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    LOCKHEED MARTIN CORPORATION 2005 Annual Report


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    2005 Financial Highlights1 (In millions, except per share data and ratios) 2005 2004 2003 Net sales $37,213 $35,526 $31,824 Operating profit from business segments 3,432 2,976 2,468 Consolidated operating profit 2,986 2,089 2,019 Net earnings 1,825 1,266 1,053 Earnings per diluted share 4.10 2.83 2.34 Average diluted common shares outstanding 445.7 447.1 450.0 Net cash provided by operating activities $ 3,194 $ 2,924 $ 1,809 Cash dividends per common share 1.05 0.91 0.58 Cash, cash equivalents and short-term investments 2,673 1,456 1,250 Total assets 27,744 25,554 26,175 Total debt 4,986 5,119 6,208 Stockholders’ equity $ 7,867 $ 7,021 $ 6,756 Common shares outstanding at year-end 432 438 446 Debt-to-total-capital ratio 39% 42% 48% Return on invested capital2 14.5% 10.8% 9.6% NOTES: 1 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 40 of this Annual Report. 2 For additional information concerning return on invested capital, including its definition, use and revised method of calculation, see Note (f) to the Consolidated Financial Data—Five Year Summary on page 74 of this Annual Report. On the Cover: Lockheed Martin’s Center for Innovation: Defining the Networked World, Delivering the Future


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    We Never Forget Who We’re Working For Lockheed Martin’s capabilities are aligned with the highest priorities of our customers in defense, homeland security and civil government agencies. As one company and one team, the 135,000 men and women of Lockheed Martin take pride in delivering the advanced technologies that protect liberty and promote progress for people worldwide. PAGE 1


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    Dear Fellow Stockholders, The solid execution of our business strategy in 2005 has yielded the strong financial results our stockholders expect from Lockheed Martin. We have in place a comprehensive strategy of disciplined growth as well as a culture of operational excellence, the ability to flex with dynamic market conditions and a leadership team that is focused squarely on making Lockheed Martin the preeminent global security enterprise. In 2005, we achieved sales of $37.2 billion, a five per- of the opportunities in the marketplace today, customer cent increase over the previous year. Significantly, we commitments must be a priority, and that means focus- can report earnings per share (EPS) of $4.10. In fact, ing on execution across the portfolio. our EPS has grown at a double-digit rate over the past Our Systems and Information Technology (IT) four years. We also generated $3.2 billion in operating businesses demonstrated particular momentum this cash in 2005, providing this company with financial year. With 50 percent of total sales coming from our flexibility. Rounding out the picture, our balance sheet Systems and IT group, we are pleased to report that we is healthy, demonstrated by a 39 percent debt-to-total- have achieved an impressive record. Lockheed Martin capital ratio. is the number one provider of Systems and IT to both Our revised calculation of Return on Invested defense and civil government agencies, and that lead- Capital (ROIC), an important barometer of our finan- ership was strengthened last year as the National cial performance and a key metric for evaluating execu- Archives and Records Administration selected tive incentive compensation, showed a 34 percent Lockheed Martin to preserve and manage all its elec- increase over 2004 to 14.5 percent in 2005. tronic records. We continue to execute a balanced cash deploy- In the defense arena, Lockheed Martin continues ment strategy by which a majority of our free cash flow to lead the way in building net-centric battlespace oper- will be returned to stockholders in the form of share ations by delivering the tools that process and share repurchases and dividends. In 2005, we repurchased information. The defense side of our business is also 19.7 million shares of our common stock, bringing the distinguished by the production of the world’s only 5th total stock repurchase to 46.1 million shares since Generation aircraft, as well as advanced space and mis- 2002. We also increased the dividend by 20 percent, sile systems that help our forces and allies maintain a reflecting our commitment to pay an attractive, com- military advantage on the front lines. We also provide a petitive dividend. wide range of technologies and systems that extend As we enter 2006, this management team is keenly beyond combat power—missions that include peace- aware that the world around us is changing at a rapid keeping and humanitarian relief. pace. Sitting still is never an option in our business, so It is increasingly important to envision applica- we are solidifying our leadership position in tradi- tions of these game-changing technologies for critical tional markets as well as gaining ground in new homeland security and civil government IT require- higher-growth areas. We know that to take advantage ments. In one example of this forward thinking, we Facing Page: Robert J. Stevens, Chairman, President and Chief Executive Officer PAGE 3


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    successfully leveraged the Systems and it expertise helicopter program. our team also laid the keel for the resident across the enterprise to offer the new York U.S. navy’s first advanced Littoral Combat Ship in Metropolitan transit Authority the best design for a 2005, although we are not a shipbuilder. these accom- critical infrastructure protection system. this project plishments are indicative of our people—their brain- will integrate command, control and communications power and unyielding passion to invent, perfect, perform capabilities throughout the entire new York City and and team with partners to create best value solutions. suburban transit system. Significant milestones in 2005 also included: Winning and delivering on this vital domestic secu- rity contract, as well as other complex systems efforts, • We are on track for the first flight of the F-35 Joint requires that we adhere to our strategy of horizontal Strike Fighter later this year, as the majority of this integration, in which we align ourselves internally and aircraft’s structural assembly was completed in 2005. apply our resources to provide the best solutions for our • the F-22 Raptor reached initial operational customers’ challenges. horizontal integration also Capability in 2005. together, the F-22 and the F-35 means teaming effectively across the global supply will ensure air dominance for the U.S. military and chain—to remain the industry partner of choice in the joint forces against threats for the next 40 years. United States and more than 50 other countries. • the Federal Aviation Administration began use of organizing the right teams and resources was the our Advanced technologies and oceanic procedures rationale behind establishing our Maritime Surveillance (Atop) system, which will increase the capacity enterprise in 2005. this corporate-wide effort to sup- and efficiency of international air travel. Sixty per- port the navy’s maritime patrol and reconnaissance mis- cent of the world’s air traffic is controlled by our sion mobilizes the expertise we need to perform at our air traffic management systems. peak on existing programs and to capture new business. • We received the first international orders for the As we continue to transform Lockheed Martin combat-proven patriot Advanced Capability-3 into a fully networked global security enterprise, we (pAC-3) missile from the netherlands and Japan. can point with great pride to the opening of our Center for innovation in April 2005. • Lockheed Martin was selected to process informa- Located in Suffolk, Virginia, the Center for tion gathered for the Year 2010 U.S. Census, build- innovation is an advanced laboratory dedicated to ing on our success on the Year 2000 U.S. Census experimentation, simulation and analysis. the Center and the 2001 U.k. Census. for innovation is backed by a nationwide network of • the venerable titan iV celebrated 50 years of suc- our best labs and brightest minds, burnishing Lockheed cess with its historic final launch on october 19. Martin’s credentials as a technology and business inno- We also celebrated 50 years of unmatched perfor- vator; it is a position that we must not cede to any of our mance of the U-2 which continues to provide high- competitors. in the long run, we believe the Center for altitude reconnaissance for our national security. innovation will support our goal to add new business • the C-130J transport aircraft, being deployed in orders and grow our backlog. southwest Asia, achieved a major performance in a time of vigorous competition, the advantage milestone by completing operational testing. it is a goes to the company with foresight and creative think- significant step to finalizing the U.S. Air Force’s ing. Although we are not a helicopter manufacturer, we operational test & evaluation. were selected in 2005 to lead the Vh-71 presidential PAGE 4


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    In 2005, we also announced a joint venture with Anticipating future opportunities demands leaders who The Boeing Company to combine our respective pro- drive operational excellence. These are men and women duction and launch operations associated with U.S. gov- who set the course, energize their teams and lead them ernment launches. Structured as a 50-50 joint venture, toward their goal. the United Launch Alliance will provide our national Full spectrum leaders operate as one team, and security and NASA launch customers with assured they take the high road distinguished by a dedication to access to space at a lower cost to the taxpayers. Recog- ethics, superlative corporate governance, integrity and nizing budgetary pressures and the need for greater accountability. We conduct consistent ethics training for efficiencies, the United Launch Alliance will eliminate every Lockheed Martin employee, embedding these rig- duplicate infrastructure and enhance reliability. As of orous standards deep into the fabric of the Corporation. this writing, we are awaiting government approval of We are an enterprise that embraces the diversity of the joint venture. its workforce and a commitment to hiring the best tal- Portfolio shaping in 2005 included selective acqui- ent. As the employer of choice, Lockheed Martin is a sitions designed to bolster our presence in the impor- company of more than 65,000 scientists and engineers. tant arena of net-centric and IT technologies, both for I was particularly gratified to witness the generos- defense and civil government applications. ity and compassion of the men and women of Lockheed We acquired The SYTEX Group, Inc. which pro- Martin as they responded to the tragic events of the vides information technology and technical support past year. Lockheed Martin and its employees contrib- services to the Department of Defense and other fed- uted well over $5 million for relief to victims of the eral agencies. SYTEX, which specializes in informa- tsunami, earthquake in Pakistan and in the aftermath tion warfare, network security solutions and integrated of hurricanes Katrina and Rita. Lockheed Martin peo- logistics, offers access to new customers and should pro- ple also lent their support to our troops overseas through vide appropriate financial returns to the shareholders. our partnership with Operation USO Care Package. We acquired two companies in the United In closing, we at Lockheed Martin are confident Kingdom, expanding Lockheed Martin’s commitment that we can continue to build on the progress we have to a critical ally and the world’s second largest defense made in the interest of our customers, partners, employ- market. STASYS Ltd. specializes in network commu- ees, stockholders and our country. Tremendous possi- nications, defense interoperability, simulation and air bilities lie ahead for all of us and we will work tirelessly traffic management consulting. INSYS Group Ltd. is a to bring them to fruition. diversified supplier of military communications sys- tems, weapons systems and advanced analysis services. March 1, 2006 In addition, we acquired Coherent Technologies Inc., a Colorado-based developer of high-performance laser-based remote sensing systems, and announced our intention to acquire Aspen Systems Corp., an informa- tion management company with experience in deliver- ing IT products to the federal government. The financial and operational muscularity of this Corporation is a testament to the full-spectrum leader- Robert J. Stevens ship that our 135,000 employees bring to the table. Chairman, President and Chief Executive Officer PAGE 5


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    » » F-35 Simulator: Partners in Joint Force Protection: The Virtual Battlespace. Homeland Security. Achieving Information Superiority. PAGE 6


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    Powered by Innovation » » » The men and women of Lockheed Martin are driven by a passion for invention in both technology and business. In April 2005, we opened the Center for Innovation, an advanced laboratory dedicated to experimentation, information integration and analysis. At the Center for Innovation, we are collaborating with our customers in testing potential solutions in a fully net-centric environment in order to address today’s critical defense and homeland security challenges. Backed by a nationwide network of our best labs and brightest minds, the Center for Innovation is a beacon for inventive thinking and cutting-edge technology. PAGE 7


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    » » Clear Skies: The FAA’s Automated Digital Speed: IT Services for Preserving Our Heritage: National Archives Flight Services Station. the Social Security Administration. and Records Administration. Forward Thinking With extensive Systems & Information Technology capabilities, Lockheed Martin has earned a reputation as the number one provider of IT solutions to the Federal Government. At Lockheed Martin, we apply this expertise to the pressing demands of our customers in defense, homeland security and civil government. As a result, we require people committed to forward thinking who can mobilize resources and talent resident throughout the Corporation. In a significant domestic security initiative, the New York Metropolitan Transit Authority selected Lockheed Martin to design and build its infrastructure protection system. PAGE 8


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    » » The High Ground: London Police: Sniper XR: Providing pilots with the most The Mobile User Objective System (MUOS) Utilizing networks to protect the public. capable and maintainable targeting system satellite will transmit vital data to in the world. mobile forces worldwide. PAGE 10


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    Global Security » » » The new and emerging threats to the security of the United States and our allies require a global security enterprise that understands how to respond and operate in a net-centric battlespace. As a dynamic systems integrator, Lockheed Martin delivers networked systems that link assets on land, at sea, in the air and in space. In an uncertain world, our goal is to provide the capabilities that can deter conflict or prevail in victory when called upon. Mission Success: Patriot Advanced Capability-3 (PAC-3) missile defense test at White Sands Missile Range. PAGE 11


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    » » VH-71 Helicopter: Redefining customer service for F-22 Support Center: Building a net-centric Lockheed Martin leads the team to build the U.K. Royal Mail. platform for air dominance in the 21st century. and integrate the new fleet of Marine One helicopters for the President of the United States. Horizontal Integration » » » As a company that takes Horizontal Integration seriously, we combine talented people across the breadth of Lockheed Martin to invent, perfect and perform. In addition to promoting internal collaboration, Horizontal Integration means organizing across the industrial base, to remain the industry partner of choice in the United States and in more than 50 countries. Whatever the challenge, our approach is straightforward: One Company, One Team. The F-35 is a truly transformational aircraft with variants that will satisfy future requirements of the U.S. Air Force, Navy and Marine Corps as well as the U.K. Royal Air Force and Royal Navy. Aside from the United Kingdom, international participants on this combat aircraft program include Italy, The Netherlands, Turkey, Canada, Australia, Denmark and Norway. Here lasers are used in F-35 advanced manufacturing. PAGE 12


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    » » In partnership with the USO, We bring our skills back to the communities in which we live and work through mentoring and other Lockheed Martin employees prepare educational initiatives. We support local math, science, engineering and computer sciences programs much appreciated care packages for from elementary education through the university level with grants. our troops overseas. PAGE 14


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    Guided by Integrity » » » At Lockheed Martin we are motivated by a commitment to ethical business conduct and superlative corporate governance at every level of the organization. There also is a steadfast belief at Lockheed Martin that we are a company of 135,000 individuals working to build a better world through support for education, our communities, and our military men and women. Whether partnering with the USO or assisting those in need after natural disasters, Lockheed Martin people respond with generosity and compassion. Lockheed Martin employees pitched in with their time and their money to help those communities affected by the tsunami as well as hurricanes Katrina and Rita. These employee volunteers made a difference in the aftermath of hurricane Katrina. PAGE 15


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    Financial Section Lockheed Martin Corporation, 2005 Annual Report 2005 Financial Highlights Inside Front Cover Management’s Discussion and Analysis of Financial Condition and Results of Operations 17 Management’s Report on the Financial Statements and Internal Control Over Financial Reporting 41 Report of Ernst & Young LLP, Independent Registered Public Accounting Firm, Regarding Internal Control Over Financial Reporting 42 Report of Ernst & Young LLP, Independent Registered Public Accounting Firm, on the Audited Consolidated Financial Statements 43 Audited Consolidated Financial Statements: Consolidated Statement of Earnings 44 Consolidated Balance Sheet 45 Consolidated Statement of Cash Flows 46 Consolidated Statement of Stockholders’ Equity 47 Notes to Consolidated Financial Statements 48 Consolidated Financial Data—Five Year Summary 73 Corporate Directory 75 General Information 77 Forward-Looking Statements—Safe Harbor Provisions 78 PAGE 16


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    Lockheed฀Martin฀Corporation MANAGEMENT’S฀DISCUSSION฀AND฀ANALYSIS฀OF฀ FINANCIAL฀CONDITION฀AND฀RESULTS฀OF฀OPERATIONS December฀31,฀2005 FINANCIAL฀SECTION฀ROADMAP฀ Reports฀ related฀ to฀ the฀ financial฀ statements฀ and฀ internal฀ The฀financial฀section฀of฀our฀Annual฀Report฀includes฀manage- control฀ over฀ financial฀ reporting฀ (pages฀ 41฀ through฀ 43) — ment’s฀discussion฀and฀analysis,฀our฀consolidated฀financial฀state- include฀the฀following:฀ ments,฀ notes฀ to฀ those฀ financial฀ statements฀ and฀ a฀ five-year฀ •฀ ฀A฀report฀from฀management,฀indicating฀our฀responsibility฀for฀ summary฀ of฀ financial฀ information.฀ We฀ have฀ prepared฀ the฀ fol- financial฀reporting,฀the฀financial฀statements,฀and฀the฀system฀ lowing฀summary,฀or฀“roadmap,”฀to฀assist฀in฀your฀review฀of฀the฀ of฀ internal฀ control฀ over฀ financial฀ reporting฀ and฀ an฀ assess- financial฀section.฀It฀is฀designed฀to฀give฀you฀an฀overview฀of฀our฀ ment฀of฀the฀effectiveness฀of฀those฀controls; company฀and฀focus฀your฀review฀by฀directing฀you฀to฀some฀of฀the฀ •฀ ฀A฀ report฀ from฀ Ernst฀ &฀ Young฀ LLP,฀ an฀ independent฀ regis- more฀important฀activities฀and฀events฀that฀occurred฀this฀year. tered฀ public฀ accounting฀ firm,฀ including฀ their฀ opinions฀ on฀ management’s฀assessment฀of฀internal฀control฀over฀financial฀ Lockheed฀Martin’s฀Business reporting฀ and฀ the฀ effectiveness฀ of฀ internal฀ control฀ over฀ Lockheed฀Martin฀Corporation฀principally฀researches,฀designs,฀ financial฀reporting;฀and develops,฀ manufactures,฀ integrates,฀ operates฀ and฀ sustains฀ •฀ ฀A฀report฀from฀Ernst฀&฀Young฀LLP,฀including฀their฀opinion฀ advanced฀ technology฀ systems,฀ products฀ and฀ services.฀ We฀ on฀the฀fair฀presentation฀of฀our฀financial฀statements฀based฀on฀ mainly฀serve฀customers฀in฀domestic฀and฀international฀defense,฀ their฀audits.฀ civil฀agencies,฀and฀homeland฀security.฀Our฀sales฀to฀agencies฀of฀ the฀ U.S.฀ Government฀ represented฀ 85%฀ of฀ our฀ sales฀ in฀ 2005.฀ Financial฀ statements฀ (pages฀ 44฀ through฀ 47) —include฀ our฀ Of฀the฀remaining฀15%฀of฀sales,฀approximately฀13%฀related฀to฀ consolidated฀statements฀of฀earnings,฀cash฀flows฀and฀stockhold- sales฀ to฀ international฀ customers,฀ with฀ the฀ remainder฀ attribut- ers’฀ equity฀ for฀ each฀ of฀ the฀ last฀ three฀ years,฀ and฀ our฀ balance฀ able฀ to฀ commercial฀ customers.฀ In฀ 2004฀ and฀ 2003,฀ sales฀ to฀ sheet฀as฀of฀the฀end฀of฀the฀last฀two฀years.฀Our฀financial฀state- agencies฀of฀the฀U.S.฀Government฀represented฀80%฀and฀78%฀of฀ ments฀are฀prepared฀in฀accordance฀with฀U.S.฀generally฀accepted฀ our฀ total฀ sales,฀ respectively.฀ Our฀ main฀ areas฀ of฀ focus฀ are฀ in฀ accounting฀principles฀(GAAP). defense,฀ space,฀ intelligence/homeland฀ security,฀ and฀ govern- ment฀information฀technology.฀ Notes฀ to฀ the฀ financial฀ statements฀ (pages฀ 48฀ through฀ 72) — We฀ operate฀ in฀ five฀ principal฀ business฀ segments:฀ provide฀ insight฀ into฀ and฀ are฀ an฀ integral฀ part฀ of฀ our฀ financial฀ Aeronautics,฀ Electronic฀ Systems,฀ Space฀ Systems,฀ Integrated฀ statements.฀ The฀ notes฀ contain฀ explanations฀ of฀ our฀ significant฀ Systems฀&฀Solutions฀(IS&S),฀and฀Information฀&฀Technology฀ accounting฀ policies,฀ details฀ about฀ certain฀ of฀ the฀ captions฀ on฀ Services฀ (I&TS).฀ As฀ a฀ lead฀ systems฀ integrator,฀ our฀ products฀ the฀ financial฀ statements,฀ information฀ about฀ significant฀ events฀ and฀services฀range฀from฀electronics฀and฀information฀systems,฀ or฀transactions฀that฀have฀occurred,฀discussions฀about฀legal฀pro- including฀integrated฀net-centric฀solutions,฀to฀missiles,฀aircraft,฀ ceedings,฀commitments฀and฀contingencies,฀and฀selected฀finan- spacecraft฀and฀launch฀services. cial฀information฀relating฀to฀our฀business฀segments.฀The฀notes฀ to฀ the฀ financial฀ statements฀ also฀ are฀ prepared฀ in฀ accordance฀ Financial฀Section฀Overview with฀GAAP. The฀financial฀section฀includes฀the฀following: Management’s฀discussion฀and฀analysis,฀or฀MD&A฀(pages฀17฀ through฀ 40) —provides฀ management’s฀ view฀ about฀ industry฀ trends,฀ risks฀ and฀ uncertainties฀ relating฀ to฀ Lockheed฀ Martin,฀ accounting฀policies฀that฀we฀view฀as฀critical฀in฀light฀of฀our฀busi- ness,฀our฀results฀of฀operations,฀including฀discussions฀about฀the฀ key฀performance฀drivers฀of฀each฀of฀our฀business฀segments,฀our฀ financial฀ position฀ and฀ cash฀ flows,฀ commitments฀ and฀ contin- gencies,฀ important฀ events฀ or฀ transactions฀ that฀ have฀ occurred฀ over฀ the฀ last฀ three฀ years,฀ and฀ forward-looking฀ information,฀฀ as฀appropriate. PAGE ฀ 17


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    Lockheed฀Martin฀Corporation MANAGEMENT’S฀DISCUSSION฀AND฀ANALYSIS฀OF฀ FINANCIAL฀CONDITION฀AND฀RESULTS฀OF฀OPERATIONS December฀31,฀2005 Highlights The฀U.S.฀Department฀of฀Defense฀(DoD)฀recently฀completed฀ The฀ financial฀ section฀ of฀ our฀ Annual฀ Report฀ describes฀ our฀ the฀ Congressionally฀ mandated฀ 2006฀ Quadrennial฀ Defense฀ ongoing฀ operations,฀ including฀ discussions฀ about฀ particular฀ Review฀(QDR).฀The฀QDR฀continues฀and฀accelerates฀the฀DoD’s฀ lines฀of฀business฀or฀programs,฀our฀ability฀to฀finance฀our฀operat- prior฀commitment฀to฀a฀transformation฀of฀the฀military฀to฀focus฀ ing฀activities,฀and฀trends฀and฀uncertainties฀in฀our฀industry฀and฀ more฀on฀the฀needs฀of฀its฀combatant฀commanders฀and฀to฀develop฀ how฀ they฀ might฀ affect฀ our฀ future฀ operations.฀ We฀ also฀ discuss฀ portfolios฀ of฀ joint฀ capabilities฀ rather฀ than฀ stove-piped฀ pro- those฀ items฀ affecting฀ our฀ results฀ that฀ were฀ not฀ considered฀ in฀ grams.฀ This฀ movement฀ towards฀ horizontally-integrated฀ struc- senior฀management’s฀assessment฀of฀the฀operating฀performance฀ tures฀ is฀ expected฀ to฀ become฀ an฀ organizing฀ principle฀ for฀ the฀ of฀our฀business฀segments.฀We฀separately฀disclose฀these฀items฀to฀ DoD฀ in฀ making฀ investment฀ decisions฀ for฀ future฀ systems.฀ We฀ assist฀in฀your฀evaluation฀of฀our฀overall฀operating฀performance฀ formed฀the฀Integrated฀Systems฀&฀Solutions฀business฀segment฀ and฀financial฀condition฀of฀the฀consolidated฀company.฀We฀would฀ in฀2003฀to฀help฀us฀better฀focus฀our฀integrated฀solutions฀capa- like฀to฀draw฀your฀attention฀to฀the฀following฀items฀disclosed฀in฀ bilities฀ across฀ the฀ Corporation฀ and฀ enhance฀ our฀ ability฀ to฀ this฀financial฀section฀and฀where฀you฀will฀find฀them: serve฀as฀a฀lead฀partner฀with฀the฀DoD.฀In฀2005,฀we฀opened฀our฀ Center฀ for฀ Innovation,฀ a฀ state-of-the-art฀ facility฀ for฀ modeling฀ Topic Location(s) and฀simulating฀our฀net-centric฀solutions฀for฀our฀customers.฀ Critical฀accounting฀policies:฀ The฀President’s฀budget฀proposal฀for฀fiscal฀year฀2007฀and฀ ฀ ฀Contract฀accounting/฀ ฀ beyond฀ presents฀ a฀ framework฀ to฀ reduce฀ the฀ federal฀ budget฀ ฀ revenue฀recognition Page฀22฀and฀page฀50 deficit฀ while฀ prosecuting฀ the฀ global฀ war฀ on฀ terrorism.฀ The฀ ฀ Postretirement฀benefit฀plans Page฀24฀and฀page฀61 DoD฀budget฀is฀growing,฀but฀at฀lower฀levels฀than฀in฀the฀past฀few฀ ฀ Environmental฀matters Page฀26,฀page฀50฀and฀page฀68 years,฀in฀order฀to฀continue฀the฀modernization฀and฀recapitaliza- Discussion฀of฀business฀segments Page฀28฀and฀page฀69 tion฀ that฀ began฀ earlier฀ this฀ decade.฀ The฀ budget฀ for฀ the฀ Liquidity฀and฀cash฀flows Page฀34฀and฀page฀46 Department฀of฀Homeland฀Security฀is฀increasing,฀while฀spend- Capital฀structure฀and฀resources Page฀35,฀page฀45,฀page฀47฀and฀ ing฀across฀other฀non-defense฀federal฀agencies฀is฀anticipated฀to฀ page฀59 decline฀through฀2011.฀These฀changes฀in฀the฀President’s฀budget฀ Legal฀proceedings,฀commitments฀฀ ฀ plan฀ reflect฀ a฀ commitment฀ to฀ a฀ 50%฀ reduction฀ in฀ the฀ federal฀ ฀ and฀contingencies Page฀37฀and฀page฀66 budget฀ deficit฀ by฀ 2009,฀ and฀ the฀ sentiment฀ expressed฀ by฀ the฀ Stock-based฀compensation Page฀38,฀page฀51฀and฀page฀60 Federal฀ Reserve฀ that฀ sustained฀ federal฀ deficits฀ could฀ hamper฀ economic฀growth. INDUSTRY฀CONSIDERATIONS฀ The฀President’s฀budget฀proposal฀includes฀$439฀billion฀for฀ Department฀of฀Defense฀Business฀ the฀DoD,฀including฀$84฀billion฀for฀procurement฀of฀systems฀and฀ Customer฀requirements฀for฀defense฀and฀related฀advanced฀tech- $73฀ billion฀ for฀ research฀ and฀ development.฀ Transformation฀ of฀ nology฀ systems฀ for฀ 2006฀ and฀ beyond฀ will฀ continue฀ to฀ be฀ the฀ DoD฀ enterprise฀ and฀ accompanying฀ budget฀ pressures฀ also฀ affected฀by฀the฀global฀war฀on฀terrorism฀through฀the฀continued฀ may฀create฀additional฀opportunities฀for฀supply฀chain฀logistics,฀ need฀ for฀ military฀ missions฀ and฀ reconstruction฀ efforts฀ in฀ Iraq฀ business฀process฀management฀and฀outsourcing฀of฀service฀func- and฀ Afghanistan฀ and฀ the฀ related฀ fiscal฀ consequences฀ of฀ war.฀ tions฀by฀the฀military฀services,฀expanding฀the฀scope฀of฀private฀ The฀ war฀ on฀ terrorism฀ has฀ focused฀ greater฀ attention฀ on฀ the฀ sector฀contracting฀opportunities฀at฀the฀DoD. security฀ of฀ our฀ homeland฀ and฀ better฀ communication฀ and฀ The฀ Fiscal฀ Year฀ 2007-2011฀ Future฀ Years฀ Defense฀ Plan฀ interoperability฀ between฀ law฀ enforcement,฀ civil฀ government฀ (FYDP)฀projects฀sustained฀growth฀in฀the฀DoD’s฀top฀line฀bud- agencies,฀ intelligence฀ agencies฀ and฀ our฀ military฀ services.฀ At฀ get,฀rising฀from฀$439฀billion฀in฀2007฀to฀$502฀billion฀in฀2011.฀ the฀same฀time,฀our฀nation’s฀overall฀defense฀posture฀continues฀ These฀estimates฀do฀not฀include฀any฀allowance฀to฀fund฀ongoing฀ to฀ move฀ toward฀ a฀ more฀ joint-capabilities-based฀ structure,฀ military฀ operations฀ in฀ Iraq,฀ Afghanistan฀ and฀ the฀ global฀ war฀฀ which฀ creates฀ the฀ ability฀ for฀ a฀ more฀ flexible฀ response฀ with฀ on฀ terrorism,฀ which฀ are฀ expected฀ to฀ be฀ addressed฀ through฀ greater฀ force฀ mobility,฀ stronger฀ space฀ capabilities,฀ enhanced฀ annual฀ supplemental฀ appropriations฀ as฀ required.฀ The฀ DoD’s฀ missile฀defense฀and฀improved฀information฀systems฀capabilities฀ continued฀ emphasis฀ on฀ systems฀ modernization฀ is฀ reflected฀ in฀ and฀security. the฀proposed฀growth฀in฀the฀FYDP฀for฀Procurement,฀which฀is฀ PAGE ฀ 18


