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    Lockheed Martin Corporation 2002 F INANCIAL H IGHLIGHTS (In millions, except per share data and number of employees) 2002 2001 2000 Net sales $26,578 $23,990 $24,541 Operating profit 1,158 833 1,105 Earnings (loss) from continuing operations 533 43 (477) Unusual items, net 632 651 951 Adoption of FAS 142 — 236 268 Adjusted earnings from continuing operations 1,165 930 742 Net earnings (loss) 500 (1,046) (519) Diluted earnings (loss) per share 1.11 (2.42) (1.29) Average diluted common shares outstanding 452.0 432.5 400.8 Net cash provided by operating activities 2,288 1,825 2,016 Cash dividends per common share 0.44 0.44 0.44 Cash and cash equivalents 2,738 912 1,505 Total assets 25,758 27,654 30,426 Total debt 7,582 7,511 9,959 Stockholders’ equity 5,865 6,443 7,160 Negotiated backlog $70,385 $71,269 $55,076 Employees 125,000 125,000 130,000 NOTE: For a discussion of unusual items, the adoption of FAS 142 and other 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 26 through 48 of this Annual Report. On the Cover: Photo Composite of F/A-22 Over New York

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    D EAR F ELLOW SHAREHOLDERS In the past year, the men and women of Lockheed Martin responded again with dedication and hard work to the daunting challenges that face free people worldwide. As a lead systems integrator, Lockheed Martin continues to deliver best-value solutions to our customers whose efforts to secure peace, prevail in combat, and serve the public good are indispensable. Your company has maintained and sharpened its resolve to address our core markets in defense, homeland security, and government information technology and services. In 2002, we focused our attention on several key areas that were fundamental to positive financial results for our shareholders and superior performance for our customers. We directed our attention to the successful execution of our backlog, which has stood at over $70 billion for two consecutive years, and the winning of new business. Over the past two years, we successfully implemented a strategy of disciplined growth that put Lockheed Martin on the path to long-term financial strength and enhanced shareholder value. This strategy has yielded robust operational and financial performance; and in 2002 resulted in an improved credit standing, greater financial flexi- bility, profitable organic sales growth, strong cash flow, and operating margin expansion. We worked to better align value in our commercial Space Systems business. Clearly, there is overcapacity in the commercial satellite and launch industries. We are committed to streamlining and strengthening the competi- tive posture of commercial satellite manufacturing by improving operational efficiencies within the business. We continue to work largely with the U.S. Air Force to improve the business model for launch vehicles. R O B E RT J. S T E V E N S , President and Chief Operating Officer VA N C E D. C O F F M A N , Chairman and Chief Executive Officer THREE

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    We focused on continued portfolio shaping by divesting and monetizing our global telecommunications assets in 2002. As of the end of the year, we closed three of the divestiture transactions and had a signed contract for the fourth. We also completed the full integration of our latest acquisition, OAO Corporation, into the Technology Services business area. Our plan has been to strengthen Lockheed Martin’s credit standing by continuing to pay down debt and improve leverage ratios. In 2002, the Corporation generated strong cash flow, and since 2000 we have paid down over $4 billion of debt, and reduced our net leverage from 64 percent to 45 percent. As a result, Lockheed Martin received credit upgrades from all of the rating agencies. We believe the outlook for further credit upgrades is positive. As a result of this corporate-wide attention to serving customers better, we are also improving financial strength. Lockheed Martin has achieved overall results that customers and shareholders desire, and that all our employees can view with pride. Of 318 critical events we measured in 2002, we achieved an impressive 97 percent rate of Mission Success. In addition, we captured about 95 percent of the available award fees on the programs we performed, equaling our record from 2001. During the year our net sales also grew to $26.6 billion, an 11 percent increase over 2001. These figures are a clear testament to the dedication, expertise and hard work of the 125,000 people who come to work at Lockheed Martin facilities every day. They are the intellectual capital of this enterprise, and we want to retain our talent pool in a competitive marketplace. We also want to recruit the best in their fields—people with diverse talents and backgrounds, offering the most creative ideas and solutions to the challenges our customers will face in the coming decades. Our LM21 Operating Excellence program continues to direct our common focus on customer value and continuous improvement. The results of increased productivity and cost reduction are being achieved through a requirement for lean processes that apply six sigma capability. The savings are passed on to our customers and help drive our margin expansion initiative. The past year is notable for vital strategic wins across all business areas, including the Deepwater program for the U.S. Coast Guard. Deepwater is the most comprehensive modernization of Coast Guard infrastructure in the service’s history, including ships, aircraft, command and control, communications and logistics. In another program key to homeland security, we assisted the U.S. Transportation Security Administration to exceed its objectives by training more than 50,000 baggage and passenger screeners ahead of schedule at all U.S. commercial airports, as well as reconfiguring airport security checkpoints. In 2002, the U.S. Federal Aviation Administration selected Lockheed Martin for the next-generation En Route Automation Modernization, an air traffic management infrastructure modernization that will enhance security and provide new capabilities to increase efficiency and capacity. Internationally, the Polish government selected the F-16 combat aircraft to modernize its air force to NATO standards, and seven nations joined the United States and United Kingdom to invest in the F-35 Joint Strike Fighter program’s System Design and Development phase. FOUR

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    Unfortunately, there were some disappointments as well. We lost several major competitions in 2002 but have worked hard at applying lessons learned to future competitions. Aside from contract wins, we achieved a number of performance successes in 2002, including the launch of the first Atlas V, a new generation of launcher; and the first supersonic missile launch from the F/A-22 air superiority fighter, the cornerstone of U.S. Air Force modernization. We remain committed to exemplary corporate governance and transparency in our financial disclosure practices. And Lockheed Martin recognizes the value of good corporate citizenship, investing not only in the next generation of technology, but in education programs and philanthropy. As a corporate citizen, we recognize that encouraging a spirit of public service inspires each and every one of us. Lockheed Martin is committed to the highest standard of ethical business conduct; and we conduct regular ethics training for every one of our employees, rooting these standards deep into our corporate culture. Overall, it was a good year for Lockheed Martin; we are strongly positioned and believe our outlook is promis- ing. In 2003, we will focus on six imperatives that drive operational excellence and financial performance: 䡲 Provide winning best-value solutions for customers. 䡲 Continue to focus on strengthening program management and driving successful execution to ensure customer satisfaction. Senior executive management will pay particular attention to the F/A-22 and the Space-Based Infrared System (SBIRS) programs. 䡲 Extract value from our Space Systems business through contract negotiations with customers as well as a focus on cost savings. 䡲 Continue to focus on margin expansion and cash generation. 䡲 Evaluate various alternatives for cash deployment and implement those that provide the greatest return for shareholders. 䡲 Continue to recruit, hire and retain the best talent in the marketplace. A talented, diverse, and innovative workforce is key to sustained success and is a company imperative. This management team recognizes Lockheed Martin’s role in the defense of America and its allies, in homeland security, and in service to government agencies in the United States and around the world as they fulfill their most critical missions. And on behalf of all Lockheed Martin employees, we offer our thoughts and prayers to the families of the heroic crew of the Space Shuttle Columbia. Their individual excellence and outstanding teamwork inspires us all. As stewards of this Corporation, we rededicate ourselves to instilling a highly ethical culture of operational and financial performance, teamwork and corporate citizenship. These are standards that cannot be compromised; they are the objectives that motivate the men and women of Lockheed Martin as they focus on every commitment, every day. March 1, 2003 Vance D. Coffman Robert J. Stevens Chairman and Chief Executive Officer President and Chief Operating Officer FIVE

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    C RITICAL R ESPONSIBILITIES : P ROTECTING AND D EFENDING L IBERTY The challenges of the new security environment require original solutions that leverage America’s advantages and protect against asymmetric vulnerabilities. The mission of the armed forces for those who hold freedom dear is to dissuade and deter, and if called upon, to defeat adversaries. The goal is an armed forces that sustains America’s strategic position which helps underpin peace and stability in the world. Six operational goals are at the heart of creating an effects-based defense: PROTECTING CRITICAL BASES OF OPERATION ON THE U.S. HOMELAND AND ABROAD, AS WELL AS OUR ALLIES AND FRIENDS. DEFEATING NUCLEAR, BIOLOGICAL AND CHEMICAL WEAPONS AND THEIR MEANS OF DELIVERY PROJECTING AND SUSTAINING U.S. FORCES IN DISTANT ANTI-ACCESS ENVIRONMENTS AND DEFEATING THOSE THREATS DENYING SANCTUARY TO ENEMIES BY PROVIDING PERSISTENT SURVEILLANCE, TRACKING AND RAPID ENGAGEMENT WITH HIGH-VOLUME PRECISION STRIKE, THROUGH A COMBINATION OF COMPLEMENTARY AIR, GROUND, AND NAVAL CAPABILITIES AGAINST CRITICAL MOBILE AND FIXED TARGETS AT VARIOUS RANGES AND IN ALL WEATHER AND TERRAINS PROVIDING INFORMATION SUPERIORITY BY LEVERAGING INFORMATION TECHNOLOGY AND INNOVATIVE CONCEPTS TO DEVELOP AN INTEROPERABLE, JOINT NETWORK-CENTRIC ARCHITECTURE AND CAPABILITY ASSURING ACCESS TO NECESSARY INFORMATION IN THE FACE OF ATTACK AND CONDUCTING EFFECTIVE INFORMATION OPERATIONS PROVIDING RELIABLE AND ASSURED ACCESS TO SPACE The enduring values shared by all people who cherish freedom must be defended in an uncertain world. Protecting those values—to live in a free and open society—has oftentimes demanded courage, duty and devotion. Through history, the men and women of the U.S. armed forces and the forces of allied nations have responded to the call of those who yearn for liberty, who chafe under oppression. Previous Spread: Aboard an Aegis Cruiser Facing Page: F/A-22 Raptor EIGHT NINE

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    As a large-scale systems integrator, Lockheed Martin provides technologies and capabilities to address these strategic goals. Missile defense capabilities including Patriot Advanced Capability (PAC-3), the Medium Extended Air Defense System (MEADS), Theater High Altitude Area Defense (THAAD) as well as command and control for National Missile Defense are critical in protecting bases of operations and defeating nuclear, biological and chemical weapons. MEADS, a partnership with Germany and Italy, made successful progress last year on its risk reduction phase. Air power projection and air mobility are provided with the F/A-22 air superiority fighter, F-16, C-130J airlifter, and C-5 modernization program; and in the future with the F-35 Joint Strike Fighter. Advanced shipboard combat systems, such as Aegis, assist in projecting and sustaining U.S. military power where it is needed. Internationally in 2002, the Republic of Korea selected Aegis for its KDX-III naval modernization program, and the Aegis system for the new F-100 Frigate was delivered to Spain. Precision strike that can deny enemies sanctuary in any weather and at any time is also the role of the F/A-22, F-35 JSF, Joint Air-to-Surface Standoff Missile, Longbow, and the Sniper/Pantera advanced targeting pod which provides pilots with the most advanced targeting and precision strike capability in the world. A truly international program, the F-35 team includes in the System Development and Demonstration phase the United States, United Kingdom, Italy, Netherlands, Turkey, Canada, Denmark, Australia and Norway. Network-centric warfare and information superiority maximize the effectiveness of U.S. and allied forces. The goal of this netted architecture is situational awareness where forces can communicate with each other, share information about their location and that of the enemy simultaneously, and see the same precise real-time picture of the battlespace. Lockheed Martin is a leader in advanced C4ISR systems with the Theater Battle Management Core Systems, cockpit electronics and radars. The Integrated Space Command and Control program integrates 40 separate systems into one architecture to weld a potent joint force. Reliable and assured access to space is vital to national security, and the Atlas family of launchers, including the most advanced Atlas V, get military assets to the ultimate high ground when needed. The Atlas V, which made its first launch in 2002, is powered by the Russian RD-180 engine, an example of inventive global partnerships. Lockheed Martin’s Milstar secure communications satellites and Space Based Infrared System (SBIRS) are essential to fulfilling vital information superiority requirements. Facing Page: High Mobility Artillery Rocket System (HIMARS) (Top Left), Patriot Advanced Capability (PAC-3) (Top Middle), Aegis Shipboard Combat System (Top Right), Atlas V Launch (Bottom) TEN ELEVEN

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    T HE F LAME OF L IBERTY S HALL N OT B E D IMMED To those who would strike at the heart of freedom’s citadel, there can be no sanctuary, but it is also imperative that as a nation we secure the homeland from the threat of terrorism. The values that sustain and guide this country from its founding to the present day are immutable, and not subject to negotiation or compromise. With a cabinet-level Department of Homeland Security, the United States is prepared to address the threats posed by the adversaries of a just and open society. The United States is challenged to: ELIMINATE MAJOR VULNERABILITIES WITH CRITICAL INFRASTRUCTURE PROTECTION PREEMPT TERRORISM WITH THREAT INFORMATION SHARING AND ALERTING AS WELL AS EFFECTIVE BORDER CONTROL PREPARE FOR INCIDENTS WITH EMERGENCY RESPONSE AND INCIDENT RESPONSE BALANCE OUR NEED FOR INCREASED SECURITY WITH CONTINUED RESPECT FOR INDIVIDUAL LIBERTIES Leveraging its capabilities as a large-scale systems integrator in both defense and civil markets worldwide, Lockheed Martin offers solutions in the key areas of homeland security: Coast Guard; border and transportation security; emergency preparedness and response; science and technology; information analysis and infrastructure protection; and Secret Service. Lockheed Martin is a partner with the U.S. Coast Guard as it fulfills its vital mission of protecting America’s shores. Lockheed Martin and its global industry team were selected in 2002 for the Deepwater Program, the most compre- hensive modernization in the Coast Guard’s history. The program encompasses modernizing ships, aircraft, command and control, communications, and logistics systems. Lockheed Martin delivers solutions for the Immigration and Naturalization Service and the U.S. Customs Service, as well as technologies to support marine traffic management and port control. In addition, Lockheed Martin technologies assist: U.S. law enforcement agencies with fingerprint identification that can match criminals to fingerprints in just minutes from a database of over 400 million prints; and the Transportation Security Administration to implement new security operations to help ensure air passenger safety at the nation’s airports. The Airport Security Rollout Program upgrades passenger security measures at airports and helped to convert passenger screening operations throughout the U.S. to federal control. In addition, Lockheed Martin assisted the Transportation Security Administration to exceed its objectives by training more than 50,000 baggage and passenger screeners ahead of schedule at all U.S. commercial airports. Abraham Lincoln called America the last best hope of Earth, expressing the desire of millions who have gazed at liberty’s flame and dreamed of a new life. Previous Spread: U.S. Coast Guard on Patrol Facing Page: Aerostat Radar Screen (Top Left), Protecting America’s Borders (Top Right), Aerostat Border Surveillance (Middle Right), Airport Security Screening (Bottom Right) FOURTEEN FIFTEEN

