| LOCKHEED MARTIN CORP ITEM 1A RISK FACTORS An investment in our common stock or debt securities involves risks and uncertainties |
| While we attempt to identify, manage and mitigate risks to our business to the extent practical under the circumstances, some level of risk and uncertainty will always be present |
| You should consider the following factors carefully, in addition to the other information contained in this Form 10-K, before deciding to purchase our securities |
| Reduced funding for defense procurement and research and development programs could adversely affect our ability to grow or maintain our revenues and profitability |
| We and other US defense contractors have benefited from an upward trend in overall defense spending in the last few years |
| The defense investment budget includes funds for weapons procurement and research and development |
| The Future Years Defense Plan submitted with the President’s budget request for fiscal year 2007 projects a strong commitment to research and development of transformational capabilities across the military services, while reducing quantities of near-term systems compared to previous projections |
| Although the ultimate size of future defense budgets remains uncertain, current indications are that the total defense budget and the investment budget as a component of overall defense spending will increase over the next few years |
| However, DoD programs in which we participate, or in which we may seek to participate in the future, must compete with other programs for consideration during our nation’s budget formulation and appropriation processes |
| Budget decisions made in this environment may have long-term consequences for our size and structure and that of the defense industry |
| While we believe that our programs are a high priority for national defense, there remains the possibility that one or more of our programs will be reduced, extended, or terminated |
| Reductions in our existing programs, unless offset by other programs and opportunities, could adversely affect our ability to grow our revenues and profitability |
| Military transformation and planning may affect future procurement priorities and existing programs |
| The DoD is committed to a transformation that will achieve and maintain advantages through changes in operational concepts, organizational structure and technologies that significantly improve warfighting capabilities |
| This defense transformation is evidenced by a trend toward smaller, more capable, interoperable and technologically advanced forces |
| To achieve these capabilities, a change in acquisition is underway toward early deployment of initial program capabilities followed by subsequent incremental improvements, cooperative international development programs and a demonstrated willingness to explore new forms of development, acquisition and support |
| Along with these trends, new system procurements are being evaluated for the degree to which they support the concept of jointness and interoperability among the services |
| 24 ______________________________________________________________________ [47]Table of Contents We cannot predict whether potential changes in priorities due to defense transformation will afford new or additional opportunities for our businesses in terms of existing, follow-on or replacement programs |
| Therefore, it is difficult to accurately assess the impact on our business going forward until more is known, including whether we would have to close existing manufacturing facilities or incur expenses beyond those that would be reimbursed if one or more of our existing contracts were terminated for convenience due to lack of funding |
| See “Management’s Discussion and Analysis – Industry Considerations” on pages 43 through 49 of this report |
| We are continuing to invest in business opportunities where we can use our customer knowledge, technical strength and systems integration capabilities to win new business |
| Whether we are successful in continuing to grow revenues and profits will depend, in large measure, on whether we are able to deliver the best value solutions for our customer |
| Our existing US Government contracts are subject to continued appropriations by Congress and may be terminated if future funding is not made available |
| We rely heavily upon sales to the US Government including both DoD and non-DoD agencies, obtaining 85prca of our revenues from those customers in 2005 |
| Future sales under our existing US Government contracts are conditioned upon the continuing availability of Congressional appropriations |
| Congress usually appropriates funds on a fiscal-year basis even though contract performance may extend over many years |
| Long-term government contracts and related orders are subject to termination if appropriations for subsequent periods become unavailable |
| We provide a wide range of defense, homeland security and information technology products and services to the US Government |
| While we believe that this diversity makes it less likely that cuts in any specific contract or program will have a long-term impact on us, termination of multiple or large programs or contracts could adversely affect our business and future financial performance |
| In addition, termination of large programs or multiple contracts affecting a particular business site could require us to evaluate the continued viability of operating that site |
| As a US Government contractor, we are subject to a number of procurement rules and regulations |
| We must comply with and are affected by laws and regulations relating to the award, administration and performance of US Government contracts |