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    Lockheed฀Martin฀Corporation estimated฀to฀increase฀from฀$84฀billion฀in฀2007฀to฀$118฀billion฀ We฀ are฀ also฀ represented฀ in฀ almost฀ every฀ aspect฀ of฀ land,฀ in฀ 2011.฀ Research,฀ Development,฀ Test฀ and฀ Engineering฀ sea,฀air฀and฀space-based฀missile฀defense,฀including฀the฀AEGIS฀ (RDT&E)฀spending฀will฀remain฀roughly฀the฀same฀during฀this฀ Weapon฀System฀program,฀the฀Medium฀Extended฀Air฀Defense฀ period,฀ ranging฀ from฀ $73฀ billion฀ in฀ 2007฀ to฀ $75฀ billion฀ in฀ System฀ (MEADS),฀ the฀ Patriot฀ Advanced฀ Capability฀ (PAC-3)฀ 2009,฀declining฀then฀to฀$71฀billion฀in฀2011. missile฀ program,฀ the฀ Terminal฀ High฀ Altitude฀ Area฀ Defense฀ While฀subject฀to฀change฀in฀future฀specific฀budget฀submis- (THAAD)฀system,฀and฀the฀Multiple฀Kill฀Vehicle฀program.฀In฀the฀ sions฀ and฀ annual฀ appropriation฀ by฀ Congress,฀ these฀ estimates฀ areas฀ of฀ space฀ intelligence฀ and฀ information฀ superiority,฀ we฀ continue฀the฀Administration’s฀long฀stated฀intent฀to฀modernize฀ have฀ leadership฀ positions฀ on฀ programs฀ such฀ as฀ the฀ TSAT฀ the฀Armed฀Forces฀while฀prosecuting฀the฀war฀on฀terrorism.฀The฀ Mission฀ Operations฀ System฀ (TMOS),฀ Mobile฀ User฀ Objective฀ differing฀ trends฀ in฀ Procurement฀ and฀ RDT&E฀ budgets฀ reflect฀ System฀ (MUOS),฀ the฀ Advanced฀ Extremely฀ High฀ Frequency฀ the฀ maturation฀ of฀ programs฀ emerging฀ from฀ RDT&E฀ funding฀ (AEHF)฀ system,฀ and฀ the฀ Space-Based฀ Infrared฀ System-High฀ into฀procurement,฀such฀as฀the฀F-35฀program. (SBIRS-H),฀and฀in฀classified฀programs฀and฀battle฀management฀ In฀the฀past฀two฀years,฀Congress฀provided฀for฀supplemental฀ command฀and฀control฀capabilities.฀In฀airlift,฀we฀have฀the฀C-130J฀ appropriations฀to฀defray฀costs฀for฀Operation฀Iraqi฀Freedom฀and฀ program฀ and฀ are฀ under฀ contract฀ to฀ upgrade฀ the฀ C-5฀ strategic฀ Operation฀ Enduring฀ Freedom฀ in฀ Afghanistan.฀ Approximately฀ airlift฀aircraft.฀Many฀of฀the฀aforementioned฀programs฀require฀ $50฀ billion฀ has฀ already฀ been฀ provided฀ relative฀ to฀ 2006฀ and฀ funding฀over฀several฀budget฀cycles.฀There฀is฀always฀an฀inher- another฀ $70฀ billion฀ has฀ been฀ requested.฀ These฀ supplemental฀ ent฀ risk฀ that฀ these฀ and฀ other฀ large,฀ highly฀ visible฀ programs฀ appropriations฀ have฀ enabled฀ the฀ DoD฀ to฀ proceed฀ on฀ critical฀ which฀ are฀ subject฀ to฀ annual฀ appropriation฀ by฀ Congress฀ could฀ modernization฀and฀acquisition฀programs,฀versus฀using฀amounts฀ become฀ potential฀ targets฀ for฀ future฀ reductions฀ or฀ elimination฀ available฀for฀those฀programs฀to฀pay฀for฀the฀Iraq฀and฀Afghanistan฀ of฀funding฀to฀pay฀for฀other฀programs. missions.฀ While฀ there฀ is฀ no฀ assurance฀ that฀ additional฀ supple- We฀continually฀explore฀opportunities฀to฀expand฀into฀adja- mental฀ appropriations฀ will฀ be฀ approved฀ by฀ Congress,฀ we฀ do฀ cent฀product฀lines฀utilizing฀our฀existing฀advanced฀technology฀ not฀believe฀that฀sustained฀operations฀in฀Iraq฀and฀Afghanistan฀ products฀ and฀ services,฀ and฀ have฀ been฀ successful฀ in฀ doing฀ so฀ will฀ materially฀ impact฀ the฀ procurement฀ and฀ research฀ and฀ through฀such฀programs฀as฀the฀Littoral฀Combat฀Ship฀and฀Marine฀ development฀budget฀in฀the฀near฀term. One฀U.S.฀Presidential฀Helicopter฀programs.฀We฀also฀are฀con- We฀believe฀that฀our฀broad฀mix฀of฀programs฀and฀capabili- tinuing฀to฀pursue฀opportunities฀to฀expand฀our฀sustainment฀and฀ ties฀ positions฀ us฀ favorably฀ to฀ support฀ the฀ future฀ needs฀ of฀ the฀ logistical฀support฀activities฀to฀enhance฀the฀longevity฀of฀the฀sys- various฀agencies฀of฀the฀U.S.฀Government฀in฀defense฀and฀infor- tems฀procured฀by฀our฀customers.฀In฀addition,฀we฀have฀focused฀ mation฀ technology.฀ Our฀ major฀ programs฀ and฀ capabilities฀ our฀efforts฀on฀select฀acquisitions,฀cost฀savings฀and฀improving฀ include:฀ missile฀ defense;฀ space฀ intelligence;฀ command,฀ con- efficiency.฀Through฀these฀activities,฀we฀have฀been฀able฀to฀pass฀ trol,฀ communications,฀ computers,฀ intelligence,฀ surveillance฀ along฀savings฀to฀our฀customers,฀mainly฀the฀U.S.฀Government. and฀ reconnaissance฀ (C4ISR);฀ air฀ mobility฀ aircraft;฀ and฀ air- power฀ projection/precision-strike฀ capability.฀ In฀ terms฀ of฀ size฀ Non-Department฀of฀Defense฀Business฀ and฀ long-term฀ potential฀ impact,฀ two฀ of฀ our฀ more฀ significant฀ We฀provide฀products฀and฀services฀to฀a฀number฀of฀government฀ programs฀are฀the฀F-22฀Raptor฀and฀the฀F-35฀Joint฀Strike฀Fighter.฀ agencies฀ other฀ than฀ the฀ DoD,฀ including฀ the฀ Departments฀ of฀ The฀ Air฀ Force฀ approved฀ the฀ F-22฀ for฀ full฀ rate฀ production,฀ Homeland฀ Security,฀ Justice,฀ Commerce,฀ Health฀ and฀ Human฀ declared฀initial฀operational฀capability฀and฀rated฀the฀F-22฀“mis- Services฀ and฀ Energy,฀ the฀ U.S.฀ Postal฀ Service,฀ the฀ Social฀ sion฀ capable”฀ based฀ on฀ successful฀ completion฀ of฀ operational฀ Security฀Administration,฀the฀Federal฀Aviation฀Administration,฀ testing.฀ The฀ DoD฀ plans฀ to฀ continue฀ production฀ of฀ the฀ F-22฀ the฀ National฀ Aeronautics฀ and฀ Space฀ Administration฀ (NASA),฀ through฀2011฀to฀coincide฀with฀the฀anticipated฀production฀of฀the฀ the฀ Environmental฀ Protection฀ Agency฀ (EPA)฀ and฀ the฀ Library฀ F-35฀ to฀ avoid฀ a฀ gap฀ in฀ 5TH฀ Generation฀ fighter฀ stealth฀ and฀ of฀ Congress.฀ Although฀ our฀ lines฀ of฀ business฀ addressing฀ civil฀ advanced฀avionics฀capabilities.฀While฀the฀ultimate฀number฀of฀ government฀needs฀are฀not฀dependent฀on฀defense฀budgets,฀they฀ F-35s฀to฀be฀produced฀will฀continue฀to฀be฀subject฀to฀debate,฀the฀ share฀many฀of฀the฀same฀risks฀as฀our฀defense฀businesses,฀as฀well฀ QDR฀and฀budget฀indicate฀support฀for฀the฀program.฀ as฀other฀risks฀unique฀to฀the฀particular฀programs.฀ PAGE ฀ 19


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    Lockheed฀Martin฀Corporation MANAGEMENT’S฀DISCUSSION฀AND฀ANALYSIS฀OF฀ FINANCIAL฀CONDITION฀AND฀RESULTS฀OF฀OPERATIONS December฀31,฀2005 For฀ example,฀ although฀ indemnification฀ by฀ the฀ U.S.฀ We฀provide฀products฀and฀services฀to฀NASA,฀including฀the฀ Government฀to฀cover฀potential฀claims฀or฀liabilities฀resulting฀from฀a฀ Space฀ Shuttle฀ program,฀ mainly฀ through฀ our฀ Space฀ Systems฀ failure฀of฀technologies฀developed฀and฀deployed฀may฀be฀available฀ and฀ Information฀ &฀ Technology฀ Services฀ business฀ segments.฀ in฀some฀instances฀for฀our฀defense฀businesses,฀U.S.฀Government฀ We฀also฀have฀a฀50%฀equity฀interest฀in฀United฀Space฀Alliance,฀ indemnification฀ may฀ not฀ be฀ available฀ for฀ homeland฀ security฀ LLC฀which฀provides฀ground฀processing฀and฀other฀operational฀ purposes.฀ While฀ we฀ maintain฀ insurance฀ for฀ some฀ business฀ services฀to฀the฀Space฀Shuttle฀program.฀We฀expect฀to฀compete฀ risks,฀it฀is฀not฀possible฀to฀obtain฀coverage฀to฀protect฀against฀all฀ for฀ NASA฀ programs฀ related฀ to฀ the฀ next฀ generation฀ manned฀ operational฀ risks฀ and฀ liabilities.฀ We฀ do฀ plan฀ to฀ seek,฀ and฀ in฀ space฀exploration฀program.฀ certain฀cases฀have฀obtained,฀limitation฀of฀such฀potential฀liabil- Non-U.S.฀ defense฀ budgets฀ have฀ generally฀ been฀ flat฀ or฀ ities฀related฀to฀the฀sale฀and฀use฀of฀our฀homeland฀security฀prod- declining฀over฀the฀past฀decade.฀As฀a฀result,฀consolidation฀has฀ ucts฀and฀services฀through฀qualification฀by฀the฀Department฀of฀ been฀occurring฀in฀the฀European฀aerospace฀industry,฀resulting฀ Homeland฀ Security฀ under฀ the฀ “SAFETY฀ Act”฀ provisions฀ of฀ in฀fewer฀but฀larger฀and฀more฀capable฀competitors. the฀Homeland฀Security฀Act฀of฀2002.฀In฀the฀event฀we฀were฀to฀ provide฀ homeland฀ security-related฀ products฀ and฀ services฀ to฀ a฀ Space฀Business฀ customer฀without฀such฀qualification,฀we฀would฀not฀be฀afforded฀ Sales฀of฀commercial฀launch฀vehicles฀and฀satellites฀continues฀to฀ the฀benefit฀of฀the฀SAFETY฀Act’s฀cap฀on฀tort฀liability฀or฀U.S.฀ be฀very฀competitive฀due฀mainly฀to฀low฀demand฀for฀new฀satel- Government฀ indemnification.฀ In฀ addition,฀ our฀ information฀ lites฀ as฀ a฀ result฀ of฀ excess฀ capacity฀ in฀ the฀ telecommunications฀ technology฀products฀and฀services฀related฀to฀Homeland฀Security฀ industry.฀The฀reduction฀in฀demand฀has฀resulted฀in฀pricing฀pres- may฀ raise฀ potential฀ liabilities฀ associated฀ with฀ privacy฀ issues฀ sures฀ for฀ both฀ launch฀ vehicles฀ and฀ satellites.฀ Despite฀ this฀ for฀which฀neither฀indemnification฀nor฀SAFETY฀Act฀coverage฀ environment,฀we฀did฀receive฀new฀orders฀for฀commercial฀satel- is฀available.฀Other฀risks฀unique฀to฀civil฀government฀programs฀ lites฀and฀launch฀vehicles฀in฀both฀2004฀and฀2005.฀For฀a฀discus- may฀ include฀ development฀ of฀ competing฀ products,฀ technologi- sion฀of฀the฀results฀of฀operations฀of฀our฀Space฀Systems฀segment,฀ cal฀feasibility฀and฀product฀obsolescence. see฀the฀“Discussion฀of฀Business฀Segments”฀section.฀ We฀ have฀ continued฀ to฀ expand฀ our฀ capabilities฀ in฀ critical฀ The฀ above฀ factors฀ have฀ impacted฀ orders฀ for฀ the฀ Evolved฀ intelligence,฀ knowledge฀ management฀ and฀ E-Government฀ Expendable฀Launch฀Vehicle฀(EELV฀or฀Atlas฀V),฀our฀next฀gen- solutions฀ for฀ our฀ customers,฀ including฀ the฀ Social฀ Security฀ eration฀ launch฀ vehicle฀ program฀ in฀ which฀ we฀ have฀ made฀ sig- Administration฀ and฀ the฀ EPA,฀ as฀ well฀ for฀ the฀ DoD.฀ We฀ also฀ nificant฀ investments฀ over฀ the฀ past฀ few฀ years.฀ The฀ Atlas฀ V฀ is฀ provide฀program฀management,฀business฀strategy฀and฀consulting,฀ available฀for฀both฀commercial฀and฀U.S.฀Government฀use.฀This฀ complex฀systems฀development฀and฀maintenance,฀complete฀life- program฀ has฀ required฀ investment฀ of฀ funds฀ for฀ research฀ and฀ cycle฀ software฀ support,฀ information฀ assurance฀ and฀ enterprise฀ development,฀start-up฀and฀other฀nonrecurring฀costs,฀and฀launch฀ solutions.฀Consistent฀with฀the฀President’s฀agenda,฀the฀expected฀ facilities.฀Some฀of฀these฀expenditures฀have฀been฀funded฀under฀ growth฀in฀business฀process฀outsourcing฀has฀been฀enabled฀by฀ an฀agreement฀with฀the฀U.S.฀Government.฀ rule฀changes฀for฀public/private฀competitions.฀Such฀a฀competi- We฀ have฀ received฀ a฀ total฀ of฀ 19฀ launch฀ assignments฀ from฀ tion฀led฀to฀the฀selection฀in฀2005฀of฀Lockheed฀Martin฀to฀operate฀ the฀U.S.฀Government,฀nine฀of฀which฀are฀under฀contract฀and฀in฀ the฀ Federal฀ Aviation฀ Administration’s฀ Automated฀ Flight฀ backlog.฀ The฀ 19฀ launch฀ assignments฀ include฀ seven฀ that฀ were฀ Services฀Station฀Network.฀In฀addition,฀recent฀trends฀continue฀to฀ reassigned฀ in฀ 2003฀ from฀ the฀ original฀ EELV฀ competition฀ indicate฀an฀increase฀in฀demand฀by฀federal฀and฀civil฀government฀ (referred฀to฀as฀“Buy฀1”)฀as฀a฀result฀of฀our฀competitor’s฀viola- agencies฀for฀upgrading฀and฀investing฀in฀new฀information฀tech- tion฀of฀the฀Procurement฀Integrity฀Act.฀Two฀of฀the฀seven฀launch฀ nology฀systems฀and฀solutions.฀As฀a฀result,฀we฀continue฀to฀focus฀ reassignments฀ were฀ for฀ West฀ Coast฀ launches฀ and,฀ since฀ then,฀ our฀ resources฀ in฀ support฀ of฀ infrastructure฀ modernization฀ that฀ the฀ Air฀ Force฀ has฀ assigned฀ us฀ four฀ additional฀ West฀ Coast฀ allows฀for฀interoperability฀and฀communication฀across฀agencies. launches.฀ To฀ prepare฀ for฀ these,฀ we฀ upgraded฀ our฀ West฀ Coast฀ In฀ addition,฀ the฀ increase฀ in฀ emphasis฀ on฀ homeland฀ secu- launch฀ facilities,฀ which฀ required฀ further฀ investment฀ in฀ the฀ rity฀may฀increase฀demand฀for฀our฀capabilities฀in฀areas฀such฀as฀ EELV฀ program฀ (see฀ Note฀ 5฀ to฀ the฀ financial฀ statements).฀ We฀ air฀traffic฀management,฀ports฀and฀waterways฀security,฀biohaz- expect฀ to฀ recover฀ the฀ investment฀ through฀ the฀ pricing฀ of฀ the฀ ard฀ detection฀ systems฀ for฀ postal฀ equipment,฀ information฀ sys- West฀Coast฀launches.฀ tems฀security฀and฀other฀global฀security฀systems฀solutions. 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    Lockheed฀Martin฀Corporation The฀U.S.฀Government฀has฀been฀awarding฀launch฀missions฀ either฀ Boeing฀ or฀ Lockheed฀ Martin฀ may฀ terminate฀ the฀ joint฀ incrementally฀as฀it฀continues฀to฀develop฀its฀acquisition฀strategy฀for฀ venture฀agreement. future฀national฀missions.฀The฀U.S.฀Government฀plans฀to฀maintain฀ Lockheed-Khrunichev-Energia฀International,฀Inc.฀(LKEI),฀ assured฀access฀to฀space฀to฀the฀maximum฀extent฀possible฀and฀has฀ a฀joint฀venture฀we฀have฀with฀two฀Russian฀government-owned฀ recognized฀ the฀ need฀ to฀ fund฀ additional฀ EELV฀ infrastructure฀ space฀ firms,฀ has฀ exclusive฀ rights฀ to฀ market฀ launches฀ of฀ com- costs฀ created฀ by฀ the฀ weaker-than-originally-anticipated฀ com- mercial,฀ non-Russian-origin฀ space฀ payloads฀ on฀ the฀ Proton฀ mercial฀ demand฀ for฀ launch฀ services.฀ We฀ had฀ three฀ Atlas฀ family฀of฀rockets฀from฀a฀launch฀site฀in฀Kazakhstan.฀One฀of฀the฀ launches฀ in฀ 2005,฀ including฀ our฀ fifth฀ Atlas฀ V฀ commercial฀ joint฀ venture฀ partners,฀ Khrunichev฀ State฀ Research฀ and฀ launch.฀As฀of฀year฀end฀2005,฀the฀Atlas฀family฀of฀launch฀vehi- Production฀Space฀Center฀(Khrunichev),฀is฀the฀manufacturer฀of฀ cles฀ had฀ a฀ record฀ of฀ 77฀ consecutive฀ successful฀ launches.฀ the฀ Proton฀ launch฀ vehicle฀ and฀ provider฀ of฀ the฀ related฀ launch฀ Commercial฀orders฀and฀prices฀for฀the฀Atlas฀V฀launch฀vehicle฀ services฀ in฀ Russia.฀ Commercial฀ Atlas฀ and฀ Proton฀ launch฀ ser- to฀date฀have฀been฀lower฀than฀we฀originally฀expected฀during฀the฀ vices฀ are฀ marketed฀ around฀ the฀ world฀ through฀ International฀ development฀phase฀of฀the฀vehicle.฀ Launch฀ Services฀ (ILS),฀ a฀ joint฀ venture฀ between฀ Lockheed฀ In฀ 2005,฀ we฀ entered฀ into฀ an฀ agreement฀ with฀ Boeing฀ to฀ Martin฀and฀LKEI.฀We฀consolidate฀the฀results฀of฀operations฀of฀ create฀ a฀ joint฀ venture฀ that฀ would฀ combine฀ the฀ production,฀ LKEI฀and฀ILS฀into฀our฀financial฀statements฀based฀on฀our฀con- engineering,฀ test฀ and฀ launch฀ operations฀ associated฀ with฀ U.S.฀ trolling฀ financial฀ interest.฀ We฀ received฀ four฀ new฀ awards฀ for฀ Government฀launches฀of฀our฀Atlas฀launch฀vehicles฀and฀Boeing’s฀ launches฀on฀Proton฀vehicles฀in฀2005.฀Contracts฀for฀launch฀ser- Delta฀launch฀vehicles.฀The฀joint฀venture,฀named฀United฀Launch฀ vices฀ usually฀ require฀ substantial฀ advances฀ from฀ the฀ customer฀ Alliance,฀ LLC฀ (ULA),฀ is฀ structured฀ as฀ a฀ 50-50฀ joint฀ venture฀ prior฀to฀launch.฀At฀the฀end฀of฀2005,฀$315฀million฀of฀advances฀ and฀would฀be฀accounted฀for฀as฀an฀equity฀investment.฀Under฀the฀ received฀ from฀ customers฀ for฀ Proton฀ launch฀ services฀ not฀ yet฀ terms฀of฀the฀joint฀venture,฀Atlas฀and฀Delta฀expendable฀launch฀ provided฀ was฀ included฀ as฀ a฀ liability฀ in฀ our฀ balance฀ sheet฀ in฀ vehicles฀would฀continue฀to฀be฀available฀as฀alternatives฀on฀indi- customer฀advances฀and฀amounts฀in฀excess฀of฀costs฀incurred. vidual฀ launch฀ missions.฀ The฀ agreement฀ also฀ stipulates฀ that,฀ A฀ sizeable฀ percentage฀ of฀ the฀ advances฀ we฀ receive฀ from฀ upon฀closing฀of฀the฀transaction,฀Lockheed฀Martin฀and฀Boeing฀ customers฀for฀Proton฀launch฀services฀are฀sent฀to฀Khrunichev.฀ will฀dismiss฀all฀claims฀against฀each฀other฀in฀the฀pending฀civil฀ If฀a฀contracted฀launch฀service฀is฀not฀provided,฀a฀sizeable฀per- litigation฀related฀to฀a฀previous฀competition฀for฀launches฀under฀ centage฀ of฀ the฀ related฀ advance฀ would฀ have฀ to฀ be฀ refunded฀ to฀ the฀Air฀Force฀EELV฀program฀(see฀Note฀15฀for฀a฀discussion฀of฀ our฀ customer.฀ At฀ year-end฀ 2005,฀ payments฀ to฀ Khrunichev฀ that฀litigation). included฀ in฀ inventories฀ for฀ launches฀ under฀ contract฀ totaled฀ The฀ closing฀ of฀ the฀ ULA฀ transaction฀ is฀ subject฀ to฀ condi- $190฀ million.฀ Our฀ ability฀ to฀ recover฀ these฀ advances฀ may฀ be฀ tions฀to฀closing,฀including฀government฀and฀regulatory฀approv- affected฀ by฀ Khrunichev’s฀ ability฀ to฀ provide฀ the฀ launch฀ ser- als฀ and฀ agreements฀ in฀ the฀ United฀ States฀ and฀ internationally.฀ vices,฀ as฀ well฀ as฀ economic฀ conditions฀ and฀ the฀ political฀ envi- On฀ August฀ 9,฀ 2005,฀ the฀ European฀ Commission฀ determined฀ ronment฀in฀Russia.฀Through฀the฀end฀of฀2005,฀launch฀services฀ that฀ ULA฀ was฀ compatible฀ with฀ European฀ Union฀ merger฀ con- through฀ LKEI฀ and฀ ILS฀ have฀ been฀ provided฀ according฀ to฀฀ trol฀ regulation.฀ On฀ October฀ 24,฀ 2005,฀ the฀ Federal฀ Trade฀ contract฀terms. Commission฀ (FTC)฀ requested฀ additional฀ information฀ from฀ The฀Corporation฀has฀entered฀into฀an฀agreement฀with฀RD฀ Lockheed฀ Martin฀ and฀ Boeing฀ related฀ to฀ ULA฀ in฀ response฀฀ AMROSS,฀a฀joint฀venture฀of฀the฀Pratt฀&฀Whitney฀division฀of฀ to฀ the฀ pre-merger฀ notice฀ under฀ the฀ Hart-Scott-Rodino฀ United฀ Technologies฀ Corporation฀ and฀ the฀ Russian฀ firm฀ NPO฀ Antitrust฀Improvements฀Act฀of฀1976฀(HSR)฀submitted฀by฀the฀ Energomash,฀for฀the฀purchase,฀subject฀to฀certain฀conditions,฀of฀ parties.฀The฀FTC’s฀“second฀request”฀extends฀the฀period฀that฀ RD-180฀ booster฀ engines฀ for฀ use฀ in฀ the฀ Corporation’s฀ Atlas฀ the฀FTC฀is฀permitted฀to฀review฀the฀transaction฀under฀the฀HSR฀ launch฀vehicles.฀Terms฀of฀the฀agreement฀call฀for฀payments฀to฀ Act.฀We฀currently฀plan฀to฀close฀the฀ULA฀transaction฀as฀soon฀ be฀ made฀ to฀ RD฀ AMROSS฀ upon฀ the฀ achievement฀ of฀ certain฀ as฀ practicable฀ following฀ satisfaction฀ of฀ all฀ the฀ closing฀ condi- milestones฀ in฀ the฀ manufacturing฀ process.฀ Payments฀ of฀ $70฀ tions.฀We฀do฀not฀expect฀that฀its฀formation฀will฀have฀a฀signifi- million฀made฀under฀this฀agreement฀for฀engines฀not฀yet฀deliv- cant฀impact฀on฀our฀results฀of฀operations฀or฀financial฀position฀ ered฀ were฀ included฀ in฀ the฀ Corporation’s฀ inventories฀ at฀ for฀2006.฀If฀the฀conditions฀to฀closing฀are฀not฀satisfied฀and฀the฀ December฀31,฀2005. ULA฀ transaction฀ is฀ not฀ consummated฀ by฀ March฀ 31,฀ 2006,฀ PAGE ฀ 21


