avatar Lockheed Martin Corporation Manufacturing


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    Lockheed Martin Corporation 2003 FINANCIAL HIGHLIGHTS (In millions, except per share data and number of employees) 2003 2002 2001 Net sales $31,824 $26,578 $23,990 Operating profit from business segments 2,468 2,020 1,709 Consolidated operating profit 2,019 1,158 833 Earnings from continuing operations 1,053 533 43 Net earnings (loss) 1,053 500 (1,046) Earnings (loss) per diluted share 2.34 1.11 (2.42) Average diluted common shares outstanding 450.0 452.0 432.5 Net cash provided by operating activities 1,809 2,288 1,825 Cash dividends per common share 0.58 0.44 0.44 Cash, cash equivalents and short-term investments 1,250 2,738 912 Total assets 26,175 26,979 27,714 Total debt 6,208 7,582 7,511 Stockholders’ equity $ 6,756 $ 5,865 $ 6,443 Debt-to-total-capital ratio 48% 56% 54% Negotiated backlog $76,899 $70,385 $71,269 Employees 130,000 125,000 125,000 NOTE: For a discussion of matters affecting the comparability of the information presented above, refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations on pages 17 through 39 of this Annual Report. CONTENTS Letter to Shareholders — PAGE 3 Narrative Section — PAGE 6 Financial Section of the 2003 Annual Report — PAGE 16 Corporate Directory — PAGE 71 General Information — PAGE 73 On the Cover: The Horizontal Integration Lab in Colorado Springs, Colorado, will enhance Lockheed Martin’s collaboration with customers and partners to develop advanced architectures for Net-Centric Operations.

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    Vance D. Coffman Robert J. Stevens Chairman and Chief Executive Officer President and Chief Operating Officer

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    DEAR FELLOW SHAREHOLDERS , With our management team united behind a straightforward and keenly focused strategy of disciplined growth, Lockheed Martin was, and continues to be, distinguished by robust operational and financial performance in 2003. As a result, we enter 2004 well positioned to fulfill the potential and promise of this innovative corporation of 130,000 dedicated men and women. This strategy of disciplined growth is to increase shareholder value by: ■ Putting operational performance and customer satisfaction at the top of our priorities. ■ Maintaining consistent financial performance including strong cash flow and increasing financial strength and flexibility. ■ Focusing on profitable growth in our core markets of Defense, Homeland Security and Government Information Technology (IT). We also look forward to working with NASA to support America’s reinvigorated commitment to space exploration. Successful execution of this strategy was demonstrated in the numbers with a third straight year of positive momentum. Net sales in 2003 grew 20 percent to $31.8 billion. We have grown segment operating profit faster than sales, reflecting steadily improving margins. For the third consecutive year, orders remain strong with a backlog of $76.9 billion at the end of 2003. Our Aeronautics business enjoyed a record year for sales and our Electronic Systems business completed a seventh consecutive year of organic growth. We continued our record of consistent cash flow generation that reached $1.8 billion in 2003, and deployed cash to enhance shareholder value through: LO C K H E E D M A RT I N A N N UA L R E P O RT 2 0 0 3 — 3 ■ Debt reduction. We reduced debt by $1.4 billion in 2003 and $3.7 billion since 2000. Our ratio of debt to total capital, at 48 percent, is now within our goal of 40 to 50 percent. We also restructured about $1 billion of debt to achieve lower interest expense. ■ Share repurchase. We have been buying back our shares periodically. Since we started our share repurchase activity about a year ago, we have retired approximately 11 million shares. ■ Dividends. Financial flexibility and vitality are also reflected in our doubling the annual dividend rate from 44 cents to 88 cents per common share. ■ Acquisitions. Growing business in our core markets is key to competing successfully, and we have made selective acquisitions to continue strengthening our position in defense and civil government IT. Lockheed Martin last year completed strategic transactions with ACS and Orincon, and announced the proposed acquisition of The Titan Corporation. We expect these transactions will bring additional capabilities, a talented workforce and customers. These transactions will help us be more competitive in the defense and civil government IT markets. About 25 percent of our sales are from IT solutions and services to defense, intelligence and civil government agencies. The Titan acquisition, when completed and integrated with Orincon, will bolster our core capabilities in critical intelligence, knowledge management and data fusion that are applicable to national defense. In the ACS transaction, we acquired the defense and most of the civil government IT business of ACS, while ACS acquired Lockheed Martin’s commercial IT business.

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    Financial performance and portfolio shaping are only part of the picture; Lockheed Martin consistently works to be a trusted and valued partner with our customers in the United States and worldwide. Consequently, last year we registered some impressive operational achievements: ■ In 2003, the F/A-22 team continued to address avionics stability challenges, operational testing began on schedule, high quality aircraft are being delivered, and the team continues to make solid progress in the transition from development to production. ■ In 2003, Lockheed Martin saw a resurgence in its space business with 11 new launches awarded and orders placed for five new commercial satellites. ■ The Patriot Advanced Capability (PAC-3) missile, the world’s first operational weapon system to employ hit-to-kill technology, made its operational debut during Operation Iraqi Freedom, defending troops and installations against ballistic missile threats. ■ We recorded two successful launches of our Atlas V in 2003. In all, there have been 68 consecutive suc- cessful Atlas launches. NASA also selected the Atlas V to launch the first space probe to Pluto in 2006. ■ The F-35 Joint Strike Fighter successfully completed its Preliminary Design Review and is proceeding toward the Design Integration Maturity Review this spring and the Critical Design Review in 2005. ■ The Spitzer Space Telescope we built for NASA was launched and began providing extraordinary infrared images of the universe. ■ The U.S. Air Force gave operational certification to the stealthy Joint Air to Surface Standoff Missile. ■ We received a vote of confidence from the U.S. Air Force and Marine Corps for the C-130J airlifter, which was reflected in a multi-year acquisition of 60 aircraft. We reorganized our business areas last year to better address the changing and increasingly complex needs of our defense customers, especially in the critical area of Information Superiority. 4 — LO C K H E E D M A RT I N A N N UA L R E P O RT 2 0 0 3 By creating a new business area, Integrated Systems & Solutions, we are leveraging technical expertise across the breadth of Lockheed Martin to address our customers’ requirements for highly integrated, networked solutions. Integrated Systems & Solutions provides customers with the benefit of focused collaboration for solutions that are technically sound, cost effective, and that enhance operational performance. As part of this effort, we are creating the Global Vision Network to enable collaboration among cus- tomers and Lockheed Martin. The central node of this high-bandwidth engineering network is the Global Vision Integration Center in Suffolk, Virginia, which will lead our development, simulation and analysis of network-centric solutions for the Department of Defense and other national security customers. Without the people of Lockheed Martin, the achievements of the past year would not have been possible. We are proud of the men and women who bring a passion for invention to their work each and every day. Our efforts to recruit and retain the best people continue apace. A diverse and talented workforce is fundamentally important to our future competitiveness. Also fundamental to this corporation are the values that inspire our management team. Ethics is not simply an add-on to our management strategy; it is inherent in the Lockheed Martin culture through regular training at all levels of the organization. We also apply these principles to meeting the highest standards of corporate governance and transparency in our financial disclosure practices. LM21 represents the commitment of all our employees to Operating Excellence and is based on the two pillars of superior development processes (and process improvement), and lean manufacturing techniques.

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    Lockheed Martin’s values are translated into action through our community and educational activities that help ensure that we as a corporate citizen give back to the communities where we work and live. The people of Lockheed Martin stood as one company in our response to the shootings in Meridian, Mississippi, and assisted those families affected by the tragedy. A year after the loss of the Space Shuttle Columbia, we honor the memory of the heroes who flew aboard that mission and stand with NASA in their commitment to manned and unmanned space exploration to the moon and beyond. As a corporation with a long history of serving the armed forces of the United States, we are acutely aware of the sacrifices our servicemen and women make every day in the defense of freedom. Our manage- ment team and the entire corporation salute those who are serving abroad and in the United States, including the nearly 300 Lockheed Martin employees now on active military duty, as well as the Lockheed Martin employees working in Iraq and worldwide. In summary, we are confident your company is well positioned for the future with: ■ Leadership in Defense, Homeland Security, Government Information Technology and Services growth markets, as well as space systems and exploration. ■ A broad portfolio of capabilities and programs that provide total systems solutions for customer challenges. ■ A strong backlog plus substantial new business opportunities. ■ Consistent financial performance and strong cash flow. ■ Cash deployment to enhance shareholder value. Lockheed Martin’s reputation as a dynamic enterprise serving our customers’, our nation’s and our allies’ most important priorities will be enhanced by adhering closely to a strategy that focuses on financial and operational performance, as well as the highest standards of business ethics. At the same time, we LO C K H E E D M A RT I N A N N UA L R E P O RT 2 0 0 3 — 5 remain keenly aware of opportunities to grow our core businesses. On a closing note, I recently announced my retirement as CEO, effective in August 2004. My 37 years with Lockheed Martin have been filled with challenge, wonder and tremendous gratification. The personal pride I feel for this company is exceeded only by the deep appreciation I have for its amazing 130,000 employees. The consolidation of the defense industry has led us through a challenging period in our history. All of you — our shareholders, customers and employees — have seen our corporation meet those demands and become stronger as a result. Having served seven years at the helm, it is now time for new leadership to take us to the next level of performance. Bob Stevens will assume leadership of Lockheed Martin upon my retirement and his energy, skill and business acumen will continue to serve you well. I am sure Bob will be a great leader, bringing fresh thinking and perspective to our company and our industry. I leave confident that the future of Lockheed Martin is indeed bright and the best years are ahead. March 1, 2004 Vance D. Coffman Chairman and Chief Executive Officer

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    PARTNERING TO HELP CUSTOMERS MEET THEIR DEFINING MOMENTS TM U.S. ARMED SERVICES and allied forces apply cutting-edge technologies from Lockheed Martin that enable them to turn data into knowledge, and knowledge into action. These systems link assets in space, in the air, at sea and on land with the goal of giving commanders the full picture of the battlespace in real-time. Information Superiority is the essence of the Department of Defense’s drive to Net-Centric Operations.

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    LOCKHEED MARTIN’S CAPABILITIES are aligned strongly with the highest priorities of our customers, which are mainly large U.S. and allied government agencies responsible for their nations’ most important challenges. Whether the mission is defense, homeland security or managing complex civil government Information Technology (IT) systems, our customers face a continuing series of defining moments. These range from equipping military forces with transformational capabilities that will help them meet a new spectrum of threats, to strengthening defenses against terrorism while preserving civil liberties, to providing numerous civil government services that are vital to the functioning of society. We recognize the importance of creating value for our customers. That means partnering with our customers and with companies in the United States and from around the world to deliver the advanced technology solutions our customers require to fulfill their most critical missions. We strive to earn a reputation as the partner of choice, supplier of choice and employer of choice in the global marketplace. LO C K H E E D M A RT I N A N N UA L R E P O RT 2 0 0 3 — 7 WE NEVER FORGET who we’re working for, and AS A TRUSTED and valued partner with government that includes the pilots of the F/A-22 Raptor. and industry, we take seriously the challenge of Built with unprecedented stealth, supercruise securing the homeland. Maritime and port traffic and avionics brainpower, the F/A-22 will protect management and security are vital national priorities aircrews in the heat of battle while destroying an in the United States and worldwide. adversary’s will to fight.

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    DISTINGUISHED BY WHOLE-SYSTEM THINKING AND ACTION TM THE EFFECTIVENESS OF MISSILE DEFENSE SYSTEMS depends on robust and extraordinarily reliable command and control systems. Lockheed Martin is working on significant missile defense programs including: Space-Based Infrared System-High (SBIRS-H), Battle Management Command and Control, Terminal High Altitude Area Defense (THAAD), Patriot Advanced Capability (PAC-3) Missile, Medium Extended Air Defense System (MEADS), Multiple Kill Vehicle, Airborne Laser, Targets and Countermeasures, Aegis sea-based missile defense, and the Boost Vehicle Plus.

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    RECOGNIZING THAT THE COMPLEX issues facing our Defense, Homeland Security and Government IT customers require integrated solutions, Lockheed Martin embraces the challenge by taking a whole-system approach. As a lead systems integrator, Lockheed Martin is adept at combining the best of technologies and teams of dedicated people — supporting Net-Centric military and Citizen-Centered civil government agencies. That includes defense electronics that raise the capabilities of platforms such as surface ships, submarines, helicopters and fixed-wing aircraft. We are combining industry teams, information systems and advanced technologies on the Deepwater Project for the U.S. Coast Guard as it fulfills its mission of protecting America’s coastlines. Deepwater will recapitalize the Coast Guard by upgrading ships, aircraft, logistics, and command and control systems. As a leader in E-Government solutions, we at Lockheed Martin apply our extensive Information Technology capability across the breadth of more than a dozen federal agencies that serve the American people, such as the Social Security Administration, which processes and delivers 50 million checks a month. LO C K H E E D M A RT I N A N N UA L R E P O RT 2 0 0 3 — 9 BY UTILIZING HIGH-SPEED and highly accurate LOCKHEED MARTIN TECHNOLOGIES help the IT solutions, government agencies can better U.S. Coast Guard and U.S. Customs & Border assist the public with benefits, information and Protection keep America secure. Our technologies services. Lockheed Martin provides the Department are being applied to chemical and biological agent of Veterans Affairs with IT infrastructure support detection as well as biometrics that can help our so those who have served their country can be government customers ensure the security and better served. safety of their operations.

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    TAKI NG O N C H A L LE NG E S W I T H A PASSION FOR INVENTION TM OUR COMBAT AIRCRAFT are designed and built with the same passion that has inspired inventors and innovators through a century of powered flight. Lockheed Martin’s Paul Bevilaqua (above) designed the unique and advanced convertible lift fan propulsion system that powers the F-35 Joint Strike Fighter. The first truly global combat aircraft, the F-35 has become an innovative model for U.S. and international partnering.

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    AT LOCKHEED MARTIN , we are driven by a passion for invention — the ability to provide a new perspective, to look at any problem, any possible solution, from all sides. We partner with the U.S. Department of Defense and allied nations to provide the advanced technology they need to deter aggression, or to project power, achieve air dominance and engage targets precisely in the event of combat. Defining moments for our customers can come when law enforcement officers, securing the homeland from the threats of terrorism and crime, can match a fingerprint out of a database of 400 million in a matter of minutes. The work we do touches the lives of millions of citizens, such as when the governments of the United States, United Kingdom and Canada conduct and analyze their censuses. Crucial government decisions on schools, roads and other services depend on a reliable count, and Lockheed Martin delivers the advanced optical character recognition and computing technologies to address that vital requirement. With inventive solutions, Lockheed Martin is helping the Environmental Protection Agency to develop an automated and integrated approach to managing the federal government’s rule-making function in support of the President’s Management Agenda. LO C K H E E D M A RT I N A N N UA L R E P O RT 2 0 0 3 — 11 THE PASSION TO TAKE ON complex challenges MOVING MORE THAN 200 BILLION pieces of mail for our customers’ most important priorities is a year accurately, quickly and securely is a nationally one reason Lockheed Martin air traffic management consequential mission for the U.S. Postal Service. products and services are a global standard for To that end, Lockheed Martin has developed the industry, managing 60 percent of the world’s integrated automation and character recognition air traffic. technologies that work together to improve the sorting, processing and delivery of the mail.