| Government contract laws and regulations affect how we do business with our customers and, in some instances, impose added costs on our business |
| A violation of specific laws and regulations could result in the imposition of fines and penalties or the termination of our contracts or debarment from bidding on contracts |
| In some instances, these laws and regulations impose terms or rights that are more favorable to the government than those typically available to commercial parties in negotiated transactions |
| For example, the US Government may terminate any of our government contracts and, in general, subcontracts, at their convenience, as well as for default based on performance |
| Upon termination for convenience of a fixed-price type contract, we normally are entitled to receive the purchase price for delivered items, reimbursement for allowable costs for work-in-process 25 ______________________________________________________________________ [48]Table of Contents and an allowance for profit on the contract or adjustment for loss if completion of performance would have resulted in a loss |
| Upon termination for convenience of a cost reimbursement contract, we normally are entitled to reimbursement of allowable costs plus a portion of the fee |
| Such allowable costs would include our cost to terminate agreements with our suppliers and subcontractors |
| The amount of the fee recovered, if any, is related to the portion of the work accomplished prior to termination and is determined by negotiation |
| A termination arising out of our default could expose us to liability and have a material adverse effect on our ability to compete for future contracts and orders |
| In addition, on those contracts for which we are teamed with others and are not the prime contractor, the US Government could terminate a prime contract under which we are a subcontractor, irrespective of the quality of our services as a subcontractor |
| In addition, our US Government contracts typically span one or more base years and multiple option years |
| The US Government generally has the right to not exercise option periods and may not exercise an option period if the agency is not satisfied with our performance on the contract |
| Our business could be adversely affected by a negative audit by the US Government |
| US Government agencies, including the Defense Contract Audit Agency and the Department of Labor, routinely audit and investigate government contractors |
| These agencies review a contractor’s performance under its contracts, cost structure and compliance with applicable laws, regulations and standards |
| The US Government also may review the adequacy of, and a contractor’s compliance with, its internal control systems and policies, including the contractor’s purchasing, property, estimating, compensation and management information systems |
| Any costs found to be improperly allocated to a specific contract will not be reimbursed, while such costs already reimbursed must be refunded |
| If an audit uncovers improper or illegal activities, we may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines and suspension or prohibition from doing business with the US Government |
| In addition, we could suffer serious reputational harm if allegations of impropriety were made against us |
| Developing new technologies entails significant risks and uncertainties that may not be covered by indemnity or insurance |
| Our business consists of designing, developing and manufacturing advanced defense and technology systems and products |
| We are often tasked to develop or integrate new technologies that may be untested or unproven |
| Components of certain of the defense systems and products we develop are explosive and inherently dangerous |
| Failures of launch vehicles, spacecraft and satellites, missile systems, command and control systems, software applications, air-traffic control systems, train-control systems, homeland security applications, nuclear facilities, and aircraft have the potential to cause loss of life and extensive property damage |
| We may face liabilities related to the maintenance or servicing of aircraft or other platforms or for training services we supply in the course of our business |
| In addition, from time-to-time, we have employees deployed on-site at active military installations or locations, or in support of military operations in hostile locations |
| Although indemnification by the US Government may be available in some instances for our defense businesses, this is not always the case |
| In some 26 ______________________________________________________________________ [49]Table of Contents instances where the US Government could provide indemnification under applicable law, it elects not to do so |
| In addition, US Government indemnification may not be available to cover potential claims or liabilities resulting from a failure of technologies developed and deployed for homeland security purposes |
| While we maintain insurance for some business risks, it is not possible to obtain coverage to protect against all operational risks and liabilities |
| We generally seek indemnification where we believe that the US Government is permitted to extend indemnification under applicable law and generally seek limitation of potential liabilities related to the sale and use of our homeland security products and services through qualification by the Department of Homeland Security under the SAFETY Act provisions of the Homeland Security Act of 2002 |
| Where we are unable to secure indemnification or qualification under the SAFETY Act, we may nevertheless elect to provide the product or service |