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    S ERVING THE P UBLIC G OOD A government that serves the governed. A government by and for the people. These are the pillars of a democracy where the rule of law is guaranteed by a Constitution forged in the battle for independence and freedom. These are values that have not changed—through war, depression, or at the peak of triumph. But solutions to government challenges can and do change with 21st century technology that moves at the speed of a mouse click. Managing large sources of data, integrating complex IT systems, as well as bringing to bear the talents of 12 software maturity level-5 and level-4 companies, Lockheed Martin is well positioned to serve and assist federal agencies accomplish their nationally consequential missions by: MANAGING LARGE INFORMATION TECHNOLOGY INFRASTRUCTURES APPLYING SYSTEMS INTEGRATION CAPABILITIES TO DELIVER VITAL SERVICES TO MILLIONS OF CITIZENS PROVIDING INNOVATIVE TECHNOLOGIES TO RAISE EFFICIENCY, MODERNIZE AND REDUCE COSTS Lockheed Martin technologies are responsible for managing over 60 percent of the world’s air traffic. In 2002, the Federal Aviation Administration (FAA) selected Lockheed Martin for the next-generation En Route Automation Modernization (ERAM), an evolutionary infrastructure upgrade of the current en route air traffic control automation system. The system is used at the 21 FAA Air Route Traffic Control Centers to control high-altitude aircraft. ERAM will upgrade the National Airspace System software and will provide the FAA with enhanced automation features to accommodate increases in air traffic. As a systems integrator serving a broad range of federal agencies, Lockheed Martin technologies are instrumental in delivering 35 million Social Security checks every month; helping a million families a year become homeowners through Fannie Mae; assisting the U.S. Postal Service sort and manage millions of letters and packages a day with improved accuracy and speed; supporting the FDIC’s commitment to insure deposits at approximately 9,700 banks, and savings and loan associations; providing information technology to the Centers for Medicare and Medicaid Services so benefits are delivered with greater speed and efficiency; and assisting inventors patent their discoveries through linked computer networks at the U.S. Patent and Trademark Office. Previous Spread: The U.S. Postal Service Uses Lockheed Martin Automation Technologies to Move More Than 200 Billion Pieces of Mail a Year Efficiently, Accurately and Safely. Facing Page: Air Traffic Control (Top), Integrated Automated Fingerprint Identification System (IAFIS) (Middle Left), The Binary Code Is Key to Information Technology (Bottom Left), Applying Systems Integration Capabilities to Deliver Vital Services (Bottom Right) EIGHTEEN NINETEEN

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    VALUES OF A C ORPORATE C ITIZEN As a corporate citizen, Lockheed Martin invests not only in the next generation of technology, but in the next generation of people who will use that technology to create a better, more secure world. Lockheed Martin’s most precious asset is its people—the men and women who come to work each day at offices and facilities worldwide. Aside from excellence in performance, Lockheed Martin people are also committed to building stronger communities. As a corporate citizen, we are motivated by the enduring values of a free people—dedicated to diversity, education, volunteerism, philanthropy, and our own set of corporate values of: ETHICS AND INTEGRITY PEOPLE AND TEAMWORK EXCELLENCE AND A “CAN-DO” SPIRIT As premier systems integrators, we know the importance of a team, and at Team Lockheed Martin every individual is a valued resource. Our goal is to recruit the brightest, most talented people to this team, building a workforce to carry our Corporation into the 21st century. Diverse experiences and backgrounds enable us to tap talents and expertise that will give Team Lockheed Martin a competitive edge to discover inventive solutions to the greatest challenges ahead for our customers, shareholders, employees and communities. The men and women of Lockheed Martin are committed to the highest standards of ethical business conduct. We conduct regular ethics training for every one of our employees, rooting these standards deep into our corporate culture. TWENTY-TWO

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    Education is another pillar of corporate citizenship and as a technology company, Lockheed Martin is vitally interested in the quantity and quality of our nation’s technology graduates. Lockheed Martin supports a variety of educational programs and initiatives, such as grants to colleges and universities that have nationally recognized science, engineering and computer science programs. In addition, Lockheed Martin initiatives are devoted to strengthening math, science and engineering education from kindergarten through grade 12. Related to these initiatives is the volunteerism of our employees who serve as mentors and tutors to children across the country. Employee volunteers also contribute to the health of the communities where they live through food and blood drives to aid those in need, as well as fundraising efforts to combat disease. Philanthropy is a vital element of Lockheed Martin’s corporate citizenship, recognizing the aesthetic and cultural value that the arts play in a free society. Ours is a company that deals in the currency of ideas, and the arts build the strength of that currency. And wherever possible we link our support for the arts directly to education, such as school visits by music and dramatic arts organizations or student visits to concerts. Freedom, education, values, citizenship, diversity and devotion are not hollow words. They are ideals which men and women have defended with their own lives. They are the ideals that have steered the course of this nation and free people worldwide, and they serve to inspire and motivate the people of Lockheed Martin. TWENTY-THREE

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    FINANCIAL SECTION of the 2 0 0 2 A N N UA L R E P O RT Financial Highlights Inside Front Cover Financial Section Roadmap 25 Management’s Discussion and Analysis of Financial Condition and Results of Operations 26 Management’s Responsibility for Financial Reporting 49 Report of Ernst & Young LLP, Independent Auditors 50 Consolidated Statement of Operations 51 Consolidated Statement of Cash Flows 52 Consolidated Balance Sheet 53 Consolidated Statement of Stockholders’ Equity 54 Notes to Consolidated Financial Statements 55 Consolidated Financial Data—Five Year Summary 79 Forward-Looking Statements—Safe Harbor Provisions 84 TWENTY-FOUR

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    Lockheed Martin Corporation F INANCIAL S ECTION ROADMAP December 31, 2002 The financial section of our Annual Report includes manage- sheet as of the end of the last two years. Our financial state- ment’s discussion and analysis, our consolidated financial ments are prepared according to accounting principles that are statements, notes to those financial statements and a 5-year generally accepted in the United States. summary of financial information. We have prepared the fol- Notes to the financial statements (pages 55 through 78)— lowing summary, or “roadmap,” to assist in your review of the provide insight into and are an integral part of our financial financial section. It is designed to give you an overview of our statements. There are explanations of our significant account- company and direct you to some of the more important events ing policies, details about certain of the captions on the finan- that happened this year. cial statements, information about significant events or LOCKHEED MARTIN’S BUSINESS transactions that have occurred, discussions about commit- Lockheed Martin Corporation is mainly involved in the ments and contingencies, and selected financial information research, design, development, manufacture, integration and relating to our business segments. The notes to the financial operation of advanced technology systems, products and serv- statements are also prepared according to accounting princi- ices. We have customers in both domestic and international ples that are generally accepted in the United States. defense and commercial markets. Our principal customers are HIGHLIGHTS agencies of the U.S. Government. Our main areas of focus are The financial section of our Annual Report describes our in the defense, space, homeland security, and government/civil ongoing operations, including discussions about particular information technology markets. lines of business or programs, our ability to finance our oper- FINANCIAL SECTION OVERVIEW ating activities, and trends and uncertainties in our industry The financial section includes the following: and how they might affect our future operations. We also dis- Management’s discussion and analysis, or MD&A (pages cuss “unusual” items relative to our ongoing operations. We 26 through 48)—provides information about industry trends, separately disclose these items to assist in your evaluation of risks and uncertainties relating to Lockheed Martin, account- our overall operating performance and financial condition. We ing policies that we view as critical in light of our operations, would like to draw your attention to the following items dis- our results of operations, including discussions about the oper- closed in this financial section and where you will find them: ations of each of our business segments, our financial position Topic Location(s) and cash flows, and important events or transactions that have Critical accounting policies Page 29 occurred over the last three years. Post-retirement benefit plans Page 30 and page 70 Financial statements, notes to the financial statements and Exit from global related reports— telecommunications business Page 32 and page 59 Reports related to the financial statements (pages 49 through Divestiture activities Page 34 and page 61 50)—include the following: Adoption of FAS 142 • A report from our management, indicating our responsibil- (accounting for goodwill) Page 35 and page 58 ity for financial reporting and maintaining an internal Summary of unusual items Page 36 control environment, and Changes in our business segment • A report from our independent auditors, Ernst & Young presentation, and discussions of LLP, which includes their opinion about the fairness of our each segment’s operations Page 38 and page 74 financial statements based on their audits. The report Cash flows Page 43 and page 52 includes their opinion about the conformity of our financial Capital structure and resources Page 44, page 53 and statements, which includes the notes to the financial state- page 54 ments, with accounting principles that are generally Environmental matters Page 32, page 47 and accepted in the United States. page 72 Stock options Page 68 Financial statements (pages 51 through 54)—include our con- Commitments and contingencies Page 72 solidated statements of operations, cash flows and stockhold- ers’ equity for each of the last three years, and our balance TWENTY-FIVE

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    Lockheed Martin Corporation M ANAGEMENT ’ S D ISCUSSION AND A NALYSIS OF F INANCIAL C ONDITION AND R ESULTS OF O PERATIONS December 31, 2002 INDUSTRY CONSIDERATIONS THAAD programs. In the areas of space intelligence and information superiority, we have leadership positions on the Defense Business Considerations Milstar, Advanced Extremely High Frequency (AEHF) and In recent years, domestic and worldwide political and eco- Space-Based Infrared System-High (SBIRS-H) programs, and nomic developments have had a significant impact on the mar- in battle management command and control capabilities. In kets for defense and advanced technology systems, products airlift, we have the C-130J program and are under contract to and services. Markets for defense and advanced technology upgrade the C-5 strategic airlift aircraft. Many of these pro- systems during 2002 and in the foreseeable future will con- grams are large and require funding over several budget tinue to be affected by the worldwide war against terrorism cycles. There are risks associated with these and other large, and threats created by the potential widespread availability of highly visible programs that are subject to appropriation by weapons of mass destruction. These realities have increased Congress which, because of their size, could be expected to the need for greater attention to the security of our homeland become potential targets for reductions or extensions of their and for better communication and interplay between law funding to pay for other programs. enforcement, civil government agencies and our military serv- In addition, the increase in emphasis on homeland secu- ices. Our nation’s overall defense posture continues to move rity may increase demand for our capabilities in areas such as toward a more capabilities-based structure, which creates the air traffic management, biohazard detection systems for postal ability for a more flexible response with greater force mobil- equipment, information systems security and other technical ity, stronger space capabilities, better missile defense and systems solutions. Recent trends have indicated an increase in improved information systems security. demand by federal and civil government agencies for upgrad- The President’s budget for the U.S. Department of ing and investing in new information technology systems. This Defense (DoD) for fiscal year 2003 and beyond reflects the is an area where we have continued to focus our resources. transformation of the country’s national defense posture and In prior years, companies in our industry had reacted to responds to increased needs for homeland security and defeat- historically shrinking defense budgets for procurement, ing terrorism. This is evidenced by budget increases for opera- research and development by combining to maintain critical tional readiness and personnel needs, as well as for both mass and achieve cost savings. More recently, we have procurement and research and development. While there is no focused our efforts on cost savings and improving efficiency, assurance that the increased DoD budget levels will be as well as generating cash to repay debt incurred during the approved by Congress, the current defense budget outlook is period of consolidation. Through our consolidation activities, one of modest growth. However, the level of growth and the we have been able to pass along savings to our customers, amount of the budget that will ultimately be allocated to the mainly the DoD. investment accounts (i.e., procurement, research and develop- Non-U.S. defense budgets have generally been declining ment) is unknown. over the past decade. As a result, consolidation has also been Our broad mix of programs and capabilities gives us the occurring in the European aerospace industry, resulting in ability to support the needs of the various agencies of the fewer but larger and more capable competitors, potentially U.S. Government that require our products and services. Our resulting in an environment where there could be less demand product areas and programs include: missile defense; space abroad for products from U.S. companies. This type of envi- intelligence; command, control, communications, computers, ronment could reduce opportunities for European partnerships intelligence, surveillance and reconnaissance (C4ISR); air and sales potential for U.S. exports. mobility aircraft; and air power projection/precision strike capability. In terms of size and long-term potential impact, Other Business Considerations two of our more important programs are the F/A-22 fighter As a government contractor, we are subject to U.S. aircraft program and the F-35 Joint Strike Fighter program. Government oversight. The Government may ask about and We are also represented in almost every aspect of land, sea, air investigate our business practices and audit our compliance and space-based missile defense, including the PAC-3 and with applicable rules and regulations. Depending on the TWENTY-SIX

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    Lockheed Martin Corporation results of those audits and investigations, the Government With respect to our work with NASA, we provide products could make claims against us. Under Government procure- and services for the Space Shuttle program mainly through our ment regulations and practices, an indictment of a government Space Systems and Technology Services business segments. In contractor could result in that contractor being fined and/or 2002, work for NASA accounted for approximately 6% of our suspended from being able to bid on, or be awarded, new gov- consolidated net sales, of which approximately one-half was ernment contracts for a period of time. A conviction could related to the Space Shuttle program. We also have a 50% result in debarment for a specific period of time. Similar gov- equity interest in United Space Alliance, LLC, which provides ernment oversight exists in most other countries where we ground processing and other operational services to the Space conduct business. Although we cannot predict the outcome of Shuttle program. We are working with the Columbia Accident these types of investigations and inquiries with certainty, Investigation Board and NASA in the investigation of the based on current facts, we do not believe that any of the February 2003 accident involving the Space Shuttle Columbia. claims, audits or investigations pending against us are likely to This tragic event did not impact our results of operations for have a material adverse effect on our business or our results of 2002, and it is too early to determine whether the accident will operations, cash flows or financial position. affect our business operations for 2003 and beyond. Changes in government procurement policies and practices We have entered into various joint venture, teaming and over the past several years, such as increases in the progress other business arrangements to help support our portfolio of payment rate and the use of performance-based payments, have products and services in commercial space as well as other had a positive effect on our financial position and cash flows. lines of business. For additional information about these ven- But we are still exposed to risks associated with U.S. tures, see the discussion in the next section concerning our Government contracting, including technological uncertainties “Commercial Space Business,” the discussion on page 34 cap- and obsolescence, and having to depend on Congressional tioned “Write-Off and Restructuring of Investment in appropriation and allotment of funds each year. Many of our Astrolink,” and the discussion on page 45 relating to Space programs involve the development and application of state-of- Imaging under the caption “Capital Structure and Resources.” the-art technologies aimed at achieving challenging goals. As These arrangements generally include a formal plan for fund- a result, setbacks, delays, cost overruns and failures can occur. ing the business which usually requires commitments from the In addition to our defense businesses, we also provide partners, and may require the business to get financing from products and services to civil government customers, as well other sources as well. To the extent the business is unable to as commercial customers. Relative to civil government cus- get financing from other sources, the business partners, our- tomers, in 2002, a joint venture in which we are participating selves included, would be required to look at alternatives for was awarded the contract for Deepwater, a modernization pro- funding the business. Some of these business arrangements gram for the Coast Guard’s fleet and systems. Our role will be include foreign partners. The conduct of international business to provide systems integration and engineering; C4ISR; air introduces other risks into our operations, including changing assets; and integrated logistics support. In addition, we pro- economic conditions, fluctuations in relative currency values, vide products and services to agencies such as the U.S. Postal regulation by foreign countries and the potential for unantici- Service, the Federal Aviation Administration, NASA and the pated cost increases resulting from the possible deterioration Transportation Security Administration. Although our lines of of political relations. business in civil government and commercial markets are not The nature of our international business also makes dependent on defense budgets, they share many of the same us subject to the export control regulations of the U.S. risks as our defense businesses, as well as other risks unique to Department of State and the Department of Commerce. If their particular marketplaces. These risks may include devel- these regulations are violated, it can result in monetary penal- opment of competing products, technological feasibility and ties and denial of export privileges. We are currently unaware product obsolescence. TWENTY-SEVEN

