Lockheed Martin Corporation — Q1 2018 Form 10-Q
Reporting period: Quarter ended March 25, 2018; comparable quarter ended March 26, 2017. Lockheed Martin is a global aerospace and defense contractor, with the U.S. Government its principal customer. The interim statements were reviewed by the independent auditor, not audited.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $11.635 billion | $11.212 billion | +3.8% |
| Operating profit | $1.725 billion | $1.402 billion | +23.0% |
| Net earnings | $1.157 billion | $789 million | +46.6% |
| Diluted EPS | $4.02 | $2.69 | +49.4% |
| Operating cash flow | $632 million | $1.666 billion | Down $1.034 billion |
Gross margin was approximately 14.3%, versus 12.5%; operating margin was 14.8%, versus 12.5%; and net margin was 9.9%, versus 7.0%. Products generated $9.762 billion of sales and services $1.873 billion; service sales grew 17% and product sales 2%.
Operating cash flow was pressured by $1.5 billion of pension contributions and working-capital outflows, including a $1.413 billion increase in contract assets. The company cited $850 million of net tax refunds and higher earnings as offsets. Capital expenditures were $216 million. Financing used $1.014 billion, including $586 million of dividends paid and $300 million of share repurchases. Cash declined $468 million to $2.393 billion.
Balance sheet and liquidity
At March 25, 2018, current assets were $17.816 billion and current liabilities $13.974 billion. Contract assets were $9.405 billion, up $1.413 billion from year-end; contract liabilities were $6.550 billion, down $478 million. Long-term debt, net, was $13.473 billion, with $750 million of current maturities; management reported total debt, net of discounts and issuance costs, of $14.2 billion. Outstanding debt principal was $15.4 billion. Stockholders’ deficit was $182 million; total deficit including noncontrolling interests was $111 million.
Cash and expected operating cash flows were described as adequate for operations and anticipated capital needs. The company had a $2.5 billion undrawn revolving credit facility, no commercial paper outstanding, and reported compliance with debt covenants. It planned $5.0 billion of 2018 pension contributions: $1.5 billion had been contributed in Q1, with $3.5 billion remaining.
Material changes and segment results
- Aeronautics: Sales rose 7% to $4.398 billion and operating profit rose 8% to $474 million, mainly on F-35 production and sustainment and F-16 modernization.
- Missiles and Fire Control: Sales rose 8% to $1.677 billion and operating profit rose 12% to $261 million, reflecting classified and tactical missile volume and favorable contract adjustments.
- Rotary and Mission Systems: Sales rose 3% to $3.223 billion; operating profit increased to $311 million from $128 million. The comparison benefited from the non-recurrence of a $120 million EADGE-T charge recorded in Q1 2017, alongside improved Sikorsky performance.
- Space: Sales fell 3% to $2.337 billion and operating profit fell 9% to $264 million, mainly due to lower government and commercial satellite volume and lower risk retirements.
Consolidated contract-related and other adjustments not tied to volume increased segment operating profit by approximately $420 million, versus $295 million a year earlier; management said these increased net earnings by approximately $332 million, or $1.15 per share. Share repurchases reduced weighted-average diluted shares by approximately 4.9 million year over year, also supporting EPS growth.
Outlook, risks, and unusual items
- Management expected 2018 net sales growth in the low-single-digit range and segment operating profit growth in the mid-single-digit range; it expected the 2018 segment operating margin to exceed 2017’s 10.2%. The outlook assumed continued U.S. Government support and funding for key programs.
- Segment outlooks: Aeronautics sales expected up mid-single digits, with operating profit up low-single digits and slightly lower margins; MFC sales and profit expected up mid-single digits, with comparable margins; RMS sales expected down low-single digits but operating profit up low- to mid-double digits; Space sales expected down mid-single digits, with operating profit comparable to 2017.
- Two developmental commercial satellite programs had cumulative losses of approximately $340 million; a further $35 million of losses was recorded in Q1. The company did not expect to meet delivery schedules and warned that further reserves could be material. Customers could terminate the contracts, potentially requiring refunds and penalties, although management considered termination remote.
- EADGE-T cumulative losses remained approximately $260 million. Additional charges were possible, though management did not then expect them to be material.
- F-35 risks included supplier and partner performance, software development, sustainment costs, funding timing, testing and schedule, cost, and requirements. The company reported 280 production aircraft delivered and 221 in backlog.
- U.S. defense funding increased for FY 2018 and FY 2019 under the 2018 budget legislation, but statutory spending limits and funding uncertainty remained for FY 2020 and beyond. Management warned that program reductions, delays, or terminations could affect results.
- Environmental liabilities were $911 million, with $791 million of related estimated recovery receivables. Changes to environmental standards could increase estimates. Other disclosed matters included False Claims Act litigation seeking approximately $52 million before potential trebling and statutory penalties, and an MTA dispute in which the MTA sought approximately $190 million and Lockheed Martin asserted approximately $95 million in claims; outcomes were uncertain.
- ASC 606 revenue recognition and ASU 2017-07 pension-cost presentation were adopted retrospectively, so comparative figures were adjusted. ASC 606 changed revenue timing for certain contracts; ASU 2017-07 shifted non-service pension costs out of operating profit without changing net income. The 2018 effective tax rate was 14.9%, versus 23.8%, including benefits associated with tax reform.
Important facts for investors to verify
- Whether contract-asset growth converts into customer billings and cash collections, and how working capital affects operating cash flow.
- Progress, cost estimates, delivery schedules, and potential customer remedies for the commercial satellite programs and EADGE-T.
- Execution of the $5.0 billion pension contribution plan and its effect on cash, commercial paper, and debt.
- Whether full-year sales, segment profit, and margin guidance remains achievable under the stated U.S. funding assumptions.
- How much of earnings growth reflects recurring operating performance versus contract estimate adjustments, tax effects, and lower share count.
- Developments in the legal and environmental contingencies, and any changes to the Sikorsky goodwill or intangible-asset impairment assessments.