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, 2006
Business Overview: Lockheed Martin is a global aerospace and defense contractor serving primarily U.S. Government agencies (85% of 2005 sales). Operations are organized into five segments: Aeronautics, Electronic Systems, Space Systems, Integrated Systems & Solutions (IS&S), and Information & Technology Services (I&TS).

Key Financial Metrics

Note: Free Cash Flow calculated as Operating Cash Flow less Capital Expenditures ($263M YTD 2006).

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 7% in Q2 and 8% YTD compared to 2005. Growth was driven by Space Systems (+29% Q2), Electronic Systems (+5% Q2), and I&TS (+7% Q2). Aeronautics sales declined 2% in Q2 due to lower F-16 and C-130J volumes.
• Profitability: Operating profit rose 23% in Q2 and 37% YTD. All five segments reported increased operating profit. Margins improved due to volume increases and improved performance on key programs (e.g., C-130J, F-35, commercial satellites).
• Non-Operating Items: "Other income and expenses, net" increased significantly YTD ($314M vs $194M) due to a $127M gain from the sale of Inmarsat shares, a $23M gain from Space Imaging asset sales, and a $20M gain from land sales. These items contributed $111M to YTD net earnings.
• Accounting Changes: Adoption of FAS 123(R) on Jan 1, 2006, resulted in $57M of stock-based compensation expense YTD, reducing net earnings by $35M ($0.08 per share).

Guidance, Outlook, and Risks

• Outlook: Management states that quarterly results are not necessarily indicative of full-year results due to long-term operating cycles. Capital expenditures are expected to increase over the next two years to support business growth.
• United Launch Alliance (ULA): The proposed 50-50 joint venture with Boeing remains pending regulatory approval (FTC "second request"). Closing is not scheduled, and the transaction may be terminated if conditions are not met. Management does not expect a material impact on 2006 results regardless of the outcome.
• Legal & Environmental:
  • Redlands, CA: Litigation regarding groundwater contamination remains stayed pending appellate review; punitive damage claims were dismissed by the Court of Appeal.
  • Meridian, MS: Lawsuits regarding a 2003 facility incident have largely been settled or dismissed.
  • Environmental Liabilities: Recorded liabilities for environmental matters totaled $464M as of June 30, 2006.
• Pension Funding: Potential new federal legislation may accelerate required pension contributions, potentially impacting cash flows starting in 2008. A proposed FASB standard could require recognizing a $3.5B reduction in stockholders' equity if enacted.

Investor Verification Checklist

• Non-Recurring Gains: Verify the sustainability of earnings by excluding the $170M in gains from asset sales (Inmarsat, Space Imaging, land) included in YTD 2006 results.
• ULA Transaction Status: Monitor the status of the FTC review for the United Launch Alliance joint venture, as this could alter the future revenue structure of the Space Systems segment.
• Pension Obligations: Assess the potential impact of pending federal pension funding legislation and the proposed FASB standard on future cash flows and equity.
• Proton Launch Risk: Review the $230M in advances paid to Russian partner Khrunichev for Proton launch services and the associated political/economic risks in Russia.
• Share Repurchases: Note the aggressive capital return strategy, with $1.6B used for share repurchases in the first half of 2006, leaving ~20M shares remaining under the current program.