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    DELIVERING DISCIPLINED PERFORMANCE TM REDEFINING WHAT IS POSSIBLE is a term that well describes America’s exploration of space for the sake of scientific discovery, defense, telecommunications and a better understanding of our own planet Earth, including its weather and natural resources. We will launch aboard our Atlas V vehicle (interior shown above) the first-ever probe to Pluto in 2006.

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    LOCKHEED MARTIN IS EQUALLY committed to operational and financial performance with a balanced business base and a focus on keeping programs on budget, on schedule and on target. As we make our customers’ mission our own, we are dedicated to delivering products and services that perform with extraordinary reliability. We must have the best talent available to meet the complex requirements of our customers in the United States and worldwide. Lockheed Martin is dedicated to hiring and retaining a diverse workforce with the creativity and innovation that will continue our long-standing commitment to excellent performance. Disciplined performance also means adherence to a high standard of corporate governance and a rigorous program of ethics training among all our employees. We are motivated by a continually reinforced set of values: ■ Ethics and Integrity ■ People and Teamwork ■ Excellence and a “Can-Do’’ Spirit LO C K H E E D M A RT I N A N N UA L R E P O RT 2 0 0 3 — 13 THE SERIOUSNESS AND URGENCY of the work WE ALSO SUPPORT our NASA customer’s mission the people of Lockheed Martin perform for the to return the U.S. Space Shuttle to flight, as well as nation and our allies around the world are keenly support the President’s goal to establish a manned felt by each and every one of us, such as when presence on the moon and to eventually send our C-130J airlifter is called to duty delivering aid astronauts to Mars. after a natural disaster or when it is necessary to deploy military forces.

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    LOCKHEED MARTIN: A TRUSTED AND VALUED PARTNER TM A NEW GENERATION OF INVENTORS, inspired by the pioneers who took to the skies a century ago, is experiencing the excitement of learning through Space Day. Lockheed Martin is a proud sponsor of Space Day, dedicated to encouraging those who yearn to push the boundaries of what is possible. Aspiring astronauts, these students (shown above) put learning into action in Space Day activities.

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    AS A CORPORATE CITIZEN , we are a trusted and valued partner with the communities in which we work. That includes joining with our schools and communities in promoting math and science education. Lockheed Martin supports science, math, computer sciences and engineering excellence, from elementary education through the university level, with grants and locally based initiatives. The men and women of Lockheed Martin recognize that the foundation of a strong and free people starts at the local level — where we live and work. We are more than a collection of offices and facilities; we are neighbors, students, mentors, coaches and parents. Building the advanced technology products and services that meet the needs of governments worldwide is part of the picture of Lockheed Martin. We are also a company of people working to build a better world by volunteering in our communities. LO C K H E E D M A RT I N A N N UA L R E P O RT 2 0 0 3 — 15 LOCKHEED MARTIN VOLUNTEERS across America VOLUNTEERISM, THROUGH PROGRAMS to aid are bringing their skills and knowledge back to our neighbors in distress, clean up the environment the communities through mentoring and tutoring or help combat disease, is vital to building a programs. As a company we are dedicated to stronger America. In 2003, Lockheed Martin educational achievement and the promise of our employees contributed more than 350,000 hours young people. of volunteer time.

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    FINANCIAL SECTION O F T H E 2 0 0 3 A N N UA L R E P O RT 2003 Financial Highlights — INSIDE FRONT COVER Management’s Discussion and Analysis of Financial Condition and Results of Operations — PAGE 17 Management’s Responsibility for Financial Reporting — PAGE 40 Report of Ernst & Young LLP, Independent Auditors — PAGE 41 Consolidated Statement of Operations — PAGE 42 Consolidated Balance Sheet — PAGE 43 Consolidated Statement of Cash Flows — PAGE 44 Consolidated Statement of Stockholders’ Equity — PAGE 45 Notes to Consolidated Financial Statements — PAGE 46 Consolidated Financial Data — Five Year Summary — PAGE 69 Forward-Looking Statements — Safe Harbor Provisions — PAGE 74 16

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    Lockheed Martin Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS December 31, 2003 FINANCIAL SECTION ROADMAP Financial statements, notes to the financial statements and The financial section of our Annual Report includes management’s related reports — discussion and analysis, our consolidated financial statements, notes to those financial statements and a 5 year summary of finan- Reports related to the financial statements cial information. We have prepared the following summary, or (pages 40 through 41) — include the following: “roadmap,” to assist in your review of the financial section. It is • A report from our management, indicating our responsibility for designed to give you an overview of our company and focus your financial reporting and maintaining an internal control environ- review by directing you to some of the more important activities and ment, and events that occurred this year. • A report from our independent auditors, Ernst & Young LLP, which includes their opinion about the fair presentation of our Lockheed Martin’s Business financial statements based on their audits. The report includes Lockheed Martin Corporation is mainly involved in the research, their opinion about the conformity of our financial statements, design, development, manufacture, integration, operation and sup- which includes the notes to the financial statements, with port of advanced technology systems, products and services. We accounting principles that are generally accepted in the United have customers in domestic and international defense, civil govern- States (GAAP). ment, and commercial markets, and over 75% of our sales over the past three years have been to agencies of the U.S. Government. Our Financial statements (pages 42 through 45) — include our con- main areas of focus are in the defense, space, homeland security, solidated statements of operations, cash flows and stockholders’ and government information technology markets. equity for each of the last three years, and our balance sheet as of We operate in five principal business segments: Aeronautics, the end of the last two years. Our financial statements are prepared Electronic Systems, Space Systems, Integrated Systems & in accordance with GAAP. Solutions and Information & Technology Services. As a lead sys- Notes to the financial statements (pages 46 through 68) — pro- tems integrator, our products and services range from aircraft, vide insight into and are an integral part of our financial statements. spacecraft and launch vehicles to missiles, electronics and informa- There are explanations of our significant accounting policies, tion systems, including integrated net-centric solutions. details about certain of the captions on the financial statements, information about significant events or transactions that have Financial Section Overview occurred, discussions about commitments and contingencies, and The financial section includes the following: selected financial information relating to our business segments. The notes to the financial statements also are prepared in accor- Management’s discussion and analysis, or MD&A (pages 17 dance with GAAP. through 39) — provides management’s view about industry trends, risks and uncertainties relating to Lockheed Martin, accounting Highlights policies that we view as critical in light of our business, our results The financial section of our Annual Report describes our on- of operations, including discussions about the key performance going operations, including discussions about particular lines of drivers of each of our business segments, our financial position and business or programs, our ability to finance our operating activi- cash flows, commitments and contingencies, important events or ties, and trends and uncertainties in our industry and how they transactions that have occurred over the last three years, and for- might affect our future operations. We also discuss those items ward-looking information, as appropriate. affecting our results that were not considered in senior manage- ment’s assessment of the operating performance of our business segments. We separately disclose these items to assist in your eval- uation of our overall operating performance and financial condi- tion of the consolidated company. 17

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    Lockheed Martin Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS December 31, 2003 We would like to draw your attention to the following items dis- Systems segments. We believe this new segment will help us better closed in this financial section and where you will find them: focus our integrated solutions capabilities across the Corporation and enhance our ability to serve as a lead partner with the DoD to Topic Location(s) respond to this customer priority. Critical accounting policies Page 21 The President’s budget for the DoD for fiscal year 2004 and beyond responds to increased needs for homeland security and Post-retirement benefit plans Page 23 and page 59 combating terrorism. This is evidenced by budget increases for Environmental matters Page 24, page 48 and page 63 operational readiness and personnel needs, as well as for both pro- Acquisition and divestiture activities Page 25 and page 50 curement and research and development. This trend was reiterated Changes in our business segment in the Future Year Defense Plan (FYDP) submitted with the presentation, and discussions of President’s budget for fiscal year 2005. It projects sustained growth each segment’s operations Page 28 and page 65 in both the procurement and research and development budgets for Unallocated Corporate (expense) the DoD through fiscal year 2006 and, in the case of the procure- income, net Page 32 and page 66 ment budgetary authority, through fiscal year 2009. While there is Liquidity and cash flows Page 33 and page 44 no assurance that the increased DoD budget levels will be approved Capital structure and resources Page 34, page 43 and page 45 by Congress, the current defense budget outlook appears to be one Commitments and contingencies Page 35 and page 63 of modest growth. However, the level of growth and the amount of Goodwill (FAS 142) Page 47 and page 50 the budget that will ultimately be allocated to the investment Stock-based compensation Page 49 and page 57 accounts most closely aligned with our business (i.e., procurement, research and development) is unknown. INDUSTRY CONSIDERATIONS During 2003, Congress appropriated additional amounts to pay Defense Business Considerations for operational costs for military missions in Iraq and Afghanistan, Domestic and worldwide political and economic developments as well as for reconstruction activities. These supplemental appro- continue to have a significant impact on the markets for defense and priations enabled the DoD to proceed on critical modernization and advanced technology systems, products and services. Markets for acquisition programs, versus using amounts available for those pro- defense and advanced technology systems during 2004 and beyond grams to pay for the Iraq and Afghanistan missions. The DoD will continue to be affected by the worldwide war against terrorism, expects a further supplemental appropriation to continue these mis- and the continued need for military missions in Iraq and sions as needed through 2005. As a result, we do not anticipate that Afghanistan and related reconstruction efforts. These realities have sustained operations in Iraq and Afghanistan will materially impact increased the need for greater attention to the security of our home- the procurement and research and development budget levels pro- land and for better communication and interplay between law jected in the 2005 to 2009 FYDP. enforcement, civil government agencies, intelligence agencies and Our broad mix of programs and capabilities gives us the abili- our military services. Our nation’s overall defense posture continues ty to support the needs of the various agencies of the U.S. to move toward a more capabilities-based structure, which creates Government that require our products and services. Our major pro- the ability for a more flexible response with greater force mobility, grams and capabilities include: missile defense; space intelligence; stronger space capabilities, enhanced missile defense and improved command, control, communications, computers, intelligence, sur- information systems capabilities and security. veillance and reconnaissance (C4ISR); air mobility aircraft; and air- We anticipate that the next Congressionally mandated power projection/precision-strike capability. In terms of size and “Quadrennial Defense Review” (QDR) undertaken by the U.S. long-term potential impact, two of our more significant programs Department of Defense (DoD) will reinforce and advance efforts at are the F/A-22 Raptor and the F-35 Joint Strike Fighter. We are also the DoD to refocus activities towards joint operations, net-centric represented in almost every aspect of land, sea, air and space-based command and control, and integrated capabilities for the armed missile defense, including the Medium Extended Air Defense forces. Recognizing this emerging priority at the DoD, we formed System (MEADS), the Patriot Advanced Capability (PAC-3) Integrated Systems & Solutions, a new business segment, in 2003 missile program, the Terminal High Altitude Area Defense from existing components of our Electronic Systems and Space (THAAD) system, the Multiple Kill Vehicle program, and the High 18

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    Lockheed Martin Corporation Altitude Airship program. In the areas of space intelligence and Non-U.S. defense budgets have generally been declining over information superiority, we have leadership positions on programs the past decade. As a result, consolidation has also been occurring such as Transformational Communications, Advanced Extremely in the European aerospace industry, resulting in fewer but larger and High Frequency (AEHF), and Space-Based Infrared System-High more capable competitors, potentially resulting in an environment (SBIRS-H), and in classified programs and battle management where there could be less demand abroad for products from U.S. command and control capabilities. In airlift, we have the companies. This type of environment could reduce opportunities for C-130J program and are under contract to upgrade the C-5 strategic European partnerships and sales potential for U.S. exports. airlift aircraft. Many of these programs are large and require fund- ing over several budget cycles. There are risks associated with these Space Business and other large, highly visible programs subject to appropriation by The commercial launch vehicle marketplace remains very compet- Congress that, because of their size, could be expected to become itive due mainly to low demand for new satellites as a result of potential targets for reduction or extension of funding to pay for excess capacity in the telecommunications industry. The reduction other programs. in demand has resulted in pricing pressures in both the launch vehi- The Office of Management and Budget recently announced its cle and satellite markets. We received new orders for both commer- intention to conduct a comprehensive review of the F/A-22 Raptor cial satellites and launch vehicles in 2003; however, the majority of program. This independent assessment will evaluate the perform- those orders relate to replacement satellites versus an expansion of ance, requirements and cost aspects of the program. We believe sus- telecommunications capacity. tained improved performance in production and testing of the The above factors have impacted orders for all of our commer- F/A-22 will re-validate the transformational qualities of this cial launch vehicles, including the Evolved Expendable Launch weapons system, and the suitability of the F/A-22 for continued Vehicle (EELV or Atlas V), our next generation launch vehicle pro- production by the U.S. Air Force. gram in which we have made significant investments over the past We continue to expand our capabilities in critical intelligence, few years. The Atlas V is available for both commercial and gov- knowledge management and E-Government solutions. Consistent ernment use. This program has required investment of funds for with the President’s agenda, the expected growth in business research and development, start-up and other nonrecurring costs, process outsourcing has been enabled by recent rule changes for and launch facilities. Some of these expenditures have been funded public/private competitions. In addition, recent trends have indicat- under an agreement with the U.S. Government. Commercial orders ed an increase in demand by federal and civil government agencies to-date for the Atlas V launch vehicle have been lower than origi- for upgrading and investing in new information technology systems nally expected and at lower prices. However, we have received a and solutions. As a result, we continue to focus our resources in sup- total of 18 EELV launch assignments from the U.S. Government port of infrastructure modernization that allows for interoperability (including those described in the following paragraph), 3 of which and communication across agencies. are under contract. We had our third Atlas V launch in 2003. In addition, the increase in emphasis on homeland security In July 2003, the U.S. Air Force announced that our competi- may increase demand for our capabilities in areas such as air traffic tor in the EELV competition had violated the Procurement Integrity management, ports and waterways security, biohazard detection Act. As a result of that determination, the Air Force reassigned 7 systems for postal equipment, information systems security and launch vehicles from the initial competition (referred to as “Buy 1”) other technical systems solutions. to us and removed our exclusion from west coast launches. At the In prior years, companies in our industry had reacted to histor- same time, the Air Force assigned us 3 new west coast launches. To ically shrinking defense budgets for procurement and research and prepare for providing the west coast launches, we are upgrading development by combining to maintain critical mass. More recent- west coast launch facilities, which will require further investment in ly, we have focused our efforts on select core acquisitions, cost sav- the EELV program. However, we expect to recover that investment ings and improving efficiency, as well as generating cash to repay through pricing of the west coast launches. The 7 reassigned launch- debt incurred during the period of consolidation. Through our con- es are expected to occur over the 2005 through 2009 time period. solidation activities, we have been able to pass along savings to our Contractual terms and conditions related to the west coast launches customers, mainly the DoD. have not yet been finalized with the Air Force. 19