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    Lockheed฀Martin฀Corporation MANAGEMENT’S฀DISCUSSION฀AND฀ANALYSIS฀OF฀ FINANCIAL฀CONDITION฀AND฀RESULTS฀OF฀OPERATIONS December฀31,฀2005 As฀discussed฀above,฀commercial฀satellite฀sales฀have฀con- The฀ nature฀ of฀ our฀ international฀ business฀ also฀ makes฀ us฀ tinued฀to฀experience฀pricing฀pressures฀due฀to฀excess฀capacity.฀ subject฀to฀the฀export฀control฀regulations฀of฀the฀U.S.฀Department฀ However,฀in฀the฀past฀two฀years,฀we฀have฀received฀six฀commer- of฀State฀and฀the฀Department฀of฀Commerce.฀If฀these฀regulations฀ cial฀satellite฀orders฀and฀are฀in฀active฀discussions฀for฀additional฀ are฀violated,฀it฀could฀result฀in฀monetary฀penalties฀and฀denial฀of฀ satellite฀ orders.฀ In฀ addition฀ to฀ commercial฀ activity,฀ we฀ also฀ export฀privileges.฀We฀are฀currently฀unaware฀of฀any฀violations฀ received฀ new฀ orders฀ for฀ government฀ satellites฀ in฀ 2004฀ and฀ of฀ export฀ control฀ regulations฀ which฀ are฀ reasonably฀ likely฀ to฀ 2005,฀ including฀ those฀ under฀ the฀ MUOS฀ program฀ and฀ certain฀ have฀a฀material฀adverse฀effect฀on฀our฀business฀or฀our฀results฀of฀ classified฀activities.฀ operations,฀cash฀flows฀or฀financial฀position. Other฀Business฀Considerations CRITICAL฀ACCOUNTING฀POLICIES As฀a฀government฀contractor,฀we฀are฀subject฀to฀U.S.฀Government฀ Contract฀Accounting/Revenue฀Recognition oversight.฀The฀government฀may฀ask฀about฀and฀investigate฀our฀ A฀ large฀ part฀ of฀ our฀ business฀ is฀ derived฀ from฀ long-term฀ con- business฀ practices฀ and฀ audit฀ our฀ compliance฀ with฀ applicable฀ tracts฀for฀design,฀development฀and฀production฀activities฀which฀ rules฀and฀regulations.฀Depending฀on฀the฀results฀of฀those฀audits฀ we฀ account฀ for฀ consistent฀ with฀ the฀ American฀ Institute฀ of฀ and฀investigations,฀the฀government฀could฀make฀claims฀against฀ Certified฀ Public฀ Accountants’฀ (AICPA)฀ audit฀ and฀ accounting฀ us.฀Under฀government฀procurement฀regulations฀and฀practices,฀ guide,฀ Audits฀ of฀ Federal฀ Government฀ Contractors,฀ and฀ the฀ an฀indictment฀of฀a฀government฀contractor฀could฀result฀in฀that฀ AICPA’s฀ Statement฀ of฀ Position฀ 81-1,฀ Accounting฀ for฀ contractor฀ being฀ fined฀ and฀ suspended฀ from฀ being฀ able฀ to฀ bid฀ Performance฀ of฀ Construction-Type฀ and฀ Certain฀ Production- on,฀ or฀ be฀ awarded,฀ new฀ government฀ contracts฀ for฀ a฀ period฀ of฀ Type฀Contracts.฀We฀also฀enter฀into฀contracts฀to฀provide฀other฀ time.฀ A฀ conviction฀ could฀ result฀ in฀ debarment฀ for฀ a฀ specific฀ services฀ that฀ are฀ not฀ associated฀ with฀ design,฀ development฀ or฀ period฀ of฀ time.฀ Similar฀ government฀ oversight฀ exists฀ in฀ most฀ production฀activities.฀We฀account฀for฀those฀contracts฀in฀accor- other฀countries฀where฀we฀conduct฀business.฀Although฀we฀cannot฀ dance฀ with฀ the฀ Securities฀ and฀ Exchange฀ Commission’s฀ Staff฀ predict฀the฀outcome฀of฀these฀types฀of฀investigations฀and฀inqui- Accounting฀ Bulletin฀ (SAB)฀ No.฀ 104,฀ Revenue฀ Recognition,฀ ries฀with฀certainty,฀based฀on฀current฀facts,฀we฀do฀not฀believe฀that฀ and฀ other฀ relevant฀ revenue฀ recognition฀ accounting฀ literature.฀ any฀of฀the฀claims,฀audits฀or฀investigations฀pending฀against฀us฀are฀ We฀ consider฀ the฀ nature฀ of฀ these฀ contracts฀ and฀ the฀ types฀ of฀ likely฀to฀have฀a฀material฀adverse฀effect฀on฀our฀business฀or฀our฀ products฀and฀services฀provided฀when฀we฀determine฀the฀proper฀ results฀of฀operations,฀cash฀flows฀or฀financial฀position. accounting฀method฀for฀a฀particular฀contract. We฀are฀exposed฀to฀risks฀associated฀with฀U.S.฀Government฀ contracting,฀including฀technological฀uncertainties,฀dependence฀ Accounting฀for฀Design,฀Development฀฀ on฀fewer฀manufacturing฀suppliers฀and฀obsolescence,฀as฀well฀as฀ and฀Production฀Contracts Congressional฀appropriation฀and฀allotment฀of฀funds฀each฀year.฀ Generally,฀ we฀ record฀ long-term,฀ fixed-price฀ design,฀ develop- Many฀ of฀ our฀ programs฀ involve฀ the฀ development฀ and฀ applica- ment฀and฀production฀contracts฀on฀a฀percentage฀of฀completion฀ tion฀ of฀ state-of-the-art฀ technologies฀ aimed฀ at฀ achieving฀ chal- basis฀using฀units-of-delivery฀as฀the฀basis฀to฀measure฀progress฀ lenging฀ goals.฀ As฀ a฀ result,฀ setbacks,฀ delays,฀ cost฀ growth฀ and฀ toward฀ completing฀ the฀ contract฀ and฀ recognizing฀ sales.฀ For฀ product฀failures฀can฀occur. example,฀ we฀ use฀ this฀ method฀ of฀ revenue฀ recognition฀ on฀ our฀ We฀ have฀ entered฀ into฀ various฀ joint฀ venture,฀ teaming฀ and฀ C-130J฀ tactical฀ transport฀ aircraft฀ program,฀ Atlas฀ and฀ Proton฀ other฀ business฀ arrangements฀ to฀ help฀ support฀ our฀ portfolio฀ of฀ launch฀vehicle฀programs,฀and฀Multiple฀Launch฀Rocket฀System฀ products฀and฀services฀in฀many฀of฀our฀lines฀of฀business.฀Some฀ program.฀For฀certain฀other฀long-term,฀fixed-price฀development฀ of฀ these฀ business฀ arrangements฀ include฀ foreign฀ partners.฀ The฀ and฀production฀contracts฀that,฀along฀with฀other฀factors,฀require฀ conduct฀ of฀ international฀ business฀ introduces฀ other฀ risks฀ into฀ us฀to฀deliver฀minimal฀quantities฀over฀a฀longer฀period฀of฀time฀or฀ our฀operations,฀including฀changing฀economic฀conditions,฀fluc- to฀perform฀a฀substantial฀level฀of฀development฀effort฀in฀compari- tuations฀ in฀ relative฀ currency฀ values,฀ regulation฀ by฀ foreign฀ son฀to฀the฀total฀value฀of฀the฀contract,฀sales฀are฀recorded฀when฀ countries฀ and฀ the฀ potential฀ for฀ unanticipated฀ cost฀ increases฀ we฀ achieve฀ performance฀ milestones฀ or฀ using฀ the฀ cost-to-cost฀฀ resulting฀from฀the฀possible฀deterioration฀of฀political฀relations. 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    Lockheed฀Martin฀Corporation method฀ to฀ measure฀ progress฀ toward฀ completion.฀ Under฀ the฀ Accounting฀for฀design,฀development฀and฀production฀con- cost-to-cost฀ method฀ of฀ accounting,฀ we฀ recognize฀ sales฀ based฀ tracts฀requires฀judgment฀relative฀to฀assessing฀risks,฀estimating฀ on฀the฀ratio฀of฀costs฀incurred฀to฀our฀estimate฀of฀total฀costs฀at฀ contract฀ revenues฀ and฀ costs,฀ and฀ making฀ assumptions฀ for฀ completion.฀ As฀ examples,฀ we฀ use฀ this฀ methodology฀ for฀ our฀ schedule฀ and฀ technical฀ issues.฀ Due฀ to฀ the฀ size฀ and฀ nature฀ of฀ F-22฀ Raptor฀ program฀ and฀ the฀ AEGIS฀ Weapon฀ System฀ pro- the฀work฀required฀to฀be฀performed฀on฀many฀of฀our฀contracts,฀ gram.฀In฀some฀instances,฀long-term฀production฀programs฀may฀ the฀estimation฀of฀total฀revenue฀and฀cost฀at฀completion฀is฀com- require฀ a฀ significant฀ level฀ of฀ development฀ and/or฀ a฀ low฀ level฀ plicated฀and฀subject฀to฀many฀variables.฀Contract฀costs฀include฀ of฀initial฀production฀units฀in฀their฀early฀phases,฀but฀will฀ulti- material,฀labor฀and฀subcontracting฀costs,฀as฀well฀as฀an฀alloca- mately฀ require฀ delivery฀ of฀ increased฀ quantities฀ in฀ later,฀ full฀ tion฀of฀indirect฀costs.฀Assumptions฀have฀to฀be฀made฀regarding฀ rate฀production฀stages.฀In฀those฀cases,฀the฀revenue฀recognition฀ labor฀productivity฀and฀availability,฀the฀complexity฀of฀the฀work฀ methodology฀may฀change฀from฀the฀cost-to-cost฀method฀to฀the฀ to฀ be฀ performed,฀ the฀ availability฀ of฀ materials,฀ the฀ length฀ of฀ units-of-delivery฀ method฀ after฀ considering,฀ among฀ other฀ time฀to฀complete฀the฀contract฀(to฀estimate฀increases฀in฀wages฀ factors,฀ program฀ and฀ production฀ stability.฀ As฀ we฀ incur฀ costs฀ and฀ prices฀ for฀ materials),฀ and฀ the฀ availability฀ and฀ timing฀ of฀ under฀ cost-reimbursement-type฀ contracts,฀ we฀ record฀ sales.฀ funding฀from฀the฀customer.฀For฀contract฀change฀orders,฀claims฀ Cost-reimbursement-type฀ contracts฀ include฀ time฀ and฀ materi- or฀similar฀items,฀we฀apply฀judgment฀in฀estimating฀the฀amounts฀ als฀ and฀ other฀ level-of-effort-type฀ contracts.฀ Examples฀ of฀ this฀ and฀assessing฀the฀potential฀for฀realization.฀These฀amounts฀are฀ type฀ of฀ revenue฀ recognition฀ include฀ the฀ F-35฀ Joint฀ Strike฀ only฀included฀in฀contract฀value฀when฀they฀can฀be฀reliably฀esti- Fighter฀ system฀ development฀ and฀ demonstration฀ (SDD)฀ pro- mated฀ and฀ realization฀ is฀ considered฀ probable.฀ We฀ have฀ gram฀and฀the฀THAAD฀missile฀defense฀program.฀Most฀of฀our฀ accounting฀policies฀in฀place฀to฀address฀these฀as฀well฀as฀other฀ long-term฀ contracts฀ are฀ denominated฀ in฀ U.S.฀ dollars,฀ includ- contractual฀ and฀ business฀ arrangements฀ to฀ properly฀ account฀ ing฀ contracts฀ for฀ sales฀ of฀ military฀ products฀ and฀ services฀ to฀ for฀long-term฀contracts.฀ foreign฀governments฀conducted฀through฀the฀U.S.฀Government฀ Products฀ and฀ services฀ provided฀ under฀ long-term฀ design,฀ (i.e.,฀foreign฀military฀sales).฀ development฀and฀production฀contracts฀make฀up฀the฀majority฀of฀ As฀a฀general฀rule,฀we฀recognize฀sales฀and฀profits฀earlier฀in฀ our฀business.฀Therefore,฀the฀amounts฀we฀record฀in฀our฀finan- a฀production฀cycle฀when฀we฀use฀the฀cost-to-cost฀and฀milestone฀ cial฀ statements฀ using฀ contract฀ accounting฀ methods฀ and฀ cost฀ methods฀ of฀ percentage฀ of฀ completion฀ accounting฀ than฀ when฀ accounting฀standards฀are฀material.฀Because฀of฀the฀significance฀ we฀ use฀ the฀ units-of-delivery฀ method.฀ In฀ addition,฀ our฀ profits฀ of฀ the฀ judgments฀ and฀ estimation฀ processes,฀ it฀ is฀ likely฀ that฀ and฀ margins฀ may฀ vary฀ materially฀ depending฀ on฀ the฀ types฀ of฀ materially฀different฀amounts฀could฀be฀recorded฀if฀we฀used฀dif- long-term฀ contracts฀ undertaken,฀ the฀ costs฀ incurred฀ in฀ their฀ ferent฀assumptions฀or฀if฀the฀underlying฀circumstances฀were฀to฀ performance,฀ the฀ achievement฀ of฀ other฀ performance฀ objec- change.฀For฀example,฀if฀underlying฀assumptions฀were฀to฀change฀ tives,฀and฀the฀stage฀of฀performance฀at฀which฀the฀right฀to฀receive฀ such฀ that฀ our฀ estimated฀ profit฀ at฀ completion฀ for฀ all฀ design,฀ fees,฀ particularly฀ under฀ incentive฀ and฀ award฀ fee฀ contracts,฀ is฀ development฀and฀production฀contracts฀was฀higher฀or฀lower฀by฀ finally฀determined.฀ 1%,฀our฀net฀earnings฀would฀increase฀or฀decrease฀by฀approxi- Incentives฀ and฀ award฀ fees฀ related฀ to฀ performance฀ on฀ mately฀$190฀million.฀When฀adjustments฀in฀estimated฀contract฀ design,฀development฀and฀production฀contracts,฀which฀are฀gener- revenues฀ or฀ costs฀ are฀ required,฀ any฀ changes฀ from฀ prior฀ esti- ally฀awarded฀at฀the฀discretion฀of฀the฀customer,฀as฀well฀as฀penal- mates฀are฀included฀in฀earnings฀in฀the฀current฀period.฀ ties฀related฀to฀contract฀performance,฀are฀considered฀in฀estimating฀ sales฀ and฀ profit฀ rates.฀ Estimates฀ of฀ award฀ fees฀ are฀ based฀ on฀ Accounting฀for฀Other฀Services฀Contracts actual฀awards฀and฀anticipated฀performance.฀Incentive฀provisions฀ Revenue฀under฀contracts฀for฀services฀other฀than฀those฀associ- which฀ increase฀ or฀ decrease฀ earnings฀ based฀ solely฀ on฀ a฀ single฀ ated฀with฀design,฀development฀or฀production฀activities฀is฀gen- significant฀ event฀ are฀ generally฀ not฀ recognized฀ until฀ the฀ event฀ erally฀ recognized฀ either฀ as฀ services฀ are฀ performed฀ or฀ when฀ occurs.฀Such฀incentives฀and฀penalties฀are฀recorded฀when฀there฀is฀ earned,฀depending฀on฀the฀contract.฀This฀methodology฀is฀mainly฀ sufficient฀information฀for฀us฀to฀assess฀anticipated฀performance.฀ used฀ by฀ our฀ Information฀ &฀ Technology฀ Services฀ segment.฀฀ PAGE ฀ 23


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    Lockheed฀Martin฀Corporation MANAGEMENT’S฀DISCUSSION฀AND฀ANALYSIS฀OF฀ FINANCIAL฀CONDITION฀AND฀RESULTS฀OF฀OPERATIONS December฀31,฀2005 Services฀ contracts฀ primarily฀ include฀ operations฀ and฀ mainte- Postretirement฀Benefit฀Plans nance฀contracts,฀and฀outsourcing-type฀arrangements.฀Revenue฀ Most฀employees฀are฀covered฀by฀defined฀benefit฀pension฀plans฀ under฀such฀contracts฀is฀generally฀recognized฀on฀a฀straight-line฀ (pension฀plans),฀and฀we฀provide฀health฀care฀and฀life฀insurance฀ basis฀over฀the฀period฀of฀contract฀performance,฀unless฀evidence฀ benefits฀to฀eligible฀retirees.฀Our฀earnings฀may฀be฀negatively฀or฀ suggests฀ that฀ the฀ revenue฀ is฀ earned฀ or฀ the฀ obligations฀ are฀ ful- positively฀ impacted฀ by฀ the฀ amount฀ of฀ expense฀ or฀ income฀ we฀ filled฀in฀a฀different฀pattern.฀Costs฀incurred฀under฀these฀services฀ record฀for฀our฀employee฀benefit฀plans.฀This฀is฀particularly฀true฀ contracts฀are฀expensed฀as฀incurred,฀except฀that฀initial฀“set-up”฀ with฀expense฀or฀income฀for฀pension฀plans฀because฀those฀calcu- costs฀are฀capitalized฀and฀recognized฀over฀the฀life฀of฀the฀agree- lations฀ are฀ sensitive฀ to฀ changes฀ in฀ several฀ key฀ economic฀ ment.฀ Operating฀ profit฀ related฀ to฀ such฀ services฀ contracts฀ may฀ assumptions฀ and฀ workforce฀ demographics.฀ Effective฀ January฀ fluctuate฀ from฀ period฀ to฀ period,฀ particularly฀ in฀ the฀ earlier฀ 1,฀ 2006,฀ new฀ non-union฀ represented฀ employees฀ that฀ we฀ hire฀ phases฀of฀the฀contract.฀Incentives฀and฀award฀fees฀related฀to฀per- are฀not฀being฀covered฀by฀defined฀benefit฀pension฀plans,฀but฀are฀ formance฀ on฀ services฀ contracts฀ are฀ recognized฀ when฀ they฀ are฀ eligible฀ to฀ participate฀ in฀ defined฀ contribution฀ plans.฀ We฀ cur- fixed฀and฀determinable,฀generally฀at฀the฀date฀of฀award.฀ rently฀plan฀to฀offer฀those฀employees฀the฀ability฀to฀participate฀in฀ our฀ retiree฀ medical฀ plans,฀ but฀ will฀ not฀ subsidize฀ the฀ cost฀ of฀ Other฀Contract฀Accounting฀Considerations their฀participation฀effective฀January฀1,฀2006. The฀majority฀of฀our฀sales฀are฀driven฀by฀pricing฀based฀on฀costs฀ We฀ account฀ for฀ our฀ pension฀ plans฀ using฀ Statement฀ of฀ incurred฀ to฀ produce฀ products฀ or฀ perform฀ services฀ under฀ con- Financial฀ Accounting฀ Standards฀ (FAS)฀ 87,฀ Employers’฀ tracts฀with฀the฀U.S.฀Government.฀Cost-based฀pricing฀is฀deter- Accounting฀for฀Pensions.฀Those฀rules฀require฀that฀the฀amounts฀ mined฀under฀the฀Federal฀Acquisition฀Regulations฀(FAR).฀The฀ we฀ record,฀ including฀ the฀ expense฀ or฀ income฀ for฀ the฀ plans,฀ be฀ FAR฀ provides฀ guidance฀ on฀ the฀ types฀ of฀ costs฀ that฀ are฀ allow- computed฀using฀actuarial฀valuations.฀These฀valuations฀include฀ able฀ in฀ establishing฀ prices฀ for฀ goods฀ and฀ services฀ under฀ U.S.฀ many฀assumptions,฀including฀assumptions฀we฀make฀relating฀to฀ Government฀contracts.฀For฀example,฀costs฀such฀as฀those฀related฀ financial฀ market฀ and฀ other฀ economic฀ conditions.฀ Changes฀ in฀ to฀ charitable฀ contributions,฀ advertising,฀ interest฀ expense,฀ and฀ key฀economic฀indicators฀can฀result฀in฀changes฀in฀the฀assump- public฀relations฀are฀unallowable,฀and฀therefore฀not฀recoverable฀ tions฀we฀use.฀The฀key฀year-end฀assumptions฀used฀to฀estimate฀ through฀sales.฀In฀addition,฀we฀may฀enter฀into฀agreements฀with฀ pension฀expense฀or฀income฀for฀the฀following฀calendar฀year฀are฀ the฀U.S.฀Government฀that฀address฀the฀subjects฀of฀allowability฀ the฀discount฀rate,฀the฀expected฀long-term฀rate฀of฀return฀on฀plan฀ and฀allocability฀of฀costs฀to฀contracts฀for฀specific฀matters.฀For฀ assets฀and฀the฀rates฀of฀increase฀in฀future฀compensation฀levels. example,฀most฀of฀the฀amounts฀we฀spend฀for฀groundwater฀treat- We฀ use฀ judgment฀ in฀ reassessing฀ these฀ assumptions฀ each฀ ment฀ and฀ soil฀ remediation฀ related฀ to฀ discontinued฀ operations฀ year฀ because฀ we฀ have฀ to฀ consider฀ current฀ market฀ conditions฀ and฀ sites฀ operated฀ in฀ prior฀ years฀ are฀ allocated฀ to฀ our฀ current฀ and,฀ in฀ the฀ case฀ of฀ the฀ expected฀ long-term฀ rate฀ of฀ return฀ on฀ operations฀ as฀ general฀ and฀ administrative฀ costs฀ under฀ agree- plan฀assets,฀past฀investment฀experience,฀judgments฀about฀future฀ ments฀reached฀with฀the฀U.S.฀Government. market฀trends,฀changes฀in฀interest฀rates฀and฀equity฀market฀per- We฀ closely฀ monitor฀ compliance฀ with฀ and฀ the฀ consistent฀ formance.฀We฀also฀have฀to฀consider฀factors฀like฀the฀timing฀and฀ application฀ of฀ our฀ critical฀ accounting฀ policies฀ related฀ to฀ con- amounts฀ of฀ expected฀ contributions฀ to฀ the฀ plans฀ and฀ benefit฀ tract฀accounting.฀Business฀segment฀personnel฀assess฀the฀status฀ payments฀to฀plan฀participants. of฀contracts฀through฀periodic฀contract฀status฀and฀performance฀ An฀ example฀ of฀ how฀ changes฀ in฀ these฀ assumptions฀ can฀ reviews.฀ Also,฀ regular฀ and฀ recurring฀ evaluations฀ of฀ contract฀ affect฀our฀financial฀statements฀occurred฀in฀2005.฀We฀reassess฀ cost,฀scheduling฀and฀technical฀matters฀are฀performed฀by฀man- our฀pension฀plan฀assumptions฀each฀year.฀Based฀on฀our฀review฀ agement฀ personnel฀ independent฀ from฀ the฀ business฀ segment฀ of฀interest฀rates฀at฀the฀end฀of฀the฀year,฀we฀lowered฀our฀discount฀ performing฀work฀under฀the฀contract.฀Costs฀incurred฀and฀allo- rate฀assumption฀to฀5.625%฀at฀December฀31,฀2005,฀compared฀to฀ cated฀to฀contracts฀with฀the฀U.S.฀Government฀are฀reviewed฀for฀ 5.75%฀used฀at฀the฀end฀of฀2004.฀Before฀the฀end฀of฀2005,฀we฀also฀ compliance฀ with฀ regulatory฀ standards฀ by฀ our฀ personnel,฀ and฀ performed฀a฀study฀of฀the฀rates฀of฀increase฀in฀future฀compensa- are฀ subject฀ to฀ audit฀ by฀ the฀ Defense฀ Contract฀ Audit฀ Agency.฀ tion฀levels.฀The฀results฀of฀that฀study฀indicated฀that฀it฀would฀be฀ For฀other฀information฀on฀accounting฀policies฀we฀have฀in฀place฀ appropriate฀to฀reduce฀that฀rate฀from฀5.50%฀to฀5.0%฀at฀the฀end฀ for฀ recognizing฀ sales฀ and฀ profits,฀ see฀ our฀ discussion฀ under฀ of฀2005.฀These฀changes,฀together฀with฀other฀factors฀such฀as฀the฀฀ “Sales฀and฀earnings”฀in฀Note฀1฀to฀the฀financial฀statements. PAGE ฀ 2 4


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    Lockheed฀Martin฀Corporation effects฀ of฀ the฀ actual฀ return฀ on฀ plan฀ assets฀ over฀ the฀ past฀ few฀ Funded฀amounts฀are฀recovered฀over฀time฀through฀the฀pricing฀ years,฀ resulted฀ in฀ our฀ projecting฀ that฀ the฀ amount฀ of฀ pension฀ of฀ our฀ products฀ and฀ services฀ on฀ U.S.฀ Government฀ contracts,฀ expense฀for฀2006฀will฀decrease฀by฀approximately฀15%฀to฀20%฀ and฀therefore฀are฀recognized฀in฀our฀net฀sales.฀The฀total฀fund- as฀compared฀to฀2005฀expense.฀The฀primary฀drivers฀of฀this฀pro- ing฀ requirement฀ for฀ pension฀ plans฀ under฀ CAS฀ in฀ 2005฀ was฀ jected฀decrease฀were฀the฀change฀in฀the฀rate฀of฀future฀compen- $498฀million.฀For฀2006,฀we฀expect฀our฀funding฀requirements฀ sation฀increases฀as฀well฀as฀the฀growth฀in฀plan฀assets฀over฀the฀ under฀ CAS฀ to฀ increase.฀ Also฀ in฀ 2006,฀ funding฀ in฀ addition฀ to฀ past฀year,฀including฀contributions฀we฀made฀to฀the฀pension฀trust.฀ the฀amount฀calculated฀under฀CAS฀will฀likely฀be฀required฀under฀ The฀ decrease฀ of฀ 50฀ basis฀ points฀ in฀ the฀ compensation฀ rate฀ Internal฀ Revenue฀ Code฀ rules.฀ Any฀ additional฀ amounts฀ com- decreased฀the฀estimated฀2006฀expense฀by฀approximately฀$100฀ puted฀ under฀ those฀ rules฀ are฀ considered฀ to฀ be฀ prepayments฀ million.฀In฀addition,฀the฀higher฀asset฀base฀at฀the฀beginning฀of฀ under฀ the฀ CAS฀ rules,฀ and฀ are฀ recorded฀ on฀ our฀ balance฀ sheet฀ 2006฀drove฀a฀higher฀expected฀return฀on฀assets฀for฀2006,฀which฀ and฀recovered฀in฀future฀periods.฀In฀2005฀and฀2004,฀we฀made฀ was฀ the฀ main฀ component฀ of฀ the฀ remaining฀ decrease฀ in฀ the฀ discretionary฀prepayments฀of฀$980฀million฀and฀$485฀million,฀ expense.฀This฀decrease฀was฀partially฀offset฀by฀an฀increase฀of฀ respectively,฀ to฀ the฀ pension฀ trust.฀ Prepayments฀ reduce฀ the฀ approximately฀ $50฀ million฀ in฀ the฀ estimated฀ 2006฀ pension฀ amount฀ of฀ future฀ cash฀ funding฀ that฀ will฀ be฀ required.฀ expense,฀ resulting฀ from฀ the฀ 12.5฀ basis฀ point฀ decrease฀ in฀ the฀ Accordingly,฀ although฀ our฀ CAS฀ funding฀ requirements฀ are฀ discount฀ rate฀ assumption.฀ The฀ annual฀ review฀ of฀ our฀ pension฀ expected฀to฀increase฀over฀the฀$498฀million฀required฀in฀2005,฀we฀ plan฀assumptions฀also฀affects฀the฀pension฀liability฀recorded฀in฀ expect฀ our฀ cash฀ contributions฀ to฀ the฀ pension฀ plans฀ to฀ be฀ $100฀ our฀balance฀sheet.฀ million฀to฀$110฀million,฀primarily฀reflecting฀the฀additional฀fund- At฀the฀end฀of฀each฀of฀the฀last฀few฀years,฀we฀have฀recorded฀ ing฀required฀under฀Internal฀Revenue฀Code฀rules. noncash฀after-tax฀adjustments฀in฀the฀stockholders’฀equity฀sec- The฀ FAS/CAS฀ pension฀ adjustment฀ represents฀ the฀ differ- tion฀of฀our฀balance฀sheet฀to฀reflect฀a฀minimum฀pension฀liabil- ence฀ between฀ pension฀ expense฀ calculated฀ in฀ accordance฀ with฀ ity฀ for฀ many฀ of฀ our฀ pension฀ plans.฀ These฀ adjustments฀ were฀ FAS฀87฀and฀pension฀costs฀calculated฀and฀funded฀in฀accordance฀ calculated฀ on฀ a฀ plan-by-plan฀ basis,฀ and฀ were฀ determined฀ by฀ with฀ CAS.฀ Since฀ the฀ CAS฀ expense฀ is฀ recovered฀ through฀ the฀ comparing฀the฀accumulated฀benefit฀obligation฀(ABO)฀for฀each฀ pricing฀of฀our฀products฀and฀services฀on฀U.S.฀Government฀con- plan฀ to฀ the฀ fair฀ value฀ of฀ that฀ plan’s฀ assets.฀ The฀ amount฀ by฀ tracts,฀ and฀ therefore฀ recognized฀ in฀ a฀ particular฀ segment’s฀ net฀ which฀the฀ABO฀exceeds฀the฀fair฀value฀of฀the฀plan฀assets,฀after฀ sales,฀ the฀ results฀ of฀ operations฀ of฀ our฀ segments฀ only฀ include฀ adjusting฀ for฀ previously฀ recorded฀ accrued฀ or฀ prepaid฀ pension฀ pension฀expense฀as฀determined฀and฀funded฀in฀accordance฀with฀ cost฀for฀the฀plan,฀must฀be฀recorded฀as฀a฀minimum฀pension฀lia- CAS฀ rules.฀ Accordingly,฀ the฀ FAS/CAS฀ adjustment฀ is฀ an฀ bility,฀with฀a฀corresponding฀increase฀in฀an฀intangible฀asset,฀if฀ amount฀included฀in฀the฀reconciliation฀of฀total฀segment฀operat- appropriate,฀and฀a฀reduction฀to฀stockholders’฀equity.฀In฀2005,฀ ing฀ profit฀ to฀ consolidated฀ operating฀ profit฀ under฀ GAAP.฀ See฀ the฀minimum฀pension฀liability฀adjustment฀we฀recorded฀reduced฀ the฀ discussion฀ of฀ “Net฀ Unallocated฀ Corporate฀ (Expense)฀ stockholders’฀ equity฀ by฀ $105฀ million฀ primarily฀ due฀ to฀ mini- Income”฀under฀“Discussion฀of฀Business฀Segments.” mum฀ pension฀ liabilities฀ associated฀ with฀ nonqualified฀ benefit฀ In฀response฀to฀the฀public’s฀concern฀over฀the฀adequacy฀of฀ plans฀and฀the฀changes฀in฀assumptions.฀At฀the฀end฀of฀2004,฀the฀ pension฀ plan฀ funding,฀ Congress฀ has฀ been฀ drafting฀ legislation฀ adjustment฀ reduced฀ stockholders’฀ equity฀ by฀ $285฀ million,฀ to฀address฀the฀amount฀of฀annual฀contributions฀that฀companies฀ mainly฀driven฀by฀the฀change฀in฀the฀discount฀rate.฀These฀adjust- are฀required฀to฀pay฀into฀their฀pension฀funds.฀Both฀the฀Senate฀ ments฀ did฀ not฀ impact฀ earnings.฀ The฀ accumulated฀ minimum฀ and฀ the฀ House฀ of฀ Representatives฀ have฀ passed฀ their฀ own฀ ver- pension฀liability฀balances฀in฀stockholders’฀equity฀at฀the฀end฀of฀ sions฀of฀a฀pension฀funding฀bill฀and฀those฀bills฀are฀expected฀to฀ 2005฀ and฀ 2004฀ were฀ $(1,629)฀ million฀ and฀ $(1,524)฀ million,฀ go฀ to฀ conference฀ during฀ the฀ latter฀ part฀ of฀ the฀ first฀ quarter฀ of฀ respectively.฀The฀amount฀of฀the฀minimum฀pension฀liability฀is฀ 2006.฀It฀is฀expected฀that฀the฀conference฀process฀will฀produce฀ computed฀ at฀ each฀ year-end฀ and฀ could฀ decrease฀ or฀ increase฀ compromises฀and฀changes฀in฀the฀Senate฀and฀House฀bills,฀and฀ depending฀on฀changes฀in฀interest฀rates฀and฀other฀factors.฀ ultimate฀passage฀of฀a฀bill฀is฀uncertain.฀This฀uncertainty฀makes฀ U.S.฀Government฀Cost฀Accounting฀Standards฀(CAS)฀are฀a฀ it฀difficult฀to฀quantify฀the฀potential฀impact฀to฀our฀pension฀fund- major฀factor฀in฀determining฀our฀pension฀funding฀requirements฀ ing.฀Generally,฀the฀Senate฀and฀House฀bills,฀as฀drafted,฀would฀ and฀govern฀the฀extent฀to฀which฀our฀pension฀costs฀are฀allocable฀ accelerate฀ the฀ required฀ amount฀ of฀ our฀ annual฀ pension฀ plan฀ to฀and฀recoverable฀under฀contracts฀with฀the฀U.S.฀Government.฀ contributions,฀which฀may฀have฀a฀material฀impact฀on฀our฀cash฀ PAGE ฀ 25