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    Lockheed Martin Corporation M ANAGEMENT ’ S D ISCUSSION AND A NALYSIS OF F INANCIAL C ONDITION AND R ESULTS OF O PERATIONS December 31, 2002 of any violations of export control regulations which are rea- the results of operations of LKEI and ILS into our financial sonably likely to have a material adverse effect on our business statements. Contracts for launch services usually require sub- or our results of operations, cash flows or financial position. stantial advances from the customer before the launch. At the end of 2002, $412 million of advances received from cus- Commercial Space Business tomers for Proton launch services not yet provided was The launch vehicle industry has continued to be affected by included as a liability on our balance sheet in the caption low demand for products and services due mainly to low “Customer advances and amounts in excess of costs incurred.” demand for satellites as a result of excess capacity in the A sizable percentage of the advances we receive from telecommunications industry. Concerns over uncertainty in the customers for Proton launch services are sent to Khrunichev economy have made it difficult for many ventures, especially State Research and Production Space Center (Khrunichev), the telecommunications and other high-technology companies, to manufacturer of the launch vehicle and provider of the related obtain funding from capital markets. Reduced demand and launch services in Russia. If a contracted launch service is not increased competition have also caused pricing pressures in provided, a sizeable percentage of the related advance would the launch vehicle market. This comes at a time when we have to be refunded to the customer. In addition, we have sent have been making significant investments in the Evolved advances to Khrunichev for launches we purchased which Expendable Launch Vehicle (Atlas V) program, our next gen- have not yet been assigned to customers. The advances sent to eration launch vehicle. This program has required investment Khrunichev are included on our balance sheet in inventories. of funds for research and development, start-up and other non- In the fourth quarter of 2002, we entered into an agreement recurring costs, and launch facilities. Some of these expendi- with Khrunichev to eliminate the requirement to provide tures have been funded under an agreement with the U.S. launch services for our prior advances that were not associated Government. We had our first Atlas V launch in August 2002, with specific customer launch orders in exchange for an successfully delivering a Eutelsat satellite into orbit. Orders arrangement to reduce future launch payments from us to to-date for the Atlas V launch vehicle have been lower than Khrunichev, contingent on the receipt of new orders as well as expected and at lower prices. a minimum number of actual launches each year. Due to the Similar to the launch vehicle market, the commercial continuing overcapacity in the launch vehicle market, we do satellite market is experiencing pricing pressures due to excess not expect to recover amounts previously advanced for an capacity and lower demand. Satellite demand also has been extended period of time. In addition, we assessed the likeli- impacted by the business difficulties encountered by some hood of customer terminations-for-convenience for launches companies in the commercial satellite services industry which currently under contract. A contract termination would require have resulted in reduced access to capital and a reduction in Khrunichev to refund a portion of the advances we have made the total market size in the near term. We expect to continue to to them and would require us to refund a portion of the reduce costs in our commercial satellite manufacturing busi- advances received from the customer. As a result of these fac- ness while keeping our focus on providing a reliable product. tors, we reduced the carrying value of our advances to In 1992, we entered into a joint venture with two Khrunichev and recognized a charge, net of state income tax Russian government-owned space firms to form Lockheed- benefits, of $173 million in the fourth quarter of 2002. The Khrunichev-Energia International, Inc. (LKEI). We own 51% charge reduced net earnings by $112 million ($0.25 per share). of LKEI. LKEI has exclusive rights to market launches of At year-end 2002, $391 million of payments to Khrunichev commercial, non-Russian-origin space payloads on the Proton were included in inventories. Our ability to realize the remain- family of rockets from a launch site in Kazakhstan. In 1995, ing amounts may be affected by Khrunichev’s ability to provide another joint venture was formed, International Launch the launch services and the political environment in Russia. Services (ILS), with Lockheed Martin and LKEI each holding a Through the end of 2002, launch services through LKEI and 50% ownership. ILS was formed to market commercial Atlas ILS have been provided according to contract terms. and Proton launch services around the world. We consolidate TWENTY-EIGHT

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    Lockheed Martin Corporation The Corporation has entered into an agreement with RD place for recognizing sales and profits, see our discussion under AMROSS, a joint venture of the Pratt & Whitney division of “Sales and earnings” in Note 1 to the financial statements. United Technologies Corporation and the Russian firm NPO Contract accounting requires judgment relative to assess- Energomash, for the development and purchase, subject to ing risks, estimating contract revenues and costs, and making certain conditions, of RD-180 booster engines for use in the assumptions for schedule and technical issues. Due to the size Corporation’s Atlas launch vehicles. Terms of the agreement call and nature of many of our contracts, the estimation of total for payments to be made to RD AMROSS upon the achievement revenues and cost at completion is complicated and subject to of certain milestones in the development and manufacturing many variables. Contract costs include material, labor and processes. Approximately $61 million of payments made under subcontracting costs, as well as an allocation of indirect costs. this agreement for engines not yet delivered were included in Assumptions have to be made regarding the length of time to the Corporation’s inventories at December 31, 2002. complete the contract because costs also include expected increases in wages and prices for materials. For contract CRITICAL ACCOUNTING POLICIES change orders, claims or similar items, we apply judgment in estimating the amounts and assessing the potential for realiza- Contract Accounting /Revenue Recognition tion. These amounts are only included in contract value when A large part of our business is derived from long-term devel- they can be reliably estimated and realization is considered opment and production contracts which we account for consis- probable. Incentives or penalties related to performance on tent with the American Institute of Certified Public contracts are considered in estimating sales and profit rates, Accountants’ (AICPA) audit and accounting guide, “Audits of and are recorded when there is sufficient information for us to Federal Government Contractors,” and the AICPA’s Statement assess anticipated performance. Estimates of award fees are of Position No. 81-1, “Accounting for Performance of also a significant factor in estimating sales and profit rates Construction-Type and Certain Production-Type Contracts.” based on actual and anticipated awards. We consider the nature of these contracts and the types of Products and services provided under long-term develop- products and services provided when we determine the proper ment and production contracts make up a large portion of accounting for a particular contract. Generally, we record our business, and therefore the amounts we record in our long-term fixed-price contracts on a percentage of completion financial statements using contract accounting methods and basis using units-of-delivery as the basis to measure progress cost accounting standards are material. We follow U.S. toward completing the contract and recognizing revenue. For Government procurement and accounting standards in assess- certain other long-term fixed-price contracts which, along with ing the allowability and the allocability of costs to contracts. other factors, require us to deliver minimal quantities over a Because of the significance of the judgments and estimation longer period of time or to perform a substantial level of devel- processes, it is likely that materially different amounts could opment effort in comparison to the total value of the contract, be recorded if we used different assumptions or if the underly- revenues are recorded when we achieve performance mile- ing circumstances were to change. We closely monitor compli- stones or using the cost-to-cost method of accounting. Under ance with and the consistent application of our critical the cost-to-cost method of accounting, we recognize revenue accounting policies related to contract accounting. Business based on the ratio of costs incurred to our estimate of total costs segment personnel perform reviews of the status of contracts at completion. We record sales under cost-reimbursement-type through periodic contract status and performance reviews. contracts as we incur the costs. As a general rule, we recognize When adjustments in estimated contract revenues or costs are sales and profits earlier in a production cycle when we use the required, any changes from prior estimates are generally cost-to-cost and milestone methods of percentage of comple- included in earnings in the current period. Also, regular and tion accounting versus when we use the units-of-delivery recurring evaluations of contract cost, scheduling and techni- method. We have accounting policies in place to address these cal matters are performed by management personnel who are and other complex issues in accounting for long-term con- independent from the business segment performing work tracts. For other information on accounting policies we have in TWENTY-NINE

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    Lockheed Martin Corporation M ANAGEMENT ’ S D ISCUSSION AND A NALYSIS OF F INANCIAL C ONDITION AND R ESULTS OF O PERATIONS December 31, 2002 under the contract. Costs incurred and allocated to contracts together with other factors such as the effects of the actual with the U.S. Government are scrutinized for compliance with return on plan assets, result in our projecting a substantial regulatory standards by our personnel, and are subject to audit amount of pension expense for 2003, compared to recording by the Defense Contract Audit Agency. pension income in 2002. Also, at the end of 2002, we recorded an adjustment in the Post-Retirement Benefit Plans stockholders’ equity section of our balance sheet to reflect a Most employees are covered by defined benefit pension plans, minimum pension liability for most of our pension plans. This and we provide health care and life insurance benefits to eligible adjustment is calculated on a plan-by-plan basis, and is deter- retirees. Our earnings may be positively or negatively impacted mined by comparing the accumulated benefit obligation by the amount of income or expense we record for our (ABO) for the plan to the fair value of that plan’s assets. The employee benefit plans. This is particularly true with income or amount by which the ABO exceeds the fair value of the plan expense for qualified defined benefit plans (pension plans) assets, after adjusting for previously recorded accrued or pre- because those calculations are sensitive to changes in several paid pension cost for the plan, must be recorded as a minimum key economic assumptions and workforce demographics. pension liability, with a corresponding increase in an intangi- We account for our pension plans using Statement of ble asset, if appropriate, and a reduction to stockholders’ Financial Accounting Standards (FAS) No. 87, “Employers’ equity, consistent with FAS 87. The noncash after-tax adjust- Accounting for Pensions” (FAS 87). Those rules require that ment related to our recording of a minimum pension liability the amounts we record, including the income or expense for in 2002 did not impact earnings, but reduced our stockholders’ the plans, be computed using actuarial valuations. These valu- equity by $1.5 billion. This adjustment is computed at each ations include many assumptions, including assumptions we year-end and could potentially reverse in the future if financial make relating to financial market and other economic condi- markets improve and interest rates increase, or could poten- tions. Changes in key economic indicators can result in tially increase if financial market performance and interest changes in the assumptions we use. The key year-end assump- rates continue to decline. tions used to estimate pension income or expense for the fol- The total funding requirement for our pension plans under lowing fiscal year are the discount rate, the expected long-term U.S. Government Cost Accounting Standards (CAS) in 2002 rate of return on plan assets and the rate of increase in future was $87 million. CAS is a major factor in determining our compensation levels. funding requirements and governs the extent to which our pen- We use judgment in selecting these assumptions each year sion costs are allocable to and recoverable under contracts because we have to consider not only current market condi- with the U.S. Government. For 2003, we expect our funding tions, but also make judgments about future market trends, requirements under CAS to increase substantially. This changes in interest rates and equity market performance. We amount is recovered over time through the pricing of our prod- also have to consider factors like the timing and amounts of ucts and services on U.S. Government contracts, and therefore expected contributions to the plans and benefit payments to is recognized in our net sales. Also in 2003, funding in addi- plan participants. tion to the amount calculated under CAS will likely be An actual example of how changes in these assumptions required under Internal Revenue Code rules. Any additional can affect our financial statements occurred in 2002. Based on amounts computed under those rules are considered to be pre- our review of market trends, actual returns on plan assets, and payments under the CAS rules, and therefore are recorded on other factors, we lowered the expected long-term rate of return our balance sheet and recovered in future periods. on plan assets for our year-end 2002 actuarial calculations to 8.5%, versus 9.5% for 2001. This rate is applied to a calcu- Impairment of Investments in Equity Securities lated value of plan assets which results in an amount that is We have investments in equity securities of several companies, included in pension income or expense in the following year. some of which are publicly traded entities. We review these We also lowered the discount rate assumption to 6.75% at investments each quarter to evaluate our ability to recover our year-end 2002, versus 7.25% used for 2001. These changes, investments. We record an impairment charge if the fair value THIRTY

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    Lockheed Martin Corporation of the investment has declined below our carrying value, and enacted which extends the deadline for Intelsat to complete its that decline is viewed to be other than temporary. initial public offering to December 31, 2003, or June 30, 2004 For publicly traded companies, the fair value of the equity if approved by the FCC. Unless there are changes in the cur- securities is determined by multiplying the number of shares rent trends and market conditions in the telecommunications we own by the stock price, as well as by computing estimates industry, as well as in the capital markets, Intelsat and of the fair values based on a variety of valuation methods (e.g., Inmarsat may have difficulty in completing their initial public discounted cash flow analyses, sum-of-the-parts valuations offerings by the ORBIT Act deadlines. If those deadlines are and trading multiples). For those companies that are not pub- not met or extended by further amendments to the legislation, licly traded, we prepare discounted cash flow analyses to com- the FCC may limit access by U.S. users to the satellite capacity pute an estimate of the fair value of the investment. Since we of the privatized entities for some services. If this were to occur, generally do not have access to internal projections of those the value of our investments could be adversely affected. companies, we prepare projections based on information that In the fourth quarter 2002, as part of the ongoing evaluation is publicly available. We use judgment in computing the fair of our ability to recover our investments, we calculated an esti- value based on our evaluation of the investee and establishing mate of the current fair values of our investments in Intelsat an appropriate discount rate and terminal value to apply in the and Inmarsat. For our investment in New Skies, we calculated calculations. In selecting these and other assumptions, we con- the current fair value based on the publicly traded stock price sider the investee’s ability to execute their business plan suc- and, for analysis purposes, also calculated an estimate of the cessfully, including their ability to obtain required funding, fair value using discounted cash flow analyses. In each case, general market conditions, and industry considerations spe- the fair value of our investment was less than our carrying cific to their business. It is likely that we could compute a amount. We then made an assessment as to whether the decline materially different fair value for an investment if different in the value of these investments was other than temporary. We assumptions were used or if circumstances were to change. reviewed investment analyst reports to the extent they were Many of our investments are concentrated in the satellite available. We also assessed future business prospects for the services and telecommunications industries, including Intelsat, companies and reviewed information regarding market and Ltd. (Intelsat), Inmarsat Ventures plc (Inmarsat) and New Skies industry trends for their businesses. Satellites, N.V. (New Skies). These industries continue to be Based on our evaluation, including the factors discussed affected by the capital markets, excess satellite capacity and above, we determined that the decline in values of these invest- competition from other kinds of telecommunications services, ments was other than temporary, and recorded impairment including fiber optic cable and other wireless communication charges related to these investments in the fourth quarter of technologies. This has been evidenced by recent bankruptcy fil- 2002. The impact of the unusual charges on operating profit ings by some telecommunications companies. Intelsat, (earnings from continuing operations before interest and taxes), Inmarsat and New Skies are also subject to regulation by the net earnings and diluted earnings per share was as follows: Federal Communications Commission (FCC). FCC decisions Earnings per and policies have had, and may continue to have, a significant Operating Net Diluted impact on these companies. In 2000, Congress passed the Open- (In millions) Profit Earnings Share Market Reorganization for the Betterment of International Write-down of investment in: Telecommunications Act (the ORBIT Act) that, among other Intelsat $(572) $(371) $(0.82) things, established deadlines for Intelsat and Inmarsat to Inmarsat (101) (66) (0.15) complete their initial public offerings. Under the ORBIT New Skies (103) (67) (0.15) Act, Intelsat and Inmarsat were required to complete their Total write-down of initial public offerings by December 31, 2002. However, telecommunications investments $(776) $(504) $(1.12) Inmarsat has received an extension from the FCC until June 30, 2003. In October 2002, legislation was THIRTY-ONE

