Lockheed Martin Corporation — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 29, 2014; comparisons are to the periods ended June 30, 2013. Figures 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 and results
Lockheed Martin is a global aerospace and security company, with the U.S. Government its principal customer. It reports five segments: Aeronautics, Information Systems & Global Solutions (IS&GS), Missiles and Fire Control (MFC), Mission Systems and Training (MST), and Space Systems. The F-35 is its largest program.
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $11,306 | $11,408 | $21,956 | $22,478 |
| Gross profit | $1,341 | $1,224 | $2,712 | $2,265 |
| Operating profit | $1,426 | $1,298 | $2,858 | $2,417 |
| Net earnings | $889 | $859 | $1,822 | $1,620 |
| Diluted EPS | $2.76 | $2.64 | $5.63 | $4.97 |
| Gross margin | 11.9% | 10.7% | 12.4% | 10.1% |
| Operating margin | 12.6% | 11.4% | 13.0% | 10.8% |
Sales fell about 1% in Q2 and 2% in the first half. Higher Aeronautics sales, particularly F-35 production, were offset by declines in IS&GS, MFC, and Space Systems; first-half MST sales also declined. Profit and EPS increased despite lower sales, reflecting improved consolidated results that included a swing in the FAS/CAS pension adjustment from expense in 2013 to income in 2014. Higher tax rates partly offset the earnings improvement.
Cash flow, balance sheet, and capital allocation
- Operating cash flow: $3,077 for the first six months, versus $2,708 in 2013. Capital expenditures were $253; operating cash flow less capital expenditures was $2,824.
- Cash: $3,436 at June 29, 2014, up from $2,617 at year-end 2013. Cash increased $819 during the half.
- Debt: Long-term debt, net, was $6,169 versus $6,152 at year-end. Outstanding principal was $7.0 billion, excluding unamortized discounts. No borrowings were outstanding on the $1.5 billion revolving facility or under commercial-paper agreements.
- Liquidity: Current assets were $14,163 and current liabilities $12,147. Management said operating cash flow was expected to support operations and anticipated capital expenditures; the company was compliant with debt covenants.
- Returns to shareholders: Repurchased 7.7 million shares for $1.2 billion and paid $865 million of dividends in the first half. Remaining repurchase authorization was $2.3 billion.
Material changes and unusual items
- Q2 segment sales and operating profit were, respectively: Aeronautics $3,855 and $453; IS&GS $1,941 and $175; MFC $1,891 and $345; MST $1,771 and $185; Space Systems $1,848 and $248. Aeronautics sales rose on F-35 production and aircraft deliveries; several other segments faced lower program volume or deliveries.
- MST Q2 operating profit declined to $185 from $275, including the absence of favorable 2013 contract-cost settlements and reserves on training and logistics programs.
- Net contract-estimate adjustments, including profit-booking-rate changes and other matters, increased segment operating profit by about $440 in Q2 and $965 in the first half, below the comparable 2013 amounts of $585 and $1.1 billion. These adjustments contributed approximately $0.88 and $1.93 per diluted share in 2014 for Q2 and the first half.
- Pension-plan amendments froze future benefits in stages beginning in 2016 and 2020. The company remeasured substantially all defined-benefit plans; the remeasurement increased other comprehensive loss by $735 net of tax, but did not affect Q2 operating results. Accrued pension liabilities were $10,046 at quarter-end.
- Stockholders’ equity declined to $4,319 from $4,918 at year-end, reflecting dividends, repurchases, and pension remeasurement effects, partly offset by earnings.
Outlook, management commentary, and risks
- Segment 2014 expectations versus 2013: Aeronautics sales up mid-single digits and operating profit up slightly; IS&GS sales and operating profit down high-single digits; MFC sales down low-single digits and operating profit down mid-single digits; MST sales flat and operating profit down low-double digits; Space Systems sales and operating profit down mid-single digits.
- Management expected 2014 diluted EPS to exceed 2013, primarily because it expected about $445 million of FAS/CAS pension income in 2014, compared with $482 million of expense in 2013. It forecast 2014 FAS pension expense of $1.2 billion and CAS cost of $1.6 billion. It also expected CAS recoveries to exceed cash contributions for 2014 and several years thereafter.
- The 2013 Bipartisan Budget Act eased spending limits for GFY 2014 and 2015, but constrained spending limits and sequestration concerns remained for later years. Management warned that budget reductions could lead to program delays or terminations, reduced production, supplier claims, restructuring, and impairment charges; short-cycle services businesses were particularly exposed.
- F-35 risks cited include supplier and partner performance, software development, sustainment and warranty costs, timely production funding, flight testing, and operational performance. At quarter-end, 87 production aircraft had been delivered and 79 were in backlog.
- Environmental liabilities were $980 and related recorded recovery receivables $848 at quarter-end. Lower future drinking-water standards could materially increase estimated environmental obligations and, for costs not recoverable through U.S. Government pricing, could affect earnings.
- Other contingencies include an MTA contract dispute, with trial scheduled for October 2014, and False Claims Act/environmental allegations concerning the Paducah plant; the company disputed the allegations and said potential losses could not be estimated. Management considered a material adverse effect on the company as a whole remote, while acknowledging an adverse outcome could affect individual periods.
- The company was evaluating a new revenue-recognition standard expected to take effect January 1, 2017, subject to any change in effective date; it could affect revenue and cost recognition across many contracts.
Investor facts to verify
- Whether expected 2014 segment sales, profits, and diluted EPS develop as guided, especially given declining federal IT budgets and planned reductions in several segments.
- How much reported profit and EPS depend on contract estimate adjustments and the favorable FAS/CAS pension adjustment, and whether those benefits persist.
- Whether pension assumptions, funding, and future CAS recoveries evolve as expected; the quarter’s remeasurement materially affected accumulated other comprehensive loss.
- Developments in F-35 execution, funding, costs, testing, and backlog, as well as the MTA case and environmental standards and claims.
- Cash generation and shareholder distributions relative to pension contributions, restructuring costs, and customer or budget-related changes.