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    Lockheed฀Martin฀Corporation MANAGEMENT’S฀DISCUSSION฀AND฀ANALYSIS฀OF฀ FINANCIAL฀CONDITION฀AND฀RESULTS฀OF฀OPERATIONS December฀31,฀2005 flows฀for฀a฀few฀years฀beginning฀in฀2007.฀Absent฀other฀changes,฀ If฀ we฀ are฀ ultimately฀ found฀ to฀ have฀ liability฀ at฀ those฀ sites฀ the฀subsequent฀annual฀funding฀requirements฀would฀be฀expected฀ where฀we฀have฀been฀designated฀a฀PRP,฀we฀expect฀that฀the฀actual฀ to฀decline฀in฀recognition฀of฀the฀accelerated฀contributions.฀ costs฀ of฀ remediation฀ will฀ be฀ shared฀ with฀ other฀ liable฀ PRPs.฀ Generally,฀PRPs฀that฀are฀ultimately฀determined฀to฀be฀responsi- Environmental฀Matters ble฀parties฀are฀strictly฀liable฀for฀site฀cleanup฀and฀usually฀agree฀ We฀are฀a฀party฀to฀various฀agreements,฀proceedings฀and฀poten- among฀themselves฀to฀share,฀on฀an฀allocated฀basis,฀the฀costs฀and฀ tial฀ proceedings฀ for฀ environmental฀ cleanup฀ issues,฀ including฀ expenses฀for฀investigation฀and฀remediation฀of฀hazardous฀mate- matters฀ at฀ various฀ sites฀ where฀ we฀ have฀ been฀ designated฀ a฀ rials.฀ Under฀ existing฀ environmental฀ laws,฀ responsible฀ parties฀ potentially฀ responsible฀ party฀ (PRP)฀ by฀ the฀ EPA฀ or฀ by฀ a฀ state฀ are฀jointly฀and฀severally฀liable฀and,฀therefore,฀we฀are฀potentially฀ agency.฀ We฀ record฀ financial฀ statement฀ accruals฀ for฀ environ- liable฀ for฀ the฀ full฀ cost฀ of฀ funding฀ such฀ remediation.฀ In฀ the฀ mental฀ matters฀ in฀ the฀ period฀ that฀ it฀ becomes฀ probable฀ that฀ a฀ unlikely฀event฀that฀we฀were฀required฀to฀fund฀the฀entire฀cost฀of฀ liability฀has฀been฀incurred฀and฀the฀amounts฀can฀be฀reasonably฀ such฀ remediation,฀ the฀ statutory฀ framework฀ provides฀ that฀ we฀ estimated฀ (see฀ the฀ discussion฀ under฀ “Environmental฀ matters”฀ may฀ pursue฀ rights฀ of฀ contribution฀ from฀ the฀ other฀ PRPs.฀ The฀ in฀ Note฀ 1฀ to฀ the฀ financial฀ statements).฀ Judgment฀ is฀ required฀ amounts฀we฀record฀do฀not฀reflect฀the฀fact฀that฀we฀may฀recover฀ when฀we฀develop฀assumptions฀and฀estimate฀costs฀expected฀to฀be฀ some฀ of฀ the฀ environmental฀ costs฀ we฀ have฀ incurred฀ through฀ incurred฀for฀environmental฀remediation฀activities฀due฀to,฀along฀ insurance฀or฀from฀other฀PRPs,฀which฀we฀are฀required฀to฀pursue฀ with฀ other฀ factors,฀ difficulties฀ in฀ assessing฀ the฀ extent฀ of฀ by฀agreement฀and฀U.S.฀Government฀regulation. environmental฀remediation฀to฀be฀performed,฀complex฀environ- Under฀ agreements฀ reached฀ with฀ the฀ U.S.฀ Government,฀ mental฀ regulations฀ and฀ remediation฀ technologies,฀ cost฀ allow- some฀of฀the฀amounts฀we฀spend฀for฀groundwater฀treatment฀and฀ ability฀ issues฀ and฀ agreements฀ between฀ PRPs฀ to฀ share฀ in฀ the฀ soil฀remediation฀are฀allocated฀to฀our฀operations฀as฀general฀and฀ cost฀of฀remediation฀as฀discussed฀below. administrative฀ costs.฀ Under฀ existing฀ government฀ regulations,฀ We฀ enter฀ into฀ agreements฀ (e.g.,฀ administrative฀ orders,฀ these฀ and฀ other฀ environmental฀ expenditures฀ relating฀ to฀ our฀ consent฀decrees)฀which฀document฀the฀extent฀and฀timing฀of฀our฀ U.S.฀ Government฀ business,฀ after฀ deducting฀ any฀ recoveries฀ obligation.฀ We฀ are฀ also฀ involved฀ in฀ remediation฀ activities฀ at฀ received฀from฀insurance฀or฀other฀PRPs,฀are฀allowable฀in฀estab- environmental฀sites฀where฀formal฀agreements฀exist฀but฀do฀not฀ lishing฀prices฀of฀our฀products฀and฀services.฀As฀a฀result,฀a฀sub- quantify฀the฀extent฀and฀timing฀of฀our฀obligation.฀Environmental฀ stantial฀amount฀of฀the฀expenditures฀we฀incur฀are฀being฀included฀ cleanup฀ activities฀ usually฀ cover฀ several฀ years,฀ which฀ makes฀ in฀ our฀ sales฀ and฀ cost฀ of฀ sales฀ according฀ to฀ U.S.฀ Government฀ estimating฀ the฀ costs฀ more฀ judgmental฀ due฀ to,฀ for฀ example,฀ agreement฀or฀regulation. changing฀ remediation฀ technologies.฀ To฀ determine฀ the฀ costs฀ At฀the฀end฀of฀2005,฀the฀total฀amount฀of฀liabilities฀recorded฀ related฀ to฀ cleanup฀ sites,฀ we฀ have฀ to฀ assess฀ the฀ extent฀ of฀ con- on฀our฀balance฀sheet฀for฀environmental฀matters฀was฀$464฀mil- tamination,฀ the฀ appropriate฀ technology฀ to฀ be฀ used฀ to฀ accom- lion.฀ About฀ 60%฀ of฀ the฀ liability฀ relates฀ to฀ sites฀ in฀ Redlands,฀ plish฀ the฀ remediation฀ and฀ continually฀ evolving฀ regulatory฀ Burbank฀ and฀ Glendale,฀ California,฀ and฀ in฀ Great฀ Neck,฀ New฀ environmental฀ standards.฀ We฀ consider฀ these฀ factors฀ in฀ our฀ York,฀mainly฀for฀remediation฀of฀soil฀and฀groundwater฀contam- estimates฀ of฀ the฀ timing฀ and฀ amount฀ of฀ any฀ future฀ costs฀ that฀ ination.฀The฀remainder฀of฀the฀liability฀relates฀to฀other฀proper- may฀be฀required฀for฀remediation฀actions.฀In฀cases฀where฀a฀date฀ ties฀(including฀current฀operating฀facilities฀and฀certain฀facilities฀ to฀complete฀activities฀at฀a฀particular฀environmental฀site฀cannot฀ operated฀ in฀ prior฀ years)฀ for฀ which฀ our฀ obligation฀ is฀ probable฀ be฀estimated฀by฀reference฀to฀agreements฀or฀otherwise,฀we฀proj- and฀the฀financial฀exposure฀can฀be฀estimated.฀We฀have฀recorded฀ ect฀costs฀over฀an฀appropriate฀time฀frame฀not฀to฀exceed฀20฀years.฀ assets฀totaling฀$353฀million฀at฀December฀31,฀2005฀for฀the฀por- Given฀the฀level฀of฀judgment฀and฀estimation฀which฀has฀to฀occur,฀ tion฀of฀environmental฀costs฀that฀are฀probable฀of฀future฀recov- it฀is฀likely฀that฀materially฀different฀amounts฀could฀be฀recorded฀ ery฀in฀pricing฀of฀our฀products฀and฀services฀for฀U.S.฀Government฀ if฀different฀assumptions฀were฀used฀or฀if฀circumstances฀were฀to฀ businesses.฀The฀amount฀that฀is฀expected฀to฀be฀allocated฀to฀our฀ change฀(e.g.,฀a฀change฀in฀environmental฀standards). commercial฀ businesses฀ has฀ been฀ expensed฀ through฀ cost฀ of฀ sales.฀Any฀recoveries฀we฀receive฀from฀other฀PRPs฀or฀insurance฀ would฀ reduce฀ the฀ allocated฀ amounts฀ included฀ in฀ our฀ future฀ U.S.฀Government฀sales฀and฀cost฀of฀sales. PAGE ฀ 2 6


  • Page 29

    Lockheed฀Martin฀Corporation ACQUISITION฀AND฀DIVESTITURE฀ACTIVITIES three฀ acquisitions฀ was฀ $180฀ million.฀ Purchase฀ accounting฀ We฀continuously฀strive฀to฀strengthen฀our฀portfolio฀of฀products฀ adjustments฀included฀recording฀combined฀goodwill฀of฀$164฀mil- and฀services฀to฀meet฀the฀current฀and฀future฀needs฀of฀our฀cus- lion.฀ These฀ acquisitions฀ were฀ not฀ material฀ to฀ our฀ consolidated฀ tomers.฀ We฀ accomplish฀ this฀ not฀ only฀ internally,฀ through฀ our฀ results฀of฀operations฀for฀2005.฀In฀January฀2006,฀we฀acquired฀ independent฀ research฀ and฀ development฀ activities,฀ but฀ also฀ Aspen฀ Systems฀ Corporation,฀ a฀ U.S.-based฀ company฀ that฀ through฀acquisitions.฀We฀selectively฀pursue฀the฀acquisition฀of฀ provides฀ a฀ range฀ of฀ business฀ process฀ and฀ technology฀ solu- businesses฀and฀investments฀that฀complement฀our฀current฀port- tions฀ primarily฀ to฀ civil฀ agencies฀ of฀ the฀ U.S.฀ Government.฀ folio฀and฀allow฀expansion฀into฀adjacent฀product฀lines฀or฀access฀ This฀acquisition฀is฀not฀expected฀to฀have฀a฀material฀impact฀ to฀ new฀ technologies.฀ We฀ have฀ made฀ a฀ number฀ of฀ such฀ niche฀ on฀consolidated฀results฀of฀operations,฀financial฀position฀or฀ acquisitions฀of฀businesses฀during฀the฀past฀several฀years.฀Over฀ cash฀flows.฀ the฀last฀five฀years,฀we฀have฀completed฀10฀such฀acquisitions฀for฀ an฀ aggregate฀ purchase฀ price฀ of฀ approximately฀ $1.5฀ billion.฀ Divestitures Conversely,฀we฀may฀also฀explore฀the฀sale฀of฀businesses,฀invest- During฀2005฀and฀2004,฀we฀continued฀to฀execute฀the฀strategy฀to฀ ments฀and฀surplus฀real฀estate.฀If฀we฀were฀to฀decide฀to฀sell฀any฀ monetize฀certain฀of฀our฀equity฀investments,฀as฀follows: such฀businesses฀or฀real฀estate,฀the฀resulting฀gains,฀if฀any,฀would฀ In฀January฀2005,฀we฀completed฀the฀sale฀of฀our฀25%฀inter- be฀ recorded฀ when฀ the฀ transactions฀ are฀ consummated฀ and฀ est฀in฀Intelsat,฀Ltd.฀to฀a฀private฀equity฀firm฀for฀$18.75฀per฀share,฀ losses,฀if฀any,฀would฀be฀recorded฀when฀the฀value฀of฀the฀related฀ or฀ $752฀ million฀ in฀ total฀ proceeds.฀ The฀ transaction฀ resulted฀฀ asset฀is฀determined฀to฀be฀impaired. in฀ the฀ recording฀ of฀ a฀ gain,฀ net฀ of฀ state฀ income฀ taxes,฀ of฀ $47฀ million฀in฀other฀income฀and฀expenses,฀and฀an฀increase฀in฀net฀ Acquisitions earnings฀of฀$31฀million฀($0.07฀per฀share). In฀ 2005,฀ we฀ completed฀ the฀ purchase฀ of฀ The฀ SYTEX฀ Group,฀ In฀ June฀ 2005,฀ Inmarsat฀ plc฀ (Inmarsat),฀ a฀ company฀ in฀ Inc.฀(SYTEX).฀The฀total฀purchase฀price,฀including฀transaction- which฀ we฀ held฀ a฀ 14%฀ interest,฀ completed฀ an฀ initial฀ public฀ related฀costs,฀was฀approximately฀$480฀million.฀Approximately฀ offering฀ (IPO)฀ of฀ 150฀ million฀ of฀ its฀ ordinary฀ shares฀ on฀ the฀ $380฀million฀of฀the฀purchase฀price฀was฀paid฀in฀cash฀at฀closing,฀ London฀ Stock฀ Exchange.฀ The฀ IPO฀ had฀ the฀ effect฀ of฀ diluting฀ with฀ most฀ of฀ the฀ remainder฀ payable฀ in฀ 2006.฀ The฀ acquisition฀ our฀ownership฀to฀8.9%฀and฀was฀the฀primary฀driver฀for฀our฀rec- was฀ accounted฀ for฀ under฀ the฀ purchase฀ method฀ of฀ accounting.฀ ognition฀ of฀ a฀ $42฀ million฀ deferred฀ gain฀ that฀ was฀ recorded฀ in฀ Purchase฀accounting฀adjustments฀were฀recorded฀by฀allocating฀ 2003฀ related฀ to฀ this฀ investment.฀ In฀ October฀ 2005,฀ we฀ sold฀ the฀purchase฀price฀to฀the฀assets฀acquired฀and฀liabilities฀assumed฀ approximately฀16฀million฀of฀our฀Inmarsat฀shares฀for฀$89฀mil- based฀ on฀ their฀ estimated฀ fair฀ values,฀ and฀ included฀ recording฀ lion,฀further฀reducing฀our฀ownership฀percentage฀to฀5.3%.฀These฀ goodwill฀of฀$395฀million,฀of฀which฀$360฀million฀will฀be฀amor- transactions฀ resulted฀ in฀ the฀ recording฀ of฀ gains,฀ net฀ of฀ state฀ tized฀ for฀ tax฀ purposes.฀ The฀ acquisition฀ expands฀ the฀ income฀ taxes,฀ totaling฀ $126฀ million฀ in฀ other฀ income฀ and฀ Corporation’s฀ information฀ technology฀ solutions฀ and฀ technical฀ expenses,฀and฀an฀increase฀in฀net฀earnings฀of฀$82฀million฀($0.18฀ support฀ services฀ businesses฀ with฀ the฀ DoD฀ and฀ other฀ federal฀ per฀share).฀At฀December฀31,฀2005,฀we฀held฀24฀million฀shares฀of฀ agencies.฀ The฀ operations฀ of฀ SYTEX฀ are฀ included฀ in฀ the฀ Inmarsat฀with฀a฀total฀market฀value฀of฀$146฀million.฀In฀January฀ Information฀&฀Technology฀Services฀business฀segment.฀ 2006,฀we฀sold฀an฀additional฀12฀million฀shares฀of฀Inmarsat฀for฀ In฀ 2005,฀ we฀ also฀ completed฀ the฀ acquisitions฀ of฀ STASYS฀ $75฀million.฀The฀gain฀is฀expected฀to฀increase฀2006฀net฀earnings฀ Limited,฀a฀U.K.-based฀technology฀and฀consulting฀firm฀special- by฀$47฀million฀($0.11฀per฀share). izing฀in฀network฀communications฀and฀defense฀interoperability;฀ In฀ the฀ fourth฀ quarter฀ of฀ 2005,฀ we฀ completed฀ the฀ sale฀ of฀ INSYS฀ Group฀ Limited,฀ a฀ U.K.-based฀ diversified฀ supplier฀ of฀ our฀ interest฀ in฀ NeuStar,฀ Inc.฀ The฀ transaction฀ resulted฀ in฀ the฀ military฀ communications฀ systems,฀ weapons฀ systems฀ and฀ recording฀of฀a฀gain,฀net฀of฀state฀income฀taxes,฀of฀$30฀million฀ advanced฀analysis฀services;฀and฀Coherent฀Technologies,฀Inc.,฀ in฀other฀income฀and฀expenses,฀and฀an฀increase฀in฀net฀earnings฀ a฀U.S.-based฀supplier฀of฀high-performance,฀laser-based฀remote฀ of฀$19฀million฀($0.04฀per฀share).฀ sensing฀systems.฀The฀aggregate฀cash฀purchase฀price฀for฀these฀฀ PAGE ฀ 2 7


  • Page 30

    Lockheed฀Martin฀Corporation MANAGEMENT’S฀DISCUSSION฀AND฀ANALYSIS฀OF฀ FINANCIAL฀CONDITION฀AND฀RESULTS฀OF฀OPERATIONS December฀31,฀2005 In฀ November฀ 2004,฀ a฀ private฀ equity฀ firm฀ purchased฀ the฀ increased฀ in฀ all฀ segments฀ except฀ Aeronautics฀ in฀ 2005,฀ where฀ outstanding฀shares฀of฀New฀Skies฀Satellites,฀N.V.฀(New฀Skies).฀ there฀ was฀ a฀ slight฀ decline฀ due฀ to฀ an฀ anticipated฀ reduction฀ in฀ We฀sold฀our฀shares฀for฀$148฀million.฀The฀transaction฀resulted฀ combat฀aircraft฀deliveries.฀The฀U.S.฀Government฀is฀our฀largest฀ in฀ the฀ recording฀ of฀ a฀ gain,฀ net฀ of฀ state฀ income฀ taxes,฀ of฀ $91฀ customer,฀ accounting฀ for฀ about฀ 85%฀ of฀ our฀ sales฀ for฀ 2005,฀ million฀in฀other฀income฀and฀expenses,฀and฀an฀increase฀in฀net฀ compared฀to฀80%฀in฀2004฀and฀78%฀in฀2003.฀ earnings฀of฀$59฀million฀($0.13฀per฀share).฀The฀carrying฀value฀ Other฀income฀and฀expenses,฀net฀was฀$449฀million฀for฀2005฀ of฀our฀investment฀in฀New฀Skies฀was฀marked฀to฀market฀through฀ compared฀to฀$121฀million฀in฀2004.฀This฀was฀due฀to฀an฀increase฀ other฀comprehensive฀income฀prior฀to฀the฀sale.฀ in฀investment฀income,฀gains฀from฀the฀sale฀of฀investments฀(pri- marily฀Intelsat฀and฀Inmarsat)฀and฀charges฀in฀2004฀for฀the฀early฀ RESULTS฀OF฀OPERATIONS retirement฀ of฀ debt.฀ Other฀ income฀ and฀ expenses,฀ net฀ increased฀ Since฀our฀operating฀cycle฀is฀long-term฀and฀involves฀many฀types฀ $78฀million฀from฀2003฀to฀2004฀due฀to฀gains฀from฀the฀sale฀of฀the฀ of฀development฀and฀production฀contracts฀with฀varying฀produc- COMSAT฀General฀business฀and฀the฀investment฀in฀New฀Skies. tion฀delivery฀schedules,฀the฀results฀of฀operations฀of฀a฀particular฀ Our฀operating฀profit฀for฀2005฀was฀$3.0฀billion,฀an฀increase฀ year,฀or฀year-to-year฀comparisons฀of฀recorded฀sales฀and฀profits,฀ of฀43%฀compared฀to฀2004.฀Our฀operating฀profit฀for฀2004฀was฀ may฀not฀be฀indicative฀of฀future฀operating฀results.฀The฀following฀ $2.1฀billion,฀an฀increase฀of฀3%฀compared฀to฀2003.฀ discussions฀ of฀ comparative฀ results฀ among฀ periods฀ should฀ be฀ Interest฀ expense฀ for฀ 2005฀ was฀ $370฀ million,฀ $55฀ million฀ viewed฀in฀this฀context.฀All฀per฀share฀amounts฀cited฀in฀this฀dis- lower฀than฀in฀2004.฀Interest฀expense฀for฀2004฀was฀$425฀million,฀ cussion฀are฀presented฀on฀a฀“per฀diluted฀share”฀basis. $62฀ million฀ lower฀ than฀ the฀ amount฀ for฀ 2003.฀ The฀ decrease฀ in฀ interest฀expense฀was฀due฀to฀reductions฀in฀our฀debt฀outstanding. Net Sales (In billions) Our฀ effective฀ tax฀ rates฀ were฀ 30.2%฀ for฀ 2005,฀ 23.9%฀ for฀ $40 2004฀and฀31.3%฀for฀2003.฀For฀each฀of฀the฀three฀years,฀our฀tax฀ 35 rate฀ was฀ reduced฀ from฀ the฀ statutory฀ rate฀ by฀ the฀ tax฀ benefits฀ related฀to฀export฀sales฀and฀tax฀deductible฀dividends.฀For฀2005,฀ 30 our฀tax฀rate฀was฀reduced฀by฀the฀new฀tax฀deduction฀for฀sales฀of฀ 25 products฀ manufactured฀ in฀ the฀ U.S.฀ For฀ 2004,฀ our฀ tax฀ rate฀ 20 reflected฀a฀$144฀million฀reduction฀in฀our฀income฀tax฀expense฀ 15 primarily฀ resulting฀ from฀ the฀ closure฀ of฀ an฀ Internal฀ Revenue฀ I&TS 10 IS&S Service฀(IRS)฀examination.฀ Space Systems 5 Electronic Systems Net฀earnings฀increased฀as฀compared฀to฀the฀prior฀year฀for฀ 0 Aeronautics the฀fourth฀straight฀year.฀We฀reported฀net฀earnings฀of฀$1.8฀bil- 2005 2004 2003 lion฀($4.10฀per฀share)฀in฀2005,฀compared฀to฀net฀earnings฀of฀$1.3฀ billion฀ ($2.83฀ per฀ share)฀ in฀ 2004฀ and฀ earnings฀ of฀ $1.1฀ billion฀ The฀following฀discussion฀of฀net฀sales฀and฀operating฀results฀ Segment Operating Profit ($2.34฀per฀share)฀in฀2003. provides฀an฀overview฀of฀our฀operations฀by฀focusing฀on฀key฀ele- (In millions) ments฀set฀forth฀in฀our฀statement฀of฀earnings.฀The฀“Discussion฀ $3,500 DISCUSSION฀OF฀BUSINESS฀SEGMENTS of฀ Business฀ 3,000 Segments”฀ which฀ follows฀ describes฀ the฀ contribu- We฀operate฀in฀five฀business฀segments:฀Aeronautics,฀Electronic฀ tions฀ of฀ each฀ of฀ our฀ business฀ segments฀ to฀ our฀ consolidated฀ 2,500 Systems,฀ Space฀ Systems,฀ Integrated฀ Systems฀ &฀ Solutions฀ sales฀and฀operating฀profit฀for฀2005,฀2004฀and฀2003.฀We฀follow฀ 2,000 (IS&S)฀and฀Information฀&฀Technology฀Services฀(I&TS).฀ an฀ integrated฀ approach฀ for฀ managing฀ the฀ performance฀ of฀ our฀ In฀ the฀ Aeronautics฀ business฀ segment,฀ sales฀ have฀ leveled฀ businesses฀and฀generally฀focus฀the฀discussion฀of฀our฀results฀of฀ 1,500 compared฀to฀the฀growth฀that฀had฀been฀experienced฀the฀last฀few฀ operations฀around฀major฀lines฀of฀business,฀versus฀distinguish- I&TS 1,000 years.฀ This฀ is฀ largely฀ due฀ to฀ lower฀ sales฀ on฀ Combat฀ Aircraft฀ ing฀ between฀ products฀ and฀ services.฀ As฀ mentioned฀ IS&S previously,฀ 500 Space Systems programs฀ driven฀ by฀ declines฀ in฀ F-16฀ volume,฀ completion฀ of฀ most฀of฀our฀services฀revenues฀are฀generated฀in฀our฀Information฀ Electronic Systems Aeronautics initial฀ ramp-up฀ activities฀ associated฀ with฀ F-35฀ development฀ &฀Technology฀Services฀segment. 0 2005 2004 2003 and฀ F-22฀ production,฀ and฀ the฀ completion฀ of฀ the฀ F-22฀ For฀2005,฀net฀sales฀were฀$37.2฀billion,฀a฀5%฀increase฀over฀ Engineering฀ and฀ Manufacturing฀ Development฀ (EMD)฀ phase฀ 2004฀ sales.฀ Sales฀ for฀ 2004฀ were฀ $35.5฀ billion,฀ an฀ increase฀ of฀ of฀the฀program.฀The฀number฀of฀F-16฀deliveries฀is฀expected฀to฀ 12%฀compared฀to฀2003.฀Sales,฀as฀compared฀to฀the฀prior฀year,฀ ating Activities Net Cash Provided By Operating Activities (In millions) PAGE ฀ 2 8 $3,500 3,000


