Lockheed Martin Corporation — Q1 2012 Form 10-Q
Reporting period: Quarter ended March 25, 2012; comparisons are with the quarter ended March 27, 2011. Financial amounts are in millions of dollars except per-share data. The interim financial statements are unaudited; Ernst & Young performed a review, not an audit.
Business context
Lockheed Martin is a global aerospace and security company operating in Aeronautics, Electronic Systems, Information Systems & Global Solutions (IS&GS), and Space Systems. In 2011, 82% of sales came from the U.S. Government, including 61% from the Department of Defense. Approximately 95% of contracts use percentage-of-completion accounting, which relies on estimates of contract costs and profits.
Financial performance
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Net sales | $11,293 | $10,626 | +6% |
| Gross profit | $974 | $814 | +20% |
| Operating profit | $1,009 | $864 | +17% |
| Net earnings from continuing operations | $665 | $556 | +20% |
| Net earnings | $668 | $530 | +26% |
| Diluted EPS | $2.03 | $1.50 | +35% |
| Operating cash flow | $458 | $1,719 | Down $1,261 |
| Capital expenditures | $131 | $130 | Approximately flat |
Gross margin was approximately 8.6% versus 7.7%; operating margin was 8.9% versus 8.1%. Cost of product sales was 88.3% of product revenue, down from 89.3%; cost of services sales was 89.4% of services revenue, down from 90.6%. The effective tax rate was 29.9%, compared with 30.3%.
Cash flow from operations less capital expenditures was approximately $327 million, versus $1,589 million a year earlier. Management attributed the cash-flow decline mainly to working-capital timing, $505 million of pension contributions (none in the comparable quarter), and taxes paid versus refunds received a year earlier. Cash ended the quarter at $3,518 million, down $64 million from year-end 2011.
At March 25, 2012, total assets were $38,340 million, current assets $14,561 million, and current liabilities $12,211 million. Long-term debt, net, was $6,472 million; cash exceeded that reported long-term debt by about $2,954 million. Accrued pension liabilities were $13,190 million. Stockholders’ equity was $1,573 million, up from $1,001 million at year-end.
Segment results and material changes
- Aeronautics: Sales of $3,706 million, up 18%; operating profit of $385 million, up 17%; margin held at 10.4%. Higher F-35 LRIP activity and additional C-130J, F-16, and C-5M deliveries contributed; F-22 production was winding down.
- Electronic Systems: Sales of $3,609 million, up 4%; operating profit of $541 million, up 25%; margin rose to 15.0% from 12.4%, largely reflecting risk retirements on programs. The company expected full-year 2012 margin to be slightly above the 12.2% reported for 2011.
- IS&GS: Sales of $2,090 million, down 3%; operating profit of $188 million versus $194 million; margin remained 9.0%. Lower activity included the cessation of JTRS and completion of a NASA outsourcing program.
- Space Systems: Sales of $1,888 million, up 2%; operating profit of $226 million, up 4%; margin was 12.0% versus 11.8%. Orion activity and satellite-program risk retirements helped; Space Shuttle-related External Tank work declined.
Product sales rose 8%, while services sales increased 1%. Diluted EPS also benefited from lower weighted-average shares following repurchases: 328.6 million diluted shares versus 352.6 million.
Cash, capital allocation, outlook and key risks
- The company repurchased 2.7 million shares for $242 million and paid $327 million of dividends during the quarter. The declared dividend was $1.00 per share, versus $0.75 a year earlier. Remaining repurchase authorization was $3.1 billion.
- Lockheed Martin contributed $505 million to qualified pension plans in Q1 and reported an additional $607 million contribution early in Q2, completing its anticipated $1.1 billion 2012 funding. It said it may consider further contributions. Expected 2012 retiree medical and life-plan contributions were approximately $110 million.
- Management said operating cash flow should continue to fund operations and anticipated capital expenditures for the foreseeable future. The filing gives no consolidated earnings or revenue guidance; the specific segment outlook disclosed was for Electronic Systems’ 2012 operating margin.
- Management identified the Budget Control Act’s $487 billion defense-spending reduction over ten years and possible FY2013 sequestration as significant risks to customer budgets, programs, and the defense industrial base. Program changes, delays, reductions, or terminations could follow.
- F-35 risks include flight testing, software development, supplier and partner performance, and timely LRIP funding. The SDD program had about $530 million of incentive fees remaining, with most milestones not yet determined. The company had orders for 93 production aircraft and had delivered 11 through quarter-end.
- An IAM bargaining unit representing 3,600 Aeronautics employees rejected the company’s offer and voted to strike on April 22, 2012. Management planned to keep operations open and use contingency plans.
Estimates, contingencies and unusual items
- Changes in contract estimates increased operating profit by approximately $485 million, net of state taxes, and net earnings by approximately $315 million, or $0.96 per share. Comparable-quarter increases were $330 million and $215 million, or $0.61 per share. These percentage-of-completion adjustments are a significant contributor to reported results and may change as contracts progress.
- Environmental liabilities were $966 million, with related recovery receivables of $838 million. The company warned that potentially lower future drinking-water standards for perchlorate and hexavalent chromium could increase estimated remediation costs; unrecoverable amounts could affect earnings.
- Outstanding letters of credit, surety bonds, and third-party guarantees totaled $3.4 billion, down from $3.9 billion at year-end, mainly following a scheduled reduction in an F-16 customer-advance letter of credit. Management said it did not expect payments under joint-venture guarantees or ULA support arrangements to be required.
- Legal matters include securities and shareholder litigation, an MTA contract dispute involving a $323 million contract (of which $241 million had been paid), and environmental proceedings. Management assessed a material adverse effect on the company as a whole as remote, while noting that loss ranges generally could not be estimated for the listed cases.
- Q1 2012 discontinued operations generated $3 million of earnings, versus a $26 million loss in Q1 2011. Savi remained classified in discontinued operations; PAE was sold in 2011.
Most important facts for investors to verify
- Whether contract estimate revisions—especially the $485 million Q1 operating-profit benefit—are sustainable and how future program costs or schedules may alter them.
- The effect of defense budget reductions or sequestration on contract awards, program volumes, and the company’s sales and margins.
- F-35 delivery, testing, software, funding, and incentive-fee progress, along with the status of the Fort Worth earned-value system re-audit.
- Cash conversion and working-capital trends, pension contributions, and the company’s ability to sustain dividends and repurchases while funding obligations.
- Developments in the IAM strike, environmental standards and recoveries, and material litigation or guarantee exposures.