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    Lockheed Martin Corporation M ANAGEMENT ’ S D ISCUSSION AND A NALYSIS OF F INANCIAL C ONDITION AND R ESULTS OF O PERATIONS December 31, 2002 Environmental Liabilities services for U.S. Government businesses. The amount that is We record financial statement accruals for environmental mat- expected to be allocated to our commercial businesses has ters in the period that it becomes probable that a liability has been expensed through cost of sales. The amounts we record been incurred and the amounts can be reasonably estimated do not reflect the fact that we may recover some of the envi- (see the discussion under “Environmental matters” in Note 1 ronmental costs we have incurred through insurance or from to the financial statements). Judgment is required when we other PRPs, which we are pursuing as required by agreement develop assumptions and estimate costs expected to be and U.S. Government regulation. Any recoveries we receive incurred for environmental remediation activities due to, along would reduce the allocated amounts included in our future with other factors, difficulties in assessing the extent of envi- U.S. Government sales and cost of sales. ronmental remediation to be performed, complex environmen- tal regulations and remediation technologies, and agreements EXIT FROM THE GLOBAL TELECOMMUNICATIONS between potentially responsible parties (PRPs) to share in the SERVICES BUSINESS cost of remediation as discussed below. In December 2001, we announced that we would exit our We enter into agreements (e.g., administrative orders, global telecommunications services business as a result of consent decrees) which document the extent of our obligation. continuing overcapacity in the telecommunications industry These agreements usually cover several years which makes esti- and weakening business and economic conditions in Latin mating the costs more judgmental due, for example, to changing America. We also decided in the fourth quarter of 2001 not to remediation technologies. To determine total costs at clean-up provide further funding to Astrolink International, LLC sites, we have to assess the appropriate technology to be used (Astrolink) and, mainly due to Astrolink’s inability to obtain to accomplish the remediation, as well as continually evolving additional funding from other sources, wrote off our invest- regulatory environmental standards. We consider these factors ment in Astrolink. We recorded unusual charges, net of state in our estimates of the timing and amount of any future costs income tax benefits, of approximately $2.0 billion in the fourth that may be required for remedial actions. Given the level of quarter of 2001 related to these actions. The charges reduced judgment and estimation which has to occur as described net earnings by about $1.7 billion ($3.98 per diluted share). above, it is likely that materially different amounts could be The global telecommunications services businesses recorded if different assumptions were used or if circumstances included the operations of COMSAT Corporation. We com- were to change (e.g., a change in environmental standards). pleted our merger with COMSAT Corporation in August 2000. Under agreements reached with the U.S. Government in The operations of COMSAT were included in the results of 1990 and 2000, some of the amounts we spend for groundwater our operations since August 1, 2000. The total purchase price treatment and soil remediation are allocated to our operations for COMSAT was approximately $2.6 billion. The COMSAT as general and administrative costs. Under existing govern- transaction was accounted for using the purchase method of ment regulations, these and other environmental expenditures accounting, where the purchase price was allocated to assets relating to our U.S. Government businesses, after deducting acquired and liabilities assumed based on their fair values. any recoveries from insurance or other PRPs, are allowable in These allocations included adjustments totaling approximately establishing prices of our products and services. As a result, a $2.1 billion to record investments in equity securities (i.e., substantial amount of the expenditures we incur are being Intelsat, Inmarsat and New Skies) at fair value, and goodwill. included in our sales and cost of sales according to U.S. The global telecommunications businesses that we Government agreement or regulation. retained included the Systems & Technology line of business At the end of 2002 and 2001, the total amount of liabili- and the COMSAT General telecommunications business unit, ties recorded on our balance sheet for environmental matters which were realigned with the Space Systems segment, and was $445 million and $300 million, respectively. We have Enterprise Solutions-U.S., which was realigned with the recorded an asset for the portion of environmental costs that Technology Services segment. The equity investments are probable of future recovery in pricing of our products and retained, including Intelsat, Inmarsat and New Skies, ACeS THIRTY-TWO

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    Lockheed Martin Corporation International, Ltd. (ACeS), Americom Asia-Pacific, LLC and Effective January 1, 2001, we adopted FAS 144, Astrolink, had a combined carrying value of about $900 mil- “Accounting for the Impairment or Disposal of Long-Lived lion at December 31, 2002. Assets.” Since the operating businesses we identified for The following discussion describes the components of the divestiture met the requirements of FAS 144 to be classified as $2.0 billion in charges based on their classification in our discontinued operations, their results of operations, as well as financial statements. the impairment and other charges related to the decision to exit the businesses, are classified as discontinued operations Discontinued Operations for all periods presented, and have been excluded from busi- The $2.0 billion in charges in 2001 included an amount, net of ness segment information. Also, the assets and liabilities of state income tax benefits, of approximately $1.4 billion related these businesses have been shown separately in the balance to global telecommunications services businesses held for sale sheet as being held for sale. Depreciation and amortization and exit costs for the elimination of the administrative func- expense were not recorded for these businesses after the date tion supporting the global telecommunications businesses and they were classified as held for sale consistent with FAS 144. investments. These charges, which reduced net earnings for LMI is recorded at estimated fair value less cost to sell at the year by $1.3 billion ($3.09 per diluted share) were December 31, 2002. Changes in the estimated fair value of included in discontinued operations in our statement of opera- LMI will be recorded in the future if appropriate. tions. The status of the businesses held for sale is as follows: We also completed the sale of Lockheed Martin IMS • Satellite Services businesses—In 2002, we completed the Corporation (IMS), a wholly-owned subsidiary, for $825 mil- sale of COMSAT Mobile Communications and COMSAT lion in cash in August 2001. This transaction resulted in a gain, World Systems. These transactions did not have a material net of state income taxes, of $476 million and increased net impact on our consolidated results of operations or financial earnings by $309 million ($0.71 per diluted share). The results position. We also reached an agreement to sell Lockheed of IMS’s operations for all periods presented, as well as the Martin Intersputnik (LMI) in the third quarter of 2002. This gain on the sale, are classified as discontinued operations in transaction is expected to close in 2003, subject to regulatory accordance with FAS 144. Net sales recorded in 2001 up to the approvals and the satisfaction of other conditions, including effective date of the divestiture totaled approximately $355 mil- a requirement that we move the LMI satellite to another lion, excluding intercompany sales. The transaction generated orbital slot. The transaction is not expected to have a material net cash proceeds of approximately $560 million after related impact on our results of operations or financial position. transaction costs and federal and state income tax payments. • COMSAT International—In 2002, we completed the sale of an 81% ownership interest in COMSAT International. The Other Charges Related to Global Telecommunications transaction did not have a material impact on our consoli- The charges recorded in the fourth quarter of 2001 also dated results of operations or financial position. included unusual charges, net of state income tax benefits, of approximately $132 million related to commitments to and Of the $1.4 billion of charges included in discontinued impairment in the values of investments in satellite joint ven- operations, about $1.2 billion related to impairment of goodwill. tures, primarily ACeS and Americom Asia-Pacific. We had The goodwill was recorded when we acquired COMSAT as previously recorded unusual charges related to other than tem- discussed above. Approximately $170 million of the $1.4 billion porary declines in the values of these investments as follows: related to impairment of some of the long-lived assets in the first quarter of 2001, a charge, net of state income tax employed by foreign businesses held for sale, mainly COMSAT benefits, of $100 million was recorded related to Americom International. The rest of the charge related to costs associated Asia-Pacific; and in the fourth quarter of 2000, a charge, net of with elimination of administrative functions, including sever- state income tax benefits, of $117 million was recorded related ance and facilities. to ACeS (see Note 8 to the financial statements for more dis- cussion of these charges). THIRTY-THREE

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    Lockheed Martin Corporation M ANAGEMENT ’ S D ISCUSSION AND A NALYSIS OF F INANCIAL C ONDITION AND R ESULTS OF O PERATIONS December 31, 2002 In addition, as part of the $2.0 billion in charges recorded OTHER DIVESTITURE ACTIVITIES in the fourth quarter 2001, about $43 million related to sever- In January 2001, we completed the divestiture of two business ance, facilities costs and impairment of certain fixed assets units in the environmental management line of business. The associated with the business units we retained. These unusual impact of these divestitures was not material to our 2001 charges reduced net earnings for 2001 by $117 million ($0.27 results of operations, cash flows or financial position due to per diluted share). the effects of unusual impairment losses recorded in prior years related to these business units. Those losses were Write-off and Restructuring of Investment in Astrolink included in other income and expenses as part of other portfo- Through 2001, we had invested $400 million in Astrolink, a lio shaping activities in the respective years. joint venture that planned to develop a broad-band satellite In November 2000, we sold our Aerospace Electronics system. In the fourth quarter of 2001, in light of market condi- Systems (AES) businesses for $1.67 billion in cash (the AES tions affecting the telecommunications industry and the diffi- Transaction). We recorded an unusual loss, including state culty Astrolink was having raising external capital, we decided income taxes, of $598 million related to this transaction which not to make an additional equity investment in Astrolink and is included in other income and expenses. The loss reduced net wrote off our 31% equity interest. As a result, we recorded an earnings for 2000 by $878 million ($2.18 per diluted share). unusual charge of $367 million, net of state income tax bene- Although the AES Transaction resulted in a pretax loss for fits, in other income and expenses to reflect the other than book purposes, it resulted in a gain for tax purposes primarily temporary decline in the value of our Astrolink investment. We because goodwill related to the AES businesses was not also recorded charges of approximately $20 million, net of included in the tax basis of the net assets of AES. Therefore, state income tax benefits, in cost of sales for certain other we were required to make state and federal income tax pay- costs related to Astrolink. On a combined basis, these charges ments associated with the divestiture. The AES Transaction reduced net earnings for 2001 by approximately $267 million generated net cash proceeds of approximately $1.2 billion ($0.62 per diluted share). after related transaction costs and federal and state income tax After several months of negotiation, in January 2003, we payments. Net sales included in the year 2000 related to the finalized an agreement with Astrolink’s other members to AES businesses totaled approximately $655 million, exclud- restructure Astrolink. As part of the transaction, Liberty Satellite ing intercompany sales. & Technology, a subsidiary of Liberty Media Corporation, may In September 2000, we sold Lockheed Martin Control acquire substantially all of Astrolink’s assets and pursue a busi- Systems (Control Systems) for $510 million in cash. This ness plan to build a one- or two-satellite system. The transaction transaction resulted in the recognition of an unusual gain, net is subject to regulatory approval, financing and other closing of state income taxes, of $302 million which is reflected in conditions. Upon closing of the asset transfer, we would con- other income and expenses. The gain increased net earnings tinue to provide launch services and be a satellite vendor, but for the year ended December 31, 2000 by $180 million ($0.45 would retain only a limited indirect equity interest in the per diluted share). This transaction generated net cash pro- restructured business. The restructuring also entails the settle- ceeds of $350 million after related transaction costs and fed- ment of existing claims related to termination of Astrolink’s eral and state income tax payments. Net sales for the first nine major procurement contracts. As part of that settlement, if months of 2000 related to Control Systems totaled approxi- Liberty Satellite & Technology does not elect to proceed with mately $215 million, excluding intercompany sales. the new system, we would acquire the remaining assets of In September 2000, we sold approximately one-third of Astrolink, including work in process under our procurement our interest in Inmarsat for $164 million. The investment in contracts with Astrolink. Certain other of the members also Inmarsat was acquired as part of the merger with COMSAT. would retain their work in process. Under either scenario, the As a result of the transaction, our interest in Inmarsat was restructuring is not expected to have a material effect on our reduced from approximately 22% to 14%. The sale of shares financial position, results of operations or cash flows. THIRTY-FOUR

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    Lockheed Martin Corporation in Inmarsat did not impact our results of operations. The trans- originally anticipated, and our outlook for potential new orders action generated net cash proceeds of about $115 million after for the F-16 during the next ten years. Relative to new orders, transaction costs and federal and state income tax payments. we expect that the F-16 will continue to be the dominant On an ongoing basis, we will continue to explore the sale fighter aircraft available for many countries in the interna- of various non-core businesses, passive equity investments and tional market until the F-35 Joint Strike Fighter is available. surplus real estate. If we were to decide to sell any such holdings As a result of the adoption, amortization expense for goodwill or real estate, the resulting gains, if any, would be recorded and certain other intangibles for 2002 was lower compared to when the transactions are consummated and losses, if any, 2001 by $274 million, and was lower compared to 2000 by would be recorded when they are probable and estimable. We $297 million. also continue to review our businesses on an ongoing basis to Net Sales identify ways to improve organizational effectiveness and per- (In billions) formance, and to focus on our core business strategy. $30 25 RESULTS OF OPERATIONS Since our operating cycle is long-term and involves many 20 types of development and production contracts with varying 15 production delivery schedules, the results of operations of a particular year, or year-to-year comparisons of recorded sales 10 and profits, may not be indicative of future operating results. Technology Services 5 Aeronautics The following discussions of comparative results among peri- Space Systems ods should be viewed in this context. 0 Systems Integration 2002 2001 2000 Effective January 1, 2002, we adopted FAS 142, “Goodwill and Other Intangible Assets,” as discussed more Continuing Operations fully in Note 1 of the notes to the financial statements. We For 2002, net sales were $26.6 billion, an 11% increase over completed the initial step of the goodwill impairment test 2001 sales. Sales for 2001 were $24.0 billion, a decrease of required by the new rules and concluded that no adjustment to 2% compared to 2000. Sales increased in all segments during the balance of goodwill at the date we adopted the standard 2002 as compared to 2001. Sales growth in our Aeronautics was required. We also reassessed the estimated remaining use- and Technology Services segments during 2001 were more ful lives of other intangible assets as part of our adoption of than offset by decreases in the remaining business segments as the Statement. As a result of that review, we extended the esti- compared to 2000. Adjusting for acquisitions and divestitures, mated remaining useful life of the intangible asset related to sales would have remained comparable when comparing 2001 our F-16 fighter aircraft program from six to ten years, effec- to 2000. The U.S. Government is our largest customer, tive January 1, 2002. The most important factors considered in accounting for about 80% of our sales for 2002 compared to making this determination included the existing backlog for 78% in 2001 and 72% in 2000. F-16 deliveries which extends production beyond the life we THIRTY-FIVE

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    Lockheed Martin Corporation M ANAGEMENT ’ S D ISCUSSION AND A NALYSIS OF F INANCIAL C ONDITION AND R ESULTS OF O PERATIONS December 31, 2002 Our results of operations for 2002, 2001 and 2000 Operating Net Earnings (Loss) (Loss) per Diluted included the effects of various unusual items. The impact of (In millions) Profit Earnings Share these items on operating profit (earnings from continuing YEAR ENDED DECEMBER 31, 2000 operations before interest and taxes), net earnings (loss) and Continuing operations amounts per diluted share is as follows: Loss related to AES Transaction $ (598) $ (878) $(2.18) Effects of unusual items: Operating Net Earnings Loss on early (Loss) (Loss) per Diluted repayment of debt (146) (95) (0.24) (In millions) Profit Earnings Share Charge related to YEAR ENDED DECEMBER 31, 2002 Globalstar guarantee (141) (91) (0.23) Continuing operations Impairment charge Write-down of related to ACeS (117) (77) (0.19) telecommunications Other portfolio shaping items (46) (30) (0.07) investments $ (776) $ (504) $(1.12) Gain on sale of Control Systems 302 180 0.45 Charge related to Partial reversal of Russian advances (173) (112) (0.25) CalComp reserve 33 21 0.05 Write-down of investment Gain on sales of surplus in Space Imaging and real estate 28 19 0.05 charge related to $ (685) $ (951) $(2.36) recording of guarantee (163) (106) (0.23) R&D tax credit settlement — 90 0.20 Our operating profit for 2002 was $1.2 billion, an increase $(1,112) $ (632) $(1.40) of 39% compared to 2001. Our operating profit for 2001 was YEAR ENDED DECEMBER 31, 2001 $833 million, a decrease of 25% compared to 2000. These Continuing operations amounts included the impacts of unusual items which reduced Write-off of investment in operating profit for 2002, 2001 and 2000 by $1,112 million, Astrolink and related costs $ (387) $ (267) $(0.62) $973 million and $685 million, respectively. The results for Write-down of investment 2001 and 2000 included amortization expense of $274 million in Loral Space (361) (235) (0.54) and $297 million, respectively, for goodwill and certain other Other charges related to global telecommunications (176) (117) (0.27) intangibles that was not included in 2002 due to the adoption Impairment charge related of FAS 142. Adjusting for the effects of the unusual items and to Americom Asia-Pacific (100) (65) (0.15) the adoption of FAS 142 for each year, operating profit for Loss on early 2002 would have been $2.3 billion, a 9% increase over the repayment of debt (55) (36) (0.08) operating profit of $2.1 billion in 2001. The operating profit Other portfolio for 2001 would have remained comparable to operating profit shaping activities (5) (3) (0.01) Gain on sale of surplus of $2.1 billion in 2000. real estate 111 72 0.17 Operating profit in 2002 increased in all four business (973) (651) (1.50) segments when compared to 2001. When comparing 2001 to Discontinued operations— 2000, increases in the Aeronautics, Space Systems and Charges related to discontinued Technology Services segments were offset by a decrease in businesses, net of IMS gain — (1,027) (2.38) operating profit in Systems Integration. $ (973) $(1,678) $(3.88) THIRTY-SIX

