of the $395 million asset step-up.
• Space Segment Trajectory: Assess the long-term impact of the ILS divestiture and ULA formation on Space Systems revenue, which declined 5% year-over-year for the six-month period.
• Share Repurchase Capacity: Note that approximately 20 million shares remain available under the current repurchase program after 88 million shares have been bought back.
• Environmental Liabilities: Review the $499 million recorded liability for environmental matters and the potential for future cost increases due to changing regulations.