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    Lockheed฀Martin฀Corporation continue฀to฀decline฀over฀the฀next฀few฀years;฀however,฀with฀the฀ performance,฀and฀Corporate฀costs฀not฀allocated฀to฀the฀operating฀ Greek฀Government’s฀contract฀authorization฀for฀30฀aircraft,฀firm฀ segments,฀as฀well฀as฀other฀miscellaneous฀Corporate฀activities. production฀is฀currently฀planned฀through฀2009.฀During฀2005,฀23฀ The฀ FAS/CAS฀ pension฀ adjustment฀ represents฀ the฀ differ- F-22s฀ were฀ delivered฀ and฀ the฀ program฀ achieved฀ initial฀฀ ence฀between฀pension฀expense฀or฀income฀calculated฀for฀finan- operational฀ capability,฀ indicating฀ its฀ readiness฀ for฀ service.฀฀ cial฀ reporting฀ purposes฀ in฀ accordance฀ with฀ FAS฀ 87,฀ and฀ The฀Lot฀5฀contract฀for฀the฀production฀of฀24฀aircraft฀is฀expected฀ pension฀ costs฀ calculated฀ and฀ funded฀ in฀ accordance฀ with฀ U.S.฀ to฀continue฀production฀of฀the฀F-22฀into฀2008,฀and฀we฀received฀ Government฀CAS,฀which฀are฀reflected฀in฀the฀business฀segment฀ advanced฀procurement฀contracts฀for฀production฀of฀Lots฀6฀and฀7฀ results.฀CAS฀is฀a฀major฀factor฀in฀determining฀our฀pension฀fund- associated฀with฀long฀lead฀activities.฀The฀initial฀F-35฀test฀aircraft฀ ing฀ requirements,฀ and฀ governs฀ the฀ extent฀ of฀ allocability฀ and฀ is฀ being฀ readied฀ for฀ its฀ first฀ flight฀ and฀ significant฀ progress฀ is฀ recoverability฀ of฀ pension฀ costs฀ on฀ government฀ contracts.฀ The฀ being฀made฀on฀the฀carrier-based฀and฀short฀takeoff฀variants฀as฀ CAS฀expense฀is฀recovered฀through฀the฀pricing฀of฀our฀products฀ well.฀ Activity฀ on฀ the฀ C-130J฀ program฀ included฀ 15฀ aircraft฀ and฀ services฀ on฀ U.S.฀ Government฀ contracts,฀ and฀ therefore฀ deliveries฀in฀2005.฀Through฀2005,฀we฀have฀delivered฀16฀of฀the฀ recognized฀ in฀ segment฀ net฀ sales.฀ The฀ results฀ of฀ operations฀ of฀ 60฀ aircraft฀ under฀ the฀ multi-year฀ award,฀ and฀ production฀ and฀ the฀segments฀only฀include฀pension฀expense฀as฀determined฀and฀ delivery฀ of฀ the฀ remaining฀ multi-year฀ aircraft฀ are฀ expected฀ to฀ funded฀in฀accordance฀with฀CAS฀rules. continue฀into฀2009. This฀table฀shows฀net฀sales฀and฀operating฀profit฀of฀the฀busi- The฀ Electronic฀ Systems฀ business฀ segment฀ has฀ a฀ broad฀ ness฀segments฀and฀reconciles฀to฀the฀consolidated฀total. portfolio฀ of฀ products฀ and฀ services.฀ Many฀ of฀ its฀ activities฀ involve฀ a฀ combination฀ of฀ both฀ development฀ and฀ production฀ (In฀millions) 2005 2004 2003 contracts฀with฀varying฀delivery฀schedules.฀This฀business฀seg- NET฀SALES ment฀has฀continued฀to฀expand฀its฀core฀competencies฀as฀a฀lead- Aeronautics $฀11,672 $฀11,785 $฀10,206 ing฀ systems฀ integrator,฀ as฀ demonstrated฀ with฀ its฀ role฀ as฀ the฀ Electronic฀Systems 10,580 9,729 8,996 prime฀ contractor฀ on฀ the฀ Presidential฀ Helicopter฀ and฀ Littoral฀ Space฀Systems 6,820 6,359 6,024 Combat฀Ship฀programs.฀ Integrated฀Systems฀&฀Solutions 4,131 3,851 3,422 The฀Space฀Systems฀business฀segment฀is฀a฀key฀supplier฀of฀ Information฀&฀Technology฀Services 4,010 3,802 3,176 space฀solutions,฀primarily฀to฀our฀U.S.฀Government฀customers.฀ $฀37,213 $฀35,526 $฀31,824 Growth฀will฀depend฀on฀our฀government฀satellite฀business฀and฀ OPERATING฀PROFIT our฀ ability฀ to฀ capture฀ market฀ share.฀ The฀ commercial฀ satellite฀ Aeronautics $฀ 994 $฀ 899 $฀ 690 and฀launch฀vehicle฀industries฀continue฀to฀be฀very฀competitive,฀ Electronic฀Systems 1,113 969 858 with฀resulting฀pricing฀pressures.฀During฀2005,฀the฀final฀Titan฀ Space฀Systems 609 489 403 IV฀ was฀ launched฀ and฀ we฀ now฀ plan฀ to฀ continue฀ to฀ provide฀ Integrated฀Systems฀&฀Solutions 365 334 291 launch฀ services฀ to฀ our฀ U.S.฀ Government฀ customers฀ with฀ our฀ Information฀&฀Technology฀Services 351 285 226 Atlas฀V฀vehicle฀through฀the฀EELV฀program. ฀ Total฀business฀segments 3,432 2,976 2,468 The฀IS&S฀and฀I&TS฀business฀segments฀continue฀to฀focus฀ Net฀unallocated฀Corporate฀expense (446) (887) (449) their฀ capabilities฀ in฀ providing฀ information฀ technology฀ ser- vices฀ to฀ defense,฀ intelligence฀ and฀ other฀ government฀ custom- $฀ 2,986 $฀ 2,089 $฀ 2,019 ers.฀ We฀ expect฀ continued฀ strong฀ growth฀ in฀ providing฀ information฀technology฀solutions฀to฀government฀agencies. The฀following฀segment฀discussions฀also฀include฀informa- In฀ the฀ following฀ table฀ of฀ financial฀ data,฀ total฀ operating฀ tion฀ relating฀ to฀ negotiated฀ backlog฀ for฀ each฀ segment.฀ Total฀ profit฀of฀the฀business฀segments฀is฀reconciled฀to฀the฀correspond- negotiated฀ backlog฀ was฀ approximately฀ $75฀ billion฀ and฀ $74฀ ing฀ consolidated฀ amount.฀ The฀ reconciling฀ item฀ “Net฀ unallo- billion฀ at฀ December฀ 31,฀ 2005฀ and฀ 2004,฀ respectively.฀ This฀ cated฀ Corporate฀ expense”฀ includes฀ the฀ FAS/CAS฀ pension฀ amount฀ included฀ both฀ funded฀ backlog฀ (unfilled฀ firm฀ orders฀ adjustment฀ (see฀ discussion฀ below),฀ earnings฀ and฀ losses฀ from฀ for฀which฀funding฀has฀been฀both฀authorized฀and฀appropriated฀ equity฀ investments,฀ interest฀ income,฀ costs฀ for฀ certain฀ stock- by฀ the฀ customer–Congress฀ in฀ the฀ case฀ of฀ U.S.฀ Government฀ based฀compensation฀programs,฀the฀effects฀of฀items฀not฀consid- agencies)฀and฀unfunded฀backlog฀(firm฀orders฀for฀which฀fund- ered฀ part฀ of฀ management’s฀ evaluation฀ of฀ segment฀ operating฀ ing฀ has฀ not฀ yet฀ been฀ appropriated).฀ Negotiated฀ backlog฀ does฀ PAGE ฀ 29


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    Lockheed฀Martin฀Corporation MANAGEMENT’S฀DISCUSSION฀AND฀ANALYSIS฀OF฀ FINANCIAL฀CONDITION฀AND฀RESULTS฀OF฀OPERATIONS December฀31,฀2005 not฀ include฀ unexercised฀ options฀ or฀ task฀ orders฀ to฀ be฀ issued฀ Net฀ sales฀ for฀ Aeronautics฀ decreased฀ by฀ $113฀ million,฀ or฀ under฀ indefinite-delivery/indefinite-quantity฀ (IDIQ)฀ con- 1%,฀in฀2005฀compared฀to฀2004.฀The฀decrease฀was฀mainly฀due฀ tracts.฀ Funded฀ backlog฀ was฀ approximately฀ $35฀ billion฀ at฀ Net Sales to฀ anticipated฀ declines฀ in฀ Combat฀ Aircraft,฀ which฀ were฀ par- December฀31,฀2005. (In billions) tially฀offset฀by฀growth฀in฀Air฀Mobility.฀Combat฀Aircraft฀sales฀ The฀ $40 Aeronautics฀ segment฀ generally฀ includes฀ fewer฀ pro- decreased฀ by฀ $480฀ million฀ for฀ the฀ year฀ primarily฀ due฀ to฀ grams฀ that฀ 35 have฀ much฀ larger฀ sales฀ and฀ operating฀ results฀ than฀ declines฀ in฀ F-16฀ volume,฀ which฀ more฀ than฀ offset฀ higher฀ F-35฀฀ programs฀included฀in฀the฀other฀segments.฀Therefore,฀due฀to฀the฀ 30 and฀F-22฀volume.฀The฀sales฀growth฀in฀Air฀Mobility฀was฀due฀to฀ large฀number฀of฀comparatively฀smaller฀programs฀in฀the฀remain- 25 additional฀ C-130J฀ deliveries฀ (15฀ in฀ 2005฀ compared฀ to฀ 13฀ in฀ ing฀ segments,฀ the฀ discussions฀ of฀ the฀ results฀ of฀ operations฀ of฀ 2004)฀and฀higher฀volume฀on฀other฀Air฀Mobility฀programs.฀ 20 these฀ business฀ segments฀ generally฀ focus฀ on฀ lines฀ of฀ business฀ Net฀ sales฀ for฀ Aeronautics฀ increased฀ by฀ 15%฀ in฀ 2004฀ 15 within฀the฀segments฀rather฀than฀on฀specific฀programs.฀The฀fol- I&TS compared฀to฀2003.฀The฀majority฀of฀the฀increase฀in฀sales,฀$1.5฀ 10 lowing฀tables฀of฀financial฀information฀and฀related฀discussions฀ IS&S billion,฀was฀due฀to฀higher฀volume฀on฀the฀F-35,฀F-16฀and฀F-22฀ Space Systems of฀the฀results฀of฀operations฀of฀our฀business฀segments฀are฀con- 5 Electronic Systems Combat฀Aircraft฀programs.฀In฀2004,฀83฀F-16s฀were฀delivered,฀ sistent฀with฀the฀presentation฀of฀segment฀information฀in฀Note฀16฀ 0 Aeronautics 21฀ more฀ than฀ in฀ 2003.฀ The฀ remaining฀ increase฀ in฀ sales฀ was฀ 2005 2004 2003 to฀the฀financial฀statements. mainly฀ due฀ to฀ higher฀ C-5฀ activities฀ in฀ Air฀ Mobility.฀ There฀ were฀13฀C-130J฀deliveries฀in฀2004฀compared฀to฀15฀deliveries฀ Segment Operating Profit in฀2003. (In millions) Operating฀profit฀for฀the฀segment฀increased฀by฀11%฀in฀2005฀ $3,500 compared฀to฀2004.฀The฀increase฀was฀due฀to฀higher฀Air฀Mobility฀ 3,000 operating฀ profit฀ that฀ exceeded฀ a฀ decline฀ in฀ Combat฀ Aircraft฀ 2,500 operating฀profit.฀Air฀Mobility฀operating฀profit฀increased฀$100฀ million฀ mainly฀ due฀ to฀ improved฀ performance฀ and฀ increased฀ 2,000 deliveries฀on฀the฀C-130J฀program.฀Combat฀Aircraft฀operating฀ 1,500 profit฀ declined฀ due฀ to฀ decreased฀ F-16฀ deliveries฀ (69฀ in฀ 2005฀ 1,000 I&TS compared฀ to฀ 83฀ in฀ 2004)฀ and฀ reduced฀ earnings฀ on฀ the฀ F-35฀ IS&S development฀ program,฀ which฀ more฀ than฀ offset฀ increased฀ vol- 500 Space Systems Electronic Systems ume฀and฀improved฀performance฀on฀the฀F-22฀program.฀ Aeronautics 0 Operating฀ profit฀ for฀ the฀ segment฀ increased฀ by฀ 30%฀ in฀ 2005 2004 2003 2004฀ compared฀ to฀ 2003.฀ Combat฀ Aircraft฀ operating฀ profit฀ increased฀$95฀million฀primarily฀as฀a฀result฀of฀higher฀sales฀vol- ume฀ on฀ the฀ programs฀ discussed฀ above฀ and฀ improved฀ perfor- Aeronautics erating Activities Net Cash Provided By Operating Activities mance฀ on฀ the฀ F-22฀ program.฀ The฀ remaining฀ increase฀ was฀ Aeronautics’฀operating฀results฀included฀the฀following: (In millions) primarily฀attributable฀to฀$85฀million฀in฀operating฀profit฀recog- $3,500 (In฀millions) 2005 2004 2003 nized฀on฀the฀C-130Js฀delivered฀in฀2004.฀The฀Corporation฀began฀ 3,000 recognizing฀profits฀on฀C-130J฀deliveries฀in฀2004฀upon฀resolu- Net฀sales $11,672 $11,785 $10,206 2,500 tion฀of฀certain฀technical฀aircraft฀performance฀risks,฀manufac- Operating฀profit 994 899 690 turing฀ performance฀ improvements฀ and฀ the฀ achievement฀ of฀ Backlog฀at฀year-end 2,000 29,580 30,489 37,580 stable฀production฀as฀a฀result฀of฀securing฀a฀multi-year฀contract฀ 1,500 in฀2003. 1,000 Backlog฀decreased฀in฀2005฀as฀compared฀to฀2004฀primar- ily฀as฀a฀result฀of฀sales฀volume฀on฀the฀F-35฀and฀F-16฀programs฀ 500 as฀well฀as฀deliveries฀of฀C-130J฀aircraft. 0 2005 2004 2003 tio Debt-To-Total Capital Ratio Return On Invested Capital Revised Return On In (In percent) 50% 0.15 15% PAGE ฀ 3 0 40% 0.12 12%


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    Lockheed฀Martin฀Corporation Electronic฀Systems฀ Space฀Systems Electronic฀Systems’฀operating฀results฀included฀the฀following: Space฀Systems’฀operating฀results฀included฀the฀following: (In฀millions) 2005 2004 2003 (In฀millions) 2005 2004 2003 Net฀sales $10,580 $฀ 9,729 $฀ 8,996 Net฀sales $฀ 6,820 $฀ 6,359 $฀ 6,024 Operating฀profit 1,113 969 858 Operating฀profit 609 489 403 Backlog฀at฀year-end 19,932 18,239 17,339 Backlog฀at฀year-end 15,925 16,112 12,813 Net฀sales฀for฀Electronic฀Systems฀increased฀9%฀in฀2005฀as฀ Net฀ sales฀ for฀ Space฀ Systems฀ increased฀ by฀ 7%฀ in฀ 2005฀ compared฀to฀2004.฀Higher฀volume฀in฀tactical฀and฀surface฀sys- compared฀to฀2004.฀During฀the฀year,฀sales฀growth฀in฀Satellites฀ tems฀programs฀contributed฀to฀increased฀sales฀of฀$495฀million฀ and฀ Strategic฀ &฀ Defensive฀ Missile฀ Systems฀ (S&DMS)฀ offset฀ at฀Maritime฀Systems฀&฀Sensors฀(MS2).฀Platform,฀Training฀&฀ declines฀ in฀ Launch฀ Services.฀ The฀ $410฀ million฀ increase฀ in฀ Transportation฀ Solutions฀ (PT&TS)฀ sales฀ increased฀ $310฀ mil- Satellites฀sales฀was฀due฀to฀higher฀volume฀on฀government฀satel- lion฀ primarily฀ due฀ to฀ platform฀ integration฀ activities.฀ Air฀ lite฀programs฀that฀more฀than฀offset฀declines฀in฀commercial฀sat- defense฀ and฀ fire฀ control฀ programs฀ contributed฀ to฀ increased฀ ellite฀activities.฀There฀were฀no฀commercial฀satellite฀deliveries฀ sales฀of฀$40฀million฀at฀Missiles฀&฀Fire฀Control฀(M&FC).฀ in฀ 2005,฀ compared฀ to฀ four฀ in฀ 2004.฀ Increased฀ sales฀ of฀ $235฀ Net฀sales฀for฀Electronic฀Systems฀increased฀8%฀in฀2004฀as฀ million฀in฀S&DMS฀were฀attributable฀to฀the฀fleet฀ballistic฀mis- compared฀ to฀ 2003.฀ The฀ increase฀ in฀ sales฀ was฀ due฀ to฀ higher฀ sile฀and฀missile฀defense฀programs.฀The฀$180฀million฀decrease฀ volume฀in฀MS2฀and฀M&FC.฀Higher฀volume฀on฀surface฀systems฀ in฀Launch฀Services’฀sales฀was฀mainly฀due฀to฀having฀three฀Atlas฀ programs฀ accounted฀ for฀ most฀ of฀ MS2’s฀ sales฀ growth฀ of฀ $450฀ launches฀in฀2005฀compared฀to฀six฀in฀2004. million.฀M&FC’s฀sales฀increased฀$265฀million,฀primarily฀due฀ Net฀ sales฀ for฀ Space฀ Systems฀ increased฀ by฀ 6%฀ in฀ 2004฀ to฀higher฀volume฀on฀fire฀control฀and฀tactical฀missile฀programs. compared฀ to฀ 2003,฀ as฀ increases฀ in฀ Satellites฀ of฀ $320฀ million฀ Operating฀ profit฀ for฀ the฀ segment฀ increased฀ by฀ 15%฀ in฀ and฀ S&DMS฀ of฀ $75฀ million฀ more฀ than฀ offset฀ a฀ $55฀ million฀ 2005฀ compared฀ to฀ 2004.฀ Operating฀ profit฀ increased฀ by฀ $80฀ decrease฀in฀Launch฀Services.฀The฀increase฀in฀Satellites฀was฀due฀ million฀at฀M&FC฀mainly฀due฀to฀improved฀performance฀on฀fire฀ to฀increased฀volume฀on฀government฀satellite฀programs฀and฀one฀ control฀and฀air฀defense฀programs.฀Performance฀on฀surface฀sys- additional฀ commercial฀ satellite฀ delivery฀ in฀ 2004.฀ In฀ S&DMS,฀ tems฀programs฀contributed฀to฀an฀increase฀in฀operating฀profit฀of฀ the฀increase฀was฀primarily฀attributable฀to฀fleet฀ballistic฀missile฀ $50฀ million฀ at฀ MS2.฀ PT&TS฀ operating฀ profit฀ increased฀ $10฀ programs.฀ The฀ lower฀ volume฀ in฀ Launch฀ Services฀ was฀ mainly฀ million฀primarily฀due฀to฀improved฀performance฀on฀simulation฀ due฀ to฀ a฀ decline฀ in฀ the฀ Titan฀ launch฀ vehicle฀ program,฀ which฀ and฀training฀programs.฀ more฀than฀offset฀increases฀in฀both฀Atlas฀launches฀(six฀in฀2004฀ Operating฀ profit฀ for฀ the฀ segment฀ increased฀ by฀ 13%฀ in฀ compared฀to฀five฀in฀2003)฀and฀Proton฀launches฀(four฀in฀2004฀ 2004฀compared฀to฀2003.฀Operating฀profit฀increased฀$145฀mil- compared฀to฀two฀in฀2003). lion฀due฀to฀improved฀performance฀on฀tactical฀missile฀and฀fire฀ Operating฀ profit฀ for฀ the฀ segment฀ increased฀ 25%฀ in฀ 2005฀ control฀ programs฀ at฀ M&FC฀ and฀ on฀ radar฀ programs฀ at฀ MS2.฀ compared฀ to฀ 2004.฀ Operating฀ profit฀ increased฀ in฀ Launch฀ The฀decrease฀in฀operating฀profit฀at฀PT&TS฀was฀due฀to฀a฀$25฀ Services,฀S&DMS฀and฀Satellites.฀In฀Launch฀Services,฀the฀$60฀ million฀loss฀provision฀recorded฀in฀the฀third฀quarter฀of฀2004฀on฀ million฀increase฀in฀operating฀profit฀was฀primarily฀attributable฀ certain฀international฀simulation฀and฀training฀contracts. to฀ improved฀ performance฀ on฀ the฀ Atlas฀ vehicle฀ program.฀ The฀ increase฀ in฀ backlog฀ during฀ 2005฀ over฀ 2004฀ resulted฀ Satellites’฀ operating฀ profit฀ increased฀ $35฀ million฀ due฀ to฀ the฀ from฀increased฀orders฀on฀development฀programs.฀ higher฀ volume฀ and฀ improved฀ performance฀ on฀ government฀ satellite฀ programs,฀ which฀ more฀ than฀ offset฀ the฀ decreased฀ operating฀ profit฀ due฀ to฀ the฀ decline฀ in฀ commercial฀ satellite฀ deliveries.฀The฀$20฀million฀increase฀in฀S&DMS฀was฀attribut- able฀ to฀ higher฀ volume฀ on฀ fleet฀ ballistic฀ missile฀ and฀ missile฀ defense฀programs. PAGE ฀ 31


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    Lockheed฀Martin฀Corporation MANAGEMENT’S฀DISCUSSION฀AND฀ANALYSIS฀OF฀ FINANCIAL฀CONDITION฀AND฀RESULTS฀OF฀OPERATIONS December฀31,฀2005 Operating฀profit฀for฀the฀segment฀increased฀21%฀in฀2004฀as฀ Information฀&฀Technology฀Services compared฀to฀2003.฀Launch฀Services’฀operating฀profit฀increased฀ Information฀&฀Technology฀Services’฀operating฀results฀included฀ $65฀ million.฀ This฀ increase฀ was฀ primarily฀ due฀ to฀ U.S.฀ the฀following: Government฀ support฀ of฀ the฀ Atlas฀ program฀ and฀ the฀ benefit฀ resulting฀from฀the฀first฀quarter฀termination฀of฀a฀launch฀vehicle฀ (In฀millions) 2005 2004 2003 contract฀ by฀ a฀ commercial฀ customer,฀ offset฀ by฀ a฀ decline฀ in฀ Net฀sales $4,010 $3,802 $3,176 activities฀on฀the฀Titan฀launch฀vehicle฀program.฀Satellites’฀oper- Operating฀profit 351 285 226 ating฀profit฀increased฀$20฀million฀due฀to฀commercial฀satellite฀ Backlog฀at฀year-end 5,414 4,560 4,817 deliveries,฀ partially฀ offset฀ by฀ lower฀ profitability฀ on฀ a฀ govern- ment฀satellite฀program.฀In฀2003,฀government฀satellites฀operat- Net฀sales฀for฀I&TS฀increased฀by฀5%฀in฀2005฀as฀compared฀ ing฀ profit฀ reflected฀ a฀ $30฀ million฀ charge฀ related฀ to฀ a฀ NASA฀ to฀ 2004.฀ The฀ increase฀ in฀ sales฀ was฀ primarily฀ attributable฀ to฀ satellite฀program. higher฀ volumes฀ of฀ $460฀ million฀ in฀ Information฀ Technology฀ The฀ decrease฀ in฀ backlog฀ during฀ 2005฀ as฀ compared฀ to฀ and฀Defense฀Services,฀which฀more฀than฀offset฀a฀sales฀decline฀ 2004฀was฀mainly฀due฀to฀sales฀related฀to฀government฀satellite฀ of฀$250฀million฀in฀NASA฀programs.฀Information฀Technology’s฀ programs. sales฀ increase฀ includes฀ the฀ impact฀ of฀ organic฀ growth฀ and฀ the฀ purchase฀of฀SYTEX฀in฀March฀2005. Integrated฀Systems฀&฀Solutions Net฀ sales฀ for฀ I&TS฀ increased฀ by฀ 20%฀ in฀ 2004฀ as฀ com- Integrated฀Systems฀&฀Solutions’฀operating฀results฀included฀the฀ pared฀to฀2003.฀The฀increase฀in฀sales฀was฀primarily฀attributable฀ following: to฀higher฀volume฀of฀$510฀million฀in฀Information฀Technology.฀ Information฀ Technology’s฀ sales฀ improved฀ due฀ to฀ organic฀ (In฀millions) 2005 2004 2003 growth,฀as฀well฀as฀the฀net฀impact฀of฀our฀purchase฀of฀Affiliated฀ Net฀sales $4,131 $3,851 $3,422 Computer฀ Services’฀ federal฀ government฀ IT฀ business฀ and฀ the฀ Operating฀profit 365 334 291 concurrent฀ sale฀ of฀ our฀ commercial฀ IT฀ business฀ in฀ November฀ Backlog฀at฀year-end 3,974 4,586 4,350 2003.฀ The฀ remaining฀ increase฀ in฀ sales฀ of฀ $120฀ million฀ was฀ primarily฀ attributable฀ to฀ higher฀ volume฀ in฀ Defense฀ Services,฀ Net฀sales฀for฀IS&S฀increased฀by฀7%฀in฀2005฀as฀compared฀ which฀offset฀a฀decline฀in฀NASA฀sales. to฀ 2004฀ and฀ by฀ 13%฀ in฀ 2004฀ as฀ compared฀ to฀ 2003.฀ For฀ both฀ Operating฀ profit฀ for฀ the฀ segment฀ increased฀ by฀ 23%฀ in฀ comparative฀periods,฀the฀sales฀increases฀were฀primarily฀attrib- 2005฀as฀compared฀to฀2004.฀The฀operating฀profit฀increase฀was฀ utable฀to฀a฀higher฀volume฀of฀intelligence,฀defense฀and฀informa- mainly฀ due฀ to฀ higher฀ volume฀ and฀ improved฀ performance฀฀ tion฀assurance฀activities.฀ in฀Information฀Technology฀and฀Defense฀Services.฀ Operating฀profit฀for฀the฀segment฀increased฀9%฀in฀2005฀as฀ Operating฀ profit฀ for฀ the฀ segment฀ increased฀ by฀ 26%฀ in฀ compared฀to฀2004฀and฀by฀15%฀in฀2004฀as฀compared฀to฀2003.฀ 2004฀as฀compared฀to฀2003.฀The฀operating฀profit฀increase฀was฀ The฀increases฀in฀operating฀profit฀for฀both฀comparative฀periods฀ mainly฀ due฀ to฀ Information฀ Technology฀ volume฀ and฀ program฀ were฀primarily฀attributable฀to฀higher฀volume฀and฀performance฀ performance. improvements฀on฀the฀activities฀described฀above.฀ The฀increase฀in฀backlog฀was฀attributable฀to฀growth฀in฀our฀ The฀ decrease฀ in฀ backlog฀ during฀ 2005฀ compared฀ to฀ 2004฀ Information฀Technology฀line฀of฀business. was฀due฀to฀the฀U.S.฀Army’s฀termination฀for฀convenience฀of฀the฀ Aerial฀Common฀Sensor฀contract. PAGE ฀ 32