| Finally, some technologies, particularly those related to Homeland Security, may raise potential liabilities related to privacy issues for which neither indemnification nor SAFETY Act coverage is available |
| Substantial claims resulting from an accident or other incident in excess of any US Government indemnity and our insurance coverage (or for which indemnity or insurance is not available) could harm our financial condition and operating results |
| Moreover, any accident or incident for which we are liable, even if fully insured, could negatively affect our reputation among our customers and the public, thereby making it more difficult for us to compete effectively, and could significantly impact the cost and availability of adequate insurance in the future |
| Our earnings and margins may vary based on the mix of our contracts and programs |
| At December 31, 2005, our backlog included both cost reimbursable and fixed-price contracts |
| Cost reimbursable contracts generally have lower profit margins than fixed-price contracts |
| Production contracts are mainly fixed-price contracts, and developmental contracts are generally cost reimbursable contracts |
| Our earnings and margins may vary materially depending on the types of long-term government contracts undertaken, the nature of the products produced or services performed under those contracts, the costs incurred in performing the work, the achievement of other performance objectives and the stage of performance at which the right to receive fees, particularly under incentive and award fee contracts, is finally determined |
| Under fixed-price contracts, we receive a fixed price irrespective of the actual costs we incur and, consequently, any costs in excess of the fixed price are absorbed by us |
| Under time and materials contracts, we are paid for labor at negotiated hourly billing rates and for certain expenses |
| Under cost reimbursable contracts, subject to a contract-ceiling amount in certain cases, we are reimbursed for allowable costs and paid a fee, which may be fixed or performance based |
| However, if our costs exceed the contract ceiling or are not allowable under the provisions of the contract or applicable regulations, we may not be able to obtain reimbursement for all such costs and may have our fees reduced or eliminated |
| The failure to perform to customer expectations and contract requirements can result in reduced fees and may affect our financial performance for the affected period |
| Under each type of contract, if we are unable to control costs we incur in performing under the contract, our financial condition and operating results could be materially adversely affected |
| Cost over-runs also may adversely affect our ability to sustain existing programs and obtain future contract awards |
| 27 ______________________________________________________________________ [50]Table of Contents If our subcontractors or suppliers fail to perform their contractual obligations, our prime contract performance and our ability to obtain future business could be materially and adversely impacted |
| Many of our contracts involve subcontracts with other companies upon which we rely to perform a portion of the services that we must provide to our customers |
| There is a risk that we may have disputes with our subcontractors, including disputes regarding the quality and timeliness of work performed by the subcontractor, customer concerns about the subcontract, our failure to extend existing task orders or issue new task orders under a subcontract, or our hiring of personnel of a subcontractor |
| A failure by one or more of our subcontractors to satisfactorily provide on a timely basis the agreed-upon supplies or perform the agreed-upon services may materially and adversely impact our ability to perform our obligations as the prime contractor |
| Subcontractor performance deficiencies could result in a customer terminating our contract for default |
| A default termination could expose us to liability and have a material adverse effect on our ability to compete for future contracts and orders |
| In addition, a delay in our ability to obtain components and equipment parts from our suppliers may affect our ability to meet our customers’ needs and may have an adverse effect upon our profitability |
| We use estimates in accounting for many of our programs |
| Contract accounting requires judgment relative to assessing risks, estimating contract revenues and costs, and making assumptions for schedule and technical issues |
| Due to the size and nature of many of our contracts, the estimation of total revenues and cost at completion is complicated and subject to many variables |
| For example, assumptions have to be made regarding the length of time to complete the contract because costs also include expected increases in wages and prices for materials |
| Similarly, assumptions have to be made regarding the future impacts of efficiency initiatives and cost reduction efforts |
| Incentives or penalties related to performance on contracts are considered in estimating revenue and profit rates, and are recorded when there is sufficient information for us to assess anticipated performance |
| Estimates of award and incentive fees are also used in estimating revenue and profit rates based on actual and anticipated awards |
| Because of the significance of the judgments and estimation processes described above, it is likely that materially different amounts could be recorded if we used different assumptions or if the underlying circumstances were to change |
| Changes in underlying assumptions, circumstances or estimates may adversely affect future period financial performance |