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    Lockheed Martin Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS December 31, 2003 Lockheed-Khrunichev-Energia International, Inc. (LKEI), a Technologies Corporation and the Russian firm NPO Energomash, joint venture we have with two Russian government-owned space for the purchase, subject to certain conditions, of RD-180 booster firms, has exclusive rights to market launches of commercial, non- engines for use in the Corporation’s Atlas launch vehicles. Terms of Russian-origin space payloads on the Proton family of rockets from the agreement call for payments to be made to RD AMROSS upon a launch site in Kazakhstan. Commercial Atlas and Proton launch the achievement of certain milestones in the manufacturing process. services are marketed around the world through International Payments of $57 million made under this agreement for engines not Launch Services (ILS), a joint venture between Lockheed Martin yet delivered were included in the Corporation’s inventories at and LKEI. We consolidate the results of operations of LKEI and December 31, 2003. ILS into our financial statements based on controlling financial As discussed above, the commercial satellite market has con- interest. We received 7 new awards for launches on Proton vehicles tinued to experience pricing pressures due to excess capacity and in 2003. Contracts for launch services usually require substantial lower demand. Satellite demand also has been impacted by the busi- advances from the customer prior to launch. At the end of 2003, ness difficulties encountered by some companies in the commercial $250 million of advances received from customers for Proton satellite services industry which have resulted in reduced access to launch services not yet provided was included as a liability on our capital and a reduction in the total market size in the near term. balance sheet in the caption “Customer advances and amounts in However, in the past year, we received 5 new commercial satellite excess of costs incurred.” orders, generally for replacement satellites versus capacity expan- A sizeable percentage of the advances we receive from cus- sion. We expect to continue to control costs in our commercial satel- tomers for Proton launch services are sent to Khrunichev State lite manufacturing business while keeping our focus on providing a Research and Production Space Center (Khrunichev), the manu- reliable product. We also received new orders for government satel- facturer of the launch vehicle and provider of the related launch lites in 2003 related to classified activities. services in Russia. If a contracted launch service is not provided, a sizeable percentage of the related advance would have to be Other Business Considerations refunded to the customer. In addition, we have sent advances to As a government contractor, we are subject to U.S. Government Khrunichev for launches we purchased which have not yet been oversight. The government may ask about and investigate our assigned to customers. The advances sent to Khrunichev are business practices and audit our compliance with applicable rules included on our balance sheet in inventories. Advances for launch- and regulations. Depending on the results of those audits and es not under contract are subject to an agreement entered into in investigations, the government could make claims against us. 2002 which provides for reduced future launch payments from us Under government procurement regulations and practices, an to Khrunichev, contingent on the receipt of new orders as well as a indictment of a government contractor could result in that con- minimum number of actual launches each year. As a result of this tractor being fined and/or suspended from being able to bid on, or agreement, as well as our assessment in 2002 of the likelihood of be awarded, new government contracts for a period of time. A con- customer terminations for convenience for launches under con- viction could result in debarment for a specific period of time. tract, we reduced the carrying value of our advances to Khrunichev Similar government oversight exists in most other countries where and recognized a charge, net of state income tax benefits, of $173 we conduct business. Although we cannot predict the outcome of million. The charge reduced 2002 net earnings by $112 million these types of investigations and inquiries with certainty, based on ($0.25 per diluted share). At year-end 2003, payments to current facts, we do not believe that any of the claims, audits or Khrunichev included in inventories, net of the amount of the investigations pending against us are likely to have a material reserve recorded in 2002, totaled $327 million. Our ability to real- adverse effect on our business or our results of operations, cash ize the remaining amounts may be affected by Khrunichev’s abili- flows or financial position. ty to provide the launch services and the political environment in Changes in government procurement policies and practices Russia. Through the end of 2003, launch services through LKEI over the past several years, such as increases in the progress pay- and ILS have been provided according to contract terms. ment rate and the use of performance-based payments, have had a The Corporation has entered into an agreement with RD positive effect on our financial position and cash flows. But we are AMROSS, a joint venture of the Pratt & Whitney division of United still exposed to risks associated with U.S. Government contracting, 20

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    Lockheed Martin Corporation including technological uncertainties and obsolescence, and having this accident will have a material impact on our results of opera- to depend on Congressional appropriation and allotment of funds tions, financial position or cash flows. We expect to compete for each year. Many of our programs involve the development and NASA programs related to the new Space Exploration Initiative application of state-of-the-art technologies aimed at achieving chal- announced by the President, which includes development of lenging goals. As a result, setbacks, delays, cost growth and product human-rated space launch and transportation systems over the next failures can occur. 15 years, replacing the current space shuttle architecture. In addition to our defense businesses, we also provide products We have entered into various joint venture, teaming and other and services to most civil government customers, as well as to business arrangements to help support our portfolio of products and commercial customers. We provide products and services to gov- services in many of our lines of business, including commercial ernment agencies such as the Department of Homeland Security, space. Some of these business arrangements include foreign part- the U.S. Postal Service, the Patent and Trademark Office, the ners. The conduct of international business introduces other risks Federal Aviation Administration, NASA, the U.S. Coast Guard and into our operations, including changing economic conditions, fluc- the Transportation Security Administration. Although our lines of tuations in relative currency values, regulation by foreign countries business in civil government and commercial markets are not and the potential for unanticipated cost increases resulting from the dependent on defense budgets, they share many of the same risks as possible deterioration of political relations. our defense businesses, as well as other risks unique to their partic- The nature of our international business also makes us sub- ular marketplaces. Although indemnification by the U.S. ject to the export control regulations of the U.S. Department of Government may be available in some instances for our defense State and the Department of Commerce. If these regulations are businesses, U.S. Government indemnification may not be available violated, it could result in monetary penalties and denial of export to cover potential claims or liabilities resulting from a failure of privileges. We are currently unaware of any violations of export technologies developed and deployed for homeland security pur- control regulations which are reasonably likely to have a material poses. While we maintain insurance for some business risks, it is not adverse effect on our business or our results of operations, cash possible to obtain coverage to protect against all operational risks flows or financial position. and liabilities. We do plan to seek limitation of such potential lia- bilities related to the sale and use of our homeland security products CRITICAL ACCOUNTING POLICIES and services through qualification by the Department of Homeland Contract Accounting/Revenue Recognition Security under the “SAFETY Act” provisions of the Homeland A large part of our business is derived from long-term contracts for Security Act of 2002. In the event we were to provide homeland development, production and service activities which we account security-related products and services to a customer without such for consistent with the American Institute of Certified Public qualification, we would not be afforded the benefit of the SAFETY Accountants’ (AICPA) audit and accounting guide, “Audits of Act’s cap on tort liability or U.S. Government indemnification. Federal Government Contractors,” the AICPA’s Statement of Other risks unique to the civil government and commercial markets Position No. 81-1, “Accounting for Performance of Construction- may include development of competing products, technological Type and Certain Production-Type Contracts,” and other relevant feasibility and product obsolescence. revenue recognition accounting literature. We consider the nature of We provide products and services to NASA, including the these contracts and the types of products and services provided Space Shuttle program, mainly through our Space Systems and when we determine the proper accounting for a particular contract. Information & Technology Services business segments. Work for Generally, we record long-term fixed-price contracts on a per- NASA accounted for approximately 5% of our consolidated net centage of completion basis using units-of-delivery as the basis to sales in 2003. We also have a 50% equity interest in United Space measure progress toward completing the contract and recognizing Alliance, LLC which provides ground processing and other opera- revenue. For example, we use this method of revenue recognition on tional services to the Space Shuttle program. We worked with our C-130J tactical transport aircraft program, Atlas and Proton NASA and others in the independent investigation of the tragic acci- launch vehicle programs and Multiple Launch Rocket System dent in February 2003 involving the Space Shuttle Columbia. The program. For certain other long-term fixed-price contracts that, investigation is now completed. We do not expect that the effects of along with other factors, require us to deliver minimal quantities 21

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    Lockheed Martin Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS December 31, 2003 over a longer period of time or to perform a substantial level of include expected increases in wages and prices for materials. For development effort in comparison to the total value of the contract, contract change orders, claims or similar items, we apply judgment revenues are recorded when we achieve performance milestones or in estimating the amounts and assessing the potential for realization. using the cost-to-cost method to measure percentage of completion. These amounts are only included in contract value when they can Under the cost-to-cost method of accounting, we recognize revenue be reliably estimated and realization is considered probable. based on the ratio of costs incurred to our estimate of total costs at Incentives and award fees related to performance on contracts, completion. As examples, we use this methodology for our F/A-22 which are generally awarded at the discretion of the customer, as Raptor program and the AEGIS Weapons System program. In some well as penalties related to contract performance, are considered in instances, long-term production programs may require a significant estimating sales and profit rates. Incentives and penalties are level of development and/or a low level of initial production units in recorded when there is sufficient information for us to assess antic- their initial phases, but will ultimately require delivery of increased ipated performance. Award fees are estimated based on actual and quantities in full rate production stages. In those cases, the revenue anticipated awards. recognition methodology may change from the cost-to-cost method The majority of our sales are driven by pricing based on costs to the units-of-delivery method after considering, among other fac- incurred to produce products or perform services under contracts tors, production stabilization. We record sales under cost-reim- with the U.S. Government, and therefore not necessarily on market- bursement-type contracts as we incur the costs. Examples of this based factors. Cost-based pricing is determined under the Federal type of revenue recognition include the F-35 Joint Strike Fighter Acquisition Regulations (FAR). The FAR provides guidance on the system development and demonstration (SDD) program and the types of costs that are allowable in establishing prices for goods and THAAD missile defense program. The majority of our long-term services under U.S. Government contracts. For example, costs such contracts are denominated in U.S. dollars, including contracts for as those related to charitable contributions, advertising, public rela- sales of military products and services to foreign governments con- tions, and stock-based compensation programs are unallowable, and ducted through the U.S. Government (i.e., foreign military sales). therefore not recoverable through sales. In addition, we may enter As a general rule, we recognize sales and profits earlier in a into agreements with the U.S. Government that address the subjects production cycle when we use the cost-to-cost and milestone meth- of allowability and allocability of costs to contracts for specific mat- ods of percentage of completion accounting than when we use the ters. For example, some of the amounts we spend for groundwater units-of-delivery method. In addition, our profits and margins may treatment and soil remediation related to discontinued operations vary materially depending on the types of long-term government and sites operated in prior years are allocated to our current opera- contracts undertaken, the costs incurred in their performance, the tions as general and administrative costs under agreements reached achievement of other performance objectives, and the stage of per- with the U.S. Government. formance at which the right to receive fees, particularly under Products and services provided under long-term development incentive and award fee contracts, is finally determined. We have and production contracts make up a large portion of our business, accounting policies in place to address these as well as other con- and therefore the amounts we record in our financial statements tractual and business arrangements in accounting for long-term using contract accounting methods and cost accounting standards contracts. For other information on accounting policies we have in are material. Because of the significance of the judgments and esti- place for recognizing sales and profits, see our discussion under mation processes, it is likely that materially different amounts could “Sales and earnings” in Note 1 to the financial statements. be recorded if we used different assumptions or if the underlying cir- Contract accounting requires judgment relative to assessing cumstances were to change. When adjustments in estimated contract risks, estimating contract revenues and costs, and making assump- revenues or costs are required, any changes from prior estimates are tions for schedule and technical issues. Due to the size and nature generally included in earnings in the current period. We closely mon- of many of our contracts, the estimation of total revenue and cost at itor compliance with and the consistent application of our critical completion is complicated and subject to many variables. Contract accounting policies related to contract accounting. Business segment costs include material, labor and subcontracting costs, as well as an personnel assess the status of contracts through periodic contract sta- allocation of indirect costs. Assumptions have to be made regarding tus and performance reviews. Also, regular and recurring evaluations the length of time to complete the contract because costs also of contract cost, scheduling and technical matters are performed by 22

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    Lockheed Martin Corporation management personnel who are independent from the business seg- Also, at the end of 2002, we recorded a noncash after-tax ment performing work under the contract. Costs incurred and allo- adjustment of $1.5 billion in the stockholders’ equity section of our cated to contracts with the U.S. Government are reviewed for com- balance sheet to reflect a minimum pension liability for most of our pliance with regulatory standards by our personnel, and are subject pension plans. The adjustment did not impact earnings, but reduced to audit by the Defense Contract Audit Agency. our stockholders’ equity. This adjustment is calculated on a plan-by- plan basis, and is determined by comparing the accumulated bene- Post-Retirement Benefit Plans fit obligation (ABO) for each plan to the fair value of that plan’s Most employees are covered by defined benefit pension plans, and assets. The amount by which the ABO exceeds the fair value of the we provide health care and life insurance benefits to eligible plan assets, after adjusting for previously recorded accrued or pre- retirees. Our earnings may be positively or negatively impacted by paid pension cost for the plan, must be recorded as a minimum pen- the amount of income or expense we record for our employee ben- sion liability, with a corresponding increase in an intangible asset, if efit plans. This is particularly true with income or expense for qual- appropriate, and a reduction to stockholders’ equity, consistent with ified defined benefit plans (pension plans) because those calcula- FAS 87. In 2003, we reduced the adjustment recorded in stock- tions are sensitive to changes in several key economic assumptions holders’ equity in 2002 by about $300 million, mainly due to favor- and workforce demographics. able asset returns for the year. Again, this minimum pension liabil- We account for our pension plans using Statement of Financial ity adjustment did not impact 2003 earnings. The amount of the Accounting Standards (FAS) No. 87, “Employers’ Accounting for minimum pension liability is computed at each year-end and could Pensions” (FAS 87). Those rules require that the amounts we record, potentially continue to reduce the amount recorded in 2002 in future including the income or expense for the plans, be computed using periods if financial markets improve and interest rates increase, or actuarial valuations. These valuations include many assumptions, could potentially increase if financial market performance and including assumptions we make relating to financial market and interest rates decline. other economic conditions. Changes in key economic indicators U.S. Government Cost Accounting Standards (CAS) is a can result in changes in the assumptions we use. The key year-end major factor in determining our funding requirements and governs assumptions used to estimate pension income or expense for the fol- the extent to which our pension costs are allocable to and recover- lowing fiscal year are the discount rate, the expected long-term rate able under contracts with the U.S. Government. Funded amounts of return on plan assets and the rate of increase in future compen- are recovered over time through the pricing of our products and sation levels. services on U.S. Government contracts, and therefore are recog- We use judgment in reassessing these assumptions each year nized in our net sales. The total funding requirement for our pen- because we have to consider current market conditions and, in the sion plans under CAS in 2003 was $184 million. For 2004, we case of the expected long-term rate of return on plan assets, past expect our funding requirements under CAS to increase. Also in investment experience, judgments about future market trends, 2004, funding in addition to the amount calculated under CAS will changes in interest rates and equity market performance. We also likely be required under Internal Revenue Code rules. Any addi- have to consider factors like the timing and amounts of expected tional amounts computed under those rules are considered to be contributions to the plans and benefit payments to plan participants. prepayments under the CAS rules, and therefore will be recorded An example of how changes in these assumptions can affect on our balance sheet and recovered in future periods. In December our financial statements occurred in 2003. As required by FAS 87, 2003, we made a discretionary prepayment of $450 million to the we reassessed the discount rate assumption at the end of 2003. pension trust, the majority of which will reduce our cash funding Based on our review of interest rates at the end of the year, we low- requirements for 2004. There is currently proposed legislation that ered our discount rate assumption to 6.25% at year-end 2003, ver- would change the measurement of the liabilities that are included sus 6.75% used for 2002 and 7.25% used for 2001. This change, in the funding calculations for 2004. Our funding projections together with other factors such as the effects of the actual return on assume that this proposed legislation will be passed and become plan assets over the past few years, resulted in our projecting that the effective for 2004. We would expect our projected funding amount of pension expense for 2004 will approximately double as requirements for 2004 to increase if the proposed legislation does compared to $484 million of expense recorded in 2003. not become law. 23