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    Lockheed฀Martin฀Corporation Unallocated฀Corporate฀(Expense)฀Income,฀Net recorded฀ related฀ to฀ the฀ early฀ repayment฀ of฀ debt,฀ are฀ not฀ The฀following฀table฀shows฀the฀components฀of฀net฀unallocated฀ considered฀by฀management฀in฀evaluating฀the฀operating฀perfor- Corporate฀(expense)฀income.฀ mance฀ of฀ business฀ segments.฀ Therefore,฀ for฀ purposes฀ of฀ segment฀ reporting,฀ the฀ following฀ items฀ were฀ included฀ in฀ (In฀millions) 2005 2004 2003 “Unallocated฀Corporate฀(expense)฀income,฀net”฀for฀2005,฀2004฀ FAS/CAS฀pension฀adjustment $(626) $(595) $(300) and฀2003: Items฀not฀considered฀in฀segment฀฀ Operating฀ Net฀ Earnings฀ ฀ operating฀performance 173 (215) (153) Profit฀ Earnings฀ (Loss)฀ Other,฀net 7 (77) 4 (In฀millions,฀except฀per฀share฀data) (Loss)฀ (Loss) Per฀Share $(446) $(887) $(449) YEAR฀ENDED฀DECEMBER฀31,฀2005 Gains฀related฀to฀Inmarsat฀฀ The฀ FAS/CAS฀ pension฀ adjustment฀ represents฀ the฀ differ- ฀ transactions $฀126 $฀ ฀82 $฀0.18 ence฀ between฀ pension฀ costs฀ calculated฀ and฀ funded฀ in฀ accor- Gain฀on฀sale฀of฀interest฀in฀฀ dance฀with฀CAS฀and฀pension฀expense฀determined฀in฀accordance฀ ฀ Intelsat 47 31 0.07 with฀FAS฀87.฀That฀difference฀is฀not฀included฀in฀segment฀oper- Gain฀on฀sale฀of฀interest฀in฀฀ ating฀results฀and฀therefore฀is฀a฀reconciling฀item฀between฀oper- ฀ NeuStar 30 19 0.04 ating฀ profit฀ from฀ the฀ business฀ segments฀ and฀ consolidated฀ Impairment฀charge฀related฀฀ operating฀profit.฀The฀CAS฀funding฀amount฀is฀allocated฀among฀ ฀ to฀a฀satellite฀ (30) (19) (0.04) the฀ business฀ segments฀ and฀ is฀ included฀ as฀ an฀ expense฀ item฀ in฀ $฀173 $฀113 $฀0.25 the฀segments’฀cost฀of฀goods฀sold.฀A฀majority฀of฀the฀cost฀is฀also฀ YEAR฀ENDED฀DECEMBER฀31,฀2004 passed฀along฀to฀our฀customers฀through฀contract฀pricing,฀and฀is฀ Charge฀for฀Pit฀9฀litigation $(180) $(117) $(0.26) consequently฀included฀in฀the฀segments’฀sales. Charge฀for฀early฀retirement฀฀ The฀ following฀ table฀ shows฀ the฀ CAS฀ funding฀ that฀ is฀ ฀ of฀debt (154) (100) (0.22) included฀ as฀ expense฀ in฀ the฀ segments’฀ operating฀ results,฀ the฀ Gain฀on฀sale฀of฀interest฀in฀฀ related฀ FAS฀ (expense)฀ income,฀ and฀ the฀ resulting฀ FAS/CAS฀ ฀ New฀Skies 91 59 0.13 pension฀adjustment: Gain฀on฀sale฀of฀COMSAT฀฀ (In฀millions) 2005 2004 2003 ฀ General฀business 28 4 0.01 Benefit฀from฀closure฀of฀an฀฀ FAS฀87฀expense $฀(1,124) $(884) $(484) ฀ IRS฀examination — 144 0.32 Less:฀CAS฀expense฀and฀funding (498) (289) (184) $(215) $฀ (10) $(0.02) ฀ FAS/CAS฀pension฀adjustment—฀ ฀ ฀ expense $฀ (626) $(595) $(300) YEAR฀ENDED฀DECEMBER฀31,฀2003 Charge฀for฀early฀retirement฀฀ As฀disclosed฀in฀Note฀13฀to฀the฀financial฀statements,฀FAS฀ ฀ of฀debt $(146) $฀ (96) $(0.21) 87฀ expense฀ increased฀ primarily฀ due฀ to฀ higher฀ recognized฀ net฀ Charge฀related฀to฀exit฀from฀the฀฀ ฀ commercial฀mail฀sorting฀฀ actuarial฀losses฀and฀higher฀service฀cost฀in฀2005,฀and฀due฀to฀a฀ ฀ business (41) (27) (0.06) lower฀expected฀return฀on฀plan฀assets฀in฀addition฀to฀these฀other฀ Gain฀on฀partial฀reversal฀of฀฀ two฀factors฀in฀2004.฀ ฀ Space฀Imaging฀charge 19 13 0.03 Certain฀items฀are฀excluded฀from฀segment฀results฀as฀part฀of฀ Gain฀on฀sale฀of฀the฀commercial฀฀ senior฀ management’s฀ evaluation฀ of฀ segment฀ operating฀ perfor- ฀ IT฀business 15 8 0.02 mance฀consistent฀with฀the฀management฀approach฀promulgated฀ by฀FAS฀131,฀Disclosures฀about฀Segments฀of฀an฀Enterprise฀and฀ $(153) $(102) $(0.22) Related฀Information.฀For฀example,฀gains฀and฀losses฀related฀to฀ the฀ disposition฀ of฀ businesses฀ or฀ investments฀ managed฀ by฀ Corporate,฀as฀well฀as฀other฀Corporate฀activities฀such฀as฀charges฀ PAGE ฀ 33


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    $40 35 Lockheed฀Martin฀Corporation 30 MANAGEMENT’S฀DISCUSSION฀AND฀ANALYSIS฀OF฀ 25 FINANCIAL฀CONDITION฀AND฀RESULTS฀OF฀OPERATIONS 20 December฀31,฀2005 15 I&TS 10 IS&S Space Systems 5 The฀increase฀in฀the฀“Other,฀net”฀component฀of฀unallocated฀ Electronic Systems The฀focus฀on฀improving฀our฀cash฀management฀processes฀contin- 0 Aeronautics Corporate฀(expense)฀income,฀net฀of฀$84฀million฀from฀2004฀to฀ 2005 2004 2003 ues฀to฀contribute฀to฀the฀aggregate฀reduction฀in฀operating฀work- 2005฀ was฀ primarily฀ due฀ to฀ higher฀ interest฀ income฀ due฀ to฀ a฀ ing฀capital฀accounts฀(receivables,฀inventories,฀accounts฀payable,฀ larger฀invested฀cash฀balance฀and฀higher฀interest฀rates฀in฀2005.฀ and฀customer฀advances฀and฀amounts฀in฀excess฀of฀costs฀incurred),฀ Segment Operating Profit The฀decrease฀of฀$81฀million฀from฀2003฀to฀2004฀was฀primarily฀ (In millions) including฀ an฀ aggregate฀ reduction฀ of฀ $106฀ million฀ in฀ 2005฀ as฀ due฀to฀lower฀earnings฀on฀our฀equity฀investments฀in฀2004.฀ $3,500 compared฀to฀a฀reduction฀of฀$492฀million฀in฀2004.฀Although฀we฀ will฀ continue฀ to฀ focus฀ on฀ management฀ of฀ operating฀ working฀ 3,000 LIQUIDITY฀AND฀CASH฀FLOWS capital฀ accounts,฀ we฀ do฀ not฀ expect฀ the฀ rate฀ of฀ improvements฀ We฀have฀a฀balanced฀cash฀deployment฀and฀disciplined฀growth฀ 2,500 we฀have฀experienced฀in฀prior฀periods฀to฀continue.฀ strategy฀to฀enhance฀our฀businesses,฀increase฀shareholder฀value฀ 2,000 and฀ position฀ ourselves฀ to฀ take฀ advantage฀ of฀ new฀ business฀ Investing฀Activities 1,500 opportunities฀ when฀ they฀ arise.฀ Consistent฀ with฀ that฀ strategy,฀ Capital฀expenditures—Capital฀expenditures฀for฀property,฀plant฀ we฀ have฀1,000 invested฀ in฀ our฀ business฀ (e.g.,฀ capital฀I&TS expenditures,฀ and฀ equipment฀ amounted฀ to฀ $865฀ million฀ in฀ 2005,฀ $769฀ mil- IS&S independent฀500 research฀ and฀ development),฀ repurchased฀ Space shares,฀ Systems lion฀in฀2004฀and฀$687฀million฀in฀2003.฀We฀expect฀our฀capital฀ Electronic Systems increased฀ our฀ dividends,฀ opportunistically฀ reduced฀ our฀ debt฀ expenditures฀to฀increase฀over฀the฀next฀two฀years฀consistent฀with฀ 0 Aeronautics and฀made฀select฀acquisitions฀of฀businesses.฀The฀following฀pro- 2005 2004 2003 the฀ expected฀ growth฀ in฀ our฀ business฀ and฀ to฀ support฀ specific฀ vides฀an฀overview฀of฀our฀execution฀of฀this฀strategy. program฀requirements.฀ Acquisitions,฀divestitures฀and฀other฀activities—We฀have฀a฀pro- perating Activities Net Cash Provided By Operating Activities cess฀ to฀ selectively฀ identify฀ businesses฀ for฀ acquisition฀ that฀ (In millions) meet฀ our฀ financial฀ targets฀ and฀ disciplined฀ growth฀ strategy.฀ $3,500 We฀have฀focused฀on฀government฀information฀technology฀pro- 3,000 viders,฀systems฀integrators฀and฀complementary฀technologies.฀ 2,500 We฀paid฀$564฀million฀for฀four฀businesses฀in฀2005,฀$91฀mil- 2,000 lion฀ for฀ two฀ businesses฀ in฀ 2004฀ and฀ $645฀ million฀ for฀ two฀ businesses฀in฀2003.฀ 1,500 During฀ 2005,฀ we฀ received฀ proceeds฀ of฀ $935฀ million฀ from฀ 1,000 the฀ divestiture฀ of฀ non-core฀ equity฀ investments.฀ The฀ proceeds฀ 500 included฀$752฀million฀from฀the฀sale฀of฀our฀investment฀in฀Intelsat,฀ Ltd.,฀ $140฀ million฀ from฀ the฀ sale฀ of฀ Inmarsat฀ shares฀ and฀ the฀ 0 2005 2004 2003 redemption฀of฀certain฀Inmarsat฀equity-related฀investments,฀and฀ $33฀million฀from฀the฀sale฀of฀our฀NeuStar฀investment.฀ During฀2004,฀New฀Skies฀Satellites,฀N.V.฀was฀sold฀to฀a฀pri- Operating฀Activities vate฀ equity฀Return firm.฀OnOur฀ portion฀ of฀ the฀ proceeds฀ was฀ $148฀ mil- Return On I atio Debt-To-Total Capital Ratio Invested Capital Revised Net฀ cash฀ provided฀ by฀ operating฀ activities฀ increased฀ by฀ $270฀ (In percent) lion,฀$140฀million฀of฀which฀was฀received฀in฀2004.฀Also฀during฀ million฀to฀$3.2฀billion฀in฀2005฀as฀compared฀to฀2004฀after฀hav- 50% 2004,฀ we฀0.15received฀ cash฀ from฀ Inmarsat฀ Group฀ Holdings,฀ 15% Ltd.฀ ing฀ increased฀ by฀ $1.1฀ billion฀ to฀ $2.9฀ billion฀ in฀ 2004฀ as฀ com- amounting฀ to฀ $50฀ million฀ which฀ reduced฀ the฀ amount฀ of฀ our฀ pared฀to฀2003.฀In฀2005,฀the฀increase฀was฀primarily฀attributable฀ 40% 0.12 investment.฀In฀2003,฀Inmarsat฀Ventures,฀Ltd.฀was฀acquired฀by฀ 12% to฀an฀increase฀in฀net฀earnings฀of฀$559฀million฀as฀compared฀to฀ a฀ consortium฀ of฀ private฀ equity฀ firms฀ in฀ a฀ leveraged฀ buyout฀ 2004,฀ which฀ 30% more฀ than฀ offset฀ a฀ $386฀ million฀ reduction฀ in฀ 0.09 transaction.฀In฀exchange฀for฀our฀interest,฀we฀received฀cash฀of฀ 9% working฀capital฀improvements฀between฀the฀years.฀In฀2004,฀the฀ $114฀ million฀ and฀ retained฀ an฀ ownership฀ interest฀ in฀ 6%the฀ new฀ 20% 0.06 increase฀was฀attributable฀to฀an฀increase฀in฀net฀earnings฀of฀$213฀ Inmarsat฀ holding฀ company,฀ Inmarsat฀ Group฀ Holdings,฀ Ltd.,฀ million,฀ and฀ also฀ to฀ an฀ increase฀ in฀ working฀ capital฀ improve- valued฀ at฀ 10% 0.03$96฀ million.฀ Also฀ in฀ 2003,฀ we฀ paid฀ $130฀3% million฀ ments฀ of฀ $799฀ million฀ compared฀ to฀ 2003.฀ The฀ remaining฀ related฀to฀our฀guarantee฀of฀Space฀Imaging,฀LLC’s฀borrowings฀ increase฀in฀cash฀between฀the฀periods฀was฀due฀to฀the฀timing฀of฀ 0% under฀its฀credit฀facility.฀ 0.00 0% income฀ tax฀ payments฀ 2005 and฀2004 various฀ other฀ 2003 operating฀ activities.฀ 2005 2004 (1) Calculation was revise the Consolidated Finan Summary on page 74 f PAGE ฀ 34 on the calculation.


  • Page 37

    3000 3,000 2500 2,500 Lockheed฀Martin฀Corporation 2000 2,000 1500 1,500 1000 1,000 I&TS IS&S 500 500 Space Systems Electronic Systems 0 0 Aeronautics Financing฀Activities quarterly฀dividends฀of฀$0.12฀per฀share฀during฀each฀of฀the฀first฀ 2005 2004 2003 Issuance฀ and฀ repayment฀ of฀ long-term฀ debt—Cash฀ provided฀ three฀ quarters฀ of฀ the฀ year฀ and฀ $0.22฀ per฀ share฀ for฀ the฀ last฀ from฀ operations฀ has฀ been฀ our฀ principal฀ source฀ of฀ funds฀ to฀ quarter฀of฀2003. reduce฀ our฀ long-term฀ debt.฀ In฀ 2005,฀ we฀ used฀ $133฀ million฀ of฀ Net Cash Provided by Operating Activities Net Cash Provided By Operating Activities cash฀for฀the฀early฀retirement฀and฀scheduled฀repayment฀of฀long- (In millions) CAPITAL฀STRUCTURE฀AND฀RESOURCES (In millions) term฀debt.฀In฀2004,฀we฀used฀$1.1฀billion฀of฀cash฀for฀the฀early฀ 3500 At฀ December฀ $3,500 31,฀ 2005฀ our฀ total฀ long-term฀ debt฀ amounted฀ to฀ retirement฀and฀scheduled฀repayment฀of฀long-term฀debt.฀Of฀that฀ $5.0฀billion.฀Our฀long-term฀debt฀is฀almost฀entirely฀in฀the฀form฀ 3000 3,000 amount,฀ $951฀ million฀ related฀ to฀ the฀ early฀ retirement฀ of฀ debt฀ of฀ publicly฀ issued฀ notes฀ and฀ debentures.฀ The฀ majority฀ of฀ our฀ through฀ tender฀ offers฀ for฀ which฀2500 we฀ incurred฀ $163฀ million฀ of฀ long-term฀debt฀bears฀interest฀at฀fixed฀rates;฀however,฀$1.0฀bil- 2,500 associated฀ costs.฀ In฀ 2003,฀ we฀ issued฀ 2000 $1.0฀ billion฀ of฀ floating฀ lion฀ of฀ convertible฀ 2,000 debentures฀ issued฀ in฀ 2003฀ have฀ a฀ floating฀ rate฀ convertible฀ senior฀ debentures฀ that฀ bear฀ interest฀ at฀ three- interest฀rate฀based฀on฀LIBOR.฀In฀2005,฀we฀repaid฀$133฀million฀ 1500 1,500 month฀LIBOR฀less฀25฀basis฀points,฀reset฀quarterly.฀We฀used฀the฀ of฀ long-term฀ debt,฀ including฀ scheduled฀ and฀ early฀ debt฀ repay- 1,000 1000 proceeds฀of฀that฀issuance,฀along฀with฀cash฀from฀operations,฀to฀ ments.฀ Through฀ our฀ repayment฀ activities,฀ our฀ long-term฀ debt฀ repay฀$2.2฀billion฀of฀debt฀in฀advance฀of฀its฀maturity฀and฀retire฀ 500 balance฀has฀declined฀over฀the฀last฀five฀years฀from฀$9.9฀billion฀ 500 other฀ high฀ cost฀ debt.฀ We฀ used฀ $175฀ million฀ of฀ cash฀ for฀ debt฀ at฀December฀31,฀2000.฀We฀improved฀our฀debt-to-total฀capital- 0 0 issuance฀ and฀ repayment฀ costs฀ to฀ complete฀ those฀ transactions฀ ization฀ ratio฀ from฀ 200558%฀ at฀ December฀ 2004 200331,฀ 2000฀ to฀ 39%฀ at฀ in฀2003.฀ December฀31,฀2005. Share฀repurchases฀and฀dividends—We฀also฀used฀cash฀in฀each฀ Debt-To-Total Capital Ratio Debt-To-Total Capital Ratio (In percent) of฀the฀last฀three฀years฀for฀common฀share฀repurchase฀activity฀as฀ 0.5 50% follows:฀ $1,222฀ million฀ for฀ 19.7฀ million฀ common฀ shares฀ in฀ 2005,฀ of฀ which฀ $1,211฀ million฀ for฀ 19.5฀ million฀ of฀ those฀ com- 0.4 40% mon฀ shares,฀ as฀ well฀ as฀ $99฀ million฀ for฀ 1.8฀ million฀ common฀ shares฀ purchased฀ in฀ 2004,฀ was฀ settled฀ 0.3 during฀ the฀ year;฀ $772฀ 30% million฀for฀14.7฀million฀common฀shares฀in฀2004,฀of฀which฀$673฀ million฀for฀12.9฀million฀common฀shares฀was฀settled฀during฀the฀ 0.2 20% year;฀ and฀ $482฀ million฀ in฀ 2003฀ for฀ 10.7฀ million฀ common฀ shares.฀ These฀ purchases฀ were฀ made฀ 0.1 under฀ a฀ share฀ repurchase฀ 10% program฀in฀place฀for฀the฀repurchase฀of฀up฀to฀88฀million฀shares฀ of฀our฀common฀stock฀from฀time-to-time฀at฀management’s฀dis- 0.0 0% 2005 2004 2003 cretion,฀ including฀ 45฀ million฀ shares฀ that฀ were฀ authorized฀ for฀ repurchase฀ under฀ the฀ program฀ in฀ September฀ 2005.฀ As฀ of฀ Our฀ stockholders’฀ equity฀ amounted฀ to฀ $7.9฀ billion฀ at฀ December฀31,฀2005,฀we฀had฀repurchased฀a฀total฀of฀46.1฀million฀ December฀ 31,฀ 2005,฀ an฀ increase฀ of฀ $846฀ million฀ from฀ shares฀ under฀ the฀ program,฀ and฀ there฀ remained฀ approximately฀ December฀31,฀2004.฀The฀increase฀came฀from฀net฀earnings฀and฀ 41.9฀million฀shares฀that฀may฀be฀repurchased฀in฀the฀future. stock฀ plan฀ activities฀ partially฀ offset฀ by฀ our฀ share฀ repurchases฀ The฀payment฀of฀dividends฀on฀our฀common฀shares฀is฀one฀of฀ and฀payment฀of฀dividends.฀ the฀key฀components฀of฀our฀balanced฀cash฀deployment฀strategy.฀ Return฀on฀invested฀capital฀(ROIC)฀improved฀by฀370฀basis฀ Shareholders฀ were฀ paid฀ cash฀ dividends฀ of฀ $462฀ million฀ in฀ points฀during฀2005฀to฀14.5%.฀We฀define฀ROIC฀as฀net฀income฀ 2005,฀$405฀million฀in฀2004฀and฀$261฀million฀in฀2003.฀We฀have฀ plus฀after-tax฀interest฀expense฀divided฀by฀average฀invested฀cap- increased฀our฀quarterly฀dividend฀rate฀in฀each฀of฀the฀last฀three฀ ital฀(stockholders’฀equity฀plus฀debt),฀after฀adjusting฀stockhold- years.฀We฀paid฀a฀quarterly฀dividend฀of฀$0.25฀per฀share฀during฀ ers’฀ equity฀ by฀ adding฀ back฀ our฀ minimum฀ pension฀ liability฀ each฀of฀the฀first฀three฀quarters฀of฀2005฀and฀$0.30฀per฀share฀for฀ balance.฀ We฀ believe฀ that฀ reporting฀ ROIC฀ provides฀ investors฀ the฀last฀quarter฀of฀2005.฀We฀paid฀a฀quarterly฀dividend฀of฀$0.22฀ with฀ greater฀ visibility฀ into฀ how฀ effectively฀ Lockheed฀ Martin฀ per฀ share฀ during฀ each฀ of฀ the฀ first฀ three฀ quarters฀ of฀ 2004฀ and฀ uses฀ the฀ capital฀ invested฀ in฀ its฀ operations.฀ We฀ use฀ ROIC฀ to฀ $0.25฀per฀share฀for฀the฀last฀quarter฀of฀2004.฀In฀2003,฀we฀paid฀ evaluate฀ multi-year฀ investment฀ decisions฀ and฀ as฀ a฀ long-term฀ PAGE ฀ 35


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    Lockheed฀Martin฀Corporation MANAGEMENT’S฀DISCUSSION฀AND฀ANALYSIS฀OF฀ FINANCIAL฀CONDITION฀AND฀RESULTS฀OF฀OPERATIONS December฀31,฀2005 performance฀measure.฀We฀also฀use฀ROIC฀as฀a฀factor฀in฀evalu- and฀bear฀interest฀at฀rates฀based,฀at฀our฀option,฀on฀the฀Eurodollar฀ ating฀management฀performance฀under฀certain฀of฀our฀incentive฀ rate฀or฀a฀bank฀Base฀Rate฀(as฀defined).฀Each฀bank’s฀obligation฀฀ compensation฀ plans.฀ The฀ adjustment฀ to฀ add฀ back฀ the฀ mini- to฀ make฀ loans฀ under฀ the฀ credit฀ facility฀ is฀ subject฀ to,฀ among฀ mum฀pension฀liability฀is฀a฀revision฀to฀our฀calculation฀in฀2005฀ other฀ things,฀ our฀ compliance฀ with฀ various฀ representations,฀ which฀ we฀ believe฀ more฀ closely฀ links฀ ROIC฀ to฀ management฀ warranties฀ and฀ covenants,฀ including฀ covenants฀ limiting฀ our฀ performance. ability฀and฀the฀ability฀of฀certain฀of฀our฀subsidiaries฀to฀encum- ROIC฀is฀not฀a฀measure฀of฀financial฀performance฀under฀gen- ber฀our฀assets,฀and฀a฀covenant฀not฀to฀exceed฀a฀maximum฀lever- erally฀accepted฀accounting฀principles฀in฀the฀U.S.,฀and฀may฀not฀ age฀ ratio.฀ We฀ cancelled฀ our฀ $500฀ million฀ 364-day฀ credit฀ be฀defined฀and฀calculated฀by฀other฀companies฀in฀the฀same฀man- facility฀on฀June฀17,฀2005. ner.฀ROIC฀should฀not฀be฀considered฀in฀isolation฀or฀as฀an฀alterna- We฀have฀agreements฀in฀place฀with฀banking฀institutions฀to฀ tive฀to฀net฀earnings฀as฀an฀indicator฀of฀performance.฀See฀Note฀(f)฀ provide฀for฀the฀issuance฀of฀commercial฀paper.฀There฀were฀no฀ to฀ the฀ Consolidated฀ Financial฀ Data—Five฀ Year฀ Summary฀ on฀ commercial฀ paper฀ borrowings฀ outstanding฀ at฀ December฀ 31,฀ page฀74฀for฀additional฀information฀concerning฀how฀we฀calculate฀ 2005.฀ If฀ we฀ were฀ to฀ issue฀ commercial฀ paper,฀ the฀ borrowings฀ ROIC.฀That฀information฀reflects฀the฀revision฀to฀the฀calculation฀as฀ would฀be฀supported฀by฀the฀$1.5฀billion฀credit฀facility. discussed฀in฀the฀preceding฀paragraph฀for฀all฀periods฀presented. We฀ have฀ an฀ effective฀ shelf฀ registration฀ statement฀ on฀ file฀ with฀the฀Securities฀and฀Exchange฀Commission฀to฀provide฀for฀ ital Revised Return On Invested Capital Ratio(1) the฀issuance฀of฀up฀to฀$1฀billion฀in฀debt฀securities.฀If฀we฀were฀ to฀issue฀debt฀under฀this฀shelf฀registration,฀we฀would฀expect฀to฀ 15% use฀ the฀ net฀ proceeds฀ for฀ general฀ corporate฀ purposes.฀ These฀ purposes฀ may฀ include฀ repayment฀ of฀ debt,฀ working฀ capital฀ 12% needs,฀capital฀expenditures,฀acquisitions฀and฀any฀other฀general฀ 9% corporate฀purpose. We฀actively฀seek฀to฀finance฀our฀business฀in฀a฀manner฀that฀ 6% preserves฀ financial฀ flexibility฀ while฀ minimizing฀ borrowing฀ costs฀ to฀ the฀ extent฀ practicable.฀ Our฀ management฀ continually฀ 3% reviews฀changes฀in฀financial,฀market฀and฀economic฀conditions฀ to฀manage฀the฀types,฀amounts฀and฀maturities฀of฀our฀indebted- 0% ness.฀ We฀ may฀ at฀ times฀ refinance฀ existing฀ indebtedness,฀ vary฀ 2005 2004 2003 our฀ mix฀ of฀ variable-rate฀ and฀ fixed-rate฀ debt,฀ or฀ seek฀ alterna- (1) Calculation was revised in 2005. See Note (f) to the Consolidated Financial Data—Five Year tive฀financing฀sources฀for฀our฀cash฀and฀operational฀needs. Summary on page 74 for additional information Cash฀ and฀ cash฀ equivalents,฀ short-term฀ investments,฀ cash฀ on the calculation. flow฀ from฀ operations฀ and฀ other฀ available฀ financing฀ resources฀ are฀ expected฀ to฀ be฀ sufficient฀ to฀ meet฀ anticipated฀ operating,฀ At฀ December฀ 31,฀ 2005,฀ we฀ had฀ in฀ place฀ a฀ $1.5฀ billion฀ capital฀ expenditure฀ and฀ debt฀ service฀ requirements,฀ as฀ well฀ as฀ ated Backlog revolving฀credit฀facility฀which฀expires฀in฀July฀2010.฀There฀were฀ Negotiated Backlog acquisition฀and฀other฀discretionary฀investment฀needs,฀projected฀ ns) (In billions) no฀borrowings฀outstanding฀under฀the฀facility฀at฀December฀31,฀ over฀the฀next฀three฀years. $80 2005.฀Borrowings฀under฀the฀credit฀facility฀would฀be฀unsecured฀ ฀ 70 60 50 40 30 I&TS 20 IS&S Space Systems 10 Electronic Systems 0 Aeronautics 2005 2004 2003 PAGE ฀ 36