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    Lockheed Martin Corporation Interest expense for 2002 was $581 million, $119 million Discontinued Operations lower than the comparable amount in 2001 mainly due to We reported losses from discontinued operations of $33 mil- reductions in our debt portfolio and the benefit from interest lion ($0.07 per diluted share) in 2002, $1.1 billion ($2.52 per rate swap agreements. Interest expense for 2001 was $700 diluted share) in 2001, and $42 million ($0.10 per diluted million, $219 million lower than the amount for 2000 mainly share) in 2000. as a result of reductions in our debt portfolio. The businesses included in discontinued operations Our effective tax rate was 7.7% for 2002, 67.7% for 2001 reported operating losses of $33 million ($0.07 per diluted and 355.7% for 2000. The rate for each year was affected by share) in 2002, $62 million ($0.14 per diluted share) in 2001, the tax impact from unusual items. Included in the unusual and $42 million ($0.10 per diluted share) in 2000. items for 2002 was a $90 million tax benefit related to the set- Discontinued operations for 2002 includes losses incurred tlement of a research and development tax credit claim. In for wind-down activities related to the global telecommunica- addition, for years prior to 2002, the rates were increased by tions services businesses, offset by the reversal of a reserve non-deductible goodwill that was being amortized for finan- associated with the sale of IMS. When recording the sale of cial accounting purposes. For 2000, the tax rate was further IMS in 2001, we established transaction-related reserves to increased by write-offs of non-deductible goodwill for busi- address various indemnity provisions in the sale agreement. nesses divested in that year. Adjusting for the impact of The risks associated with certain of these indemnity provisions unusual items and the adoption of FAS 142, our effective tax have been resolved and $39 million, net of taxes, was reversed rates would have been 31% for 2002, 32.6% for 2001 and through discontinued operations in 2002. 36.2% for 2000. For 2002 and 2001 these adjusted effective Included in the 2001 loss from discontinued operations tax rates were lower than the 35% statutory rate primarily due was an unusual after-tax charge of $1.3 billion ($3.09 per to the lower tax rates on extraterritorial income. For 2000, the diluted share) related to our decision to exit the global adjusted rate was higher than the statutory rate due to adjust- telecommunications services business. The 2001 results also ments for revisions to prior year estimates. include an unusual after-tax gain of $309 million ($0.71 per For 2002, we reported earnings from continuing opera- diluted share) from the third quarter 2001 sale of Lockheed tions of $533 million ($1.18 per diluted share) compared to $43 Martin IMS Corporation. million ($0.10 per diluted share) for 2001. In 2000, we reported Net Earnings (Loss) a loss from continuing operations of $477 million ($1.19 per We reported net earnings of $500 million ($1.11 per diluted diluted share). These amounts included the after-tax effects of share) in 2002, compared to net losses of $1 billion ($2.42 per unusual items which reduced earnings for 2002, 2001 and 2000 diluted share) in 2001 and $519 million ($1.29 per diluted by $632 million, $651 million and $951 million, respectively. share) in 2000. These amounts included the after-tax effects of The results for 2001 and 2000 included after-tax amortization unusual items which reduced earnings for 2002, 2001 and expense of $236 million and $268 million, respectively, for 2000 by $632 million, $1,678 million and $951 million, goodwill and certain other intangibles that was not included in respectively. The results for 2001 and 2000 included after-tax 2002 due to the adoption of FAS 142. Adjusting for the unusual amortization expense of $236 million and $268 million, items and the adoption of FAS 142, earnings from continuing respectively, for goodwill and certain other intangibles that operations would have been $1.2 billion in 2002, $930 million was not included in 2002 due to the adoption of FAS 142. in 2001, and $742 million in 2000. THIRTY-SEVEN

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    Lockheed Martin Corporation M ANAGEMENT ’ S D ISCUSSION AND A NALYSIS OF F INANCIAL C ONDITION AND R ESULTS OF O PERATIONS December 31, 2002 Segment Operating Profit • The difference between pension costs calculated (In millions) and funded in accordance with Cost Accounting $2,500 Standards (CAS), which are reported in the business 2,000 segment results, and pension expense or income determined in accordance with FAS 87 as reported in 1,500 Note 13 to the financial statements (FAS/CAS adjust- ment). This amount was previously allocated to the 1,000 business segments; • The costs of our common stock-based compensation Technology Services 500 plans, including our Long-Term Incentive Performance Aeronautics Space Systems Award Program. This amount was also allocated to 0 Systems Integration 2002 2001 2000 the business segments previously; • Corporate costs not allocated to the business seg- DISCUSSION OF BUSINESS SEGMENTS ments and other miscellaneous Corporate activities, We changed the way we report the results of our business seg- including interest income and earnings and losses ments in the fourth quarter of 2002. The change in presentation from our equity investments. is being made to align the way segment operating results are — Impact of adoption of FAS 142 (discussed under reported to senior management for their evaluation of segment Results of Operations above)—The impact of goodwill operating performance. We continue to operate in four princi- no longer being amortized and the change in the esti- pal business segments: Systems Integration, Space Systems, mated remaining useful life of the contract intangible Aeronautics and Technology Services. The changes include asset related to the F-16 program is now excluded from the following: segment results for all periods before January 1, 2002. • The Corporate and Other segment has been eliminated; For more information on the changes in our segment • Operating profit (loss) from the operations of the four presentation and the reasons for the changes, see Note 16 to principal business segments is reconciled to the reported the financial statements. The following tables of financial consolidated results utilizing the following items: information and the discussions of the results of operations of — Unallocated Corporate income (expense), net—this our business segments have been adjusted to reflect the new caption includes— presentation of segment operating results and correspond to • Unusual items (discussed under Results of Operations segment information presented in Note 16. above)—The effects of unusual items that are not considered part of management’s evaluation of the segment’s operating results (e.g., sales of surplus real estate, impairment charges, divestitures and other portfolio shaping activities) are excluded from the business segment results; THIRTY-EIGHT

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    Lockheed Martin Corporation This table shows net sales and operating profit of the busi- Communication, Computers and Intelligence (C4I) sales ness segments and reconciles to the consolidated total. increased by $275 million mainly as a result of volume on infor- (In millions) 2002 2001 2000 mation superiority programs. Naval Electronics & Surveillance NET SALES Systems (NE&SS) sales increased by $145 million primarily Systems Integration $ 9,603 $ 9,014 $ 9,647 due to higher volumes on surface systems and radar systems Space Systems 7,384 6,836 7,339 programs. These increases were partially offset by a $115 Aeronautics 6,471 5,355 4,885 million decrease in sales related to volume declines on plat- Technology Services 3,104 2,763 2,649 form integration programs in the Systems Integration-Owego Total business segments 26,562 23,968 24,520 line of business. Other 16 22 21 Net sales for the segment declined by 7% in 2001 compared $26,578 $23,990 $24,541 to 2000. Sales would have increased 4% for 2001 compared to OPERATING PROFIT (LOSS) 2000 had the sales attributable to the segment’s Aerospace Systems Integration $ 952 $ 906 $ 981 Electronic Systems (AES) and Control Systems businesses, Space Systems 443 360 345 which were divested in the second half of 2000, and the trans- Aeronautics 448 329 280 fer of the Payload Launch Vehicle (PLV) contract to the Space Technology Services 177 114 106 Systems segment at the start of 2001, been excluded from the Total business segments 2,020 1,709 1,712 comparisons. Sales increased by $270 million as a result of Unallocated Corporate expense, net (862) (602) (310) volume increases in NE&SS, primarily on tactical systems and Impact of FAS 142 adoption — (274) (297) surface systems programs, and undersea and radar systems $ 1,158 $ 833 $ 1,105 activities. M&FC sales increased by $235 million, mainly due to higher volume on certain tactical missile programs and the The Space Systems and Aeronautics segments generally THAAD missile program. C4I sales increased slightly year- include fewer programs that have much larger sales and oper- over-year. These increases were partially offset by a $275 mil- ating results than programs included in the other segments. lion decrease in sales related to volume declines on platform Therefore, due to the large number of comparatively smaller integration programs at Systems Integration-Owego. programs in the Systems Integration and Technology Services Operating profit for the segment increased by 5% in 2002 segments, the discussions of the results of operations of these compared to 2001. Increased operating profit of $60 million business segments generally focus on lines of business within from the sales growth at M&FC, C4I and NE&SS more than the segments. offset lower operating profit of $14 million at Systems Integration-Owego. Overall, a decline in volume on mature Systems Integration production programs (at Owego and M&FC) and higher volume Systems Integration’s operating results included the following: on development programs (at NE&SS and M&FC) contributed (In millions) 2002 2001 2000 to the slight decline in margins. Net sales $9,603 $9,014 $9,647 Operating profit for the segment decreased 8% in 2001 Operating profit 952 906 981 compared to 2000. Operating profit would have increased by Net sales for Systems Integration increased 7% in 2002 4% for 2001 from the previous year had the operating profit as compared to 2001. Sales increased as a result of higher related to the divested AES and Control Systems businesses, volume in three of the segment’s four lines of business. as well as the PLV contract transfer, been excluded from the Increased sales at Missiles & Fire Control (M&FC) of $285 comparisons. Increased operating profit of $85 million from million were mainly due to higher volumes on the Theater the sales growth at NE&SS, C4I, and M&FC more than offset High Altitude Area Defense (THAAD) missile program and the decrease resulting from the volume decline at Systems on certain tactical missile programs. Command, Control, Integration-Owego. THIRTY-NINE

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    Lockheed Martin Corporation M ANAGEMENT ’ S D ISCUSSION AND A NALYSIS OF F INANCIAL C ONDITION AND R ESULTS OF O PERATIONS December 31, 2002 Space Systems commercial launch market, financial results on commercial Space Systems’ operating results included the following: launch vehicles continue to be challenging. During 2002, this (In millions) 2002 2001 2000 trend led to a decline in operating profit of $10 million on Net sales $7,384 $6,836 $7,339 commercial launch vehicles when compared to 2001. This Operating profit 443 360 345 decrease was primarily due to lower profitability of $55 mil- lion on the three additional launches in the current year, addi- Net sales for Space Systems increased by 8% in 2002 tional charges of $60 million (net of a favorable contract compared to 2001. The increase in sales for 2002 resulted adjustment of $20 million) for market and pricing pressures from higher volume in government space of $370 million and and included the adverse effect of a $35 million adjustment for commercial space of $180 million. In government space, commercial launch vehicle contract settlement costs. The 2001 increases of $470 million in government satellite programs results also included charges for market and pricing pressures, and $130 million in ground systems activities more than offset which reduced that year’s operating profit by $145 million. volume declines of $175 million on government launch vehi- The $10 million decrease in government space’s operating cles and $55 million on strategic missile programs. The profit for the year is primarily due to the reduced volume on increase in commercial space sales is primarily attributable to government launch vehicles and strategic missile programs, an increase in launch vehicle activities, with nine commercial which combined to decrease operating profit by $80 million, launches during 2002 compared to six in 2001. partially offset by increases of $40 million in government Net sales for the segment decreased by 7% in 2001 com- satellite programs and $30 million in ground systems activities. pared to 2000. The decrease in sales for 2001 resulted from Operating profit for the segment increased by 4% in 2001 volume declines in commercial space of $560 million, which compared to 2000. Operating profit increased in 2001 due to a more than offset increases in government space of $60 million. $35 million increase in government space partially offset by In commercial space, sales declined due to volume reductions higher year-over-year losses of $20 million in commercial of $480 million in commercial launch vehicle activities and space. In government space, operating profit increased due to $80 million in satellite programs. There were six launches in the impact of higher volume and improved performance in 2001 compared to 14 launches in 2000. The increase in gov- ground systems and government satellite programs. The year- ernment space resulted from a combined increase of $230 mil- to-year comparison of operating profit was not affected by lion related to higher volume on government satellite the $50 million favorable Titan IV adjustment recorded programs and ground systems activities. These increases were in 2000 discussed above, due to a $55 million charge related to partially offset by a $110 million decrease related to volume a more conservative assessment of government launch vehi- declines in government launch vehicle activity, primarily due cle programs that was recorded in the fourth quarter of 2000. to program maturities, and by $50 million due to the absence In commercial space, decreased operating profit of $15 mil- in 2001 of favorable adjustments recorded on the Titan IV pro- lion on launch vehicles more than offset lower losses on satel- gram in 2000. lite manufacturing activities. The commercial launch vehicle Operating profit for the segment increased 23% in 2002 operating results included $60 million in higher charges for as compared to 2001, mainly driven by the commercial space market and pricing pressures when compared to 2000. These business. Reduced losses in commercial space during 2002 negative adjustments were partially offset by $50 million of resulted in increased operating profit of $90 million when favorable contract adjustments on certain launch vehicle con- compared to 2001. Commercial satellite manufacturing losses tracts. Commercial satellite manufacturing losses decreased declined $100 million in 2002 as operating performance slightly from 2000 and included the adverse impact of a $40 improved and satellite deliveries increased. In the first quarter million loss provision recorded in the first quarter of 2001 for of 2001, a $40 million loss provision was recorded on certain certain commercial satellite contracts related to schedule and commercial satellite manufacturing contracts. Due to the technical issues. industry-wide oversupply and deterioration of pricing in the FORTY