| For additional information on accounting policies and internal controls we have in place for recognizing sales and profits, see our discussion under Management’s Discussion and Analysis – “Critical Accounting Policies – Contract Accounting/Revenue Recognition” on pages 49 through 52 and “Controls and Procedures” on page 74, and Note 1 – Significant Accounting Policies on pages 84 through 92 of this Form 10-K New accounting standards could result in changes to our methods of quantifying and recording accounting transactions, and could affect our financial results and financial position |
| Changes to Generally Accepted Accounting Principles in the United States (GAAP) arise from new and revised standards, interpretations and other guidance issued by the Financial 28 ______________________________________________________________________ [51]Table of Contents Accounting Standards Board, the SEC, and others |
| The effects of such changes may include prescribing an accounting method where none had been previously specified, prescribing a single acceptable method of accounting from among several acceptable methods that currently exist, or revoking the acceptability of a current method and replacing it with an entirely different method, among others |
| Such changes could result in unanticipated effects on our results of operations, financial position and other financial measures |
| The level of returns on pension and postretirement plan assets, changes in interest rates and other factors could affect our earnings in future periods |
| Our earnings may be positively or negatively impacted by the amount of expense we record for our employee benefit plans |
| This is particularly true with expense for our pension plans |
| GAAP requires that we calculate expense for the plans using actuarial valuations |
| These valuations are based on assumptions that we make relating to financial market and other economic conditions |
| Changes in key economic indicators can result in changes in the assumptions we use |
| The key year-end assumptions used to estimate pension expense for the following year are the discount rate, the expected long-term rate of return on plan assets and the rate of increase in future compensation levels |
| For a discussion regarding how our financial statements can be affected by pension plan accounting policies, see Management’s Discussion and Analysis – “Critical Accounting Policies – Postretirement Benefit Plans” on pages 52 through 54 of this Form 10-K International sales and suppliers may pose potentially greater risks |
| Our international business may pose greater risks than our domestic business due to the greater potential for changes in foreign economic and political environments |
| In return, however, these greater risks are often accompanied by the potential to earn higher profits than from our domestic business |
| Our international business is also highly sensitive to changes in foreign national priorities and government budgets |
| Sales of military products are affected by defense budgets (both in the US and abroad) and US foreign policy |
| Sales of our products and services internationally are subject to local government regulations and procurement policies and practices (including regulations relating to import-export control, investments, exchange controls and repatriation of earnings), as well as to varying currency, political and economic risks |
| Our contracts, however, generally are denominated in US dollars |
| We also frequently team with international subcontractors and suppliers, and are exposed to similar risks |
| In international sales, we face substantial competition from both domestic manufacturers and foreign manufacturers, whose governments sometimes provide research and development assistance, marketing subsidies and other assistance for their commercial products |
| Some international customers require contractors to comply with industrial cooperation regulations and enter into industrial participation agreements, sometimes referred to as offset agreements |
| Offset agreements may require in-country purchases, manufacturing and financial support projects as a condition to obtaining orders or other arrangements |
| Offset agreements generally extend over several years and may provide for penalties in the event we fail to perform in accordance with offset requirements |
| See “Contractual Commitments and Off-Balance Sheet Arrangements” in Management’s Discussion and Analysis on page 71 of this Form 10-K 29 ______________________________________________________________________ [52]Table of Contents If we fail to manage acquisitions, divestitures and other extraordinary transactions successfully, our financial results, business and future prospects could be harmed |
| In pursuing our business strategy, we routinely conduct discussions, evaluate targets and enter into agreements regarding possible investments, acquisitions, joint ventures and divestitures |
| As part of our business strategy, we seek to identify acquisition opportunities to expand or complement our existing products and services, or customer base, at attractive valuations |
| We often compete with others for the same opportunities |
| To be successful, we must conduct due diligence to identify valuation issues and potential loss contingencies, negotiate transaction terms, complete and close complex transactions and manage post-closing issues (eg, integrate acquired companies and employees, realize anticipated operating synergies and improve margins) efficiently and effectively |
| At the same time, extraordinary transactions require substantial management resources and have the potential to divert our attention from our existing business |
| If we are not successful in identifying and closing extraordinary transactions, we may not be able to maintain our competitive leadership position or may be required to expend additional resources to develop capabilities internally in certain segments |
