Lockheed Martin Corporation — Q1 2014 Form 10-Q
Reporting period: Quarter ended March 30, 2014; comparison is with the quarter ended March 31, 2013. Amounts are in U.S. dollars; financial statement amounts are in millions unless stated otherwise. The interim financial statements are unaudited and were reviewed by Ernst & Young.
Business context
Lockheed Martin is a global security and aerospace contractor operating five segments: Aeronautics, Information Systems & Global Solutions (IS&GS), Missiles and Fire Control (MFC), Mission Systems and Training (MST), and Space Systems. The U.S. Government is its principal customer; 82% of 2013 sales were to U.S. Government customers. The F-35 is its largest program.
Financial performance and liquidity
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Net sales | $10.650 billion | $11.070 billion | Down 3.8% |
| Gross profit | $1.371 billion | $1.041 billion | Up 31.7% |
| Operating profit | $1.432 billion | $1.119 billion | Up 28.0% |
| Net earnings | $933 million | $761 million | Up 22.6% |
| Diluted EPS | $2.87 | $2.33 | Up 23.2% |
| Operating cash flow | $2.100 billion | $2.085 billion | Up $15 million |
- Gross margin was approximately 12.9%, versus 9.4%; operating margin was approximately 13.4%, versus 10.1%. The improvement reflected lower costs relative to sales and a more favorable pension adjustment, among other items.
- Effective tax rate increased to 30.8% from 25.8%. Q1 2013 benefited from $46 million of R&D tax credits; the credit had expired and no 2014 benefit was expected absent new legislation.
- Cash and cash equivalents were $3.264 billion at March 30, up from $2.617 billion at year-end 2013. Current assets were $14.234 billion and current liabilities $11.995 billion.
- Long-term debt, net, was $6.152 billion; outstanding principal was $7.0 billion, excluding unamortized discounts. Estimated fair value of outstanding debt was $7.6 billion. No borrowings were outstanding under the $1.5 billion revolving facility or commercial paper arrangements; the company reported compliance with debt covenants.
- Investing cash outflow was $126 million, including $103 million of capital expenditures. Financing cash outflow was $1.327 billion, including $1.106 billion of share repurchases and $444 million of dividends paid. The company repurchased 7.0 million shares and had $2.5 billion of remaining authorization.
Changes versus the prior comparable period
- Sales fell $420 million, as lower sales in IS&GS, MFC, MST, and Space Systems outweighed higher Aeronautics sales. Aeronautics sales grew 6%, supported by F-35 production and C-5 and F-16 deliveries; IS&GS sales fell 9% and MST sales fell 11%.
- Segment operating profit increased in four segments: Aeronautics $393 million (up $14 million), MFC $358 million (up $14 million), MST $250 million (up $49 million), and Space Systems $254 million (up $24 million). IS&GS operating profit declined to $174 million from $189 million.
- Consolidated operating profit included a positive $86 million FAS/CAS pension adjustment, versus a $121 million expense in Q1 2013. Management attributed the swing mainly to lower GAAP pension expense following a higher year-end discount rate and higher CAS costs.
- Net contract estimate adjustments and other non-volume items increased segment operating profit by approximately $525 million, compared with $470 million a year earlier; management estimated they increased net earnings by about $340 million ($1.05 per share), versus $305 million ($0.93 per share).
- Operating cash flow was nearly unchanged. Share repurchases and dividends were higher than in Q1 2013; cash rose by $647 million during the quarter.
Outlook, commentary, risks and contingencies
- The filing provides no specific full-year revenue or EPS guidance. Management said operating cash flows were expected to remain sufficient for operations and anticipated capital expenditures.
- Management planned $1.0 billion of qualified pension contributions in 2014; $515 million was contributed early in Q2. New longevity assumptions expected to be adopted at the next measurement date could increase pension obligations and reduce earnings. The company had not yet reflected those assumptions in the reported obligation or Q1 expense.
- A restructuring plan targets approximately 4,000 workforce reductions and facility consolidations in IS&GS, MST, and Space Systems, with completion expected in 2015. The company estimated $200 million in accelerated and incremental costs through completion; approximately $30 million had been incurred by March 30. It expected to recover a substantial amount through customer pricing.
- Management cited continuing U.S. defense budget constraints and uncertainty, including sequestration beyond GFY 2015, as risks to funding, program volume, supplier activity, and costs. Shorter-term contracts, particularly in IS&GS and certain services businesses, were described as more exposed.
- For F-35, 81 production aircraft had been delivered and 85 were in backlog at March 30. Development was expected to be substantially complete in 2017, with less significant work into 2019. Disclosed challenges include software, supplier and partner performance, testing, sustainment costs, funding timing, and program schedule and cost oversight.
- Environmental liabilities were $1.0 billion, with $874 million of recorded receivables for probable future recovery. The company warned that substantially tighter drinking-water standards for perchlorate or hexavalent chromium could increase estimated liabilities; unrecoverable costs could materially affect earnings in an interim period.
- Two highlighted legal matters are the MTA contract dispute, for which trial was scheduled to begin July 7, 2014, and DOJ False Claims Act/environmental allegations relating to the Paducah plant. Loss estimates for these matters could not be made. The company said it believed the overall probability of a material adverse effect from its legal matters was remote.
- The company reported no material change to previously disclosed risk factors or market-risk exposures, and said disclosure controls were effective as of March 30, 2014.
Important facts for investors to verify
- Whether the sizable contract estimate adjustments—approximately $1.05 per share in Q1—are repeatable and how they affect future margins.
- Whether sales declines in IS&GS, MST, MFC, and Space Systems continue, and whether Aeronautics and F-35 production can offset them.
- How U.S. budget decisions, sequestration, and customer funding affect awards, production schedules, and contract economics.
- The financial effects of pension funding and updated longevity assumptions, and the extent to which restructuring costs are recovered from customers.
- Developments in F-35 testing, software, suppliers, cost, and funding; environmental rulemaking and remediation recoveries; and the MTA and Paducah proceedings.
- Cash generation and liquidity after substantial repurchases and dividends, alongside the company’s debt and pension obligations.