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    Lockheed Martin Corporation Aeronautics were favorably affected by having five fewer C-130J deliveries Aeronautics’ operating results included the following: as compared to 2000. (In millions) 2002 2001 2000 Technology Services Net sales $6,471 $5,355 $4,885 Technology Services’ operating results included the following: Operating profit 448 329 280 (In millions) 2002 2001 2000 Net sales for Aeronautics increased by 21% in 2002 com- Net sales $3,104 $2,763 $2,649 pared to 2001. The higher sales were primarily driven by vol- Operating profit 177 114 106 ume increases of $860 million on the F-35 Joint Strike Fighter Net sales for Technology Services increased by 12% in 2002 program, $475 million on F/A-22 production contracts and a compared to 2001. For the year, the increase in sales was prima- combined increase of $340 million from higher volume on the rily attributable to growth of $335 million in the government F-16 and C-5 programs. These increases were partially offset information technology line of business, due to increased volume by a $335 million decline resulting from seven fewer C-130J on existing programs and the acquisition of OAO Corporation deliveries compared to 2001 and a $140 million decrease due effective December 1, 2001, and $155 million in the defense to lower volume on F/A-22 Engineering, Manufacturing and line of business. This growth was partially offset by a combined Development (EMD) activities. $160 million decline in sales related to volume on the commer- Net sales for the segment increased by 10% in 2001 com- cial information technology and NASA lines of business. pared to 2000. During 2001, sales increased by $400 million Net sales for the segment increased by 4% in 2001 com- primarily due to the initial ramp up on F/A-22 production pared to 2000. Excluding the sales attributable to Lockheed contracts and increased volume on F-16 programs. Volume Martin Energy Technologies and Retech, two business units increases from F-16 and C-130 support activities also increased that were divested in 2000, and the acquisition of OAO sales by $230 million. These increases were partially offset by Corporation, sales would have increased 7% for the year. Sales declines in sales of $260 million resulting from fewer F-16 increased $190 million primarily due to increased volume in and C-130J deliveries in 2001. the government information technology and military aircraft Operating profit for the segment increased by 36% in lines of business. This growth was partially offset by lower 2002 compared to 2001. Increased operating profit of $119 sales volume associated with the segment’s energy-related million primarily resulted from the higher volume on the pro- contracts due to program completions. grams noted in the discussion of sales. Operating profit for Operating profit for the segment increased by 55% in 2002 was negatively affected by a $15 million charge recorded 2002 compared to 2001. The increase is mainly due to in the third quarter for performance issues on an aircraft mod- improved performance in commercial information technology ification contract and by a $15 million change in estimate and the higher volume in government information technology, adjustment recorded in the fourth quarter related to cost which together, increased operating profit by $100 million. growth on F/A-22 EMD activities. Margins in 2002 were These increases were partially offset by a combined decrease favorably affected by having seven fewer C-130J deliveries in in operating profit of $30 million on the military aircraft, the year as compared to 2001. The C-130J deliveries do not NASA, defense and energy lines of business. impact operating profit due to the previously disclosed suspen- Operating profit for the segment increased by 8% for 2001 sion of earnings recognition on the program. compared to 2000. Operating profit increased by $30 million in Operating profit for the segment increased by 18% for 2001 from higher volumes in the government information tech- 2001 compared to 2000. For the year, operating profit nology and military aircraft lines of business. This improvement increased by $49 million due to increased volume and per- was partially offset by a $20 million reduction in operating formance on the F/A-22 program, development activities on profit due to the completion of energy-related contracts. F-16 and other aeronautical programs. This increase was par- tially offset by a decline in F-16 deliveries. Margins in 2001 FORTY-ONE

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    Lockheed Martin Corporation M ANAGEMENT ’ S D ISCUSSION AND A NALYSIS OF F INANCIAL C ONDITION AND R ESULTS OF O PERATIONS December 31, 2002 The Technology Services segment has a business unit Negotiated Backlog (In billions) which provides services to the government of Argentina. At $80 December 31, 2002, we had investments in and advances to the business unit totaling about $30 million. While we expect that these amounts will be recoverable, there is always the 60 potential that further devaluation of the Argentine peso, deteri- oration in the Argentine economy or other factors could 40 adversely affect our ability to recover those amounts. Unallocated Corporate Income (Expense), Net 20 Technology Services Aeronautics The following table shows the components of unallocated Space Systems Corporate income (expense), net: 0 Systems Integration 2002 2001 2000 (In millions) 2002 2001 2000 UNALLOCATED CORPORATE BACKLOG INCOME (EXPENSE), NET Unusual items $(1,112) $(973) $(685) Total negotiated backlog was $70.4 billion at December 31, FAS/CAS adjustment 243 360 309 2002. This amount includes both funded backlog (unfilled Other 7 11 66 firm orders for our products for which funding has been both $ (862) $(602) $(310) authorized and appropriated by the customer—Congress in the case of U.S. Government agencies) and unfunded backlog For information about unusual items, see the table under (firm orders for which funding has not been appropriated). the previous discussion of continuing operations. Funded backlog was $36.1 billion at December 31, 2002. The difference between pension costs calculated and The following table shows total backlog by segment at the funded in accordance with CAS and pension expense or income end of each of the last three years: determined in accordance with FAS 87 is not included in seg- (In millions) 2002 2001 2000 ment operating results and therefore is a reconciling item BACKLOG between operating profit from the business segments and consol- Systems Integration $17,671 $17,027 $16,706 idated operating profit (FAS/CAS adjustment). The CAS fund- Space Systems 12,620 12,977 15,505 ing amount is allocated among the business segments and is Aeronautics 35,477 36,149 17,570 included as an expense item in the segments’ cost of goods Technology Services 4,617 5,116 5,295 sold. This cost is also passed along to our customers through $70,385 $71,269 $55,076 contract pricing, and is consequently included in the segments’ sales. The following table shows the CAS funding that is included as expense in the segments’ operating results, the related FAS income, and the FAS/CAS adjustment: (In millions) 2002 2001 2000 FAS 87 income $156 $354 $302 CAS funding and expense (87) (6) (7) FAS/CAS adjustment—income $243 $360 $309 FORTY-TWO

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    Lockheed Martin Corporation Net Cash Provided by proceeds of $134 million from the sale of our discontinued Operating Activities (In millions) telecommunications businesses and $93 million primarily $2,500 from the disposal of property, plant and equipment. Investments of $104 million were made in 2002, primarily 2,000 related to our acquisition of OAO Corporation. During 2001, we received proceeds of $825 million from 1,500 the sale of our IMS business. Investments in affiliated compa- nies of $192 million primarily consisted of $140 million to 1,000 complete our funding commitment to Astrolink and $30 mil- lion to Intelsat. The remainder of the 2001 activity was attrib- 500 utable to proceeds from the disposal of property, plant and 0 equipment, and various other investing activities. 2002 2001 2000 During 2000, we received $1.7 billion from the sale of our AES business, $510 million from the sale of our Control LIQUIDITY AND CASH FLOWS Systems business and $164 million from the sale of a portion Operating Activities of our investment in Inmarsat. Investments in affiliated compa- Operating activities provided $2.3 billion of cash in 2002, nies of $257 million mainly consisted of our funding commit- compared to $1.8 billion in 2001 and $2.0 billion in 2000. ment to Astrolink of $127 million and an additional Operating activities included earnings (loss) from continuing investment in Intelsat of $58 million. Proceeds from the sale operations, as adjusted for noncash items, and the cash pro- of property and other activities contributed $175 million to our vided by changes in our operating assets and liabilities. investing activities. Management of our working capital accounts (accounts Financing Activities receivable, inventory, accounts payable and customer Financing activities provided $77 million of cash in 2002, as advances) contributed $202 million of cash flow in 2002, $1.1 compared to using $2.6 billion in 2001 and $2.7 billion in billion in 2001 and $355 million in 2000. The timing of 2000. Proceeds of $436 million from stock option activity income tax payments or refunds also affects our operating more than offset dividend payments of $199 million, repay- cash flows. In 2002, we received $117 million from the settle- ment of debt (primarily ESOP obligations) of $110 million ment of the R&D tax credit claim while in 2001, we paid $655 and $50 million for the repurchase of 1 million shares of com- million of income taxes related to divested businesses. mon stock in 2002. Including the $450 million of debentures Included in operating activities is cash provided from discon- we called in 2003 to be repaid early and the $150 million of tinued operations of $25 million in 2002, $34 million in 2001 debt we recorded relating to our guarantee of Space Imaging, and $25 million in 2000. Operating cash flows were sufficient LLC’s existing credit facility (see the related discussions to operate our businesses, finance capital expenditures and to under Capital Structure and Resources), debt maturities will pay dividends on our common stock each year. amount to $1,365 million in 2003. Investing Activities During 2001, improved operating cash flows and cash Investing activities used $539 million of cash in 2002, com- provided by investing activities allowed us to reduce our long- pared to providing $139 million in 2001 and $1.8 billion in term debt by approximately $2.4 billion. The reduction in 2000. Cash used for property, plant and equipment expendi- long-term debt was primarily attributable to the pre-payment tures increased 7% in 2002 and 24% in 2001 and included $10 of notes issued to a wholly-owned subsidiary of General million in 2002, $74 million in 2001 and $58 million in 2000 Electric Company (GE), payments on scheduled debt maturi- for the discontinued businesses. During 2002, we received ties, and the early retirement of certain other debt instruments. FORTY-THREE

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    Lockheed Martin Corporation M ANAGEMENT ’ S D ISCUSSION AND A NALYSIS OF F INANCIAL C ONDITION AND R ESULTS OF O PERATIONS December 31, 2002 Debt retirements in 2000 were mainly attributable to our million during the year partially offset the decline. As a result completing tender offers for some of our long-term debt dur- of the above factors, our total debt-to-capitalization ratio ing the fourth quarter of 2000. We used $2.1 billion to con- increased from 53.8% at December 31, 2001 to 56.4% at summate the tender offers, resulting in the early repayment of December 31, 2002. $1.9 billion in long-term debt and an unusual loss, net of state In 2003, in order to reduce interest expense and improve income tax benefits, of $146 million, or $95 million after tax. our debt-to-capitalization ratio, we decided to issue irrevoca- We paid dividends of $199 million in 2002, $192 million ble redemption notices to the trustees for two issuances of in 2001 and $183 million in 2000. callable debentures totaling $450 million. These debentures have interest rates that are higher than current market rates. One Other notice was for $300 million of 7.875% debentures due on We receive advances on some contracts to finance inventories. March 15, 2023, which were callable on or after March 15, At December 31, 2002 and 2001, approximately $4.3 billion 2003. The second was for $150 million of 7.75% debentures and $2.9 billion, respectively, in advances, performance-based due on April 15, 2023, which were callable on or after April 15, payments and progress payments for work in process were 2003. We expect to repay amounts due on March 15, 2003 and received from customers and recorded as a reduction to inven- April 15, 2003, respectively. Therefore, we have included the tories in our balance sheet. Also at December 31, 2002 and $450 million in current maturities of long-term debt on our 2001, $466 million and $566 million, respectively, of customer balance sheet at December 31, 2002. We expect to incur a loss advances, performance-based payments and progress pay- on the early repayment of the debt, net of state income tax ben- ments were recorded in receivables as a reduction to unbilled efits, of approximately $16 million, or $10 million after tax. costs and accrued profits. Approximately $4.5 billion and $5.0 At the end of 2002, we had in place a $1.5 billion revolv- billion of customer advances and amounts in excess of costs ing credit facility; no borrowings were outstanding. This credit incurred, which are usually from foreign governments and facility will expire in November 2006. Borrowings under the commercial customers, were included in current liabilities at credit facility would be unsecured and bear interest at rates the end of 2002 and 2001, respectively (see Note 1). based, at our option, on the Eurodollar rate or a bank Base Rate (as defined). Each bank’s obligation to make loans under CAPITAL STRUCTURE AND RESOURCES the credit facility is subject to, among other things, our compli- Total debt increased by $71 million during 2002 from a bal- ance with various representations, warranties and covenants, ance of $7.5 billion at December 31, 2001. Current maturities including covenants limiting our ability and the ability of cer- of long-term debt at December 31, 2002 included $450 million tain of our subsidiaries to encumber our assets, and a covenant of debentures we called in 2003 to be repaid early and $150 not to exceed a maximum leverage ratio. In October 2002, we million of debt we recorded relating to our guarantee of Space terminated our $1.0 billion 1-year credit facility. Imaging, LLC’s existing credit facility (see the related discus- We have agreements in place with banking institutions to sions below). Our long-term debt is mainly in the form of pub- provide for the issuance of commercial paper. There were no licly issued, fixed-rate notes and debentures. At December 31, commercial paper borrowings outstanding at December 31, 2002, we held cash and cash equivalents of $2.7 billion, some 2002. If we were to issue commercial paper, the borrowings of which will be used to meet scheduled long-term debt matu- would be supported by the $1.5 billion credit facility. rities in 2003. We have an effective shelf registration statement on file Total stockholders’ equity was $5.9 billion at December 31, with the Securities and Exchange Commission (SEC) to pro- 2002, a decrease of $578 million from December 31, 2001. vide for the issuance of up to $1 billion in debt securities. If This decrease was mainly attributable to our recognition of an we were to issue debt under this shelf registration, we would additional minimum pension liability, which reduced stock- expect to use the net proceeds for general corporate purposes. holders’ equity on an after-tax basis by $1.5 billion, the payment These purposes may include repayment of debt, working capi- of dividends of $199 million and the repurchase of 1 million tal needs, capital expenditures, acquisitions and any other gen- shares of common stock for $50 million. Stock option and eral corporate purpose. ESOP activity of $752 million and net earnings of $500 FORTY-FOUR

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    Lockheed Martin Corporation We actively seek to finance our business in a manner that We have entered into standby letter of credit agreements preserves financial flexibility while minimizing borrowing and other arrangements with financial institutions and cus- costs to the extent practicable. Our management continually tomers mainly relating to the guarantee of future performance reviews changes in financial, market and economic conditions on some of our contracts to provide products and services to to manage the types, amounts and maturities of our indebted- customers. At December 31, 2002, we had contingent liabili- ness. Periodically, we may refinance existing indebtedness, ties on outstanding letters of credit, guarantees and other vary our mix of variable-rate and fixed-rate debt, or seek alter- arrangements, as follows: native financing sources for our cash and operational needs. Commitment Expiration per Period Cash and cash equivalents (including temporary invest- Total Less ments), internally generated cash flow from operations and Commit- than 1–3 4–5 After (In millions) ment 1 Year Years Years 5 Years other available financing resources, including those described above, are expected to be sufficient to meet anticipated operat- Surety bonds(a) $291 $117 $ 74 $100 $— Standby letters ing, capital expenditure and debt service requirements, as well of credit(a) 288 200 73 4 11 as discretionary investment needs, during the next twelve Guarantees 3 2 1 — — months. Consistent with our desire to generate cash to reduce Total commitments $582 $319 $148 $104 $11 debt and invest in our core businesses, we expect that, subject (a) Approximately $100 million and $5 million of surety bonds in the to prevailing financial, market and economic conditions, we “less than 1 year” and “1–3 year” periods, respectively, and will continue to explore the sale of non-core businesses, pas- approximately $143 million and $4 million of standby letters of sive equity investments and surplus real estate. credit in the “less than 1 year” and “1–3 year” periods, respec- tively, are expected to automatically renew for additional one-to- At December 31, 2002, we had contractual commitments two year periods until completion of the contractual obligation. to repay debt (including capital lease obligations), and to make We have issued standby letters of credit and surety bonds payments under operating leases. Generally, our long-term totaling $4.1 billion related to advances received from cus- debt obligations are subject to, along with other things, com- tomers and/or to secure our performance under long-term con- pliance with certain covenants, including covenants limiting tracts. Amounts included in the table above totaling $579 our ability and the ability of certain of our subsidiaries to million are those amounts over and above advances received encumber our assets. Payments due under these long-term from customers which are recorded in the balance sheet as obligations are as follows: either offsets against inventories or in customer advances and Payments Due by Period amounts in excess of costs incurred. Of the $3.5 billion Less recorded in the balance sheet, approximately $2 billion relates than 1–3 4–5 After (In millions) Total 1 Year Years Years 5 Years to a standby letter of credit to secure advance payments Long-term debt received under an F-16 contract from an international cus- and capital tomer. This letter of credit is available for draw down only in lease obligations(a) $7,557 $1,365 $156 $ 816 $5,220 the event of our nonperformance. Similar to the letter of credit Operating lease for the F-16 contract, letters of credit and surety bonds for commitments(b) 1,042 222 356 236 228 other contracts are available for draw down only in the event Total contractual of our nonperformance. cash obligations $8,599 $1,587 $512 $1,052 $5,448 We hold a 46% interest in a joint venture called Space (a) Amounts exclude a $25 million adjustment to the fair value of Imaging, LLC (Space Imaging) which we account for under the long-term debt relating to the Corporation’s interest rate swap agreements which will not be settled in cash. equity method. Space Imaging was recently successful in obtain- (b) Includes future payments related to a leasing arrangement with a ing certain long-term commitments from the U.S. Government for state government authority for Atlas V launch facilities. Total purchases of commercial satellite imagery on an as needed basis. payments under the arrangement are expected to be approxi- mately $320 million over a 10-year period. Lease payments However, to execute its current business plans and fund future began in August 2002. replacement satellites, Space Imaging will likely need, but has FORTY-FIVE