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    Lockheed Martin Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS December 31, 2003 The FAS/CAS pension adjustment represents the difference to the financial statements). Judgment is required when we develop between pension expense or income calculated in accordance with assumptions and estimate costs expected to be incurred for envi- FAS 87 and pension costs calculated and funded in accordance with ronmental remediation activities due to, along with other factors, CAS. Since the CAS expense is recovered through the pricing of difficulties in assessing the extent of environmental remediation to our products and services on U.S. Government contracts, and there- be performed, complex environmental regulations and remediation fore recognized in a particular segment’s net sales, the results of technologies, and agreements between PRPs to share in the cost of operations of our segments only include pension expense as deter- remediation as discussed below. mined and funded in accordance with CAS rules. Accordingly, the We enter into agreements (e.g., administrative orders, consent FAS/CAS adjustment is an amount included in the reconciliation of decrees) which document the extent and timing of our obligation. We total segment operating profit to consolidated operating profit are also involved in remediation activities at environmental sites under GAAP. See the discussion of “Unallocated Corporate where formal agreements exist but do not quantify the extent and tim- (Expense) Income, Net” under “Discussion of Business Segments.” ing of our obligation. Environmental clean-up activities usually cover The Medicare Prescription Drug, Improvement and several years, which makes estimating the costs more judgmental due Modernization Act of 2003 (the Act) was signed into law by the to, for example, changing remediation technologies. To determine the President in December 2003. Historically, Medicare has not provid- costs related to clean-up sites, we have to assess the extent of con- ed prescription drug benefits. Under the new law, Medicare will tamination, the appropriate technology to be used to accomplish the provide a prescription drug benefit beginning in 2006. The Act also remediation and continually evolving regulatory environmental stan- provides for a federal subsidy to eligible sponsors of retiree health dards. We consider these factors in our estimates of the timing and care benefits. At this point, there is a lack of clarity regarding how amount of any future costs that may be required for remediation some of the key provisions of the Act will be applied and adminis- actions. In cases where a date to complete activities at a particular tered, and how it will impact the prescription drug benefits that we environmental site cannot be estimated by reference to agreements or provide our retirees. In addition, specific authoritative guidance on otherwise, we project costs over a reasonable time frame not to the accounting for the federal subsidy is still pending and that guid- exceed 20 years. Given the level of judgment and estimation which ance, when issued, could require a change to previously reported has to occur, it is likely that materially different amounts could be information. In recognition of these uncertainties, the Financial recorded if different assumptions were used or if circumstances were Accounting Standards Board decided to allow companies to defer to change (e.g., a change in environmental standards). recognition of the impact of the new law on the benefit obligations If we are ultimately found to have liability at those sites where they provide their retirees, which we have elected to do. we have been designated a PRP, we expect that the actual costs of Accordingly, the accumulated post-retirement benefit obligation remediation will be shared with other liable PRPs. Generally, PRPs (APBO) for our retiree health care benefits, as well as the net peri- that are ultimately determined to be responsible parties are strictly odic post-retirement benefit cost, included in our financial state- liable for site clean-up and usually agree among themselves to ments and the accompanying notes do not reflect the effects of the share, on an allocated basis, the costs and expenses for investigation Act. It is expected that any such change would result in some reduc- and remediation of hazardous materials. Under existing environ- tion to the APBO and the net periodic post-retirement benefits cost. mental laws, however, responsible parties are jointly and severally liable and, therefore, we are potentially liable for the full cost of Environmental Matters funding such remediation. In the unlikely event that we were We are a party to various agreements, proceedings and potential required to fund the entire cost of such remediation, the statutory proceedings for environmental clean-up issues, including matters at framework provides that we may pursue rights of contribution from various sites where we have been designated a potentially responsi- the other PRPs. The amounts we record do not reflect the fact that ble party (PRP) by the Environmental Protection Agency or by a we may recover some of the environmental costs we have incurred state agency. We record financial statement accruals for environ- through insurance or from other PRPs, which we are required to mental matters in the period that it becomes probable that a pursue by agreement and U.S. Government regulation. liability has been incurred and the amounts can be reasonably esti- Under agreements reached with the U.S. Government, some of mated (see the discussion under “Environmental matters” in Note 1 the amounts we spend for groundwater treatment and soil 24

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    Lockheed Martin Corporation remediation are allocated to our operations as general and adminis- acquired are included in the Information & Technology Services trative costs. Under existing government regulations, these and (I&TS) business segment. The majority of the operations divested other environmental expenditures relating to our U.S. Government had been included in the I&TS segment, with the remainder from business, after deducting any recoveries received from insurance or the Information Systems & Solutions business segment. other PRPs, are allowable in establishing prices of our products and In September 2003, we announced that Lockheed Martin and services. As a result, a substantial amount of the expenditures we The Titan Corporation had entered into a merger agreement for incur are being included in our sales and cost of sales according to Lockheed Martin to acquire Titan. The announced value of the U.S. Government agreement or regulation. transaction, including the assumption of Titan’s long-term debt, is At the end of 2003 and 2002, the total amount of liabilities approximately $2.4 billion before accumulated tax benefits. Under recorded on our balance sheet for environmental matters was the merger agreement, stockholders of Titan may elect to receive approximately $425 million and $445 million, respectively. About $22 per share in cash, an equivalent amount of Lockheed Martin two-thirds of the liability recorded at the end of 2003 related to sites common stock based on an exchange rate or a combination of cash in Redlands, Burbank and Glendale, California, and in Great Neck, and stock, subject to the allocation procedures set forth in the merg- New York, mainly for remediation of soil and groundwater contam- er agreement. The merger agreement provides that 50% of Titan’s ination. The remainder of the liability related to other properties outstanding common stock must be exchanged for Lockheed (including current operating facilities and certain facilities operated Martin common stock, and 50% of the Titan common stock must in prior years) for which the financial exposure can be estimated. be exchanged for cash. The exchange rate will be determined by We have recorded an asset for the portion of environmental costs dividing $22 by the average trading price of Lockheed Martin com- that are probable of future recovery in pricing of our products and mon stock over a 10 day trading period, subject to upper and lower services for U.S. Government businesses. The amount that is limits, or “collars,” of $58 and $46 per share. Under certain cir- expected to be allocated to our commercial businesses has been cumstances, the exchange rate for the stock portion of the merger expensed through cost of sales. Any recoveries we receive would consideration will be fixed based on the upper collar of $58 per reduce the allocated amounts included in our future U.S. share or the lower collar of $46 per share. Upon consummation of Government sales and cost of sales. the merger, we would expect to issue between 16 and 22 million shares of our common stock, depending on the exchange rate. We ACQUISITION AND DIVESTITURE ACTIVITIES plan to finance the cash portion of the transaction principally using In November 2003, we completed transactions resulting in our existing cash and short-term investment holdings. acquisition of the majority of the federal government information On February 13, 2004, Lockheed Martin and Titan announced technology (IT) business of Affiliated Computer Services, Inc. that representatives of both companies had initiated meetings with (ACS), and ACS’ concurrent acquisition of our commercial IT the Department of Justice and the SEC to advise of an internal business. The total purchase price related to our acquisition of ACS’ review relating to certain agreements between Titan and interna- federal government IT business, including transaction-related costs, tional consultants and related payments in foreign countries. The was approximately $585 million. As part of our accounting for the SEC informed Lockheed Martin and Titan that it has commenced acquisition of the federal IT business, we recorded intangible assets an investigation into whether payments by Titan were made in vio- totaling about $112 million related to contracts acquired and a lation of applicable law. Lockheed Martin is independently review- covenant not to compete which will be amortized over 5 to 7 year ing Titan’s payments to international consultants to assess whether periods, and goodwill of about $460 million. This acquisition all conditions to the closing of the proposed merger will be satis- expands our capabilities in business process outsourcing and man- fied. Lockheed Martin has requested that Titan afford it access to aged services, thereby enhancing our ability to support civil and all relevant information related to its relationships with internation- defense government agencies. The divestiture of our commercial IT al consultants so that the review may be completed in advance of the business to ACS resulted in a cash payment to us from ACS of Titan stockholders’ meeting. Titan is cooperating with this request, approximately $110 million and a gain, net of state income taxes, of as well as conducting its own review. $15 million. The gain increased net earnings by approximately $8 During the course of our review, we learned of allegations that million ($0.02 per diluted share). The operations of the business improper payments were made, or items of value were provided, by 25

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    Lockheed Martin Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS December 31, 2003 consultants for Titan or its subsidiaries directly or indirectly to for- eign officials. The alleged payments and provision of items of value, if true, raise questions concerning whether there has been a violation of the Foreign Corrupt Practices Act. We also are review- ing with Titan whether payments made by Titan to consultants were accurately reflected on Titan’s books and records. Our review is ongoing. Together with Titan, we disclosed the allegations to the SEC and the Department of Justice. During that meeting, Lockheed Martin and Titan were informed that the Department of Justice has initiated a criminal inquiry into this matter. Closing of the Titan transaction is subject to approval of Titan’s stockholders, the absence of any material adverse change in Titan and other conditions set forth in the merger agreement. Either Lockheed Martin or Titan may terminate the merger agreement if Continuing Operations the merger is not completed by March 31, 2004, provided that the The following discussion of net sales and operating results will party seeking to terminate the agreement is not then in material provide an overview of our operations by focusing on key ele- breach of its obligations under the merger agreement in a manner ments set forth in our “Consolidated Statement of Operations.” The that has contributed to the failure to consummate the merger. The “Discussion of Business Segments” which follows, will review the full text of the merger agreement is publicly available as an attach- contributions of each of our business segments to our consolidated ment to the proxy statement/prospectus mailed to Titan stockhold- results for 2003, 2002 and 2001. ers and as an exhibit to Lockheed Martin’s 2003 Form 10-K. For 2003, net sales were $31.8 billion, a 20% increase over On an ongoing basis, we plan to continue to explore the sale of 2002 sales. Sales for 2002 were $26.6 billion, an increase of 11% various non-core businesses, passive equity investments and surplus compared to 2001. Sales increased in all segments as compared to real estate. If we were to decide to sell any such holdings or real the prior year for the second straight year. The U.S. Government is estate, the resulting gains, if any, would be recorded when the trans- our largest customer, accounting for about 78% of our sales for actions are consummated and losses, if any, would be recorded 2003, compared to 80% in 2002 and 78% in 2001. when they are probable and estimable. We also continue to review For 2003, 2002 and 2001 the items in the table below, among other our businesses on an ongoing basis to identify ways to improve things, were included in “Unallocated Corporate (expense) income, net” organizational effectiveness and performance, and to focus on our (see the related “Discussion of Business Segments” below). core business strategy. Operating Net (Loss) (Loss) (Loss) Earnings per RESULTS OF OPERATIONS (In millions, except per share data) Profit Earnings Diluted Share Since our operating cycle is long-term and involves many types of YEAR ENDED DECEMBER 31, 2003 development and production contracts with varying production Loss on early retirement of debt $ (146) $ (96) $(0.21) delivery schedules, the results of operations of a particular year, or Charge related to exit from year-to-year comparisons of recorded sales and profits, may not be the commercial mail indicative of future operating results. The following discussions of sorting business (41) (27) (0.06) Gain on partial reversal of comparative results among periods should be viewed in this context. Space Imaging guarantee 19 13 0.03 Gain on sale of the commercial IT business 15 8 0.02 $ (153) $(102) $(0.22) 26

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    Lockheed Martin Corporation Operating Net (Loss) settlement, and the rate for 2001 was increased by non-deductible (Loss) (Loss) Earnings per (In millions, except per share data) Profit Earnings Diluted Share goodwill that was being amortized for financial reporting purposes. YEAR ENDED DECEMBER 31, 2002 The effective tax rates for all periods were reduced by tax benefits Write-down of telecommunications related to export sales, changes to prior year liabilities arising from investments $ (776) $(504) $(1.12) tax refund initiatives and adjustments to true-up actual tax return Charge related to a Russian liabilities. The 2002 tax rate was also reduced by a favorable IRS launch services provider (173) (112) (0.25) audit settlement. Write-down of investment in Congress is considering new tax legislation that would repeal Space Imaging and charge related the extraterritorial income exclusion relating to export sales and to recording of guarantee (163) (106) (0.23) enact new rules providing for a tax reduction on profits from the Benefit from R&D tax sale of products manufactured in the United States. If such legisla- credit settlement — 90 0.20 tion were passed, we do not expect that it would adversely impact $(1,112) $(632) $(1.40) the Corporation’s effective tax rate. In the event that this or other tax YEAR ENDED DECEMBER 31, 2001 legislation is enacted, its impact on our deferred tax balances and Write-off of investment in effective tax rate will be recognized as of the date the new tax rules Astrolink and related costs $ (387) $(267) $(0.62) are enacted. Write-down of investment For 2003, we reported net earnings from continuing operations in Loral Space (361) (235) (0.54) of $1.1 billion ($2.34 per diluted share) compared to $533 million Other charges related to ($1.18 per diluted share) for 2002. In 2001, we reported earnings global telecommunications (176) (117) (0.27) from continuing operations of $43 million ($0.10 per diluted share). Impairment charge related to Americom Asia-Pacific (100) (65) (0.15) Discontinued Operations Loss on early repayment of debt (55) (36) (0.08) Gain on sale of surplus real estate 111 72 0.17 During 2003, the activities of the remaining telecommunications Other activities, net (5) (3) (0.01) service business held for sale were immaterial and had no impact on earnings. We reported total losses from discontinued operations $ (973) $(651) $(1.50) of $33 million ($0.07 per diluted share) in 2002 and $1.1 billion ($2.52 per diluted share) in 2001. Operating losses of the busi- Our operating profit for 2003 was $2.0 billion, an increase of nesses included in discontinued operations totaled $33 million 74% compared to 2002. Our operating profit for 2002 was ($0.07 per diluted share) in 2002 and $62 million ($0.14 per dilut- $1.2 billion, an increase of 39% compared to 2001. The results for ed share) in 2001. 2001 included amortization expense of $274 million for goodwill Discontinued operations for 2002 included losses incurred for and certain other intangibles that was not included in 2002 or 2003 wind-down activities related to the global telecommunications serv- due to the adoption of FAS 142. See Note 1 to the financial state- ices businesses, offset by the reversal of a reserve associated with ments for information regarding our adoption of FAS 142. the sale of Lockheed Martin IMS Corporation (IMS). When record- Interest expense for 2003 was $487 million, $94 million lower ing the sale of IMS in 2001, we established transaction-related than the amount for 2002. This was primarily the result of reduc- reserves to address various indemnity provisions in the sale agree- tions in our debt portfolio and the favorable impact of having issued ment. The risks associated with certain of these indemnity provi- $1.0 billion of convertible notes in August 2003 to replace higher sions were resolved and $39 million, net of taxes, was recognized cost debt. Interest expense for 2002 was $581 million, through discontinued operations in 2002. $119 million lower than in 2001 mainly due to reductions in our Included in the 2001 loss from discontinued operations was an debt portfolio and the benefit from interest rate swap agreements. after-tax charge of $1.3 billion ($3.09 per diluted share) related to Our effective tax rates were 31.3% for 2003, 7.7% for 2002 our decision to exit the global telecommunications services busi- and 67.7% for 2001. The tax rate for 2002 was reduced by a $90 ness. The 2001 results also included an after-tax gain of $309 mil- million tax benefit related to a research and development tax credit lion ($0.71 per diluted share) from the sale of IMS. 27

