Lockheed Martin Corporation — Q1 2016 Form 10-Q
Reporting period: Quarter ended March 27, 2016; comparative quarter ended March 29, 2015. Amounts are in millions of dollars except per-share data. Interim financial statements are unaudited; Ernst & Young performed a review, not an audit.
Business context
Lockheed Martin is a defense and aerospace contractor whose principal customer is the U.S. Government. Results cover five segments: Aeronautics, IS&GS, Missiles and Fire Control (MFC), Mission Systems and Training (MST), and Space Systems. The quarter includes Sikorsky, acquired in November 2015, within MST; the prior-year quarter does not, limiting direct comparability. IS&GS remained in continuing operations pending its planned transaction with Leidos.
Financial results and liquidity
| Metric | Q1 2016 | Q1 2015 |
|---|---|---|
| Net sales | $11,702 | $10,111 |
| Gross profit | $1,235 | $1,263 |
| Operating profit | $1,297 | $1,356 |
| Net earnings | $794 | $878 |
| Diluted EPS | $2.58 | $2.74 |
| Operating cash flow | $1,563 | $957 |
| Capital expenditures | $151 | $118 |
| Dividends paid per share | $1.65 | $1.50 |
- Sales rose 16%, while operating profit fell 4% and net earnings fell 10%. Gross margin was approximately 10.6% versus 12.5%; operating margin approximately 11.1% versus 13.4%.
- Operating cash flow improved by $606, principally because working-capital cash use was lower. Cash and cash equivalents were $1,452 at quarter-end, up from $1,090 at year-end. Operating cash flow less capital expenditures was approximately $1,412.
- At March 27, total current assets were $15,767 and current liabilities $14,912 (current ratio approximately 1.06). Total debt carrying value was about $15.3 billion; principal outstanding was $16.2 billion. The company reported compliance with debt covenants, no revolver or commercial-paper borrowings, and $2.5 billion available under its revolving facility.
- Cash returned to shareholders included $501 of repurchases and $533 of dividends paid. The remaining repurchase authorization was $3.1 billion.
Material changes versus prior year
- Product sales increased 14% and services sales 22%. Sikorsky contributed about $990 of MST sales; Aeronautics growth reflected higher F-35 activity and aircraft deliveries.
- Segment sales and operating profit: Aeronautics $3,799 and $420 (up from $3,134 and $371); IS&GS $1,334 and $109 (down from $1,390 and $145); MFC $1,434 and $221 (up from $1,383 and $286); MST $3,004 and $229 (up from $1,979 and $180); Space Systems $2,131 and $244 (down from $2,225 and $324).
- Product and service cost ratios increased: product costs were 90.5% of product sales versus 88.5%; service costs were 89.3% of service sales versus 86.4%. Interest expense rose to $164 from $93, largely reflecting debt issued to fund Sikorsky.
- Consolidated segment adjustments not related to volume increased segment operating profit by approximately $405, compared with $490 in the prior-year quarter. These estimates and contract adjustments can materially affect period results.
Outlook, risks and unusual items
- The filing provides no specific full-year revenue or EPS guidance. Management said operating cash flows are expected to fund operations and anticipated capital expenditures for the foreseeable future.
- The planned tax-efficient Reverse Morris Trust transaction with Leidos was expected to close in Q3 or Q4 2016. Lockheed Martin expected approximately $1.8 billion in cash plus about 50.5% of Leidos equity for its stockholders; value, structure, timing, approvals and closing remain uncertain. Management expected to use the cash payment for debt repayment, dividends or repurchases.
- Q1 included $99 of severance charges ($80 Aeronautics; $19 IS&GS), primarily for planned workforce reductions. Sikorsky purchase-price allocation remained preliminary and could change, including future amortization.
- A contract for an integrated air and missile defense system remained under reassessment after performance issues and prior reserves, including a $70 reserve in Q1 2015. Additional loss reserves could be material; the company could not estimate total expected costs.
- F-35 risks include supplier and partner performance, software development, schedule and cost, sustainment and warranty costs, funding timing, testing and customer requirements. The company reported 160 production aircraft delivered and 108 in backlog; it was pursuing U.S. Air Force initial operating capability for the F-35A in 2016.
- Environmental liabilities were $991 and associated recovery receivables $849 at quarter-end. A materially stricter drinking-water standard could increase environmental estimates and affect earnings for unrecoverable costs.
- Other contingencies include a government False Claims Act suit seeking approximately $148 (which the company disputes; DOJ closed the related criminal investigation with no action) and an MTA dispute in which the MTA seeks about $190 while Lockheed Martin asserts about $95 in damages. The company stated that loss estimates for many proceedings cannot be made. Outstanding letters of credit, surety bonds and third-party guarantees aggregated $3.7 billion.
- Other risks include U.S. defense budgets and funding, contract execution and cost estimates, competition, pension assumptions, cybersecurity, international markets, and the successful completion and integration of acquisitions or divestitures.
Key facts for investors to verify
- Whether sales growth and cash generation persist after accounting for Sikorsky’s contribution and working-capital timing.
- Progress and final terms of the Leidos transaction, including the cash payment, share value, approvals and expected closing.
- Performance, cost estimates and any additional reserves on the international air and missile defense contract, and trends in segment contract adjustments.
- Sikorsky integration results, preliminary purchase accounting, and the effect of acquisition-related debt and amortization.
- F-35 execution, funding, deliveries and sustainment exposure, alongside environmental and legal contingencies.