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    Lockheed Martin Corporation M ANAGEMENT ’ S D ISCUSSION AND A NALYSIS OF F INANCIAL C ONDITION AND R ESULTS OF O PERATIONS December 31, 2002 not been able to obtain commitments for, additional invest- QUANTITATIVE AND QUALITATIVE DISCLOSURE ment or funding. In addition to our equity investment, we also OF MARKET RISK guarantee up to $150 million of Space Imaging’s borrowings Our main exposure to market risk relates to interest rates and, under a credit facility that matures on March 31, 2003, and to a lesser extent, foreign currency exchange rates. Our finan- have about $33 million in receivables from the joint venture at cial instruments which are subject to interest rate risk mainly the end of 2002. In light of our decision and the decision of include commercial paper and fixed-rate long-term debt. At the other major member in the joint venture not to provide fur- December 31, 2002, we did not have any commercial paper ther funding at this time, our assessment that Space Imaging outstanding. We use interest rate swaps to manage our expo- will likely not be able to repay its obligation under the credit sure to fixed and variable interest rates. At the end of the year facility when due, and the uncertainties as to whether Space 2002, we had agreements in place to swap fixed interest rates Imaging will be successful in obtaining the additional invest- on about $920 million of our long-term debt for variable inter- ment necessary to fund replacement satellites, we wrote off est rates based on LIBOR. The interest rate swap agreements our investment in the joint venture and recorded the obligation are designated as effective hedges of the fair value of the to fund amounts due from us under the guarantee. As a result, underlying fixed-rate debt instruments. At December 31, 2002, we recorded a charge, net of state income taxes, of $163 million the fair values of interest rate swap agreements outstanding which reduced net earnings by $106 million ($0.23 per diluted totaled about $25 million. The amounts of gains and losses share), and increased current maturities of long-term debt by from changes in the fair values of the swap agreements were $150 million, representing our obligation under the guarantee, entirely offset by those from changes in the fair value of the which is expected to be paid in the first quarter of 2003. associated debt obligations. The interest rate swaps create a In March 2000, we converted our 45.9 million shares of market exposure to changes in the LIBOR rate. To the extent Loral Space & Communications Ltd. Series A Preferred Stock that the LIBOR index on which the swaps are based increases into an equal number of shares of Loral Space common stock. or decreases by 1%, our interest expense would increase or Due to the market price of Loral Space stock and the potential decrease by $9 million annually on a pretax basis. Changes in impact of underlying market and industry conditions on Loral swap rates would affect the market value of the agreements, Space’s ability to execute its current business plans, we but those changes in value would be offset by changes in value recorded an unusual charge, net of state income tax benefits, of the underlying debt. A 1% rise in swap rates from those at of $361 million in the third quarter of 2001 related to our December 31, 2002 would result in a decrease in market value investment in Loral Space. The charge reduced net earnings by of about $11 million. A 1% decline would increase the market $235 million, or $0.54 per diluted share (see Note 8 to the value by a like amount. financial statements). The value of our investment continues to We use forward foreign exchange and option contracts to be impacted by adverse market and industry conditions, manage our exposure to fluctuations in foreign exchange rates. including low demand for commercial satellites as a result of These contracts are designated as qualifying hedges of the excess capacity in the telecommunications industry. cash flows associated with firm commitments or specific We satisfied our contractual obligation relating to our guar- anticipated transactions, and related gains and losses on the antee of certain indebtedness of Globalstar, L.P. (Globalstar) contracts, to the extent they are effective hedges, are recog- with a net payment of $150 million on June 30, 2000 to repay nized in income when the hedged transaction occurs. To the a portion of Globalstar’s borrowings under a revolving credit extent the hedges are ineffective, gains and losses on the con- agreement. This payment resulted in our recording an unusual tracts are recognized currently. At December 31, 2002, the fair charge, net of state income tax benefits, of approximately value of forward exchange and option contracts outstanding, $141 million in 2000 which reduced net earnings for the year as well as the amounts of gains and losses recorded during the by $91 million, or $0.23 per diluted share (see Note 9 to the year, were not material. We do not hold or issue derivative financial statements for more information). We have no financial instruments for trading purposes. remaining guarantees related to Globalstar. On February 15, 2002, Globalstar and certain of its affiliates filed a voluntary petition under Chapter 11 of the U.S. Bankruptcy Code. FORTY-SIX

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    Lockheed Martin Corporation ENVIRONMENTAL MATTERS We have also been conducting remediation activities to As more fully described in Note 15 to the financial statements, address soil and groundwater contamination by chlorinated we have property that is subject to environmental matters. In solvents at our former operations in Great Neck, New York. our opinion, the probability is remote that the outcome of Until the third quarter of 2002, all of the remediation work these matters will have a material adverse effect on our con- associated with this site had been performed on the site itself. solidated results of operations, financial position or cash In the third quarter, we entered into negotiations with the State flows. Certain expenditures related to the recorded liabilities of New York to implement an off-site interim remedial meas- discussed below, after deducting any recoveries from insur- ure intended to address an off-site plume of groundwater con- ance or other PRPs, are allowable in establishing the prices of tamination that was found to be moving more rapidly than our products and services under contracts with the U.S. originally anticipated. This has led to an increase of approxi- Government. The recorded amounts do not reflect the possible mately $50 million in the projected future costs for the site. future recoveries of portions of the environmental costs Total projected future costs are now estimated to be about $70 through insurance policy coverage or from other PRPs, which million through 2025. This amount is included in our balance we are pursuing as required by agreement and U.S. Gov- sheet at December 31, 2002. As at other sites, we are pursuing ernment regulation. These matters include the following items: claims against other PRPs, including the U.S. Government, to We are responding to three administrative orders issued help with clean-up costs. by the California Regional Water Quality Control Board in Since 1990, we have been responding to various consent connection with our former facilities in Redlands, California. decrees and orders relating to soil and regional groundwater We are also coordinating with the U.S. Air Force, which is contamination in the San Fernando Valley associated with our working with the aerospace and defense industry to conduct former operations in Burbank and Glendale, California. Under preliminary studies of the potential health effects of perchlo- an agreement reached with the U.S. Government in 2000, we rate exposure associated with several sites across the country, will continue to be reimbursed in an amount equal to about including the Redlands site. The results of these studies are 50% of future expenditures for certain remediation activities intended to assist us in determining our ultimate clean-up obli- by the U.S. Government in its capacity as a PRP under the gation, if any, with respect to perchlorates. In January 2002, Comprehensive Environmental Response, Compensation and the State of California reduced the provisional standard for Liability Act. We have recorded a liability of approximately perchlorate concentration in water from 18 parts per billion $60 million representing our estimate of the total expenditures (ppb) to 4 ppb. Although this provisional standard does not required over the remaining terms of the consent decrees and create a legally enforceable requirement for us at this time, we orders for the Glendale and Burbank sites, net of the effects of have developed a preliminary remediation plan that would the agreement. meet the provisional standard if it were to become final. We are a party to other proceedings and potential pro- Because this plan entails a long lead-time to be implemented, ceedings for environmental clean-up issues, including matters we have decided to begin implementing the plan and recog- at various sites where we have been designated a PRP by the nize the increased costs that are associated with the plan. The EPA or by a state agency. If we are ultimately found to have balance sheet at December 31, 2002 includes a liability of liability at those sites where we have been designated a PRP, approximately $185 million which is our estimate of the we expect that the actual burden for the costs of remediation remaining expenditures necessary to implement the remedia- will be shared with other liable PRPs. Generally, PRPs that are tion and other work at the site over the next 30 years. This ultimately determined to be responsible parties are strictly amount is approximately $100 million more than the amount liable for site clean-up and usually agree among themselves to recorded at December 31, 2001. As at other sites, we are pursu- share, on an allocated basis, the costs and expenses for investi- ing claims against other potentially responsible parties (PRPs), gation and remediation of hazardous materials. Under existing including the U.S. Government, to help with clean-up costs. environmental laws, however, responsible parties are jointly FORTY-SEVEN

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    Lockheed Martin Corporation M ANAGEMENT ’ S D ISCUSSION AND A NALYSIS OF F INANCIAL C ONDITION AND R ESULTS OF O PERATIONS December 31, 2002 and severally liable and, therefore, we are potentially liable for CONTROLS AND PROCEDURES the full cost of funding such remediation. In the unlikely event We maintain disclosure controls and procedures that are that we were required to fund the entire cost of such remedia- designed to ensure that information required to be disclosed in tion, the statutory framework provides that we may pursue our periodic filings with the SEC is recorded, processed, sum- rights of contribution from the other PRPs. marized and reported within the time periods specified in the In addition to the amounts related to the Redlands, SEC’s rules and forms, and that such information is accumu- Burbank, Glendale and Great Neck sites described above, a lated and communicated to our management, including our liability of approximately $130 million for the other properties Chief Executive Officer (CEO) and Chief Financial Officer (including current operating facilities and certain facilities (CFO), as appropriate, to allow timely decisions regarding operated in prior years) in which an estimate of financial expo- required disclosure. In designing and evaluating the disclosure sure can be determined has been recorded. We believe that it is controls and procedures, management recognized that any unlikely that any additional liability we may have for known controls and procedures, no matter how well designed and environmental issues would have a material adverse effect on operated, can provide only reasonable assurance of achieving our consolidated results of operations or financial position. the desired control objectives, and management necessarily As described in Note 15 to the financial statements, we was required to use its judgment in evaluating the cost to are continuing to pursue recovery of a significant portion of benefit relationship of possible controls and procedures. Also, the unanticipated costs we incurred for a $180 million fixed- we have investments in certain unconsolidated entities. As we price contract with the U.S. Department of Energy (DoE) for do not control or manage these entities, our disclosure controls the remediation of waste found in Pit 9. We have been unsuc- and procedures with respect to those entities are necessarily cessful to date in reaching agreement with the DoE on cost substantially more limited than those we maintain with respect recovery or other contract restructuring matters. In 1998, the to our consolidated subsidiaries. management contractor for the project, a wholly-owned sub- Within 90 days prior to the date of this report, we per- sidiary of ours, at the DoE’s direction, terminated the Pit 9 formed an evaluation of the effectiveness of the design and contract for default. We sued the DoE in the U.S. Court of operation of our disclosure controls and procedures. The eval- Federal Claims seeking to overturn the default termination and uation was performed with the participation of senior manage- to recover our costs. The management contractor, at the DoE’s ment of each business segment and key Corporate functions, direction, sued us in the U.S. District Court in Idaho seeking, and under the supervision of the CEO and CFO. Based on the among other things, recovery of about $54 million previously evaluation, our management, including the CEO and CFO, paid to us under the contract. We filed counterclaims, again seek- concluded that our disclosure controls and procedures were ing to overturn the default termination and recover our costs. In effective. There have been no significant changes in our inter- 2001, the Court of Federal Claims dismissed our lawsuit against nal controls or in other factors that could significantly affect the DoE, finding that we lacked privity of contract with the internal controls after the date we completed the evaluation. DoE. On September 30, 2002, the U.S. Court of Appeals for the Federal Circuit affirmed the dismissal. We did not appeal the decision further and will continue to seek resolution of the Pit 9 dispute through non-litigation means while pursuing our remedies in the Idaho proceeding, which is set for trial in August 2003. FORTY-EIGHT

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

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    Lockheed Martin Corporation R EPORT OF E RNST & YOUNG LLP, I NDEPENDENT AUDITORS Board of Directors and Stockholders Lockheed Martin Corporation We have audited the accompanying consolidated balance sheet of Lockheed Martin Corporation as of December 31, 2002 and 2001, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2002. 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 auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of mate- rial 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 consolidated financial statements referred to above present fairly, in all material respects, the consoli- dated financial position of Lockheed Martin Corporation at December 31, 2002 and 2001, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States. As discussed in Note 1 of the Notes to Consolidated Financial Statements, in 2002 the Corporation adopted Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets,” and in 2001 adopted Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” McLean, Virginia January 22, 2003 FIFTY

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    Lockheed Martin Corporation C ONSOLIDATED S TATEMENT OF O PERATIONS Year Ended December 31, (In millions, except per share data) 2002 2001 2000 NET SALES $26,578 $23,990 $24,541 Cost of sales 24,629 22,447 22,881 Earnings from operations 1,949 1,543 1,660 Other income and expenses, net (791) (710) (555) 1,158 833 1,105 Interest expense 581 700 919 Earnings from continuing operations before income taxes 577 133 186 Income tax expense 44 90 663 Earnings (loss) from continuing operations 533 43 (477) Discontinued operations (33) (1,089) (42) NET EARNINGS (LOSS) $ 500 $ (1,046) $ (519) EARNINGS (LOSS) PER COMMON SHARE: Basic: Continuing operations $ 1.20 $ 0.10 $ (1.19) Discontinued operations (0.07) (2.55) (0.10) $ 1.13 $ (2.45) $ (1.29) Diluted: Continuing operations $ 1.18 $ 0.10 $ (1.19) Discontinued operations (0.07) (2.52) (0.10) $ 1.11 $ (2.42) $ (1.29) See accompanying Notes to Consolidated Financial Statements. FIFTY-ONE

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    Lockheed Martin Corporation C ONSOLIDATED S TATEMENT OF C ASH F LOWS Year Ended December 31, (In millions) 2002 2001 2000 OPERATING ACTIVITIES Earnings (loss) from continuing operations $ 533 $ 43 $ (477) Adjustments to reconcile earnings (loss) from continuing operations to net cash provided by operating activities: Loss from discontinued operations (33) (1,089) (42) Depreciation and amortization 433 425 464 Amortization of goodwill and other intangible assets 125 398 423 Deferred federal income taxes (463) (118) (96) Write-down of investments and other charges 1,127 476 125 Net charges related to discontinued operations, write-off of Astrolink and other charges — 1,511 — Net loss related to divestiture of AES and Control Systems — — 222 Changes in operating assets and liabilities: Receivables 394 (34) 239 Inventories 585 651 (194) Accounts payable (317) 192 (42) Customer advances and amounts in excess of costs incurred (460) 318 352 Income taxes 44 (456) 522 Other 320 (492) 520 Net cash provided by operating activities 2,288 1,825 2,016 INVESTING ACTIVITIES Expenditures for property, plant and equipment (662) (619) (500) Acquisition of/investments in affiliated companies (104) (192) (257) Proceeds from divestiture of affiliated companies 134 825 2,344 Other 93 125 175 Net cash (used for) provided by investing activities (539) 139 1,762 FINANCING ACTIVITIES Net decrease in short-term borrowings — (12) (463) Repayments of long-term debt (110) (2,566) (2,096) Issuances of common stock 436 213 14 Repurchases of common stock (50) — — Common stock dividends (199) (192) (183) Net cash provided by (used for) financing activities 77 (2,557) (2,728) Net increase (decrease) in cash and cash equivalents 1,826 (593) 1,050 Cash and cash equivalents at beginning of year 912 1,505 455 Cash and cash equivalents at end of year $2,738 $ 912 $ 1,505 See accompanying Notes to Consolidated Financial Statements. FIFTY-TWO