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    Lockheed฀Martin฀Corporation CONTRACTUAL฀COMMITMENTS฀AND฀฀ and฀the฀customer฀terminated฀the฀contract฀for฀convenience,฀any฀ OFF-BALANCE฀SHEET฀ARRANGEMENTS amounts฀we฀would฀be฀required฀to฀pay฀to฀settle฀the฀related฀com- At฀ December฀ 31,฀ 2005,฀ we฀ had฀ contractual฀ commitments฀ to฀ mitments,฀as฀well฀as฀amounts฀previously฀incurred,฀would฀gen- repay฀debt,฀make฀payments฀under฀operating฀leases,฀settle฀obli- erally฀be฀reimbursed฀by฀the฀customer.฀This฀would฀also฀be฀true฀ gations฀related฀to฀agreements฀to฀purchase฀goods฀and฀services,฀ in฀cases฀where฀we฀perform฀sub-contract฀work฀for฀a฀prime฀con- and฀settle฀other฀long-term฀liabilities.฀Capital฀lease฀obligations฀ tractor฀under฀a฀U.S.฀Government฀contract.฀The฀termination฀for฀ were฀ negligible.฀ Payments฀ due฀ under฀ these฀ long-term฀ obliga- convenience฀language฀may฀also฀be฀included฀in฀contracts฀with฀ tions฀and฀commitments฀are฀as฀follows: foreign,฀state฀and฀local฀governments.฀In฀addition,฀we฀have฀con- tracts฀with฀customers฀that฀do฀not฀include฀termination฀for฀con- Payments฀Due฀By฀Period venience฀ provisions,฀ including฀ contracts฀ with฀ commercial฀ Less฀Than฀฀ 1–3฀฀ 3–5฀฀ After฀ customers.฀ (In฀millions) ฀฀Total 1฀Year Years Years 5฀Years Total฀ purchase฀ obligations฀ in฀ the฀ preceding฀ table฀ related฀ Long-term฀debt (a) $฀ 4,986 $฀฀ 202 $฀ 136 $฀ 248 $4,400 to฀capital฀expenditures฀generally฀include฀amounts฀for฀facilities฀ Operating฀lease฀฀ and฀equipment฀at฀various฀of฀our฀locations,฀related฀to฀customer฀ ฀ obligations 1,157 261 386 262 248 contracts. Purchase฀obligations Amounts฀ related฀ to฀ “Other฀ long-term฀ liabilities”฀ in฀ the฀ ฀ ฀Operating฀฀ preceding฀ table฀ represent฀ the฀ contractual฀ obligations฀ for฀ cer- ฀ activities 23,566 11,001 7,880 2,752 1,933 tain฀ long-term฀ liabilities฀ recorded฀ as฀ of฀ December฀ 31,฀ 2005.฀ ฀ Capital฀฀ Such฀ amounts฀ mainly฀ include฀ expected฀ payments฀ under฀ ฀ ฀ expenditures 462 344 118 — — deferred฀compensation฀plans,฀non-qualified฀pension฀plans฀and฀ Other฀long-term฀฀ environmental฀liabilities.฀Obligations฀related฀to฀environmental฀ ฀ liabilities 1,289 213 256 169 651฀ liabilities฀represent฀our฀estimate฀of฀remediation฀payment฀obli- Total฀contractual฀฀ gations฀ under฀ government฀ consent฀ decrees฀ and฀ agreements,฀ ฀ cash฀obligations $31,460 $12,021 $ 8,776 $3,431 $7,232 excluding฀amounts฀reimbursed฀by฀the฀U.S.฀Government฀in฀its฀ (a)฀ Long-term฀debt฀includes฀scheduled฀principal฀payments฀only. capacity฀as฀a฀potentially฀responsible฀party฀under฀an฀agreement฀ entered฀into฀in฀2000. Generally,฀ our฀ long-term฀ debt฀ obligations฀ are฀ subject฀ to,฀ We฀ also฀ may฀ enter฀ into฀ industrial฀ participation฀ agree- along฀ with฀ other฀ things,฀ compliance฀ with฀ certain฀ covenants,฀ ments,฀sometimes฀referred฀to฀as฀offset฀agreements,฀as฀a฀condi- including฀covenants฀limiting฀our฀ability฀and฀the฀ability฀of฀cer- tion฀ to฀ obtaining฀ orders฀ for฀ our฀ products฀ and฀ services฀ from฀ tain฀of฀our฀subsidiaries฀to฀encumber฀our฀assets. certain฀ customers฀ in฀ foreign฀ countries.฀ These฀ agreements฀ are฀ Purchase฀obligations฀related฀to฀operating฀activities฀include฀ designed฀to฀enhance฀the฀social฀and฀economic฀environment฀of฀ agreements฀ and฀ requirements฀ contracts฀ that฀ give฀ the฀ supplier฀ the฀ foreign฀ country฀ by฀ requiring฀ the฀ contractor฀ to฀ promote฀ recourse฀ to฀ us฀ for฀ cancellation฀ or฀ nonperformance฀ under฀ the฀ investment฀in฀the฀country.฀Offset฀agreements฀may฀be฀satisfied฀ contract฀ or฀ contain฀ terms฀ that฀ would฀ subject฀ us฀ to฀ liquidated฀ through฀activities฀that฀do฀not฀require฀us฀to฀use฀cash,฀including฀ damages.฀Such฀agreements฀and฀contracts฀may,฀for฀example,฀be฀ transferring฀ technology,฀ providing฀ manufacturing฀ and฀ other฀ related฀ to฀ direct฀ materials,฀ obligations฀ to฀ sub-contractors฀ and฀ consulting฀support฀to฀in-country฀projects,฀and฀the฀purchase฀by฀ outsourcing฀ arrangements.฀ Total฀ purchase฀ obligations฀ in฀ the฀ third฀ parties฀ (e.g.,฀ our฀ vendors)฀ of฀ supplies฀ from฀ in-country฀ preceding฀ table฀ include฀ approximately฀ $22฀ billion฀ related฀ to฀ vendors.฀These฀agreements฀may฀also฀be฀satisfied฀through฀our฀ contractual฀commitments฀entered฀into฀as฀a฀result฀of฀contracts฀ use฀of฀cash฀for฀such฀activities฀as฀purchasing฀supplies฀from฀in- we฀ have฀ with฀ our฀ U.S.฀ Government฀ customers.฀ However,฀ the฀ country฀ vendors,฀ providing฀ financial฀ support฀ for฀ in-country฀ U.S.฀ Government฀ would฀ generally฀ be฀ required฀ to฀ pay฀ us฀ for฀ projects,฀and฀building฀or฀leasing฀facilities฀for฀in-country฀oper- any฀costs฀we฀incur฀relative฀to฀these฀commitments฀if฀they฀were฀ ations.฀We฀do฀not฀commit฀to฀offset฀agreements฀until฀orders฀for฀ to฀terminate฀the฀related฀contracts฀“for฀convenience”฀pursuant฀ our฀products฀or฀services฀are฀definitive.฀Offset฀programs฀gener- to฀ FAR.฀ For฀ example,฀ if฀ we฀ had฀ commitments฀ to฀ purchase฀ ally฀extend฀over฀several฀years฀and฀may฀provide฀for฀penalties฀in฀ goods฀and฀services฀that฀were฀entered฀into฀as฀a฀result฀of฀a฀spe- the฀event฀we฀fail฀to฀perform฀in฀accordance฀with฀offset฀require- cific฀contract฀we฀received฀from฀our฀U.S.฀Government฀customer฀ ments.฀ No฀ such฀ penalties฀ have฀ been฀ incurred฀ during฀ the฀ last฀ PAGE ฀ 37


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    Lockheed฀Martin฀Corporation MANAGEMENT’S฀DISCUSSION฀AND฀ANALYSIS฀OF฀ FINANCIAL฀CONDITION฀AND฀RESULTS฀OF฀OPERATIONS December฀31,฀2005 five฀ years.฀ The฀ amounts฀ ultimately฀ applied฀ against฀ our฀ offset฀ At฀ December฀ 31,฀ 2005,฀ we฀ had฀ no฀ material฀ off-balance฀ agreements฀ are฀ based฀ on฀ negotiations฀ with฀ the฀ customer฀ and฀ sheet฀arrangements฀as฀those฀arrangements฀are฀defined฀by฀the฀ generally฀require฀cash฀outlays฀that฀represent฀only฀a฀fraction฀of฀ Securities฀and฀Exchange฀Commission฀(SEC).฀ the฀original฀amount฀in฀the฀offset฀agreement.฀At฀December฀31,฀ 2005,฀we฀had฀outstanding฀offset฀agreements฀totaling฀$8.4฀bil- QUANTITATIVE฀AND฀QUALITATIVE฀DISCLOSURE฀ lion,฀primarily฀related฀to฀our฀Aeronautics฀segment,฀that฀extend฀ OF฀MARKET฀RISK฀ through฀ 2015.฀ To฀ the฀ extent฀ we฀ have฀ entered฀ into฀ purchase฀ Our฀main฀exposure฀to฀market฀risk฀relates฀to฀interest฀rates฀and฀ obligations฀at฀December฀31,฀2005฀that฀also฀satisfy฀offset฀agree- foreign฀ currency฀ exchange฀ rates.฀ Our฀ financial฀ instruments฀ ments,฀those฀amounts฀are฀included฀in฀the฀preceding฀table. that฀are฀subject฀to฀interest฀rate฀risk฀principally฀include฀fixed- We฀ have฀ entered฀ into฀ standby฀ letter฀ of฀ credit฀ agreements฀ rate฀and฀floating฀rate฀long-term฀debt.฀If฀interest฀rates฀were฀to฀ and฀other฀arrangements฀with฀financial฀institutions฀and฀custom- change฀by฀plus฀or฀minus฀1%,฀interest฀expense฀would฀increase฀ ers฀mainly฀relating฀to฀advances฀received฀from฀customers฀and/or฀ or฀decrease฀by฀approximately฀$10฀million฀related฀to฀our฀float- the฀guarantee฀of฀future฀performance฀on฀some฀of฀our฀contracts.฀ ing฀ rate฀ debt.฀ The฀ estimated฀ fair฀ values฀ of฀ the฀ Corporation’s฀ At฀ December฀ 31,฀ 2005,฀ we฀ had฀ outstanding฀ letters฀ of฀ credit,฀ long-term฀debt฀instruments฀at฀December฀31,฀2005฀aggregated฀ surety฀bonds฀and฀guarantees,฀as฀follows: approximately฀$6.2฀billion,฀compared฀with฀a฀carrying฀amount฀ of฀ approximately฀ $5.0฀ billion.฀ The฀ majority฀ of฀ our฀ long-term฀ Commitment฀Expiration฀By฀Period debt฀obligations฀are฀not฀callable฀until฀maturity.฀We฀have฀used฀ Less฀ After฀ interest฀rate฀swaps฀in฀the฀past฀to฀manage฀our฀exposure฀to฀fixed฀ Total฀ Than฀฀ 1–3฀฀ 3–5฀฀ 5฀ and฀variable฀interest฀rates;฀however,฀at฀year-end฀2005,฀we฀had฀ (In฀millions) Commitment 1฀Year (a) Years (a) Years Years no฀such฀agreements฀in฀place. Standby฀letters฀฀ We฀use฀forward฀foreign฀exchange฀contracts฀to฀manage฀our฀ ฀ of฀credit $2,630 $2,425 $171 $18 $16 exposure฀ to฀ fluctuations฀ in฀ foreign฀ currency฀ exchange฀ rates,฀ Surety฀bonds 434 79 352 3 — and฀do฀so฀in฀ways฀that฀qualify฀for฀hedge฀accounting฀treatment.฀ Guarantees 2 1 1 — —฀ These฀exchange฀contracts฀hedge฀the฀fluctuations฀in฀cash฀flows฀ Total฀commitments $3,066 $2,505 $524 $21 $16 associated฀ with฀ firm฀ commitments฀ or฀ specific฀ anticipated฀ (a)฀ ฀Approximately฀ $2,262฀ million฀ and฀ $49฀ million฀ of฀ standby฀ letters฀ of฀ credit฀ in฀ the฀ transactions฀ contracted฀ in฀ foreign฀ currencies,฀ or฀ hedge฀ the฀ “Less฀Than฀1฀Year”฀and฀“1-3฀Year”฀periods,฀respectively,฀and฀approximately฀$38฀ exposure฀ to฀ rate฀ changes฀ affecting฀ foreign฀ currency฀ denomi- million฀of฀surety฀bonds฀in฀the฀“Less฀Than฀1฀Year”฀period฀are฀expected฀to฀renew฀for฀ nated฀ assets฀ or฀ liabilities.฀ Related฀ gains฀ and฀ losses฀ on฀ these฀ additional฀periods฀until฀completion฀of฀the฀contractual฀obligation. contracts,฀ to฀ the฀ extent฀ they฀ are฀ effective฀ hedges,฀ are฀ recog- nized฀ in฀ income฀ at฀ the฀ same฀ time฀ the฀ hedged฀ transaction฀ is฀ Included฀in฀the฀table฀above฀is฀approximately฀$200฀million฀ recognized฀ or฀ when฀ the฀ hedged฀ asset฀ or฀ liability฀ is฀ adjusted.฀ representing฀letter฀of฀credit฀and฀surety฀bond฀amounts฀for฀which฀ To฀ the฀ extent฀ the฀ hedges฀ are฀ ineffective,฀ gains฀ and฀ losses฀ on฀ related฀ obligations฀ or฀ liabilities฀ are฀ also฀ recorded฀ in฀ the฀ bal- the฀ contracts฀ are฀ recognized฀ in฀ the฀ current฀ period.฀ At฀ ance฀ sheet,฀ either฀ as฀ reductions฀ of฀ inventories,฀ as฀ customer฀ December฀31,฀2005,฀the฀fair฀value฀of฀forward฀exchange฀con- advances฀and฀amounts฀in฀excess฀of฀costs฀incurred,฀or฀as฀other฀ tracts฀outstanding,฀as฀well฀as฀the฀amounts฀of฀gains฀and฀losses฀ liabilities.฀ Approximately฀ $2฀ billion฀ of฀ the฀ standby฀ letters฀ of฀ recorded฀ during฀ the฀ year฀ then฀ ended,฀ were฀ not฀ material.฀ We฀ credit฀ in฀ the฀ table฀ above฀ were฀ to฀ secure฀ advance฀ payments฀ do฀not฀hold฀or฀issue฀derivative฀financial฀instruments฀for฀trad- received฀ under฀ an฀ F-16฀ contract฀ from฀ an฀ international฀ cus- ing฀or฀speculative฀purposes. tomer.฀ These฀ letters฀ of฀ credit฀ are฀ available฀ for฀ draw฀ down฀ in฀ the฀ event฀ of฀ our฀ nonperformance,฀ and฀ the฀ amount฀ available฀ RECENT฀ACCOUNTING฀PRONOUNCEMENTS will฀be฀reduced฀as฀certain฀events฀occur฀throughout฀the฀period฀ In฀ December฀ 2004,฀ the฀ FASB฀ issued฀ FAS฀ 123(R),฀ Share- of฀performance฀in฀accordance฀with฀the฀contract฀terms.฀Similar฀ Based฀Payments,฀which฀will฀impact฀our฀net฀earnings฀and฀earn- to฀ the฀ letters฀ of฀ credit฀ for฀ the฀ F-16฀ contract,฀ other฀ letters฀ of฀ ings฀per฀share฀and฀change฀the฀classification฀of฀certain฀elements฀ credit฀ and฀ surety฀ bonds฀ are฀ available฀ for฀ draw฀ down฀ in฀ the฀ of฀ the฀ statement฀ of฀ cash฀ flows.฀ FAS฀ 123(R)฀ requires฀ stock฀ event฀of฀our฀nonperformance. options฀and฀other฀share-based฀payments฀made฀to฀employees฀to฀ be฀accounted฀for฀as฀compensation฀expense฀and฀recorded฀at฀fair฀ PAGE ฀ 38


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    Lockheed฀Martin฀Corporation value,฀ and฀ to฀ reflect฀ the฀ related฀ excess฀ tax฀ benefit฀ received฀ FIN฀ 47฀ also฀ clarifies฀ when฀ an฀ entity฀ would฀ have฀ sufficient฀ upon฀ exercise฀ of฀ the฀ options,฀ if฀ any,฀ in฀ the฀ statement฀ of฀ cash฀ information฀ to฀ reasonably฀ estimate฀ the฀ fair฀ value฀ of฀ an฀ asset฀ flows฀as฀a฀financing฀activity฀inflow฀rather฀than฀an฀adjustment฀ retirement฀obligation.฀The฀adoption฀of฀FIN฀47฀did฀not฀have฀a฀ of฀operating฀activity฀as฀currently฀presented.฀We฀currently฀use฀ significant฀impact฀on฀our฀financial฀position฀or฀results฀of฀opera- the฀Black-Scholes฀model฀to฀compute฀the฀fair฀value฀of฀our฀stock฀ tions.฀This฀is฀primarily฀due฀to฀the฀fact฀that฀the฀fair฀values฀of฀ options฀ in฀ connection฀ with฀ our฀ disclosure฀ of฀ the฀ pro฀ forma฀ the฀ majority฀ of฀ our฀ asset฀ retirement฀ obligations฀ could฀ not฀ be฀ effects฀on฀net฀earnings฀and฀earnings฀per฀share฀as฀if฀compensa- reasonably฀ estimated฀ because฀ they฀ had฀ indeterminate฀ settle- tion฀cost฀had฀been฀recognized฀for฀such฀options฀at฀the฀date฀of฀ ment฀dates,฀since฀the฀range฀of฀time฀over฀which฀we฀may฀settle฀ grant฀(see฀Note฀1฀to฀the฀financial฀statements).฀ the฀ obligations฀ is฀ unknown฀ and฀ could฀ not฀ be฀ estimated.฀ ฀We฀adopted฀FAS฀123(R),฀and฀related฀SEC฀rules฀included฀ Consistent฀with฀the฀provisions฀of฀FIN฀47,฀each฀obligation฀will฀ in฀ SAB฀ No.฀ 107,฀ on฀ a฀ modified฀ prospective฀ basis฀ effective฀ be฀recorded฀at฀the฀time฀the฀settlement฀date฀is฀no฀longer฀inde- January฀ 1,฀ 2006.฀ We฀ will฀ continue฀ to฀ use฀ the฀ Black-Scholes฀ terminate฀and฀the฀obligation฀can฀be฀reasonably฀estimated.฀ option-pricing฀model฀to฀estimate฀the฀fair฀value฀of฀stock฀options฀ In฀May฀2004,฀the฀Financial฀Accounting฀Standards฀Board฀ granted฀ subsequent฀ to฀ the฀ date฀ of฀ adoption.฀ The฀ Lockheed฀ (FASB)฀ issued฀ FASB฀ Staff฀ Position฀ (FSP)฀ 106-2,฀ Accounting฀ Martin฀ Amended฀ and฀ Restated฀ 2003฀ Incentive฀ Performance฀ and฀ Disclosure฀ Requirements฀ Related฀ to฀ the฀ Medicare฀ Award฀ Plan฀ provides฀ for฀ the฀ grant฀ of฀ various฀ types฀ of฀ stock- Prescription฀ Drug,฀ Improvement฀ and฀ Modernization฀ Act฀ of฀ based฀ incentive฀ awards,฀ including฀ options฀ to฀ purchase฀ com- 2003.฀This฀FSP฀provides฀specific฀authoritative฀guidance฀on฀the฀ mon฀stock,฀stock฀appreciation฀rights,฀restricted฀stock฀and฀stock฀ accounting฀ for฀ the฀ federal฀ subsidy฀ to฀ eligible฀ sponsors฀ of฀ units.฀The฀types฀and฀mix฀of฀stock-based฀incentive฀awards฀are฀ retiree฀health฀care฀benefits฀provided฀under฀this฀law.฀Using฀this฀ evaluated฀on฀an฀ongoing฀basis฀and฀may฀vary฀based฀on฀manage- guidance,฀we฀estimated฀a฀projected฀reduction฀in฀our฀accumu- ment’s฀ overall฀ strategy฀ regarding฀ compensation,฀ including฀ lated฀ postretirement฀ benefit฀ obligation฀ as฀ of฀ December฀ 31,฀ consideration฀ of฀ the฀ impact฀ of฀ the฀ expensing฀ of฀ stock฀ option฀ 2004฀ of฀ $295฀ million฀ from฀ the฀ effects฀ of฀ the฀ new฀ law.฀ This฀ awards฀on฀our฀results฀of฀operations฀subsequent฀to฀the฀adoption฀ obligation฀will฀be฀recognized฀over฀the฀remaining฀service฀lives฀ of฀FAS฀123(R).฀Based฀on฀current฀analyses฀and฀information,฀we฀ of฀the฀employees฀eligible฀for฀the฀benefit.฀In฀January฀2005,฀the฀ expect฀ that฀ the฀ combination฀ of฀ expensing฀ stock฀ options฀ upon฀ Center฀ for฀ Medicare฀ and฀ Medicaid฀ Services฀ released฀ regula- adoption฀of฀FAS฀123(R)฀in฀2006฀and฀grants฀of฀restricted฀stock฀ tions฀governing฀the฀application฀of฀the฀law฀and฀continued฀to฀pro- units฀will฀result฀in฀additional฀expense,฀net฀of฀state฀income฀tax฀ vide฀clarifying฀guidance฀during฀2005.฀Based฀on฀this฀guidance,฀ benefits,฀ totaling฀ approximately฀ $100฀ million฀ (or฀ a฀ reduction฀ the฀impact฀of฀adoption฀of฀the฀FSP฀was฀a฀reduction฀of฀the฀FAS฀ in฀net฀earnings฀per฀share฀of฀$0.15)฀on฀a฀full฀year฀basis.฀ 106฀ postretirement฀ expense฀ for฀ the฀ year฀ ended฀ December฀ 31,฀ We฀ also฀ adopted฀ FASB฀ Interpretation฀ No.฀ (FIN)฀ 47,฀ 2005฀ of฀ approximately฀ $35฀ million.฀ The฀ postretirement฀ Accounting฀for฀Conditional฀Asset฀Retirement฀Obligations—an฀ expense฀computed฀under฀FAS฀106฀does฀not฀include฀the฀effects฀ interpretation฀of฀FASB฀Statement฀No.฀143,฀in฀the฀fourth฀quarter฀ of฀U.S.฀Government฀Cost฀Accounting฀Standards฀or฀income฀tax฀ of฀2005.฀FIN฀47฀clarifies฀the฀term฀“conditional฀asset฀retirement฀ benefits.฀ The฀ adoption฀ of฀ the฀ FSP฀ did฀ not฀ have฀ a฀ material฀ obligation”฀as฀used฀in฀FAS฀143,฀Accounting฀for฀Asset฀Retirement฀ impact฀on฀our฀results฀of฀operations,฀financial฀position฀or฀cash฀ Obligations,฀ and฀ requires฀ that฀ a฀ liability฀ and฀ a฀ corresponding฀ flows฀for฀the฀year฀ended฀December฀31,฀2005. increase฀in฀the฀value฀of฀the฀underlying฀asset฀be฀recorded,฀and฀ depreciation฀ on฀ the฀ increased฀ asset฀ value฀ be฀ expensed,฀ if฀ the฀ fair฀ value฀ of฀ the฀ obligation฀ can฀ be฀ reasonably฀ estimated.฀ The฀ types฀ of฀ asset฀ retirement฀ obligations฀ that฀ are฀ covered฀ by฀ FIN฀47฀are฀those฀for฀which฀an฀entity฀has฀a฀legal฀obligation฀to฀ perform฀ an฀ asset฀ retirement฀ activity,฀ even฀ though฀ the฀ timing฀ and/or฀ method฀ of฀ settling฀ the฀ obligation฀ are฀ conditional฀ on฀ a฀ future฀event฀that฀may฀or฀may฀not฀be฀within฀the฀control฀of฀the฀ entity.฀An฀example฀of฀a฀condition฀giving฀rise฀to฀an฀asset฀retire- ment฀obligation฀is฀the฀presence฀of฀embedded฀asbestos,฀radiation฀ sources฀or฀other฀regulated฀materials฀in฀buildings฀or฀equipment.฀ PAGE ฀ 39


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    Lockheed฀Martin฀Corporation MANAGEMENT’S฀DISCUSSION฀AND฀ANALYSIS฀OF฀ FINANCIAL฀CONDITION฀AND฀RESULTS฀OF฀OPERATIONS December฀31,฀2005 CONTROLS฀AND฀PROCEDURES We฀ performed฀ an฀ evaluation฀ of฀ the฀ effectiveness฀ of฀ our฀ We฀ maintain฀ disclosure฀ controls฀ and฀ procedures,฀ including฀ disclosure฀controls฀and฀procedures,฀including฀internal฀control฀ internal฀ control฀ over฀ financial฀ reporting,฀ that฀ are฀ designed฀ to฀ over฀financial฀reporting,฀as฀of฀December฀31,฀2005.฀The฀evalua- ensure฀ that฀ information฀ required฀ to฀ be฀ disclosed฀ in฀ our฀ peri- tion฀ was฀ performed฀ with฀ the฀ participation฀ of฀ senior฀ manage- odic฀filings฀with฀the฀SEC฀is฀reported฀within฀the฀time฀periods฀ ment฀ of฀ each฀ business฀ segment฀ and฀ key฀ Corporate฀ functions,฀ specified฀in฀the฀SEC’s฀rules฀and฀forms,฀and฀to฀provide฀reason- and฀under฀the฀supervision฀of฀the฀CEO฀and฀CFO.฀Based฀on฀our฀ able฀assurance฀that฀assets฀are฀safeguarded฀and฀transactions฀are฀ evaluation,฀we฀concluded฀that฀our฀disclosure฀controls฀and฀pro- properly฀ executed฀ and฀ recorded.฀ Our฀ disclosure฀ controls฀ and฀ cedures฀were฀effective฀as฀of฀December฀31,฀2005.฀ procedures฀ are฀ also฀ designed฀ to฀ ensure฀ that฀ information฀ is฀ During฀2005,฀we฀also฀performed฀a฀separate฀evaluation฀of฀ accumulated฀and฀communicated฀to฀our฀management,฀including฀ our฀ internal฀ control฀ over฀ financial฀ reporting฀ in฀ accordance฀ our฀Chief฀Executive฀Officer฀(CEO)฀and฀Chief฀Financial฀Officer฀ with฀Section฀404฀of฀the฀Sarbanes-Oxley฀Act,฀including฀perform- (CFO),฀ as฀ appropriate,฀ to฀ allow฀ timely฀ decisions฀ regarding฀ ing฀self-assessment฀and฀monitoring฀procedures.฀Based฀on฀those฀ required฀disclosure.฀In฀designing฀and฀evaluating฀such฀controls฀ activities฀ and฀ other฀ evaluation฀ procedures,฀ our฀ management,฀ and฀procedures,฀we฀recognize฀that฀any฀controls฀and฀procedures,฀ including฀ the฀ CEO฀ and฀ CFO,฀ concluded฀ that฀ internal฀ control฀ no฀ matter฀ how฀ well฀ designed฀ and฀ operated,฀ can฀ provide฀ only฀ over฀ financial฀ reporting฀ was฀ effective฀ as฀ of฀ December฀ 31,฀ reasonable฀ assurance฀ of฀ achieving฀ the฀ desired฀ control฀ objec- 2005.฀ Management’s฀ report฀ on฀ our฀ financial฀ statements฀ and฀ tives,฀and฀management฀necessarily฀is฀required฀to฀use฀its฀judg- internal฀ control฀ over฀ financial฀ reporting฀ appears฀ on฀ page฀ 41.฀ ment฀ in฀ evaluating฀ the฀ cost-benefit฀ relationship฀ of฀ possible฀ In฀addition,฀both฀our฀assessment฀and฀the฀effectiveness฀of฀inter- controls฀and฀procedures.฀Also,฀we฀have฀investments฀in฀certain฀ nal฀control฀over฀financial฀reporting฀were฀audited฀by฀our฀inde- unconsolidated฀entities.฀As฀we฀do฀not฀control฀or฀manage฀these฀ pendent฀registered฀public฀accounting฀firm.฀Their฀report฀appears฀ entities,฀our฀controls฀and฀procedures฀with฀respect฀to฀those฀enti- on฀page฀42. ties฀ are฀ necessarily฀ substantially฀ more฀ limited฀ than฀ those฀ we฀ There฀were฀no฀changes฀in฀our฀internal฀control฀over฀finan- maintain฀with฀respect฀to฀our฀consolidated฀subsidiaries. cial฀reporting฀during฀the฀most฀recently฀completed฀fiscal฀quar- We฀ routinely฀ review฀ our฀ system฀ of฀ internal฀ control฀ over฀ ter฀ that฀ materially฀ affected,฀ or฀ are฀ reasonably฀ likely฀ to฀ financial฀ reporting฀ and฀ make฀ changes฀ to฀ our฀ processes฀ and฀ materially฀affect,฀our฀internal฀control฀over฀financial฀reporting. systems฀ to฀ improve฀ controls฀ and฀ increase฀ efficiency,฀ while฀ ensuring฀ that฀ we฀ maintain฀ an฀ effective฀ internal฀ control฀ envi- ronment.฀Changes฀may฀include฀such฀activities฀as฀implementing฀ new,฀more฀efficient฀systems,฀consolidating฀the฀activities฀of฀two฀ or฀more฀business฀units,฀and฀migrating฀certain฀processes฀to฀our฀ Shared฀ Services฀ centers.฀ In฀ addition,฀ when฀ we฀ acquire฀ new฀ businesses,฀ we฀ review฀ the฀ controls฀ and฀ procedures฀ of฀ the฀ acquired฀business฀as฀part฀of฀our฀integration฀activities. PAGE ฀ 4 0


