Dinesh J Vatani MBA 640 AE: Annual Report Prof.

Lewis Shaw

Lockheed Martin Corporation

Lockheed Martin Corporation is primarily engaged in the design, research and development, production, and integration of advanced technology systems and related products. They also provide a wide range of management, information, logistic, scientific, technical and engineering services. Their main areas of focus are in defense, space, intelligence, homeland security and government information technology. Their five principal business segments are: Aeronautics, Electronic Systems, Space Systems, Information Technology & Global Services and Integrated Systems & Solutions. After a substantial increase in defense spending (in response to the terrorist attacks of 2001) for the wars in Iraq and Afghanistan, the aerospace and defense market in the US experienced a decline in 2005. Although growth in 2006 surpassed 8%, a decrease in defense spending is expected going forward. The aerospace and defense market generated total revenues of $502.6 billion in 2006, representing a growth rate of 6.7% for the five year period spanning 2002-2006. Defense sales amounted to 92.1% of total revenues with the rest 7.9% coming from the civil aerospace. The performance of the market is forecast to decelerate, with an anticipated growth rate of 3.4% for the five year period 2006-2011 expected to drive the market to a value of $594.5 billion by the end of 2011 (Figure 1 in appendix)1. The two major competitors to Lockheed Martin in the aerospace and defense industry are The Boeing Company and United Technologies Corporation (Table 1 in appendix). Even though Boeing has a larger share of the market (7.60%), it is Lockheed Martin (5.50%) that is favored by the US government customers to be its leading supplier of military fighter aircrafts and the sole supplier for the US Navy and Federal IT services as the company possess a diverse portfolio

of programs. Strengths of Lockheed Martin Advanced Technology Base Lockheed Martin invests heavily in research and development activities and is constantly improving its products to enhance performance and develop new products which are expected to be the cornerstone of future defense capabilities. Diversity of programs in portfolio Lockheed Martin's diverse range of programs from missiles, combat aircrafts and space shuttles to information management systems, help the company to minimize risks, if there is a shift in customer demand or change in future funding. For instance, last year NASA chose Lockheed Martin as its industry partner to build the Orion crew exploration vehicle. Credibility and strong brand name Lockheed Martin has shown consistent performance in terms of delivering programs and providing high quality products. This, along with the fact that they have always complied with federal regulations, has won the trust of the US government. Weaknesses of Lockheed Martin Heavy dependence on the US government Lockheed Martin depends heavily on U.S. government customers with 84% of its net sales in 2006 coming from them. This makes them susceptible to any change in government defense spending, severely impacting the company's business. Although, the US defense expenditure has been steadily increasing for the past few years, the defense expenditure growth rate is expected

to decline in the next few years, hampering the company's growth. Weak commercial satellite/airline market business Demand for Lockheed Martin's commercial launch vehicles for satellites has not been up to the expectation level of the company. The company also has no exposure in the commercial airline industry. Opportunities for Lockheed Martin International demand for products The U.S. government has always been the major driver for product design and development for all kinds of combat and combat aircrafts at Lockheed Martin. However, with the fast increasing demand from international customers, a great opportunity lies ahead for Lockheed Martin to expand its international operations. New program initiatives Several new initiatives taken by the US Department of Defense such as transformational communications, global positioning, space based radar and planetary exploration offer great business opportunities for Lockheed Martin. Global war on terrorism Lockheed Martin is in an excellent position to capitalize on opportunities arising from military missions and the global war on terrorism in Iraq and Afghanistan. In addition, the increase in terrorist activities has led to greater demand for its enhanced defense programs and improved mission critical data management at home.