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    Lockheed Martin Corporation C ONSOLIDATED BALANCE S HEET December 31, (In millions) 2002 2001 ASSETS Current assets: Cash and cash equivalents $ 2,738 $ 912 Receivables 3,655 4,049 Inventories 2,250 3,140 Deferred income taxes 1,277 1,566 Assets of businesses held for sale 210 638 Other current assets 496 473 Total current assets 10,626 10,778 Property, plant and equipment, net 3,258 2,991 Investments in equity securities 1,009 1,884 Intangible assets related to contracts and programs acquired 814 939 Goodwill 7,380 7,371 Prepaid pension cost — 2,081 Other assets 2,671 1,610 $25,758 $27,654 LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable $ 1,102 $ 1,419 Customer advances and amounts in excess of costs incurred 4,542 5,002 Salaries, benefits and payroll taxes 1,272 1,100 Income taxes 107 63 Current maturities of long-term debt 1,365 89 Liabilities of businesses held for sale 122 387 Other current liabilities 1,311 1,629 Total current liabilities 9,821 9,689 Long-term debt 6,217 7,422 Post-retirement benefit liabilities 1,480 1,565 Pension liabilities 651 — Deferred income taxes — 992 Other liabilities 1,724 1,543 Stockholders’ equity: Common stock, $1 par value per share 455 441 Additional paid-in capital 2,796 2,142 Retained earnings 4,262 3,961 Unearned ESOP shares (50) (84) Accumulated other comprehensive loss (1,598) (17) Total stockholders’ equity 5,865 6,443 $25,758 $27,654 See accompanying Notes to Consolidated Financial Statements. FIFTY-THREE

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    Lockheed Martin Corporation C ONSOLIDATED S TATEMENT OF S TOCKHOLDERS ’ E QUITY Accumulated Additional Unearned Other Total Comprehensive Common Paid-In Retained ESOP Comprehensive Stockholders’ Income (In millions, except per share data) Stock Capital Earnings Shares Loss Equity (Loss) Balance at December 31, 1999 $398 $ 222 $ 5,901 $(150) $ (10) $ 6,361 Net loss — — (519) — — (519) $ (519) Common stock dividends declared ($0.44 per share) — — (183) — — (183) — Stock awards and options, and ESOP activity 6 177 — 35 — 218 — Stock issued in COMSAT merger 27 1,319 — — — 1,346 — COMSAT stock options assumed — 71 — — — 71 — Other comprehensive loss: Net unrealized loss from available-for-sale investments — — — — (129) (129) (129) Other — — — — (5) (5) (5) Balance at December 31, 2000 431 1,789 5,199 (115) (144) 7,160 $ (653) Net loss — — (1,046) — — (1,046) $(1,046) Common stock dividends declared ($0.44 per share) — — (192) — — (192) — Stock awards and options, and ESOP activity 10 353 — 31 — 394 — Other comprehensive income (loss): Reclassification adjustment related to available-for-sale investments — — — — 151 151 151 Minimum pension liability — — — — (33) (33) (33) Net unrealized gain from available-for-sale investments — — — — 23 23 23 Net foreign currency translation adjustments — — — — (20) (20) (20) Net unrealized gain from hedging activities — — — — 6 6 6 Balance at December 31, 2001 441 2,142 3,961 (84) (17) 6,443 $ (919) Net earnings — — 500 — — 500 $ 500 Common stock dividends declared ($0.44 per share) — — (199) — — (199) — Stock awards and options, and ESOP activity 15 703 — 34 — 752 — Repurchases of common stock (1) (49) — — — (50) — Other comprehensive income (loss): Minimum pension liability — — — — (1,537) (1,537) (1,537) Reclassification adjustments related to available-for-sale investments — — — — 53 53 53 Net foreign currency translation adjustments — — — — (7) (7) (7) Net unrealized gain from hedging activities — — — — 10 10 10 Net unrealized loss from available-for-sale investments — — — — (100) (100) (100) Balance at December 31, 2002 $455 $2,796 $ 4,262 $ (50) $(1,598) $ 5,865 $(1,081) See accompanying Notes to Consolidated Financial Statements. FIFTY-FOUR

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    Lockheed Martin Corporation N OTES TO C ONSOLIDATED F INANCIAL S TATEMENTS December 31, 2002 NOTE 1—SIGNIFICANT ACCOUNTING POLICIES not yet billed to customers. As such revenues are recognized, Organization—Lockheed Martin Corporation (Lockheed appropriate amounts of customer advances, performance- Martin or the Corporation) is engaged in the conception, based payments and progress payments are reflected as an off- research, design, development, manufacture, integration and set to the related accounts receivable balance. operation of advanced technology systems, products and serv- Inventories—Inventories are stated at the lower of cost or esti- ices. As a lead systems integrator, its products and services mated net realizable value. Costs on long-term contracts and range from aircraft, spacecraft and launch vehicles to missiles, programs in progress represent recoverable costs incurred for electronics and information systems. The Corporation serves production, allocable operating overhead, advances to suppli- customers in both domestic and international defense and ers and, where appropriate, research and development and commercial markets, with its principal customers being agen- general and administrative expenses. Pursuant to contract pro- cies of the U.S. Government. visions, agencies of the U.S. Government and certain other Basis of consolidation and classifications—The consolidated customers have title to, or a security interest in, inventories financial statements include the accounts of wholly-owned related to such contracts as a result of advances, performance- subsidiaries and majority-owned entities which the Corporation based payments and progress payments. Such advances and controls. Intercompany balances and transactions have been payments are reflected as an offset against the related inven- eliminated in consolidation. Receivables and inventories are tory balances. General and administrative expenses related to primarily attributable to long-term contracts or programs in commercial products and services provided essentially under progress for which the related operating cycles are longer than commercial terms and conditions are expensed as incurred. 1 year. In accordance with industry practice, these items are Costs of other product and supply inventories are principally included in current assets. determined by the first-in, first-out or average cost methods. Certain amounts for prior years have been reclassified to Property, plant and equipment—Property, plant and equipment conform with the 2002 presentation. are carried principally at cost. Depreciation is provided on Use of estimates—The preparation of consolidated financial plant and equipment generally using accelerated methods dur- statements in conformity with accounting principles generally ing the first half of the estimated useful lives of the assets; accepted in the United States requires management to make thereafter, straight-line depreciation is used. Estimated useful estimates and assumptions, including estimates of anticipated lives generally range from 10 to 40 years for buildings and 5 contract costs and revenues utilized in the earnings recognition to 15 years for machinery and equipment. process, that affect the reported amounts in the financial state- Investments in equity securities—Investments in equity securi- ments and accompanying notes. Due to the size and nature of ties include the Corporation’s ownership interests in affiliated many of the Corporation’s programs, the estimation of total companies accounted for under the equity method of account- revenues and cost at completion is subject to a wide range of ing. Under this method of accounting, which generally applies variables, including assumptions for schedule and technical to investments that represent a 20% to 50% ownership of the issues. Actual results could differ from those estimates. equity securities of the investees, the Corporation’s share of Cash and cash equivalents—Cash equivalents are generally the earnings or losses of the affiliated companies is included in composed of highly liquid instruments with maturities of 3 other income and expenses. The Corporation recognizes cur- months or less when purchased. Due to the short maturity of rently gains or losses arising from issuances of stock by these instruments, carrying value on the Corporation’s consol- wholly-owned or majority-owned subsidiaries, or by equity idated balance sheet approximates fair value. method investees. These gains or losses are also included in other income and expenses. Investments in equity securities Receivables—Receivables consist of amounts billed and cur- also include the Corporation’s ownership interests in compa- rently due from customers, and include unbilled costs and nies in which its investment represents less than 20%. If clas- accrued profits primarily related to revenues on long-term con- sified as available for sale, these investments are accounted for tracts that have been recognized for accounting purposes but FIFTY-FIVE

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    Lockheed Martin Corporation N OTES TO C ONSOLIDATED F INANCIAL S TATEMENTS December 31, 2002 at fair value, with unrealized gains and losses recorded in Government agreement or regulation. At the time a liability is other comprehensive income, in accordance with Statement of recorded for future environmental costs, an asset is recorded Financial Accounting Standards (FAS) No. 115, “Accounting for estimated future recovery considered probable through the for Certain Investments in Debt and Equity Securities.” If pricing of products and services to agencies of the U.S. declines in the value of investments accounted for under either Government. The portion of those costs expected to be allo- the equity method or FAS 115 are determined to be other than cated to commercial business is reflected in cost of sales at the temporary, a loss is recorded in earnings currently. time the liability is established. Investments not accounted for under one of these methods are Sales and earnings—Sales and anticipated profits under long- generally accounted for under the cost method of accounting. term fixed-price production contracts are recorded on a per- Goodwill and other intangible assets—Intangible assets centage of completion basis, generally using units-of-delivery related to contracts and programs acquired are amortized over as the basis to measure progress toward completing the con- the estimated periods of benefit (15 years or less) and are dis- tract and recognizing revenue. Estimated contract profits are played in the consolidated balance sheet net of accumulated taken into earnings in proportion to recorded sales. Sales amortization. In periods prior to the adoption of FAS 142 (see under certain long-term fixed-price contracts which, among discussion under the caption “New accounting pronounce- other factors, provide for the delivery of minimal quantities or ments” in this Note), goodwill, as well as the amount by require a substantial level of development effort in relation to which the Corporation’s investment in Intelsat exceeded its total contract value, are recorded upon achievement of per- share of Intelsat’s net assets, was amortized ratably over formance milestones or using the cost-to-cost method of appropriate periods, generally 30 to 40 years. Beginning accounting where sales and profits are recorded based on the January 1, 2002, these amounts are no longer amortized. ratio of costs incurred to estimated total costs at completion. Goodwill is displayed on the consolidated balance sheet net of Sales under cost-reimbursement-type contracts are accumulated amortization of $1,382 million at December 31, recorded as costs are incurred. Applicable estimated profits are 2002 and 2001. Under FAS 142, goodwill is evaluated for included in earnings in the proportion that incurred costs bear potential impairment annually by comparing the fair value of a to total estimated costs. Sales of products and services pro- reporting unit to its carrying value, including goodwill vided essentially under commercial terms and conditions are recorded by the reporting unit. If the carrying value exceeds recorded upon delivery and passage of title. the fair value, impairment is measured by comparing the Amounts representing contract change orders, claims or derived fair value of goodwill to its carrying value, and any other items are included in sales only when they can be reliably impairment determined is recorded in the current period. estimated and realization is probable. Incentives or penalties related to performance on contracts are considered in estimating Customer advances and amounts in excess of costs incurred— sales and profit rates, and are recorded when there is sufficient The Corporation receives advances, performance-based pay- information to assess anticipated contract performance. Estimates ments and progress payments from customers which may of award fees are also considered in estimating sales and profit exceed costs incurred on certain contracts, including contracts rates based on actual and anticipated awards. Incentive provi- with agencies of the U.S. Government. Such advances, other sions which increase or decrease earnings based solely on a than those reflected as an offset to accounts receivable or inven- single significant event are generally not recognized until the tories as discussed above, are classified as current liabilities. event occurs. Environmental matters—The Corporation records a liability When adjustments in contract value or estimated costs are for environmental matters when it is probable that a liability determined, any changes from prior estimates are generally has been incurred and the amount can be reasonably esti- reflected in earnings in the current period. Anticipated losses mated. A substantial portion of these costs are expected to on contracts are charged to earnings when identified and deter- be reflected in sales and cost of sales pursuant to U.S. mined to be probable. FIFTY-SIX

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    Lockheed Martin Corporation Research and development and similar costs— Corporation- “Accounting for Derivative Instruments and Hedging sponsored research and development costs primarily include Activities.” The effect of adopting FAS 133 was not material independent research and development and bid and proposal to the Corporation’s consolidated results of operations, cash efforts related to government products and services. Except for flows or financial position. Under FAS 133, all derivatives are certain arrangements described below, these costs are gener- recorded as either assets or liabilities in the consolidated bal- ally included as part of the general and administrative costs ance sheet, and periodically adjusted to fair value. The classi- that are allocated among all contracts and programs in fication of gains and losses resulting from changes in the fair progress under U.S. Government contractual arrangements. values of derivatives is dependent on the intended use of the Corporation-sponsored product development costs not other- derivative and its resulting designation. Adjustments to reflect wise allocable are charged to expense when incurred. Under changes in fair values of derivatives that are not considered certain arrangements in which a customer shares in product highly effective hedges are reflected in earnings. Adjustments development costs, the Corporation’s portion of such unreim- to reflect changes in fair values of derivatives that are consid- bursed costs is expensed as incurred. Total independent ered highly effective hedges are either reflected in earnings research and development costs charged to cost of sales and largely offset by corresponding adjustments related to the in 2002, 2001 and 2000, including costs related to bid and fair values of the hedged items, or reflected in other compre- proposal efforts, were $830 million, $875 million and $863 hensive income until the hedged transaction matures and the million, respectively. Customer-sponsored research and entire transaction is recognized in earnings. The change in fair development costs incurred pursuant to contracts are value of the ineffective portion of a hedge is immediately rec- accounted for as contract costs. ognized in earnings. Interest rate swap agreements are designated as effective Restructuring activities—Under existing U.S. Government hedges of the fair value of certain existing fixed-rate debt instru- regulations, certain costs incurred for consolidation or restruc- ments. Forward currency exchange contracts are designated as turing activities that can be demonstrated to result in savings qualifying hedges of cash flows associated with firm commit- in excess of the cost to implement those actions can be ments or specific anticipated transactions. At December 31, deferred and amortized for government contracting purposes 2002, the fair values of interest rate swap agreements and for- and included as allowable costs in future pricing of the ward currency exchange contracts outstanding, as well as the Corporation’s products and services. Included in the consoli- amounts of gains and losses recorded during the year, were not dated balance sheet at December 31, 2002 and 2001 is approx- material. The Corporation does not hold or issue derivative imately $215 million and $308 million, respectively, of financial instruments for trading purposes. deferred costs related to various consolidation actions. Stock-based compensation—The Corporation measures com- Impairment of certain long-lived assets—Generally, the carry- pensation cost for stock-based compensation plans using the ing values of long-lived assets other than goodwill are intrinsic value method of accounting as prescribed in reviewed for impairment if events or changes in the facts and Accounting Principles Board Opinion No. 25, “Accounting for circumstances indicate that their carrying values may not be Stock Issued to Employees,” and related interpretations. The recoverable. Any impairment determined is recorded in the Corporation has adopted those provisions of FAS 123, current period and is measured by comparing the fair value of “Accounting for Stock-Based Compensation” and FAS 148, the related asset to its carrying value. “Accounting for Stock-Based Compensation—Transition and Derivative financial instruments—The Corporation sometimes Disclosure,” which require disclosure of the pro forma effects uses derivative financial instruments to manage its exposure to on net earnings and earnings per share as if compensation cost fluctuations in interest rates and foreign exchange rates. had been recognized based upon the fair value-based method Effective January 1, 2001, the Corporation began to account for at the date of grant for options awarded. derivative financial instruments in accordance with FAS 133, FIFTY-SEVEN

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