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    Lockheed฀Martin฀Corporation MANAGEMENT’S฀REPORT฀ON฀THE฀FINANCIAL฀STATEMENTS฀AND INTERNAL฀CONTROL฀OVER฀FINANCIAL฀REPORTING The฀management฀of฀Lockheed฀Martin฀is฀responsible฀for฀the฀consolidated฀financial฀statements฀and฀all฀related฀financial฀infor- mation฀contained฀in฀this฀Annual฀Report฀on฀Form฀10-K.฀The฀consolidated฀financial฀statements,฀which฀include฀amounts฀based฀on฀ estimates฀and฀judgments,฀have฀been฀prepared฀in฀accordance฀with฀accounting฀principles฀generally฀accepted฀in฀the฀United฀States.฀ Management฀believes฀the฀consolidated฀financial฀statements฀fairly฀present,฀in฀all฀material฀respects,฀the฀financial฀condition,฀results฀ of฀operations฀and฀cash฀flows฀of฀the฀Corporation.฀The฀consolidated฀financial฀statements฀have฀been฀audited฀by฀Ernst฀&฀Young฀LLP,฀ an฀independent฀registered฀public฀accounting฀firm,฀as฀stated฀in฀their฀report฀included฀herein. The฀ management฀ of฀ Lockheed฀ Martin฀ is฀ also฀ responsible฀ for฀ establishing฀ and฀ maintaining฀ an฀ adequate฀ system฀ of฀ internal฀ control฀over฀financial฀reporting฀of฀the฀Corporation฀(as฀defined฀by฀the฀Securities฀Exchange฀Act฀of฀1934).฀This฀system฀is฀designed฀ to฀provide฀reasonable฀assurance,฀based฀on฀an฀appropriate฀cost-benefit฀relationship,฀that฀assets฀are฀safeguarded฀and฀transactions฀are฀ properly฀ executed฀ and฀ recorded.฀ An฀ environment฀ that฀ provides฀ for฀ an฀ appropriate฀ level฀ of฀ control฀ consciousness฀ is฀ maintained฀ through฀a฀comprehensive฀program฀of฀management฀testing฀to฀identify฀and฀correct฀deficiencies,฀examinations฀by฀internal฀auditors฀ and฀ audits฀ by฀ the฀ Defense฀ Contract฀ Audit฀ Agency฀ for฀ compliance฀ with฀ federal฀ government฀ rules฀ and฀ regulations฀ applicable฀ to฀ contracts฀with฀the฀U.S.฀Government. Management฀ conducted฀ an฀ evaluation฀ of฀ the฀ effectiveness฀ of฀ the฀ Corporation’s฀ system฀ of฀ internal฀ control฀ over฀ financial฀ reporting฀based฀on฀the฀framework฀in฀Internal฀Control–Integrated฀Framework฀issued฀by฀the฀Committee฀of฀Sponsoring฀Organizations฀ of฀the฀Treadway฀Commission.฀Based฀on฀this฀evaluation,฀management฀concluded฀that฀the฀Corporation’s฀system฀of฀internal฀control฀ over฀financial฀reporting฀was฀effective฀as฀of฀December฀31,฀2005.฀Management’s฀assessment฀has฀been฀audited฀by฀Ernst฀&฀Young฀ LLP,฀as฀stated฀in฀their฀report฀included฀herein. 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).฀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฀are฀forwarded฀directly฀ to฀the฀Audit฀Committee฀of฀the฀Corporation’s฀Board฀of฀Directors. The฀Audit฀Committee,฀which฀is฀composed฀of฀five฀directors฀who฀are฀not฀members฀of฀management,฀has฀oversight฀responsibility฀ for฀the฀Corporation’s฀financial฀reporting฀process฀and฀the฀audits฀of฀the฀consolidated฀financial฀statements฀and฀internal฀control฀over฀ financial฀ reporting.฀ Both฀ the฀ independent฀ auditors฀ and฀ the฀ internal฀ auditors฀ meet฀ periodically฀ with฀ members฀ of฀ the฀ Audit฀ Committee,฀with฀or฀without฀management฀representatives฀present.฀The฀Audit฀Committee฀recommended,฀and฀the฀Board฀of฀Directors฀ approved,฀that฀the฀audited฀consolidated฀financial฀statements฀be฀included฀in฀the฀Corporation’s฀Annual฀Report฀on฀Form฀10-K฀for฀ filing฀with฀the฀Securities฀and฀Exchange฀Commission. ฀ ฀฀ ฀ ROBERT฀J.฀STEVENS฀ CHRISTOPHER฀E.฀KUBASIK ฀ Chairman,฀President฀and฀Chief฀ Executive฀Vice฀President฀and฀Chief฀ ฀ Executive฀Officer฀ Financial฀Officer PAGE ฀ 41


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    Lockheed฀Martin฀Corporation REPORT฀OF฀ERNST฀&฀YOUNG฀LLP,฀INDEPENDENT฀REGISTERED฀PUBLIC฀ ACCOUNTING฀FIRM,฀REGARDING฀INTERNAL฀CONTROL฀OVER฀FINANCIAL฀REPORTING Board฀of฀Directors฀and฀Stockholders Lockheed฀Martin฀Corporation We฀have฀audited฀management’s฀assessment,฀included฀in฀the฀accompanying฀Management’s฀Report฀on฀the฀Financial฀Statements฀ and฀ Internal฀ Control฀ Over฀ Financial฀ Reporting,฀ that฀ Lockheed฀ Martin฀ Corporation฀ maintained฀ effective฀ internal฀ control฀ over฀ financial฀reporting฀as฀of฀December฀31,฀2005,฀based฀on฀criteria฀established฀in฀Internal฀Control–Integrated฀Framework฀issued฀by฀the฀ Committee฀of฀Sponsoring฀Organizations฀of฀the฀Treadway฀Commission฀(the฀COSO฀criteria).฀Lockheed฀Martin฀Corporation’s฀man- agement฀is฀responsible฀for฀maintaining฀effective฀internal฀control฀over฀financial฀reporting฀and฀for฀its฀assessment฀of฀the฀effective- ness฀of฀internal฀control฀over฀financial฀reporting.฀Our฀responsibility฀is฀to฀express฀an฀opinion฀on฀management’s฀assessment฀and฀an฀ opinion฀on฀the฀effectiveness฀of฀the฀Corporation’s฀internal฀control฀over฀financial฀reporting฀based฀on฀our฀audit. We฀ conducted฀ our฀ audit฀ in฀ accordance฀ with฀ the฀ standards฀ of฀ the฀ Public฀ Company฀ Accounting฀ Oversight฀ Board฀ (United฀ States).฀Those฀standards฀require฀that฀we฀plan฀and฀perform฀the฀audit฀to฀obtain฀reasonable฀assurance฀about฀whether฀effective฀inter- nal฀control฀over฀financial฀reporting฀was฀ maintained฀in฀all฀material฀respects.฀Our฀audit฀included฀obtaining฀an฀understanding฀of฀ internal฀ control฀ over฀ financial฀ reporting,฀ evaluating฀ management’s฀ assessment,฀ testing฀ and฀ evaluating฀ the฀ design฀ and฀ operating฀ effectiveness฀ of฀ internal฀ control,฀ and฀ performing฀ such฀ other฀ procedures฀ as฀ we฀ considered฀ necessary฀ in฀ the฀ circumstances.฀฀ We฀believe฀that฀our฀audit฀provides฀a฀reasonable฀basis฀for฀our฀opinion. A฀ company’s฀ internal฀ control฀ over฀ financial฀ reporting฀ is฀ a฀ process฀ designed฀ to฀ provide฀ reasonable฀ assurance฀ regarding฀ the฀ reliability฀of฀financial฀reporting฀and฀the฀preparation฀of฀financial฀statements฀for฀external฀purposes฀in฀accordance฀with฀generally฀ accepted฀accounting฀principles.฀A฀company’s฀internal฀control฀over฀financial฀reporting฀includes฀those฀policies฀and฀procedures฀that฀ (1)฀pertain฀to฀the฀maintenance฀of฀records฀that,฀in฀reasonable฀detail,฀accurately฀and฀fairly฀reflect฀the฀transactions฀and฀dispositions฀ of฀the฀assets฀of฀the฀company;฀(2)฀provide฀reasonable฀assurance฀that฀transactions฀are฀recorded฀as฀necessary฀to฀permit฀preparation฀ of฀ financial฀ statements฀ in฀ accordance฀ with฀ generally฀ accepted฀ accounting฀ principles,฀ and฀ that฀ receipts฀ and฀ expenditures฀ of฀ the฀ company฀are฀being฀made฀only฀in฀accordance฀with฀authorizations฀of฀management฀and฀directors฀of฀the฀company;฀and฀(3)฀provide฀ reasonable฀assurance฀regarding฀prevention฀or฀timely฀detection฀of฀unauthorized฀acquisition,฀use,฀or฀disposition฀of฀the฀company’s฀ assets฀that฀could฀have฀a฀material฀effect฀on฀the฀financial฀statements. Because฀of฀its฀inherent฀limitations,฀internal฀control฀over฀financial฀reporting฀may฀not฀prevent฀or฀detect฀misstatements.฀Also,฀ projections฀ of฀ any฀ evaluation฀ of฀ effectiveness฀ to฀ future฀ periods฀ are฀ subject฀ to฀ the฀ risk฀ that฀ controls฀ may฀ become฀ inadequate฀ because฀of฀changes฀in฀conditions,฀or฀that฀the฀degree฀of฀compliance฀with฀the฀policies฀or฀procedures฀may฀deteriorate. In฀our฀opinion,฀management’s฀assessment฀that฀Lockheed฀Martin฀Corporation฀maintained฀effective฀internal฀control฀over฀finan- cial฀reporting฀as฀of฀December฀31,฀2005,฀is฀fairly฀stated,฀in฀all฀material฀respects,฀based฀on฀the฀COSO฀criteria.฀Also,฀in฀our฀opinion,฀ Lockheed฀ Martin฀ Corporation฀ maintained,฀ in฀ all฀ material฀ respects,฀ effective฀ internal฀ control฀ over฀ financial฀ reporting฀ as฀ of฀ December฀31,฀2005,฀based฀on฀the฀COSO฀criteria. We฀also฀have฀audited,฀in฀accordance฀with฀the฀standards฀of฀the฀Public฀Company฀Accounting฀Oversight฀Board฀(United฀States),฀ the฀consolidated฀balance฀sheets฀of฀Lockheed฀Martin฀Corporation฀and฀subsidiaries฀as฀of฀December฀31,฀2005฀and฀2004,฀and฀the฀ related฀consolidated฀statements฀of฀earnings,฀stockholders’฀equity,฀and฀cash฀flows฀for฀each฀of฀the฀three฀years฀in฀the฀period฀ended฀ December฀ 31,฀ 2005฀ of฀ Lockheed฀ Martin฀ Corporation฀ and฀ our฀ report฀ dated฀ February฀ 22,฀ 2006฀ expressed฀ an฀ unqualified฀ opinion฀thereon. ฀ /s/฀Ernst฀&฀Young฀LLP ฀ ERNST฀&฀YOUNG฀LLP Baltimore,฀Maryland February฀22,฀2006 PAGE ฀ 42


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    Lockheed฀Martin฀Corporation REPORT฀OF฀ERNST฀&฀YOUNG฀LLP,฀INDEPENDENT฀REGISTERED฀PUBLIC฀ ACCOUNTING฀FIRM,฀ON฀THE฀AUDITED฀CONSOLIDATED฀FINANCIAL฀STATEMENTS฀ Board฀of฀Directors฀and฀Stockholders Lockheed฀Martin฀Corporation We฀ have฀ audited฀ the฀ accompanying฀ consolidated฀ balance฀ sheets฀ of฀ Lockheed฀ Martin฀ Corporation฀ and฀ subsidiaries฀ as฀ of฀ December฀31,฀2005฀and฀2004,฀and฀the฀related฀consolidated฀statements฀of฀earnings,฀stockholders’฀equity,฀and฀cash฀flows฀for฀each฀ of฀the฀three฀years฀in฀the฀period฀ended฀December฀31,฀2005.฀These฀financial฀statements฀are฀the฀responsibility฀of฀the฀Corporation’s฀ management.฀Our฀responsibility฀is฀to฀express฀an฀opinion฀on฀these฀financial฀statements฀based฀on฀our฀audits. We฀ conducted฀ our฀ audits฀ in฀ accordance฀ with฀ the฀ standards฀ of฀ the฀ Public฀ Company฀ Accounting฀ Oversight฀ Board฀ (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฀misstatement.฀An฀audit฀includes฀examining,฀on฀a฀test฀basis,฀evidence฀supporting฀the฀amounts฀and฀ disclosures฀in฀the฀financial฀statements.฀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฀financial฀statements฀referred฀to฀above฀present฀fairly,฀in฀all฀material฀respects,฀the฀consolidated฀financial฀ position฀of฀Lockheed฀Martin฀Corporation฀and฀subsidiaries฀at฀December฀31,฀2005฀and฀2004,฀and฀the฀consolidated฀results฀of฀their฀ operations฀ and฀ their฀ cash฀ flows฀ for฀ each฀ of฀ the฀ three฀ years฀ in฀ the฀ period฀ ended฀ December฀ 31,฀ 2005฀ in฀ conformity฀ with฀ U.S.฀฀ generally฀accepted฀accounting฀principles.฀ We฀also฀have฀audited,฀in฀accordance฀with฀the฀standards฀of฀the฀Public฀Company฀Accounting฀Oversight฀Board฀(United฀States),฀ the฀effectiveness฀of฀Lockheed฀Martin฀Corporation’s฀internal฀control฀over฀financial฀reporting฀as฀of฀December฀31,฀2005฀based฀on฀ criteria฀ established฀ in฀ Internal฀ Control–Integrated฀ Framework฀ issued฀ by฀ the฀ Committee฀ of฀ Sponsoring฀ Organizations฀ of฀ the฀ Treadway฀Commission฀and฀our฀report฀dated฀February฀22,฀2006฀expressed฀an฀unqualified฀opinion฀thereon. Baltimore,฀Maryland February฀22,฀2006 PAGE ฀ 43


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    Lockheed฀Martin฀Corporation CONSOLIDATED฀STATEMENT฀OF฀EARNINGS Year฀Ended฀December฀31, (In฀millions,฀except฀per฀share฀data) 2005 2004 2003 NET฀SALES Products $31,518 $30,202 $27,290 Services 5,695 5,324 4,534 37,213 35,526 31,824 COST฀OF฀SALES Products 28,800 27,879 25,306 Services 5,073 4,765 4,099 Unallocated฀Corporate฀costs 803 914 443 34,676 33,558 29,848 2,537 1,968 1,976 Other฀income฀and฀expenses,฀net 449 121 43 Operating฀profit 2,986 2,089 2,019 Interest฀expense 370 425 487 Earnings฀before฀taxes 2,616 1,664 1,532 Income฀tax฀expense 791 398 479 NET฀EARNINGS฀ $฀ 1,825 $฀ 1,266 $฀ 1,053 EARNINGS฀PER฀COMMON฀SHARE: ฀ Basic $฀ 4.15 $฀ 2.86 $฀ 2.36 ฀ Diluted฀ $฀ 4.10 $฀ 2.83 $฀ 2.34 See฀accompanying฀Notes฀to฀Consolidated฀Financial฀Statements. PAGE ฀ 4 4


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    Lockheed฀Martin฀Corporation CONSOLIDATED฀BALANCE฀SHEET December฀31, (In฀millions) 2005 2004 ASSETS Current฀assets ฀ Cash฀and฀cash฀equivalents $฀฀2,244 $฀฀1,060 ฀ Short-term฀investments 429 396 ฀ Receivables 4,579 4,094 ฀ Inventories 1,921 1,864 ฀ Deferred฀income฀taxes 861 982 ฀ Other฀current฀assets 495 557 ฀ ฀ Total฀current฀assets 10,529 8,953 Property,฀plant฀and฀equipment,฀net 3,924 3,599 Investments฀in฀equity฀securities 196 812 Goodwill 8,447 7,892 Purchased฀intangibles,฀net 560 672 Prepaid฀pension฀asset 1,360 1,030 Other฀assets 2,728 2,596 $27,744 $25,554 LIABILITIES฀AND฀STOCKHOLDERS’฀EQUITY Current฀liabilities ฀ Accounts฀payable $฀฀1,998 $฀฀1,726 ฀ Customer฀advances฀and฀amounts฀in฀excess฀of฀costs฀incurred 4,331 4,028 ฀ Salaries,฀benefits฀and฀payroll฀taxes 1,475 1,346 ฀ Current฀maturities฀of฀long-term฀debt 202 15 ฀ Other฀current฀liabilities 1,422 1,451 ฀ ฀ Total฀current฀liabilities 9,428 8,566 Long-term฀debt 4,784 5,104 Accrued฀pension฀liabilities 2,097 1,660 Other฀postretirement฀benefit฀liabilities 1,277 1,236 Other฀liabilities 2,291 1,967 Stockholders’฀equity ฀ Common฀stock,฀$1฀par฀value฀per฀share 432 438 ฀ Additional฀paid-in฀capital 1,724 2,223 ฀ Retained฀earnings 7,278 5,915 ฀ Accumulated฀other฀comprehensive฀loss (1,553) (1,532) ฀ Other (14) (23) ฀ ฀ Total฀stockholders’฀equity 7,867 7,021 $27,744 $25,554 See฀accompanying฀Notes฀to฀Consolidated฀Financial฀Statements. PAGE ฀ 45


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    Lockheed฀Martin฀Corporation CONSOLIDATED฀STATEMENT฀OF฀CASH฀FLOWS Year฀Ended฀December฀31, (In฀millions) 2005 2004 2003 OPERATING฀ACTIVITIES Net฀earnings $฀1,825 $฀1,266 $฀1,053 Adjustments฀to฀reconcile฀net฀earnings฀to฀net฀cash฀provided฀by฀operating฀activities: ฀ Depreciation฀and฀amortization 555 511 480 ฀ Amortization฀of฀purchased฀intangibles฀ 150 145 129 ฀ Deferred฀federal฀income฀taxes 24 (58) 467 ฀ Changes฀in฀operating฀assets฀and฀liabilities: ฀ ฀ Receivables (390) (87) (258) ฀ ฀ Inventories (39) 519 (94) ฀ ฀ Accounts฀payable 239 288 330 ฀ ฀ Customer฀advances฀and฀amounts฀in฀excess฀of฀costs฀incurred 296 (228) (285) ฀ Other 534 568 (13) ฀ ฀ ฀ Net฀cash฀provided฀by฀operating฀activities 3,194 2,924 1,809 INVESTING฀ACTIVITIES Expenditures฀for฀property,฀plant฀and฀equipment (865) (769) (687) Acquisition฀of฀businesses/investments฀in฀affiliated฀companies (564) (91) (821) Proceeds฀from฀divestiture฀of฀businesses/investments฀in฀affiliated฀companies 935 279 234 Purchase฀of฀short-term฀investments,฀net (33) (156) (240) Other 28 29 53 ฀ ฀ ฀ Net฀cash฀used฀for฀investing฀activities (499) (708) (1,461) FINANCING฀ACTIVITIES Repayments฀of฀long-term฀debt (133) (1,089) (2,202) Issuances฀of฀long-term฀debt — — 1,000 Long-term฀debt฀repayment฀and฀issuance฀costs (12) (163) (175) Issuances฀of฀common฀stock 406 164 44 Repurchases฀of฀common฀stock (1,310) (673) (482) Common฀stock฀dividends (462) (405) (261) ฀ ฀ ฀ Net฀cash฀used฀for฀financing฀activities (1,511) (2,166) (2,076) Net฀increase฀(decrease)฀in฀cash฀and฀cash฀equivalents 1,184 50 (1,728) Cash฀and฀cash฀equivalents฀at฀beginning฀of฀year 1,060 1,010 2,738 Cash฀and฀cash฀equivalents฀at฀end฀of฀year $฀2,244 $฀1,060 $฀1,010 See฀accompanying฀Notes฀to฀Consolidated฀Financial฀Statements. PAGE ฀ 4 6


  • Page 49

    Lockheed฀Martin฀Corporation CONSOLIDATED฀STATEMENT฀OF฀STOCKHOLDERS’฀EQUITY Accumulated Compre- Additional Other Total hensive Common Paid-In Retained Comprehensive Stockholders’ Income (In฀millions,฀except฀per฀share฀data) Stock Capital Earnings (Loss)฀Income Other Equity (Loss) Balance฀at฀December฀31,฀2002 $455 $฀2,796 $4,262 $(1,598) $(50) $฀5,865 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-based฀awards฀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 (1,204) (17) 6,756 $1,447 Net฀earnings — — 1,266 — — 1,266 $1,266 Common฀stock฀dividends฀declared฀฀ ฀ ($0.91฀per฀share) — — (405) — — (405) — Repurchases฀of฀common฀stock (15) (757) — — — (772) — Stock-based฀awards฀and฀ESOP฀activity 7 503 — — (6) 504 — Other฀comprehensive฀income฀(loss): ฀ Minimum฀pension฀liability — — — (285) — (285) (285) ฀ Reclassification฀adjustments฀related฀to฀฀ ฀ ฀ available-for-sale฀investments — — — (56) — (56) (56) ฀ Other — — — 13 — 13 13 Balance฀at฀December฀31,฀2004 438 2,223 5,915 (1,532) (23) 7,021 $฀ 938 Net฀earnings — — 1,825 — — 1,825 $1,825 Common฀stock฀dividends฀declared฀฀ ฀ ($1.05฀per฀share) — — (462) — — (462) — Repurchases฀of฀common฀stock (20) (1,202) — — — (1,222) — Stock-based฀awards฀and฀ESOP฀activity 14 703 — — 9 726 — Other฀comprehensive฀income฀(loss): ฀ Minimum฀pension฀liability — — — (105) — (105) (105) ฀ Net฀unrealized฀gain฀from฀฀ ฀ ฀ available-for-sale฀investments — — — 97 — 97 97 ฀ Other — — — (13) — (13) (13) Balance฀at฀December฀31,฀2005 $432 $฀1,724 $7,278 $(1,553) $(14) $฀7,867 $1,804 See฀accompanying฀Notes฀to฀Consolidated฀Financial฀Statements. PAGE ฀ 47


  • Page 50

    Lockheed฀Martin฀Corporation NOTES฀TO฀CONSOLIDATED฀FINANCIAL฀STATEMENTS December฀31,฀2005 NOTE฀1—SIGNIFICANT฀ACCOUNTING฀POLICIES Short-term฀ investments—The฀ Corporation’s฀ short-term฀ Organization—Lockheed฀ Martin฀ Corporation฀ (Lockheed฀ investments฀ consist฀ of฀ marketable฀ securities฀ that฀ are฀ catego- Martin฀or฀the฀Corporation)฀is฀engaged฀in฀the฀research,฀design,฀ rized฀ as฀ available-for-sale฀ securities฀ as฀ defined฀ by฀ Statement฀ development,฀manufacture,฀integration,฀operation฀and฀sustain- of฀Financial฀Accounting฀Standards฀(FAS)฀115,฀Accounting฀for฀ ment฀of฀advanced฀technology฀systems,฀products฀and฀services.฀ Certain฀ Investments฀ in฀ Debt฀ and฀ Equity฀ Securities.฀ Realized฀ As฀a฀leading฀systems฀integrator,฀its฀products฀and฀services฀range฀ gains฀ and฀ losses฀ are฀ recorded฀ in฀ other฀ income฀ and฀ expenses.฀ from฀electronics฀and฀information฀systems,฀including฀integrated฀ For฀ purposes฀ of฀ computing฀ realized฀ gains฀ and฀ losses,฀ cost฀ is฀ net-centric฀ solutions,฀ to฀ missiles,฀ aircraft,฀ spacecraft฀ and฀ determined฀ on฀ a฀ specific฀ identification฀ basis.฀ The฀ fair฀ values฀ launch฀ services.฀ The฀ Corporation฀ serves฀ customers฀ in฀ both฀ of฀marketable฀securities฀are฀estimated฀based฀on฀quoted฀market฀ domestic฀and฀international฀defense฀and฀commercial฀businesses,฀ prices฀for฀the฀respective฀securities. with฀ its฀ principal฀ customers฀ being฀ agencies฀ of฀ the฀ U.S.฀ The฀ Corporation฀ records฀ short-term฀ investments฀ at฀ fair฀ Government. value.฀At฀year฀end,฀the฀investment฀portfolio฀was฀composed฀of฀ the฀following: Basis฀ of฀ consolidation฀ and฀ classifications—The฀ consolidated฀ Year฀Ended฀December฀31, financial฀ statements฀ include฀ the฀ accounts฀ of฀ wholly-owned฀ 2005 2004 subsidiaries฀and฀other฀entities฀which฀the฀Corporation฀controls.฀ Intercompany฀balances฀and฀transactions฀have฀been฀eliminated฀ Amortized฀ Fair฀ Amortized฀ Fair฀ in฀ consolidation.฀ Receivables฀ and฀ inventories฀ are฀ primarily฀ (In฀millions) Cost Value Cost Value attributable฀to฀long-term฀contracts฀or฀programs฀in฀progress฀for฀ U.S.฀treasury฀and฀฀ which฀ the฀ related฀ operating฀ cycles฀ are฀ longer฀ than฀ one฀ year.฀฀ ฀ government฀agency฀฀ In฀accordance฀with฀industry฀practice,฀these฀items฀are฀included฀ ฀ securities $125 $124 $252 $251 in฀current฀assets.฀ Corporate฀debt฀securities 145 144 117 117 Certain฀amounts฀for฀prior฀years฀have฀been฀reclassified฀to฀ Mortgage-backed฀and฀฀ conform฀with฀the฀2005฀presentation.฀ ฀ other฀securities 161 161 28 28 $431 $429 $397 $396 Use฀ of฀ estimates—The฀ preparation฀ of฀ consolidated฀ financial฀ statements฀in฀conformity฀with฀accounting฀principles฀generally฀ Approximately฀ 60%฀ of฀ the฀ securities฀ had฀ contractual฀ accepted฀in฀the฀United฀States฀(GAAP)฀requires฀management฀to฀ maturities฀of฀one฀year฀or฀less.฀An฀additional฀36%฀of฀the฀securi- make฀estimates฀and฀assumptions,฀including฀estimates฀of฀antic- ties฀had฀contractual฀maturities฀of฀one฀to฀five฀years.฀Marketable฀ ipated฀contract฀costs฀and฀revenues฀utilized฀in฀the฀earnings฀rec- securities฀ sales฀ proceeds฀ totaled฀ $461฀ million฀ in฀ 2005฀ and฀ ognition฀ process,฀ that฀ affect฀ the฀ reported฀ amounts฀ in฀ the฀ $384฀million฀in฀2004.฀Gross฀gains฀and฀losses฀related฀to฀sales฀ financial฀ statements฀ and฀ accompanying฀ notes.฀ Due฀ to฀ the฀ size฀ of฀marketable฀securities฀for฀both฀years,฀as฀well฀as฀net฀unreal- and฀nature฀of฀many฀of฀the฀Corporation’s฀programs,฀the฀estima- ized฀gains฀and฀losses฀at฀each฀year฀end,฀were฀not฀material.฀ tion฀of฀total฀revenues฀and฀cost฀at฀completion฀is฀subject฀to฀a฀wide฀ range฀of฀variables,฀including฀assumptions฀for฀schedule฀and฀tech- Receivables—Receivables฀ consist฀ of฀ amounts฀ billed฀ and฀ cur- nical฀issues.฀Actual฀results฀may฀differ฀from฀those฀estimates. rently฀ due฀ from฀ customers,฀ and฀ unbilled฀ costs฀ and฀ accrued฀ profits฀ primarily฀ related฀ to฀ revenues฀ on฀ long-term฀ contracts฀ Cash฀ and฀ cash฀ equivalents—Cash฀ equivalents฀ are฀ generally฀ that฀have฀been฀recognized฀for฀accounting฀purposes฀but฀not฀yet฀ composed฀ of฀ highly฀ liquid฀ instruments฀ with฀ original฀ maturi- billed฀to฀customers.฀As฀such฀revenues฀are฀recognized,฀appro- ties฀ of฀ 90฀ days฀ or฀ less.฀ Due฀ to฀ the฀ short฀ maturity฀ of฀ these฀ priate฀amounts฀of฀customer฀advances,฀performance-based฀pay- instruments,฀carrying฀value฀on฀the฀Corporation’s฀consolidated฀ ments฀and฀progress฀payments฀are฀reflected฀as฀an฀offset฀to฀the฀ balance฀sheet฀approximates฀fair฀value. related฀receivables฀balance. PAGE ฀ 4 8

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