Lockheed Martin Corporation — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; filed February 8, 2019. This is an annual report, with fourth-quarter results also disclosed. Lockheed Martin is a global aerospace and defense contractor operating through Aeronautics, Missiles and Fire Control (MFC), Rotary and Mission Systems (RMS), and Space. The U.S. Government accounted for 70% of sales, including 60% from the Department of Defense; international customers accounted for 28%.
Financial results and liquidity
| Metric | 2018 | 2017 |
|---|---|---|
| Net sales | $53.762 billion | $49.960 billion |
| Operating profit | $7.334 billion | $6.744 billion |
| Net earnings | $5.046 billion | $1.963 billion |
| Diluted EPS | $17.59 | $6.75 |
| Operating cash flow | $3.138 billion | $6.476 billion |
| Capital expenditures | $1.278 billion | $1.177 billion |
| Cash and cash equivalents at year-end | $772 million | $2.861 billion |
| Total debt, net of discounts and issuance costs | $14.104 billion | $14.263 billion |
| Total equity | $1.449 billion | $(776) million |
Gross profit was $7.274 billion, a 13.5% gross margin; operating margin was 13.6% and net margin was 9.4%. The 2018 effective tax rate was 13.6%, compared with 64.0% in 2017. The prior-year result included a $2.0 billion largely non-cash Tax Act charge, so the reported earnings and EPS increase substantially reflects an unusually low 2017 comparison. 2018 included a $110 million non-cash impairment related to equity-method investee AMMROC and $96 million of severance and restructuring charges.
Operating cash flow fell $3.3 billion year over year, mainly reflecting $5.0 billion of qualified pension contributions and greater working-capital use, including timing of F-35 and Sikorsky collections. Free cash flow, defined by the company as operating cash flow less capital expenditures, was approximately $1.86 billion. Cash dividends paid were $2.347 billion; share repurchases were $1.492 billion. Year-end current assets were $16.103 billion and current liabilities were $14.398 billion. The company had $600 million of commercial paper outstanding and a $2.5 billion revolving credit facility with no facility borrowings at year-end; it reported compliance with debt covenants.
Performance and material changes
- Sales rose 7.6% year over year. Product sales increased 6%; service sales increased 17%, with growth led by F-35 production and sustainment, tactical and strike missiles, and RMS mission-system programs.
- Segment sales and operating profit: Aeronautics $21.242 billion and $2.272 billion; MFC $8.462 billion and $1.248 billion; RMS $14.250 billion and $1.302 billion; Space $9.808 billion and $1.055 billion.
- RMS operating margin improved to 9.1% from 6.6%, aided by better Sikorsky cost performance and the non-recurrence of the 2017 EADGE-T charge. MFC margin rose to 14.7% from 14.2%. Aeronautics margin was 10.7% versus 11.2%; Space was 10.8% versus 10.2%.
- Backlog increased to $130.5 billion from $105.5 billion; funded backlog was $86.4 billion. Management expected to recognize about 38% of backlog as revenue in the next 12 months and 66% within 24 months.
- Net income improved from 2017, but comparisons are affected by the prior-year Tax Act charge. The company adopted ASC 606 retrospectively, adjusting prior-period presentation; 2018 financial statements received an unqualified audit opinion.
Outlook, risks and unusual items
For 2019, management forecast mid-single-digit sales growth, total business-segment operating margin of approximately 10.8%, and operating cash flow of at least $7.4 billion, assuming continued U.S. Government support and funding. Aeronautics sales were expected to grow at a high-single-digit rate, principally from F-35 volume; MFC sales at a low-double-digit rate; RMS sales slightly above 2018; and Space sales approximately flat, with Space operating profit expected to decline in the low-double-digit range because of lower equity earnings. The company did not expect qualified defined-benefit pension contributions in 2019 after its $5.0 billion 2018 contributions.
- F-35 concentration and execution: F-35 generated 27% of consolidated sales in 2018. Formal Initial Operational Test and Evaluation was expected to conclude in 2019, supporting a government decision on full-rate production. Risks include testing, software, suppliers, production funding, sustainment costs, and potential changes in orders.
- Government and contract exposure: Funding uncertainty, continuing resolutions, shutdowns, sequestration risk, audits, contract termination, bid protests, and fixed-price cost overruns could affect sales, margins, or cash flow. Management noted the recent shutdown’s impact was not material but warned a prolonged future shutdown could be more consequential.
- Program performance and estimates: Two commercial satellite programs had cumulative losses of about $380 million; 2018 losses were about $75 million. The Warrior Capability Sustainment Program had cumulative losses of about $140 million following an $85 million 2018 charge. EADGE-T cumulative losses remained about $260 million. Further performance issues could prompt additional charges.
- Pensions and equity exposure: Qualified pension obligations remained underfunded by $11.3 billion at year-end, despite the large contribution and risk-transfer transactions. Management estimated a potential approximately $350 million settlement loss when a pension buy-in is converted to a buy-out, anticipated as early as 2020. Sikorsky goodwill and intangible assets were considered vulnerable to deterioration in outlook; no impairment was recorded in 2018.
- Commitments and contingencies: Remaining offset obligations had a stated notional value of $12.1 billion, with estimated potential penalties of approximately $1.5 billion. Environmental liabilities were $864 million, partly offset by $750 million of expected recoveries. Litigation includes a False Claims Act matter, a long-running MTA dispute, and potential indemnity exposure related to the Hanford investigation; the company did not consider a material loss probable in the matters described, though outcomes remain uncertain.
- Other risks include cybersecurity and supply-chain security, international trade and export restrictions, foreign offsets, skilled-worker availability, and changes in environmental standards. The company stated that it substantially hedges currency exposure and did not expect Brexit to have a material financial impact.
Important facts for investors to verify
- Whether 2019 F-35 testing, production transition, delivery cadence, and sustainment performance support the sales and margin outlook.
- Whether the $7.4 billion operating-cash-flow target is achieved, particularly given working-capital timing and pension-cost recovery.
- Progress and remaining exposure on the commercial satellite, Warrior, and EADGE-T programs, including any new reserves or penalties.
- Developments in U.S. appropriations, contract awards, and the company’s reliance on U.S. Government customers.
- Changes in pension assumptions, funded status, expected settlement costs, and the sensitivity of Sikorsky goodwill and intangibles to operating performance.
- Updates to environmental recoveries, offset commitments, and legal proceedings or indemnity exposures.