| In evaluating transactions, we are required to make valuation assumptions and exercise judgment regarding business opportunities and potential liabilities |
| Our assumptions or judgment may prove to be inaccurate |
| Our due diligence reviews may not identify all of the material issues necessary to accurately estimate the cost of a particular transaction |
| Future acquisitions might require that we issue stock or incur indebtedness |
| This could dilute returns to existing stockholders, or adversely affect our credit rating or future financial performance, if our integration plans are not successful |
| We also may incur unanticipated costs or expenses, including post-closing asset impairment charges, expenses associated with eliminating duplicate facilities, litigation and other liabilities |
| While we believe that we have established appropriate procedures and processes to mitigate many of these risks, there is no assurance that our integration efforts and business acquisition strategy will be successful |
| Business disruptions could seriously affect our future revenue and financial condition or increase our costs and expenses |
| Our business may be impacted by disruptions including, but not limited to, threats to physical security, information technology attacks or failures, damaging weather or other acts of nature and pandemics or other public health crises |
| Such disruptions could affect our internal operations or services provided to customers, and could impact our revenue, increase our expenses or adversely affect our reputation or our stock price |
| Unforeseen environmental costs could impact our future earnings |
| Our operations are subject to and affected by a variety of federal, state, local and foreign environmental protection laws and regulations |
| We are involved in environmental responses at some of our facilities and former facilities, and at third-party sites not owned by us where we have been designated a potentially responsible party by the EPA or by a state agency |
| 30 ______________________________________________________________________ [53]Table of Contents We manage various government-owned facilities on behalf of the government |
| At such facilities, environmental compliance and remediation costs have historically been the responsibility of the government and we relied (and continue to rely with respect to past practices) upon government funding to pay such costs |
| While the government remains responsible for capital and operating costs associated with environmental compliance, responsibility for fines and penalties associated with environmental noncompliance are typically borne by either the government or the contractor, depending on the contract and the relevant facts |
| Most of the laws governing environmental matters include criminal provisions |
| If we were convicted of a violation of the Federal Clean Air Act or the Clean Water Act, our facility or facilities involved in the violation would be placed by EPA on the “Excluded Parties List” maintained by the General Services Administration |
| The listing would continue until the EPA concluded that the cause of the violation had been cured |
| Listed facilities cannot be used in performing any US Government contract awarded to us during any period of listing by the EPA We have incurred and will likely continue to incur liabilities under various state and federal statutes for the cleanup of pollutants previously released into the environment |
| The extent of our financial exposure cannot in all cases be reasonably estimated at this time |
| Among the variables management must assess in evaluating costs associated with these cases and remediation sites generally are changing cost estimates, continually evolving governmental environmental standards and cost allowability issues |
| For information regarding these matters, including current estimates of the amounts that we believe are required for remediation or cleanup to the extent estimable, see “Environmental Matters” in Management’s Discussion and Analysis on pages 54 through 55 and Note 15-Legal Proceedings, Commitments and Contingencies on pages 113 through 116 of this Form 10-K Unanticipated changes in our tax provisions or exposure to additional income tax liabilities could affect our profitability |
| Our business operates in many locations under government jurisdictions that impose income taxes |
| Changes in domestic or foreign income tax laws and regulations, or their interpretation, could result in higher or lower income tax rates assessed or changes in the taxability of certain revenues or the deductibility of certain expenses, thereby affecting our income tax expense and profitability |
| In addition, audits by income tax authorities could result in unanticipated increases in our income tax expense |
| We are involved in a number of legal proceedings |
| We cannot predict the outcome of litigation and other contingencies with certainty |
| Our business may be adversely affected by the outcome of legal proceedings and other contingencies (including environmental remediation costs) that cannot be predicted with certainty |
| As required by GAAP in the US, we estimate material loss contingencies and establish reserves based on our assessment of contingencies where liability is deemed probable and reasonably estimable in light of the facts and circumstances known to us at particular point in time |
| Subsequent developments in legal proceedings may affect our assessment and estimates of the loss contingency recorded as a liability or as a reserve against assets in our financial statements |