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    Lockheed Martin Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS December 31, 2003 Net Earnings (Loss) aircraft program and produce aircraft under the new award. We We reported net earnings of $1.1 billion, or $2.34 per diluted share, expect the program will return to profitability in 2004. in 2003, compared to net earnings of $500 million, or $1.11 per The Electronic Systems business segment has a broad portfo- diluted share, in 2002 and a net loss of $1.0 billion ($2.42 per dilut- lio of products and services. Many of its activities involve a combi- ed share) in 2001. nation of both development and production contracts with varying delivery schedules. We expect this mix of contract types to contin- ue in the short term, and it may affect the year-to-year comparisons of segment margins and the operating results of the lines of business within Electronic Systems. The Space Systems business segment is a key supplier of space solutions, primarily to our U.S. Government customers. Satellites and Strategic & Defensive Missile System activities, primarily for our U.S. Government customers, are expected to experience steady growth as we work on our existing backlog and any new awards that we may receive. However, the com- mercial satellite and launch vehicle industries continue to be very competitive. We did receive new orders for both commer- cial satellites and launch vehicles in 2003; however, the majori- ty of those orders relate to replacement satellites versus an DISCUSSION OF BUSINESS SEGMENTS expansion of telecommunications capacity. The Satellites line of As described more fully in Note 16 to the financial statements, we business received 5 new commercial satellite orders during announced the formation of Integrated Systems & Solutions 2003. The Launch Services line of business received 11 new (IS&S), a new business segment, in 2003. With the formation of awards for launch missions, including 7 Proton, 1 Atlas V and 3 IS&S, the former Systems Integration business segment is now EELV missions. To date, the segment has received 18 EELV mis- named Electronic Systems. Also in 2003, we changed the name of sion assignments from the U.S. Government, including the 3 our Technology Services business segment to Information & under contract. The activities in the Titan program will continue, Technology Services (I&TS) to better reflect the scope of its activ- though at a lower level than prior years, as we work to complete ities. We operate in five business segments: Aeronautics, Electronic the remaining 3 missions. Systems, Space Systems, IS&S, and I&TS. The following segment The IS&S and the I&TS business segments have strengthened information has been reclassified from amounts previously report- their capabilities in providing information technology services to ed to reflect the current business segments. defense, intelligence and other government customers. We expect Net sales have increased in each of our business segments over continued strong growth in providing information technology serv- the last 3 years. Our demonstrated performance and broad portfolio ices to government agencies. of capabilities have contributed to this growth. In the following tables of financial data, the total of the operat- In the Aeronautics business segment, sales have increased as ing results of the business segments is reconciled to the correspon- we ramped up activities on the F-35 program, delivered more F-16 ding consolidated amount. With respect to the caption “Operating aircraft and entered low-rate production on the F/A-22 program. profit,” the reconciling item “Unallocated Corporate (expense) During 2003, we increased deliveries of F-16s to 62 aircraft, from income, net” includes the FAS/CAS pension adjustment (see dis- the 21 aircraft delivered in 2002, reflecting the backlog associated cussion below), earnings and losses from equity investments (main- with several of our international F-16 customers. We anticipate the ly telecommunications), interest income, costs for stock-based F-16 deliveries to be in the range of 70 – 75 aircraft over the next compensation programs, the effects of items not considered part of 2 years. The C-130J program was awarded a multi-year award for management’s evaluation of segment operating performance, and 60 aircraft during 2003. This award solidifies our production plan- Corporate costs not allocated to the operating segments, as well as ning and long-term supplier pricing as we complete the initial 119 other miscellaneous Corporate activities. 28

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    Lockheed Martin Corporation The FAS/CAS pension adjustment represents the difference between pension expense or income calculated for financial report- ing purposes in accordance with FAS 87, and pension costs calcu- lated and funded in accordance with U.S. Government CAS, which are reflected in the business segment results. CAS is a major factor in determining our pension funding requirements, and governs the extent of allocability and recoverability of pension costs on govern- ment contracts. The CAS expense is recovered through the pricing of our products and services on U.S. Government contracts, and therefore recognized in segment net sales. The results of operations of the segments only include pension expense as determined and funded in accordance with CAS rules. This table shows net sales and operating profit of the business segments and reconciles to the consolidated total. The following segment discussions also include information (In millions) 2003 2002 2001 relating to negotiated backlog for each segment. Total negotiated NET SALES backlog was $76.9 billion at December 31, 2003. This amount Aeronautics $10,202 $ 6,471 $ 5,355 included both funded backlog (unfilled firm orders for our products Electronic Systems 8,991 8,685 8,079 and services for which funding has been both authorized and appro- Space Systems 6,021 5,287 4,801 Integrated Systems & Solutions 3,420 3,015 2,970 priated by the customer — Congress in the case of U.S. Information & Technology Services 3,174 3,104 2,763 Government agencies) and unfunded backlog (firm orders for Total business segments 31,808 26,562 23,968 which funding has not yet been appropriated). Negotiated backlog Other 16 16 22 does not include unexercised options or task orders to be issued $31,824 $26,578 $23,990 under indefinite-delivery/indefinite-quantity (IDIQ) type contracts. OPERATING PROFIT Funded backlog was $39.1 billion at December 31, 2003. Aeronautics $ 690 $ 448 $ 329 The Aeronautics segment generally includes fewer programs Electronic Systems 858 875 816 that have much larger sales and operating results than programs Space Systems 403 279 225 included in the other segments. Therefore, due to the large number Integrated Systems & Solutions 291 241 225 of comparatively smaller programs in the remaining segments, the Information & Technology Services 226 177 114 discussions of the results of operations of these business segments Total business segments 2,468 2,020 1,709 generally focus on lines of business within the segments. The fol- Unallocated Corporate lowing tables of financial information and related discussions of (expense) income, net (449) (862) (602) the results of operations of our business segments are consistent Impact of FAS 142 adoption — — (274) with the presentation of segment information in Note 16 to the $ 2,019 $ 1,158 $ 833 financial statements. 29

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    Lockheed Martin Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS December 31, 2003 Aeronautics Electronic Systems Aeronautics’ operating results included the following: Electronic Systems’ operating results included the following: (In millions) 2003 2002 2001 (In millions) 2003 2002 2001 Net sales $10,202 $ 6,471 $ 5,355 Net sales $ 8,991 $ 8,685 $ 8,079 Operating profit 690 448 329 Operating profit 858 875 816 Backlog at year-end 37,580 35,477 36,149 Backlog at year-end 17,339 16,034 15,333 Net sales for Aeronautics increased by 58% in 2003 compared Net sales for Electronic Systems increased 4% in 2003 as com- to 2002 due to growth in the Combat Aircraft and Air Mobility lines pared to 2002. Sales increases in Missiles & Fire Control (M&FC) of business. Approximately half the growth in Combat Aircraft was and Maritime Systems & Sensors (MS2) more than offset a decline due to higher volume on the F-35 Joint Strike Fighter program with at Platform, Training & Transportation Systems (PT&TS). a majority of the remaining growth attributable to F-16 programs as Increased volume in air defense and tactical missile programs a result of increased deliveries. In 2003, 62 F-16s were delivered, accounted for the majority of M&FC’s $250 million sales growth 41 more than in 2002. Increased C-130J deliveries contributed $470 over 2002. In MS2, the $155 million increase in sales was primari- million to the year-over-year growth in sales. There were 15 C-130J ly due to higher volume on radar and surface systems programs. deliveries in 2003 compared to 8 deliveries in 2002. The PT&TS decline of $100 million was the result of lower volume Net sales for Aeronautics increased by 21% in 2002 compared on transportation and security system activities. The majority of this to 2001 due to growth in the Combat Aircraft line of business. decline is attributable to the 2002 rapid deployment of Approximately 60% of the growth was due to higher volume on the Transportation Security Administration (TSA) programs. F-35 program with the majority of the remaining increase attribut- Net sales for Electronic Systems increased 8% in 2002 as com- able to the F/A-22 program. Sales in Air Mobility declined $180 pared to 2001. Sales increased as a result of higher volume in all million year-over-year, as 7 fewer C-130J deliveries more than off- three of the segment’s lines of business. Increased sales at M&FC set sales growth in other Air Mobility programs. of $285 million were mainly due to higher volumes in air defense Operating profit for the segment increased by 54% in 2003 and on certain tactical missile programs. PT&TS’sales increased by compared to the 2002 periods. This increase was primarily due to $175 million mainly as a result of volume on transportation and the impact of the volume increases in Combat Aircraft and per- security system activities (primarily the TSA programs), which off- formance on other programs. set declines on platform integration programs. MS2 sales increased Operating profit for the segment increased by 36% in 2002 by $145 million primarily due to higher volumes on surface systems compared to 2001. This increase primarily resulted from the higher and radar systems programs. volume in Combat Aircraft. Operating profit for 2002 was nega- Operating profit for the segment decreased by 2% in 2003 tively affected by $30 million in charges recorded for performance compared to 2002. PT&TS’ operating profit declined by $40 mil- issues on an aircraft modification contract and a change in estimate lion due to a mix of program maturity and initial development activ- adjustment related to cost growth on F/A-22 activities. ities on platform integration programs, as well as the impact of the In all periods, the C-130J deliveries do not impact operating decline in volume in transportation and security system activities. profit due to the previously disclosed suspension of earnings recog- These decreases more than offset a $25 million increase in operat- nition on the program. ing profit primarily attributable to higher volume on air defense pro- Backlog increased in 2003 as compared to 2002 primarily as a grams at M&FC. result of booking the C-130J U.S. Government multi-year and Operating profit for the segment increased by 7% in 2002 international F-16 contracts. compared to 2001. The increase in operating profit was primarily 30

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    Lockheed Martin Corporation driven by higher volumes at M&FC and PT&TS as noted in the on commercial satellite activities and volume increases on gov- preceding discussion of sales. ernment satellite programs, including the impact of a $30 million The increase in backlog during 2003 over 2002 resulted from charge recorded in 2003 related to a handling incident on a increased orders on development programs which more than offset NASA satellite program. In Launch Services, operating profit declines in orders on mature production programs. increased by $35 million. The increase was primarily due to improved performance and risk retirement activities on the matur- Space Systems ing Titan program, which were partially offset by the impact of a Space Systems’ operating results included the following: decline in Proton launches in 2003. S&DMS’ operating profit increased by $20 million due to the impact of the volume increas- (In millions) 2003 2002 2001 es discussed above. Net sales $ 6,021 $ 5,287 $ 4,801 Operating profit for the segment increased 24% in 2002 as Operating profit 403 279 225 compared to 2001. Satellites’ operating profit increased $150 mil- Backlog at year-end 12,813 10,701 10,797 lion due to reduced commercial satellite losses and the impact of volume increases in government satellite programs when com- Net sales for Space Systems increased by 14% in 2003 com- pared to 2001. The commercial satellite manufacturing losses pared to 2002. Sales increased by $570 million in Satellites and declined $100 million in 2002 as operating performance improved $140 million in Strategic & Defensive Missile Systems (S&DMS) (including the benefit of closing out certain manufacturing con- compared to 2002. The growth in Satellites is due to higher volume tracts) and satellite deliveries increased. Also, in the first quarter of on government satellite programs. The growth in S&DMS is attrib- 2001, a $40 million loss provision was recorded on certain com- utable to increases in both fleet ballistic missile and missile defense mercial satellite manufacturing contracts. The Satellites increase activities. In Launch Services, increased Titan activities offset lower was partially offset by an $85 million decline in profitability in sales resulting from a decline in Proton deliveries (2 in 2003 and 4 Launch Services. Reduced volume on government launch vehicle in 2002). There were 5 Atlas launches in both 2003 and 2002. programs, primarily driven by a decrease in Titan activities, Net sales for Space Systems increased by 10% in 2002 com- accounted for almost all of the decrease in year-over-year operat- pared to 2001. The increase in sales for 2002 resulted from higher ing profit. In 2002, operating profit on Atlas and Proton launch volume in Satellites of $520 million, due to government satellite vehicles declined $10 million when compared to 2001. This activities. This growth was partially offset by sales declines in both decrease was primarily due to lower profitability of $55 million on S&DMS and Launch Services. the 3 additional launches in 2002, additional charges of $60 mil- Operating profit for the segment increased 44% in 2003 as lion (net of a favorable contract adjustment of $20 million) for compared to 2002. Satellites’ operating profit increased by $70 market and pricing pressures and included the adverse effect of a million over the 2002 period mainly due to improved performance $35 million adjustment for commercial launch vehicle contract 31

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    Lockheed Martin Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS December 31, 2003 settlement costs. The 2001 results included charges for market and results included the net impact of our purchase of the ACS federal pricing pressures, which reduced that year’s operating profit by government IT business and the concurrent sale of our commercial $145 million. IT business in November 2003. The increase in backlog during 2003 as compared to 2002 was Net sales for I&TS increased by 12% in 2002 compared to mainly due to an increase in orders for launch services, commercial 2001. For the year, the increase in sales was primarily attributable to satellites, and missile defense and classified activities. growth of $240 million in Information Technology, due to increased volume on existing programs and the acquisition of OAO Integrated Systems & Solutions Corporation in December 2001, and $160 million in Defense Integrated Systems & Solutions’ operating results included the fol- Services. This growth was partially offset by a decline in sales relat- lowing: ed to volume on NASA programs. Operating profit for the segment increased by 28% in 2003 as (In millions) 2003 2002 2001 compared to 2002. The operating profit increase was mainly due to Net sales $3,420 $3,015 $2,970 the higher volume in Information Technology and improved per- Operating profit 291 241 225 formance across all lines of business. Backlog at year-end 4,350 3,556 3,874 Operating profit for the segment increased by 55% in 2002 compared to 2001. The increase is mainly due to higher volumes Net sales for IS&S increased by 13% in 2003 as compared to and improved performance (primarily on commercial programs) in 2002 and by 2% for 2002 over 2001. For both comparative periods, Information Technology. These increases were partially offset by a the sales increases were primarily attributable to a higher volume of combined decrease in operating profit of $30 million on NASA and intelligence, defense and information assurance activities. Defense Services programs. Operating profit for the segment increased 21% in 2003 as Backlog increased mainly due to the fourth quarter 2003 ACS compared to 2002 and by 7% for 2002 over 2001. The increases in acquisition and as a result of a higher volume of Information operating profit for both comparative periods were primarily attrib- Technology orders. utable to higher volume and performance improvements on the The I&TS segment has a business unit that provides services activities described above. to the government of Argentina. At December 31, 2003, we had net investments in and advances totaling about $20 million. While we Information & Technology Services expect that these amounts will be recoverable, there is always the Information & Technology Services’ operating results included the potential that further devaluation of the Argentine peso, deteriora- following: tion in the Argentine economy or other factors could adversely affect our ability to recover those amounts. (In millions) 2003 2002 2001 Net sales $3,174 $3,104 $2,763 Unallocated Corporate (Expense) Income, Net Operating profit 226 177 114 The following table shows the components of Unallocated Backlog at year-end 4,817 4,617 5,116 Corporate (expense) income, net. For a discussion of the FAS/CAS pension adjustment and other types of items included in Net sales for I&TS increased by 2% in 2003 as compared to Unallocated Corporate (expense) income, net, see Note 16 to the 2002. The sales increase for the year was mainly the result of vol- financial statements. For information about items not considered in ume increases of $110 million in Information Technology, which segment operating performance, see the table under the previous more than offset lower sales volume totaling $40 million on discussion of continuing operations. Defense Services and NASA programs. Information Technology’s 32