Threats Decline in proposed US government defense expenditure Owing to the global war against terrorism in the last few years, Lockheed Martin has benefited from the growth in the US defense expenditure. However, plans by the US government to cut its defense expenditure by 2009, from which Lockheed derives 60% of its net sales, is likely to have an adverse affect on the company's business2. Changes in domestic and international governmental policies Being a primary provider for the U.S. government, the company has to comply with strict restrictions and regulations. The company's international business is more susceptible to respective local government regulations due to frequent changes in economic and political conditions. Priority is given to national companies by foreign governments in sensitive defense projects. Analysis of Lockheed Martin's Financial Information and Ratios Year after year, Lockheed Martin has been able to grow revenues from $37.2 billion in 2005 to $39.6 billion in 2006. Most impressively, the company has been able to reduce the percentage of sales devoted to cost of goods sold from 91.02% to 90.08%. This was a driver that led to a bottom line growth from $1.8 billion to $2.5 billion2. Liquidity Lockheed Martin's current ratio decreased from 1.12 in 2005 to 1.06 in 2006. The industry median for 2006 was 1.62. Since majority of Lockheed's programs take anywhere from

2 years to 5 years and maybe more to complete, the company does not require high a high current ratio. They deal with the latest technology products, which do not become obsolete in the short run and whose prices may increase because of inflation. In addition, the government promises to buy the produced inventory at the contract price till it meets the performance standards. This reduces the company's risk. A more appropriate measure for industries that involve long product production cycles, such as is the case here for Lockheed Martin, is the quick ratio, as it excludes inventories. The company's median here was 0.68 for 2006 in comparison to the industry average of 1.0. Lockheed's liquidity is less than what other companies have in the aerospace and defense industry, but by no means is the company in financial trouble because Lockheed has much more effective and stronger receivables policy than other companies in the industry. This can be illustrated from their receivables turnover ratio, which was 8.62 as of December 31, 2006 compared to the industry average of 6.2. Profitability The company's profit margin for the year 2006 increased to 6.38% from 4.90% in 2005. Also, they were much higher than the industry average of 3.10% for 2006. This is more than adequate to cover the operating expenses and to provide for fixed charges, dividends and accumulation of reserves. In addition, with a high profit margin, the company is in an excellent position to face adverse economic conditions such as price competition and low demand. The return on assets for Lockheed for 2006 (8.95%) is much greater than the industry median for 2006 (4.3%), which denotes that the primary objective of earning returns has been achieved. Moreover, it reveals how efficiently Lockheed is using its financial resources. This measure also tells us that investment prospects in Lockheed Martin look much promising than the rest of the industry. Lockheed Martin made tremendous profits in 2006, as seen from their return on equity ratio

(36.73%) which was twice more than the industry median (15.3%). These profits can be made available to shareholders of the company as dividends. Lockheed's high return on equity reflects an important indicator of shareholder value creation and is of great importance to present or prospective shareholders. On analyzing the 12 months data for Lockheed, we see that their earnings per share has a growth of 28.5% compared to the industry's 16.0%, illustrating a good measure of profitability when compared to its competitors. The companys high earnings will attract new government funding, investments (domestic and international) and future shareholders in expectation of constant dividends or realization of higher stock prices.

Long-Term Solvency Ratios The company's debt to equity ratio was at 64% in 2006. Although slightly higher than the industry average of 57%, they have been slowly reducing their total debt through repayment activities. Lockheed Martin's long-term debt balance has declined $3.1 billion over the last five years from $7.5 billion at December 31, 20012. Their long-term creditors feel secured in extending debt as they have a much better interest coverage ratio (11.76) compared to the industry (6.69). Hence even if earnings fall, the firm shall be able to meet its commitment of fixed interest charges.

Conclusion Lockheed Martin's high profitability, high market capitalization and strong cash flow make it a very attractive investment opportunity. The company has significant upside potential based on its above average return on invested capital, new product development, and continued strong earnings and cash flow growth. Going forward, management intends to explore the strong

business opportunities outside the traditional defense focused arena, specifically in areas of civil, government and the commercial space business. Ratio Valuation

Ratio

2006

2005

Industry (2006)3

Current Ratio

1.06

1.12

1.62

Quick Ratio

0.68

0.72

1.00

Receivable Turnover

8.62

8.12

6.20

Profit Margin

6.38

4.90

3.10

Return on Assets

8.95

6.57

4.30

Return on Equity

36.73%

23.20%

15.30%

Earnings per Share

$ 5.91

$ 4.15

--

Debt to Equity Ratio

64%

61%

57%

Interest Coverage Ratio

11.76

7.57

6.69

Appendix Figure 1

Table 1

Sources Cited

1. Datamonitor 2. Lockheed Martin 2006 annual report 3. Hoovers.com

10