Business context and reporting period
Lockheed Martin Corporation filed this unaudited Form 10-Q for the quarter ended September 28, 2014, with comparative results for the quarter and nine months ended September 29, 2013. The company operates in five segments: Aeronautics, Information Systems & Global Solutions (IS&GS), Missiles and Fire Control (MFC), Mission Systems and Training (MST), and Space Systems. Its principal customer is the U.S. Government.
Financial performance and position
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $11.114bn | $11.347bn | $33.070bn | $33.825bn |
| Operating profit | $1.392bn | $1.254bn | $4.250bn | $3.671bn |
| Net earnings | $888m | $873m | $2.710bn | $2.493bn |
| Diluted EPS | $2.76 | $2.66 | $8.39 | $7.63 |
| Operating cash flow | Not stated for quarter | Not stated for quarter | $4.067bn | $3.608bn |
- Gross profit was $1.275bn for Q3 and $3.987bn for the first nine months. Reported cost of products sales was 89.0% of product sales in Q3 (87.6% prior year); cost of services sales was 88.7% of services sales (88.5% prior year).
- Nine-month investing cash outflow was $1.064bn, including $622m for acquisitions and investments; financing cash outflow was $2.657bn, including $1.676bn of share repurchases and $1.286bn of dividends paid. Cash increased $346m to $2.963bn.
- At September 28, cash was $2.963bn, current assets $13.684bn and current liabilities $12.133bn. Long-term debt, net, was $6.165bn; the company reported $7.0bn outstanding principal before unamortized discounts. Stockholders’ equity was $4.574bn.
- The company contributed $1.0bn to qualified pension plans in the first nine months and expected another $1.0bn contribution in Q4 2014. Accrued pension liabilities were $9.556bn.
Material changes versus prior comparable periods
- Quarterly sales declined 2%; nine-month sales declined 2%. Product sales fell in both periods, while service sales rose slightly in Q3 but declined for the nine months.
- Operating profit rose 11% in Q3 and 16% year to date despite lower total business-segment operating profit: segment profit was down 7% in Q3 and 3% year to date. The consolidated increase chiefly reflected a favorable swing in unallocated pension adjustments: FAS/CAS pension income of $84m in Q3 and $255m year to date versus expense of $121m and $362m in 2013.
- Net earnings and diluted EPS increased; EPS also benefited from about four million fewer shares outstanding year over year, primarily from repurchases. The 2013 comparison included $31m of discontinued-operations tax benefit.
- Segment sales and profit were mixed. Nine-month Aeronautics sales increased 5%, driven primarily by F-35 production, while IS&GS, MFC, MST and Space Systems sales declined. Nine-month operating profit fell at IS&GS, MFC and MST; Aeronautics and Space Systems were approximately flat.
- Nine-month operating cash flow increased $459m. Management cited improved operating results, lower pension contributions and working-capital timing, partly offset by higher net tax payments ($1.0bn versus $387m).
Outlook, management commentary, risks and unusual items
- Management’s preliminary 2015 outlook was for net sales to decline at a low-single-digit rate from 2014 and total business-segment operating margin of 11.5%–12.0%. This assumes continued support and funding for key programs and a GFY 2015 budget consistent with the President’s proposal.
- For 2014, management expected Aeronautics sales to increase mid-single digits; IS&GS sales and operating profit to decline high single digits; MFC sales to decline low single digits and profit mid-single digits; MST sales to decline slightly and profit high single digits; and Space Systems sales to remain flat with profit down mid-single digits.
- U.S. Government budget constraints, sequestration beyond GFY 2015, continuing-resolution funding, contract delays or cancellations, price-based competition and reduced demand for services were identified as significant risks. The company noted that short-term service-oriented businesses are particularly exposed.
- F-35 program risks include supplier and partner performance, software development, cost of sustainment and warranties, timely production funding, flight testing and findings from testing. At quarter-end, 95 production aircraft had been delivered and 71 were in backlog.
- In June 2014, pension plan amendments began a phased freeze of future benefits for certain non-union employees. Re-measurement lowered obligations by $4.6bn from the pay-based freeze but increased them by $6.5bn from actuarial-assumption changes, including longevity and discount-rate changes. The net re-measurement increased other comprehensive loss by $735m after tax. Pension assumptions and investment returns could materially affect future expense and equity.
- The company repurchased 10.3m shares for $1.7bn year to date; the board increased authorization by $2.0bn, leaving $3.9bn available. Management anticipated at least $2.0bn of repurchases in 2015, subject to market conditions and discretion, and declared a Q4 dividend of $1.50 per share, 13% above Q3.
- Environmental liabilities were $963m, with $834m of related recovery receivables recorded. The company warned that tighter drinking-water standards could increase estimates and, for costs not recoverable through U.S. Government contract pricing, could affect earnings.
- Significant proceedings included the MTA contract dispute, whose bench trial began October 6, 2014, and False Claims Act/environmental allegations concerning the Paducah plant. The company disputed the allegations; it said a reasonably possible loss could not be estimated for the latter matter. It considered a material adverse effect on the company as a whole remote, while acknowledging individual matters could affect a particular interim period.
- Goodwill impairment risk was highlighted for IS&GS Civil and MFC Technical Services reporting units, whose estimated fair values exceeded carrying values by about 15%. The 2014 annual impairment test was due in Q4.
- Management noted that contract estimates and profit-booking adjustments are inherently judgmental. Net non-volume adjustments increased segment operating profit by approximately $400m in Q3 and $1.4bn year to date, versus $510m and $1.6bn in 2013.
Important facts for investors to verify
- Whether GFY 2015 appropriations and later defense-budget decisions support the company’s sales and margin assumptions.
- F-35 execution, funding, testing, supplier performance, delivery schedule and sustainment economics.
- Whether contract cost estimates, profit-booking adjustments and warranty reserves develop as expected, particularly in MST, MFC and Aeronautics.
- Pension funding needs and the sensitivity of pension expense, obligations and equity to discount rates, longevity assumptions and asset returns.
- Progress on the MTA and Paducah proceedings, environmental remediation estimates and potential changes in recoverable costs.
- Results of the Q4 goodwill impairment test for the Civil and Technical Services reporting units.
- Execution of planned buybacks and dividends alongside acquisition spending, pension contributions and liquidity needs.