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    Lockheed Martin Corporation (In millions) 2003 2002 2001 FAS/CAS pension adjustment $(300) $ 243 $ 360 Items not considered in segment operating performance (153) (1,112) (973) Other, net 4 7 11 $(449) $ (862) $(602) The difference between pension costs calculated and funded in accordance with CAS and pension expense or income deter- mined in accordance with FAS 87 is not included in segment operating results and therefore is a reconciling item between operating profit from the business segments and consolidated operating profit (FAS/CAS adjustment). The CAS funding amount is allocated among the business segments and is included Operating Activities as an expense item in the segments’ cost of goods sold. A Our operating cash flow continues to be the primary source majority of the cost is also passed along to our customers of funds for financing our activities. Cash from operations through contract pricing, and is consequently included in the amounted to $1.8 billion in 2003, $2.3 billion in 2002 and segments’ sales. $1.8 billion in 2001. Our earnings, adjusted for non-cash items The change in the FAS/CAS pension adjustment in 2003 such as depreciation, amortization and impairment charges, was mainly due to the Corporation reporting FAS pension were the driving force behind these cash flows. Our working expense versus FAS pension income in 2002. The following capital has remained relatively stable the last 2 years, even table shows the CAS funding that is included as expense in the though our sales have increased by 20 percent in 2003 and segments’ operating results, the related FAS (expense) income, 11 percent in 2002 when compared to the prior year. We attribute and the resulting FAS/CAS adjustment: this to our continued discipline in managing our cash conversion cycle, including the negotiation of performance-based progress (In millions) 2003 2002 2001 payment or advance payment terms in our contracts, inventory FAS 87 (expense) income $(484) $156 $354 management, and billing and collection activities. Cash from Less: CAS expense and funding (184) (87) (6) operations is net of internal investments we have made in our FAS/CAS pension adjustment — business relative to independent research and development and (expense) income $(300) $243 $360 bid and proposal activities aggregating $903 million in 2003, $830 million in 2002 and $679 million in 2001. In December 2003, we made a discretionary prepayment of $450 million to LIQUIDITY AND CASH FLOWS our defined benefit pension plan trust that reduced cash from Our management has set forth strategic cash deployment objec- operations, the majority of which will reduce our cash funding tives to help ensure that we keep a focus toward growing our requirements for 2004. Our 2002 cash from operations included core business and increasing shareholder value, and that we are $117 million from the settlement of a research and development in a position to take advantage of opportunities to do so when tax credit claim, while in 2001 we paid $655 million of income they arise. Those objectives include internal investment in our taxes related to divested businesses. We expect cash from oper- business (e.g., capital expenditures, independent research and ations to continue to be strong over the next 2 years. development), share repurchases, increases in dividends, debt reduction and management, and acquisitions of businesses that will complement our core operations. The following discussion highlights our cash depolyment activities over the past three years as well as our future plans. 33

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    Lockheed Martin Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS December 31, 2003 Investing Activities Interest rates on the debt we retired early ranged from 7.25% to Capital expenditures — Capital expenditures for property, plant 8.375%. We also used $110 million in 2002 and $2.6 billion in and equipment amounted to $687 million in 2003, $662 million 2001, to repay our long-term debt. The result has been a in 2002 and $619 million in 2001. We expect our capital expen- decrease in our total debt balance from $9.9 billion at ditures to increase over the next 2 years consistent with the December 31, 2000 to $6.2 billion at December 31, 2003, and a expected growth in our business. decrease in interest paid from $707 million in 2001 to $519 million in 2003. We expect interest payments to decline further in 2004 Acquisitions and divestitures — In addition to our internal when the full impact of the debt repayment and refinancing investment in capital expenditures and independent research activities in 2003 will be reflected in our operating results. and development activities, we also selectively identify Scheduled debt maturities are $136 million in 2004 and $15 mil- businesses for potential acquisition. During 2003, we paid lion in 2005. We currently do not expect any material early approximately $645 million for two businesses that will repayments of long-term debt over the next 2 years. strengthen our capabilities in providing IT services to defense, intelligence and other government customers. Relative to our Share repurchases and dividends — We also used cash to pending acquisition of Titan, we plan to finance the cash opportunistically repurchase 10.7 million of our common portion of the transaction principally using existing cash and shares for $482 million in 2003 and 1.0 million of our common short-term investment holdings. shares for $50 million in 2002. These transactions were pursuant During the past 3 years, we have divested non-core busi- to our share repurchase program initiated in 2002. In February nesses, primarily those serving commercial markets. We 2004, an additional 20 million shares were authorized for repur- received cash of approximately $110 million in 2003 from the sale chase under the program. As a result of the increase, a total of of our commercial IT business, $134 million in 2002 from the sale 31.3 million shares may be repurchased in the future under the of certain discontinued telecommunications businesses and program. $825 million in 2001 from the sale of IMS. Shareholders were paid dividends of $261 million in 2003, In December 2003, Inmarsat Ventures, Ltd., a venture in $199 million in 2002 and $192 million in 2001. We paid a quar- which we held a 14% interest, was acquired by a consortium of terly dividend of $0.12 per share during each of the first three private equity firms in a leveraged buyout transaction. In quarters of 2003 and $0.22 per share for the last quarter of exchange for our interest, we received cash of $114 million and 2003. Quarterly dividends of $0.11 per share were paid during a 14% ownership interest in the new Inmarsat holding company, 2002 and 2001. Inmarsat Holdings, Ltd., valued at $96 million. We recorded a We are currently expecting to deploy a majority of the cash deferred gain of $42 million from the transaction, which we we generate from operations over the next 2 years (after capital would expect to recognize at such time as we sell all or a portion expenditures) to repurchase shares and pay dividends. of our interest in the new company. CAPITAL STRUCTURE AND RESOURCES Financing Activities At December 31, 2003, our total long-term debt amounted to Issuance and repayment of long-term debt — Cash provided $6.2 billion. Our long-term debt is mainly in the form of pub- from operations has been our principal source of funds to reduce licly issued notes and debentures. The newly issued $1.0 billion our long-term debt. In 2003, we issued $1.0 billion of floating of convertible debentures discussed in more detail below has a rate convertible senior debentures that bear interest at three- floating interest rate based on LIBOR. The balance of our long- month LIBOR less 25 basis points, reset quarterly (the interest term debt bears interest at fixed rates. Through our repayment rate on this debt at December 31, 2003 was 0.93%). We used the activities, our long-term debt balance has declined from a bal- proceeds from that issuance, along with cash provided by oper- ance of $9.9 billion at December 31, 2000. During the last 3 ations, to repay $2.2 billion of debt in advance of its maturity years, we improved our debt-to-total capital ratio from 58% at and retire other high cost debt. We used $175 million of cash for December 31, 2000 to 48% at December 31, 2003. debt issuance and repayment costs to complete those transactions. 34

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    Lockheed Martin Corporation Our stockholders’ equity amounted to $6.8 billion at We have agreements in place with banking institutions to December 31, 2003, an increase of about $900 million from provide for the issuance of commercial paper. There were no December 31, 2002. Net earnings, stock plan activities and a commercial paper borrowings outstanding at December 31, reduction of our minimum pension liability, more than offset 2003. If we were to issue commercial paper, the borrowings our payment of dividends and share repurchase activities. would be supported by the $1.5 billion credit facility. The $1.0 billion in floating rate convertible debentures we We have an effective shelf registration statement on file issued in 2003 are due in 2033. They bear interest at a rate equal with the Securities and Exchange Commission to provide for to three-month LIBOR less 25 basis points, reset quarterly. the issuance of up to $1 billion in debt securities. If we were to Accordingly, to the extent three-month LIBOR increases or issue debt under this shelf registration, we would expect to use decreases by 1%, our interest expense would increase or the net proceeds for general corporate purposes. These pur- decrease by $10 million on a pretax basis. Interest on the deben- poses may include repayment of debt, working capital needs, tures is payable quarterly through August 15, 2008, after which capital expenditures, acquisitions and any other general corpo- the interest will accrue as part of the value of the debenture and rate purpose. will be payable, along with the principal amount, at maturity. We actively seek to finance our business in a manner that The debentures are convertible by their holders into our com- preserves financial flexibility while minimizing borrowing mon stock in certain limited circumstances as outlined in the costs to the extent practicable. Our management continually indenture agreement. Upon conversion, we have the right to reviews changes in financial, market and economic conditions deliver, in lieu of common stock, cash or a combination of cash to manage the types, amounts and maturities of our indebted- and common stock. We have the right to redeem any or all of ness. We may at times refinance existing indebtedness, vary our the debentures at any time after August 15, 2008. mix of variable-rate and fixed-rate debt, or seek alternative In 2003, we repaid a total of $2.2 billion of long-term debt, financing sources for our cash and operational needs. including scheduled and early debt repayments, and the repay- At December 31, 2003, we had contractual commitments ment of $130 million related to our guarantee of Space to repay debt (including capital lease obligations), make pay- Imaging, LLC’s borrowings under its credit facility. We repaid ments under operating leases, settle obligations related to several issuances of our long-term debt early through the com- agreements to purchase goods and services, and settle other pletion of tender offers, redemption of certain callable debt long-term liabilities. Payments due under these long-term obli- securities and open market purchases of other outstanding debt gations and commitments are as follows: issuances. Through these activities, we repaid debt totaling $1.4 billion with interest rates ranging from 7.25% to 8.375% Payments Due by Period and maturities ranging from 2006 to 2026. In connection with Less than 1–3 4–5 After the early repayments, we recorded losses in 2003, net of state (In millions) Total 1 year years years 5 years income tax benefits, totaling $146 million. The losses reduced Long-term debt net earnings by $96 million ($0.21 per diluted share). and capital At the end of 2003, we had in place a $1.5 billion revolving lease obligations $ 6,208 $ 136 $ 253 $ 725 $5,094 credit facility under which no borrowings were outstanding. Operating lease This credit facility will expire in November 2006. Borrowings commitments 1,135 254 349 219 313 under the credit facility would be unsecured and bear interest at Purchase obligations 1,660 827 553 207 73 rates based, at our option, on the Eurodollar rate or a bank Base Other long-term Rate (as defined). Each bank’s obligation to make loans under liabilities 1,051 120 202 145 584 the credit facility is subject to, among other things, our compli- Total contractual ance with various representations, warranties and covenants, cash obligations $10,054 $1,337 $1,357 $1,296 $6,064 including covenants limiting our ability and the ability of cer- tain of our subsidiaries to encumber our assets, and a covenant Generally, our long-term debt obligations are subject to, not to exceed a maximum leverage ratio. along with other things, compliance with certain covenants, 35

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    Lockheed Martin Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS December 31, 2003 including covenants limiting our ability and the ability of cer- We have entered into standby letter of credit agreements tain of our subsidiaries to encumber our assets. and other arrangements with financial institutions and cus- Purchase obligations include agreements and require- tomers mainly relating to the guarantee of future performance ments contracts that give the supplier recourse to us for can- on some of our contracts to provide products and services to cellation or nonperformance under the contract or contain customers. At December 31, 2003, we had contingent liabilities terms that would subject us to liquidated damages. Such on outstanding letters of credit, guarantees and other agreements and contracts may, for example, be related to arrangements, as follows: direct materials, obligations to sub-contractors, outsourcing arrangements, and non-cancelable commitments for property, Commitment Expiration plant and equipment. Generally, amounts for purchase obligations per Period Total Less in the preceding table exclude contractual commitments Commit- than 1–3 4–5 After entered into as a result of contracts we have with our U.S. (In millions) ment 1 year years years 5 years Government customers. These commitments are excluded Surety bonds(a) $253 $ 61 $ 68 $124 $— because the U.S. Government would be required to pay us for Standby letters any costs we incur if they terminate our contracts with them of credit(a) 261 180 57 13 11 “for convenience” pursuant to the FAR. For example, if we Guarantees 4 3 1 — — had commitments to purchase goods and services that were Total commitments $518 $244 $126 $137 $ 11 entered into as a result of a specific contract we received from a U.S. Government customer and the customer termi- (a) Approximately $43 million of surety bonds in the “less than 1 year” period, and approximately $117 million and $15 million of standby letters of cred- nated the contract for convenience, any amounts we would be it in the “less than 1 year” and “1–3 year” periods, respectively, are required to pay to settle the related commitments, as well as expected to automatically renew for additional 1–2 year periods until com- amounts previously incurred, would generally be reimbursed pletion of the contractual obligation. by the customer. This would also be true in cases where we per- form sub-contract work for a prime contractor under a U.S. We have issued standby letters of credit and surety bonds Government contract. The termination for convenience lan- totaling $3.9 billion related to advances received from cus- guage may also be included in contracts with foreign, state tomers and/or to secure our performance under long-term con- and local governments. If so, amounts related to purchase tracts. Amounts included in the table above totaling $514 million obligations entered into in support of those contracts were are those amounts over and above advances received from excluded from the preceding table. To the extent contracts customers which are recorded in the balance sheet as either with customers do not include termination for convenience offsets against inventories or in customer advances and provisions, including contracts with commercial customers, amounts in excess of costs incurred. Of the $3.4 billion related purchase obligation amounts are included in the table. recorded in the balance sheet, approximately $2 billion relates Amounts related to “Other long-term liabilities” in the to a standby letter of credit to secure advance payments preceding table represent the contractual obligations for received under an F-16 contract from an international cus- certain long-term liabilities recorded as of December 31, tomer. This letter of credit is available for draw down only in 2003. Such amounts mainly include expected payments under the event of our nonperformance. Similar to the letter of credit deferred compensation plans, non-qualified pension plans for the F-16 contract, letters of credit and surety bonds for and environmental liabilities. Obligations related to environ- other contracts are available for draw down only in the event mental liabilities represent our estimate of remediation pay- of our nonperformance. ment obligations under government consent decrees and Cash and cash equivalents, short-term investments, cash agreements, excluding amounts reimbursed by the U.S. flow from operations and other available financing resources, Government in its capacity as a PRP under an agreement are expected to be sufficient to meet anticipated operating, entered into in 2000. capital expenditure and debt service requirements, as well as acquisition and other discretionary investment needs, 36

