Fitch Upgrades Lockheed Martin's Ratings to 'A-'.

NEW YORK -- Fitch Ratings has raised Lockheed Martin's (LMT) Issuer Default rating (IDR), senior unsecured debt rating, and bank facility rating to 'A-' from 'BBB+', and has affirmed LMT's 'F2' commercial paper rating. The Rating Outlook is Stable. These actions cover approximately $5 billion of outstanding debt.

The upgrade is based on LMT's strong operating performance including margin expansion and cash generation, the more stable outlook for some of LMT's largest defense programs, substantial financial flexibility, and the level of LMT's credit statistics relative to its defense peers and other industrial corporations rated by Fitch. The upgrade is also based on the recent releases of the fiscal year 2007 Department of Defense (DOD) Budget Request and the Quadrennial Defense Review, both of which reduced uncertainty in the defense spending environment. The possibility of large, multi-billion dollar acquisitions remains a key credit concern, and Fitch could review the ratings and/or the Outlook if LMT finances acquisitions with debt.

The ratings reflect the company's position as a leading defense contractor, high U.S. defense spending, strong cash flow and liquidity, and large backlog. Concerns include a cash deployment strategy focused on share repurchases and dividends, U.S. government budget deficits and their potential impact on future defense spending, a large pension deficit, and some modest program concentration in the Aeronautics segment. The ratings incorporate expectations for substantial cash deployment but stable debt levels, as discussed below.

LMT has improved its margins and credit statistics in the past several years because of improving program performance. Segment margins rose 80 basis points (bps) in 2005 after rising 60 basis points in 2004. LMT's EBITDA margin increased 90 bps in 2005 to 8.8%, and the EBITDAP (EBITDA adjusted for non-cash pension expense) margin was up 100 bps to 10.5%. The higher margins led to improved credit statistics, with debt-to-EBITDA and debt-to-EBITDAP improving to 1.5x and 1.3x, respectively, in 2005 from 1.8x and 1.5x in 2004. EBITDA/Interest and EBITDAP/Interest were 8.7x and 10.4x in 2005, respectively. LMT's margins remain below the margins of some of its defense peers, giving LMT the opportunity for additional margin expansion.

LMT's liquidity, cash flow and financial flexibility are key factors supporting the ratings. LMT's liquidity as of Dec. 31, 2005 was $4 billion, consisting of $1.5 billion of credit facility availability and $2.7 billion in cash and marketable securities, less $202 million of current debt maturities. In 2005 LMT generated strong cash from operations ($3.2 billion, 8.6% of revenues) and free cash flow (cash from operations less capital expenditures and dividends) of $1.9 billion. The strength of LMT's cash flow is highlighted by the fact that these results include $980 million of discretionary pension contributions. The healthy cash generation in 2005 was a continuation of the trend seen in the past several years, with increases driven by higher sales, better profitability, and improvements in working capital management. Fitch expects free cash flow in 2006 to be $1.7 billion-$1.8 billion, a reduction compared to the 2005 amount because of higher cash taxes, capital expenditures, and dividends, as well as advance payment burn-off.

Cash deployment is a key credit issue because of a focus on share repurchases, dividend increases, and the possibility of large acquisitions. Fitch's ratings for LMT incorporate expectations for substantial cash deployment actions, but debt reduction will be modest in the next several years due to few maturities. Share repurchases totaled approximately $2.5 billion in the past three years, and Fitch expects share repurchases to remain a significant use of cash in the future, barring significant acquisitions. Fitch expects dividends to continue to rise to approximately $550 million in 2006. With a $5 billion pension deficit, LMT could make additional pension contributions, but the credit impact of the pension deficit is mitigated by low required contributions ($100 million-$110 million in 2006) and the fact that pension costs are allowable costs in U.S. defense contracts. Divestitures have generated $2.4 billion in the past five years, but proceeds should decline going forward since most of LMT's non-core holdings have been sold.

Acquisitions are an element of LMT's strategy to increase its non-DOD revenues and to increase the amount of Operations & Maintenance revenues with the DOD. As such, LMT plans to continue to make selective acquisitions in core businesses. Acquisition spending in the past five years has been moderate, totaling approximately $1.8 billion, but LMT has considered several larger acquisitions that were not completed. The possibility of large, multi-billion dollar acquisitions remains a key credit concern. However, Fitch believes that LMT has the capacity to make sizable acquisitions given its cash position, free cash flow, and the ability to reduce or stop share repurchases. Fitch will continue to evaluate acquisitions on a case-by-case basis with a focus on price and rationale. If LMT executes a large acquisition that is debt-financed in whole or in part, Fitch could review the ratings and/or the Outlook.

High U.S. defense spending levels continue to support LMT's credit ratings. Fitch believes that the February releases of the fiscal year 2007 DOD budget request and the Quadrennial Defense Review (QDR) lessened near-term uncertainty in the defense sector because projected spending in the request was higher than Fitch expected and the QDR reflected the DOD's existing transformation strategy. Modernization spending in the budget request is projected to grow at a 5% compound annual growth rate through 2011, the speculated 'cuts' to the budget growth rates did not materialize, and growth rates are better than the low-single digit growth rates incorporated into most of Fitch's defense ratings.

The outlooks for some of LMT's key defense programs have stabilized in the past year. The F-22 program was approved for full-rate production in April 2005, and 59 aircraft had been delivered through the end of 2005. The F-35 Joint Strike Fighter continues to progress, and Fitch does not expect recent comments by some of the program's foreign partners will have a material effect on the program. The C-130J program survived threats of early termination, and the program is currently set to run through 2008. On the other hand, a few of LMT's programs still require monitoring, such as the SBIRS program, and the Aerial Common Sensor was cancelled.

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