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    Lockheed Martin Corporation projected over the next 3 years. Consistent with our desire to Space Imaging’s borrowings under a credit facility that matured generate cash to reduce debt and invest in our core businesses, on March 30, 2003. At December 31, 2002, we increased current we expect that, depending on prevailing financial, market and maturities of long-term debt by $150 million representing our economic conditions, we will continue to explore the sale of estimated obligation under the guarantee. On March 31, 2003, non-core businesses, passive equity investments and surplus we paid $130 million to acquire Space Imaging’s outstanding real estate. borrowings under Space Imaging’s credit facility, and the guar- antee was eliminated. We therefore reversed, net of state income EQUITY INVESTMENTS taxes, approximately $19 million of the charge recorded in In 2002, we recorded impairment charges, net of state income December 2002, representing the unutilized portion of the credit tax benefits, totaling $776 million related to our investments facility covered by our guarantee. This gain increased 2003 net in Intelsat, Ltd. (Intelsat), Inmarsat and New Skies Satellites, N.V. earnings by $13 million ($0.03 per diluted share). (New Skies). The charges reduced net earnings by $504 million In 2001, we recorded a charge, net of state income tax bene- ($1.12 per diluted share). The charges were recorded primarily fits, of $361 million related to the impairment of our investment due to unfavorable trends in the satellite services and telecom- in Loral Space & Communications Ltd. (see Note 8 to the finan- munications industries that were not expected to be resolved in cial statements). The charge reduced net earnings by $235 million the near term. ($0.54 per diluted share). In July 2003, Loral Space and certain Intelsat, Inmarsat and New Skies are subject to regulation by of its subsidiaries filed voluntary petitions for reorganization the Federal Communications Commission (FCC). FCC decisions under Chapter 11 of the U.S. Bankruptcy Code. In the third and policies have had, and may continue to have, a significant quarter of 2003, we sold our ownership interest in Loral Space. impact on these companies. The Open-Market Reorganization The sale did not have a material impact on our results of oper- for the Betterment of International Telecommunications Act (the ations, financial position or cash flows. We are an unsecured ORBIT Act), passed by Congress in 2000, established deadlines creditor of Loral Space in the bankruptcy proceeding. Loral for Intelsat and Inmarsat to complete initial public offerings. Space has made a claim that they are entitled to a refund of pay- Based on congressional and regulatory extensions received to ments made to us under various terminated launch service con- date, and unless otherwise extended by Congress, each is required tracts. We believe that the claim is without merit and that we are to complete their initial public offerings by June 30, 2004. Their entitled to retain the amounts under the terms of the contracts. ability to do so may be impacted by changes in trends and mar- We do not expect these events to have a material impact on our ket conditions in the telecommunications industry, as well as in results of operations, financial position or cash flow. the capital markets. If those deadlines are not met or extended by In 2001, we recorded a charge, net of state income tax bene- further amendments to the legislation, the FCC may limit access fits, of $367 million related to impairment in the value of our by U.S. users to the satellite capacity of the privatized entities for investment in Astrolink International LLC. We also recorded some services. If this were to occur, the value of our investments charges of approximately $20 million, net of state income tax ben- could be adversely affected. In December 2003, Inmarsat was efits, in cost of sales for certain other costs related to Astrolink. acquired in a leveraged buyout transaction and, in doing so, On a combined basis, these charges reduced net earnings for 2001 believes it has complied with the ORBIT Act requirements. There by approximately $267 million ($0.62 per diluted share). In is no assurance that the FCC will accept Inmarsat’s position that January 2003, we entered into an agreement with Astrolink’s other it has satisfied the ORBIT Act requirement by completing a members to restructure Astrolink. As part of the transaction, leveraged buyout transaction. In January 2004, Intelsat Liberty Satellite & Technology, a subsidiary of Liberty Media announced its intention to conduct an initial public offering of its Corporation, had an option to acquire Astrolink's assets and pur- shares in an amount up to $500 million, and expects the offering sue a business plan to build a one- or two-satellite system. On to occur on or before June 30, 2004. October 24, 2003, Liberty Satellite & Technology notified us that In December 2002, we recorded a charge, net of state they would not exercise the option to acquire Astrolink’s assets income tax benefits, of $163 million related to our investment in and build the satellite system. As a result, as part of the restruc- Space Imaging, LLC and our guarantee of up to $150 million of turing agreement, Astrolink’s procurement contracts were 37

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    Lockheed Martin Corporation MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS December 31, 2003 terminated, and we acquired the remaining ownership interests in still holding and actively marketing the business for sale, and Astrolink. The restructuring also entailed the settlement of existing there are interested potential buyers. The operating results of claims related to termination of Astrolink's procurement contracts LMI had no impact on the statement of earnings in 2003, and its with its members, certain of their affiliates and other vendors. assets and liabilities, which represented less than 1% of our con- Under these settlements, we retained our work in process. solidated assets and liabilities at the end of 2003, were included Completion of the restructuring did not have a material impact on in our balance sheet in other current assets and other current lia- our financial position, results of operations or cash flows. bilities. We do not expect that the operating results of LMI (until In 2001 we recorded charges, net of state income tax ben- such time as we sell the business), or its ultimate sale, will have efits, of approximately $232 million related to commitments to a material effect on our consolidated results of operations, finan- and impairment in the values of investments in satellite joint cial position or cash flows. ventures, primarily Asia Cellular Satellite System and We completed the sale of IMS, a wholly-owned subsidiary, Americom Asia-Pacific, LLC. The charges reduced net earn- for $825 million in cash in August 2001. This transaction resulted ings for 2001 by $153 million ($0.35 per diluted share). in a gain, net of state income taxes, of $476 million and Realization and valuation of our investments in equity increased net earnings by $309 million ($0.71 per diluted securities may be affected by an investee’s ability to obtain ade- share). The results of IMS’ operations, as well as the gain on the quate funding, including through public and private sales of its sale, were classified as discontinued operations. debt and equity securities, and execute its business plans, as well as by general market conditions, industry considerations QUANTITATIVE AND QUALITATIVE DISCLOSURE specific to the investee’s business, and/or other factors. The OF MARKET RISK inability of an investee to obtain future funding or successfully Our main exposure to market risk relates to interest rates and, to execute its business plan could adversely affect our earnings in a lesser extent, foreign currency exchange rates. Our financial the periods affected by those events. instruments that are subject to interest rate risk principally include short-term investments and long-term debt. Our long- DISCONTINUED OPERATIONS term debt obligations, other than the $1.0 billion in convertible In the fourth quarter of 2001, we announced that we would exit debentures issued in 2003, are generally not callable until matu- our global telecommunications services business and recorded rity. We sometimes use interest rate swaps to manage our expo- related charges, net of state income tax benefits, of approxi- sure to fixed and variable interest rates. At year-end 2003, we mately $1.4 billion. The charges reduced net earnings by about had agreements in place to swap fixed interest rates on approx- $1.3 billion ($3.09 per diluted share). imately $70 million of our long-term debt for variable interest The charges related to global telecommunications services rates based on LIBOR. The interest rate swap agreements are businesses held for sale and exit costs for the elimination of the designated as effective hedges of the fair value of the underly- administrative function supporting the global telecommunica- ing fixed-rate debt instruments. At December 31, 2003, the fair tions businesses and investments. Amounts recorded included values of interest rate swap agreements outstanding were not about $1.2 billion related to impairment of goodwill, with the material. The amounts of gains and losses from changes in the remainder related to impairment of some of the long-lived assets fair values of the swap agreements were entirely offset by those employed by foreign businesses held for sale and costs associated from changes in the fair value of the associated debt obliga- with elimination of administrative functions. We completed tions. Changes in swap rates would affect the market value of sales of all of the businesses classified as held for sale in 2002 the agreements, but those changes in value would be offset by with the exception of Lockheed Martin Intersputnik (LMI). changes in the value of the underlying debt obligations. Those transactions did not have a material impact on our con- We use forward foreign exchange contracts to manage our solidated results of operations or financial position. exposure to fluctuations in foreign exchange rates. These con- We reached an agreement to sell LMI in the third quarter of tracts are designated as qualifying hedges of the cash flows 2002; however, in April 2003, the agreement was terminated. We associated with firm commitments or specific anticipated trans- are continuing to treat LMI as a discontinued operation, as we are actions, and related gains and losses on the contracts, to the 38

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    Lockheed Martin Corporation extent they are effective hedges, are recognized in income when At December 31, 2003, we performed an evaluation of the the hedged transaction occurs. To the extent the hedges are inef- effectiveness of the design and operation of our disclosure con- fective, gains and losses on the contracts are recognized currently. trols and procedures. The evaluation was performed with the At December 31, 2003, the fair value of forward exchange con- participation of senior management of each business segment tracts outstanding, as well as the amounts of gains and losses and key Corporate functions, and under the supervision of the recorded during the year then ended, were not material. We do not CEO and CFO. Based on the evaluation, our management, hold or issue derivative financial instruments for trading purposes. including the CEO and CFO, concluded that our disclosure con- trols and procedures were effective. CONTROLS AND PROCEDURES There have been no significant changes in our internal con- We maintain disclosure controls and procedures that are designed trols over financial reporting during the most recently completed to ensure that information required to be disclosed in our fiscal quarter that materially affected, or are reasonably likely to periodic filings with the SEC is recorded, processed, summa- materially affect, our internal controls over financial reporting. rized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer (CEO) and Chief Financial Officer (CFO), as appropriate, to allow for timely decisions regarding required dis- closure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and proce- dures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily is required to use its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Also, we have investments in certain unconsolidated entities. As we do not control or manage those entities, our disclosure controls and procedures with respect to those entities are necessarily substantially more limited than those we maintain with respect to our consolidated subsidiaries. 39

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    Lockheed Martin Corporation MANAGEMENT’S RESPONSIBILITY FOR FINANCIAL REPORTING The management of Lockheed Martin prepared and is responsible for the consolidated financial statements and all related financial information contained in this Annual Report. The consolidated financial statements, which include amounts based on esti- mates and judgments, have been prepared in accordance with accounting principles generally accepted in the United States. In recognition of its responsibility for the integrity and objectivity of data in the financial statements, the Corporation main- tains a system of internal controls over financial reporting designed and intended to provide reasonable assurance, based on an appropriate cost-benefit relationship, that assets are safeguarded and transactions are properly executed and recorded. The Corporation also maintains a system of disclosure controls and procedures which includes controls and procedures designed to ensure that information required to be disclosed in its filings with the Securities and Exchange Commission (SEC) is gathered and communicated to management for timely consideration of disclosure. An environment that provides for an appropriate level of con- trol consciousness is maintained and monitored and includes examinations by an internal audit staff, examinations by the inde- pendent auditors in connection with their reviews of interim financial information and their annual audit, and audits by the Defense Contract Audit Agency of our compliance with federal government rules and regulations applicable to contracts with the U.S. Government. In addition, a Disclosure Controls Committee assists in monitoring and evaluating disclosure controls and procedures, and to review interim and annual reports of financial information filed with the SEC for accuracy and completeness. Essential to the Corporation’s internal control system is management’s dedication to the highest standards of integrity, ethics and social responsibility. To support these standards, management has issued the Code of Ethics and Business Conduct (the Code) and developed policy statements that cover, among other topics, maintaining accurate and complete accounting records, proper business practices, regulatory compliance, potentially conflicting outside interests of employees, and adherence to high standards of conduct and practices in dealings with customers, including the U.S. Government. The Code provides for a help line that employees can use to confidentially or anonymously communicate to the Corporation’s ethics office complaints or concerns about accounting, internal control or auditing matters. These matters, if requested by the employee, must be forwarded directly to the Corporation’s Audit and Ethics Committee. The importance of ethical behavior is regularly communicated to all employees through the distribu- tion of the Code, and through ongoing education and review programs designed to create a strong compliance environment. The Audit and Ethics Committee of the Board of Directors is composed of seven independent directors. This Committee meets periodically with the independent auditors, internal auditors and management to review their activities. Both the independent audi- tors and the internal auditors have unrestricted access to meet with members of the Audit and Ethics Committee, with or without management representatives present. The Audit and Ethics Committee is responsible for the selection, retention and compensation of the independent auditors. The consolidated financial statements included in this Annual Report have been audited by Ernst & Young LLP, whose report follows. Vance D. Coffman Christopher E. Kubasik Chairman and Chief Executive Officer Senior Vice President and Chief Financial Officer Robert J. Stevens Rajeev Bhalla President and Chief Operating Officer Vice President and Controller 40

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    Lockheed Martin Corporation REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS Board of Directors and Stockholders Lockheed Martin Corporation We have audited the accompanying consolidated balance sheet of Lockheed Martin Corporation as of December 31, 2003 and 2002, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Corporation’s management. Our respon- sibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material mis- statement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial state- ments. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Lockheed Martin Corporation at December 31, 2003 and 2002, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles gen- erally accepted in the United States. As discussed in Note 1 of the Notes to Consolidated Financial Statements, in 2002 the Corporation adopted Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets.” McLean, Virginia January 27, 2004 41

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    Lockheed Martin Corporation CONSOLIDATED STATEMENT OF OPERATIONS Year ended December 31, (In millions, except per share data) 2003 2002 2001 NET SALES $ 31,824 $ 26,578 $23,990 Cost of sales 29,848 24,629 22,447 Earnings from operations 1,976 1,949 1,543 Other income and expenses, net 43 (791) (710) 2,019 1,158 833 Interest expense 487 581 700 Earnings from continuing operations before taxes 1,532 577 133 Income tax expense 479 44 90 Earnings from continuing operations 1,053 533 43 Discontinued operations — (33) (1,089) NET EARNINGS (LOSS) $ 1,053 $ 500 $ (1,046) EARNINGS (LOSS) PER COMMON SHARE: Basic: Continuing operations $ 2.36 $ 1.20 $ 0.10 Discontinued operations — (0.07) (2.55) $ 2.36 $ 1.13 $ (2.45) Diluted: Continuing operations $ 2.34 $ 1.18 $ 0.10 Discontinued operations — (0.07) (2.52) $ 2.34 $ 1.11 $ (2.42) See accompanying Notes to Consolidated Financial Statements. 42

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    Lockheed Martin Corporation CONSOLIDATED BALANCE SHEET December 31, (In millions) 2003 2002 ASSETS Current assets: Cash and cash equivalents $ 1,010 $ 2,738 Short-term investments 240 — Receivables 4,039 3,655 Inventories 2,348 2,250 Deferred income taxes 921 1,277 Other current assets 843 706 Total current assets 9,401 10,626 Property, plant and equipment, net 3,489 3,258 Investments in equity securities 1,060 1,009 Goodwill 7,879 7,380 Purchased intangibles, net 807 814 Prepaid pension asset 1,213 1,221 Other assets 2,326 2,671 $26,175 $26,979 LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable $ 1,434 $ 1,102 Customer advances and amounts in excess of costs incurred 4,256 4,542 Salaries, benefits and payroll taxes 1,418 1,272 Income taxes 91 107 Current maturities of long-term debt 136 1,365 Other current liabilities 1,558 1,433 Total current liabilities 8,893 9,821 Long-term debt 6,072 6,217 Post-retirement benefit liabilities 1,440 1,480 Accrued pension liabilities 1,100 1,872 Other liabilities 1,914 1,724 Stockholders’ equity: Common stock, $1 par value per share 446 455 Additional paid-in capital 2,477 2,796 Retained earnings 5,054 4,262 Unearned ESOP shares (17) (50) Accumulated other comprehensive loss (1,204) (1,598) Total stockholders’ equity 6,756 5,865 $26,175 $26,979 See accompanying Notes to Consolidated Financial Statements. 43

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    Lockheed Martin Corporation CONSOLIDATED STATEMENT OF CASH FLOWS Year ended December 31, (In millions) 2003 2002 2001 OPERATING ACTIVITIES Earnings from continuing operations $ 1,053 $ 533 $ 43 Adjustments to reconcile earnings from continuing operations to net cash provided by operating activities: Depreciation and amortization 480 433 425 Amortization of purchased intangibles 129 125 154 Amortization of goodwill — — 244 Deferred federal income taxes 467 (463) (118) Loss from discontinued operations — (33) (1,089) Write-down of investments and other charges 42 1,127 1,051 Net charges related to discontinued operations — — 936 Changes in operating assets and liabilities: Receivables (258) 394 (34) Inventories (94) 585 651 Accounts payable 330 (317) 192 Customer advances and amounts in excess of costs incurred (285) (460) 318 Income taxes (16) 44 (456) Other (39) 320 (492) Net cash provided by operating activities 1,809 2,288 1,825 INVESTING ACTIVITIES Expenditures for property, plant and equipment (687) (662) (619) Acquisition of businesses / investments in affiliated companies (821) (104) (192) Purchase of short-term investments, net (240) — — Proceeds from divestiture of affiliated companies 234 134 825 Other 53 93 125 Net cash (used for) provided by investing activities (1,461) (539) 139 FINANCING ACTIVITIES Issuances of long-term debt 1,000 — — Repayments of long-term debt (2,202) (110) (2,508) Long-term debt issuance and repayment costs (175) — (58) Issuances of common stock 44 436 213 Repurchases of common stock (482) (50) — Common stock dividends (261) (199) (192) Other — — (12) Net cash (used for) provided by financing activities (2,076) 77 (2,557) Net (decrease) increase in cash and cash equivalents (1,728) 1,826 (593) Cash and cash equivalents at beginning of year 2,738 912 1,505 Cash and cash equivalents at end of year $ 1,010 $ 2,738 $ 912 See accompanying Notes to Consolidated Financial Statements. 44

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    Lockheed Martin Corporation CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY Accumulated Additional Unearned Other Total Common Paid-In Retained ESOP Comprehensive Stockholders’ Comprehensive (In millions, except per share data) Stock Capital Earnings Shares (Loss) Income Equity (Loss) Income Balance at December 31, 2000 $ 431 $ 1,789 $5,199 $(115) $ (144) $7,160 Net loss — — (1,046) — — (1,046) $(1,046) Common stock dividends declared ($0.44 per share) — — (192) — — (192) — Stock awards and options, and ESOP activity 10 353 — 31 — 394 — Other comprehensive income (loss): Minimum pension liability — — — — (33) (33) (33) Net unrealized gain from available-for- sale investments — — — — 23 23 23 Reclassification adjustment related to available-for-sale investments — — — — 151 151 151 Other — — — — (14) (14) (14) Balance at December 31, 2001 441 2,142 3,961 (84) (17) 6,443 $ (919) Net earnings — — 500 — — 500 $ 500 Common stock dividends declared ($0.44 per share) — — (199) — — (199) — Stock awards and options, and ESOP activity 15 703 — 34 — 752 — Repurchases of common stock (1) (49) — — — (50) — Other comprehensive income (loss): Minimum pension liability — — — — (1,537) (1,537) (1,537) Net unrealized loss from available- for-sale investments — — — — (100) (100) (100) Reclassification adjustments related to available-for-sale investments — — — — 53 53 53 Other — — — — 3 3 3 Balance at December 31, 2002 455 2,796 4,262 (50) (1,598) 5,865 $(1,081) Net earnings — — 1,053 — — 1,053 $ 1,053 Common stock dividends declared ($0.58 per share) — — (261) — — (261) — Repurchases of common stock (11) (471) — — — (482) — Stock awards and options, and ESOP activity 2 152 — 33 — 187 — Other comprehensive income (loss): Minimum pension liability — — — — 331 331 331 Net unrealized gain from available-for-sale investments — — — — 46 46 46 Other — — — — 17 17 17 Balance at December 31, 2003 $ 446 $ 2,477 $5,054 $ (17) $ (1,204) $6,756 $ 1,447 See accompanying Notes to Consolidated Financial Statements. 45

  • Page 48

    Lockheed Martin Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2003 NOTE 1 — SIGNIFICANT ACCOUNTING POLICIES available-for-sale securities as defined by Statement of Organization — Lockheed Martin Corporation (Lockheed Financial Accounting Standards (FAS) No. 115, “Accounting Martin or the Corporation) is engaged in the conception, for Certain Investments in Debt and Equity Securities.” research, design, development, manufacture, integration and Unrealized gains and losses on those securities are reflected as operation of advanced technology systems, products and serv- a net amount under the caption of accumulated other compre- ices. As a leading systems integrator, its products and services hensive income (loss) in the statement of stockholders’ equity. range from aircraft, spacecraft and launch vehicles to missiles, Realized gains and losses are recorded in the statement of oper- electronics and information systems. The Corporation serves ations under the caption other income or expenses. For purposes customers in both domestic and international defense and com- of computing realized gains and losses, cost is determined on a mercial markets, with its principal customers being agencies of specific identification basis. The fair values of marketable secu- the U.S. Government. rities are estimated based on quoted market price for the respec- tive securities. Basis of consolidation and classifications — The consolidated At December 31, 2003, the Corporation recorded short- financial statements include the accounts of wholly-owned sub- term investments with an aggregate amortized cost of $239 mil- sidiaries and majority-owned entities which the Corporation lion and fair value of $240 million. There were no short-term controls. Intercompany balances and transactions have been investments at December 31, 2002. The investment portfolio eliminated in consolidation. Receivables and inventories are was composed of the following: primarily attributable to long-term contracts or programs in (In millions) Amortized Cost Fair Value progress for which the related operating cycles are longer than U.S. treasury and government 1 year. In accordance with industry practice, these items are agency securities $125 $ 126 included in current assets. Corporate debt securities 94 94 Certain amounts for prior years have been reclassified to Mortgage-backed and other securities 20 20 conform with the 2003 presentation. $239 $ 240 Use of estimates — The preparation of consolidated financial Over 80% of the securities had contractual maturities of 1 statements in conformity with accounting principles generally to 5 years. Proceeds from sales of marketable securities totaled accepted in the United States (GAAP) requires management to $116 million in 2003. Gross gains and losses related to sales of make estimates and assumptions, including estimates of antici- marketable securities for the year, as well as net unrealized pated contract costs and revenues utilized in the earnings recog- gains and losses at year-end, were not material. nition process, that affect the reported amounts in the financial statements and accompanying notes. Due to the size and nature Receivables — Receivables consist of amounts billed and cur- of many of the Corporation’s programs, the estimation of total rently due from customers, and include unbilled costs and revenues and cost at completion is subject to a wide range of accrued profits primarily related to revenues on long-term con- variables, including assumptions for schedule and technical tracts that have been recognized for accounting purposes but issues. Actual results may differ from those estimates. not yet billed to customers. As such revenues are recognized, appropriate amounts of customer advances, performance-based Cash and cash equivalents — Cash equivalents are generally payments and progress payments are reflected as an offset to the composed of highly liquid instruments with maturities of 3 related accounts receivable balance. months or less. Due to the short maturity of these instruments, carrying value on the Corporation’s consolidated balance sheet Inventories — Inventories are stated at the lower of cost or esti- approximates fair value. mated net realizable value. Costs on long-term contracts and programs in progress represent recoverable costs incurred for Short-term investments — The Corporation’s short-term invest- production, allocable operating overhead, advances to suppliers ments consist of marketable securities that are categorized as and, where appropriate, research and development and general 46

  • Page 49

    Lockheed Martin Corporation and administrative expenses. Pursuant to contract provisions, information regarding market and industry trends for the agencies of the U.S. Government and certain other customers investee’s business, and investment analyst reports, if available. have title to, or a security interest in, inventories related to such Investments not accounted for under one of these methods are contracts as a result of advances, performance-based payments generally accounted for under the cost method of accounting. and progress payments. Such advances and payments are reflected as an offset against the related inventory balances. Goodwill — Beginning January 1, 2002, goodwill is no longer General and administrative expenses related to commercial amortized. Goodwill is displayed on the consolidated balance products and services provided essentially under commercial sheet net of accumulated amortization of $1,382 million at terms and conditions are expensed as incurred. Costs of other December 31, 2003 and 2002. Under FAS 142 (see discussion product and supply inventories are principally determined by under the caption “Recent accounting pronouncements” in this the first-in first-out or average cost methods. Note), goodwill is evaluated for potential impairment annually by comparing the fair value of a reporting unit to its carrying Property, plant and equipment — Property, plant and equip- value, including goodwill recorded by the reporting unit. If the ment are carried principally at cost. Depreciation is provided on carrying value exceeds the fair value, impairment is measured plant and equipment generally using accelerated methods dur- by comparing the derived fair value of goodwill to its carrying ing the first half of the estimated useful lives of the assets; value, and any impairment determined is recorded in the cur- thereafter, straight-line depreciation is used. Estimated useful rent period. lives generally range from 10 to 40 years for buildings and 5 to 15 years for machinery and equipment. Purchased intangibles, net — Intangible assets acquired as part of business combinations are amortized over their estimated Investments in equity securities — Investments in equity securi- useful lives unless their useful lives are determined to be indef- ties include the Corporation’s ownership interests in affiliated inite. For material business combinations, amounts recorded companies accounted for under the equity method of account- related to purchased intangibles are determined from independent ing. Under this method of accounting, which generally applies valuations. The Corporation’s purchased intangibles primarily to investments that represent a 20% to 50% ownership of the relate to contracts and programs acquired which are amortized equity securities of the investees, the Corporation’s share of the over periods of 15 years or less. Purchased intangibles are dis- earnings or losses of the affiliated companies is included in played in the consolidated balance sheet net of accumulated other income and expenses. The Corporation recognizes cur- amortization of $1,491 million and $1,364 million at December rently gains or losses arising from issuances of stock by wholly- 31, 2003 and 2002, respectively. Amortization expense related owned or majority-owned subsidiaries, or by equity method to these intangible assets was $129 million, $125 million, and investees. These gains or losses are also included in other $154 million for the years ended December 31, 2003, 2002 and income and expenses. Investments in equity securities also 2001, respectively, and is estimated to be approximately $145 include the Corporation’s ownership interests in companies in million per year in 2004 through 2006, $125 million in 2007 which its investment represents less than 20%. If classified as and $75 million in 2008, excluding the effects of any future available-for-sale, these investments are accounted for at fair acquisitions or divestitures. value, with unrealized gains and losses recorded in other com- prehensive income, in accordance with FAS 115. If declines in Customer advances and amounts in excess of costs incurred — the value of investments accounted for under either the equity The Corporation receives advances, performance-based pay- method or FAS 115 are determined to be other than temporary, ments and progress payments from customers which may a loss is recorded in earnings currently. The Corporation makes exceed costs incurred on certain contracts, including contracts such determinations by considering, among other factors, the with agencies of the U.S. Government. Such advances, other length of time the fair value of the investment has been less than than those reflected as an offset to accounts receivable or inven- the carrying value, future business prospects for the investee, tories as discussed above, are classified as current liabilities. 47

  • Page 50

    Lockheed Martin Corporation NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2003 Environmental matters — The Corporation records a liability When adjustments in contract value or estimated costs are for environmental matters when it is probable that a liability has determined, any changes from prior estimates are generally been incurred and the amount can be reasonably estimated. A reflected in earnings in the current period. Anticipated losses on substantial portion of these costs are expected to be reflected in contracts are charged to earnings when identified and deter- sales and cost of sales pursuant to U.S. Government agreement mined to be probable. or regulation. At the time a liability is recorded for future envi- ronmental costs, an asset is recorded for estimated future recov- Research and development and similar costs — Corporation- ery considered probable through the pricing of products and sponsored research and development costs primarily include services to agencies of the U.S. Government. The portion of independent research and development and bid and proposal those costs expected to be allocated to commercial business or efforts related to government products and services. Except for that is determined to be unallowable for pricing under U.S. certain arrangements described below, these costs are generally Government contracts is reflected in cost of sales at the time the included as part of the general and administrative costs that are liability is established. allocated among all contracts and programs in progress under U.S. Government contractual arrangements. Corporation-sponsored Sales and earnings — Sales and anticipated profits under long- product development costs not otherwise allocable are charged term fixed-price production contracts are recorded on a per- to expense when incurred. Under certain arrangements in which centage of completion basis, generally using units-of-delivery a customer shares in product development costs, the as the basis to measure progress toward completing the contract Corporation’s portion of unreimbursed costs is generally and recognizing revenue. Estimated contract profits are taken expensed as incurred. Total independent research and develop- into earnings in proportion to recorded sales. Sales under cer- ment costs charged to cost of sales in 2003, 2002 and 2001, tain long-term fixed-price contracts which, among other fac- including costs related to bid and proposal efforts, were $903 tors, provide for the delivery of minimal quantities or require a million, $830 million and $679 million, respectively. Costs substantial level of development effort in relation to total con- incurred under customer-sponsored research and development tract value, are recorded upon achievement of performance programs pursuant to contracts are accounted for as sales and milestones or using the cost-to-cost method of accounting cost of sales under the contract. where sales and profits are recorded based on the ratio of costs incurred to estimated total costs at completion. Restructuring activities — Under existing U.S. Government Sales under cost-reimbursement-type contracts are recorded regulations, certain costs incurred for consolidation or restruc- as costs are incurred. Applicable estimated profits are included turing activities that can be demonstrated to result in savings in in earnings in the proportion that incurred costs bear to total excess of the cost to implement those actions can be deferred estimated costs. Sales of products and services provided essen- and amortized for government contracting purposes and includ- tially under commercial terms and conditions are recorded upon ed as allowable costs in future pricing of the Corporation’s delivery and passage of title. products and services. Included in other assets in the consoli- Amounts representing contract change orders, claims or dated balance sheet at December 31, 2003 and 2002 is approx- other items are included in sales only when they can be reliably imately $155 million and $215 million, respectively, of deferred estimated and realization is probable. Incentives or penalties costs related to various consolidation actions. related to performance on contracts are considered in estimating sales and profit rates, and are recorded when there is sufficient Impairment of certain long-lived assets — Generally, the carry- information to assess anticipated contract performance. ing values of long-lived assets other than goodwill are reviewed Estimates of award fees are also considered in estimating sales for impairment if events or changes in the facts and circum- and profit rates based on actual and anticipated awards. stances indicate that their carrying values may not be recover- Incentive provisions which increase or decrease earnings based able. Any impairment determined is recorded in the current solely on a single significant event are generally not recognized period and is measured by comparing the fair value of the related until the event occurs. asset to its carrying value. 48

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