LOCKHEED MARTIN CORP quarterly report, Q2 FY2018

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Lockheed Martin Corporation — Q2 2018 Form 10-Q

Reporting period: Quarter and six months ended June 24, 2018; comparisons are to periods ended June 25, 2017. Figures are unaudited. The company is a global aerospace and defense contractor, with 71% of first-half sales from the U.S. Government, 28% international and 1% U.S. commercial and other.

Financial performance

MetricQ2 2018Q2 2017Six months 2018Six months 2017
Net sales$13.40B$12.56B$25.03B$23.78B
Operating profit$1.80B$1.72B$3.52B$3.12B
Net earnings$1.16B$955M$2.32B$1.74B
Diluted EPS$4.05$3.28$8.07$5.97
Operating margin13.4%13.7%14.1%13.1%
  • Quarterly sales rose about 7% and first-half sales about 5%. First-half operating profit increased about 13%, net earnings about 33%, and diluted EPS about 35% year over year.
  • Quarterly gross margin was approximately 13.1%, versus 13.2% a year earlier; quarterly net margin was approximately 8.7%, versus 7.6%. Lower effective tax rates and fewer diluted shares also supported EPS growth.
  • First-half operating cash flow was $560M, down from $3.21B. The company cited $3.5B of pension contributions, weaker working-capital cash generation—especially revenue recognized ahead of collections—and higher earnings; net tax refunds partly offset the decline. Investing cash outflow was $329M; financing cash outflow was $1.91B.
  • Cash and equivalents were $1.18B at June 24, down from $2.86B at year-end. Debt was $14.2B net of discounts and issuance costs; principal outstanding was $15.4B. A $2.5B revolving facility was undrawn, and there were no commercial-paper borrowings at quarter-end. Total equity was $479M, compared with a $776M deficit at year-end.
  • Contract assets increased $1.3B to $9.3B, while contract liabilities declined $615M to $6.4B. These balances reflect the timing of revenue recognition, billings and customer payments.

Segment trends and material changes

  • Aeronautics: First-half sales grew 7% to $9.72B and operating profit rose 4% to $1.05B. Higher F-35 production and sustainment contributed; C-5 modernization activity declined. Full-year outlook: sales growth in the high-single digits; operating profit growth in the low-single digits, with slightly lower margin.
  • Missiles and Fire Control: First-half sales grew 13% to $3.76B and operating profit rose 11% to $540M. Volume increased in classified, tactical missile, sensor and air/missile-defense programs. Warrior turret program charges partly offset gains. Full-year outlook: low-double-digit growth in sales and operating profit, with slightly higher margin.
  • Rotary and Mission Systems: First-half sales grew 4% to $6.79B; operating profit rose to $652M from $399M, partly because the prior-year period included a $120M EADGE-T charge. Higher IWSS and C6ISR volume and improved Sikorsky performance also helped. Full-year outlook: low-single-digit sales growth and mid-double-digit operating profit growth, with improved margin.
  • Space: First-half sales declined 2% to $4.76B and operating profit declined 1% to $538M. Lower government and commercial satellite volume was partly offset by strategic and missile-defense programs. Full-year sales are expected to be comparable with 2017; operating profit is expected to grow in the mid-single digits.
  • Ending backlog was $105B; management expected to recognize approximately 40% over the next 12 months and 65% over the next 24 months.

Outlook, commentary and risks

  • Management expected 2018 sales growth in the mid-single digits, segment operating profit growth in the low-double digits, and a segment operating margin above 2017’s 10.2%. The outlook assumes continued U.S. Government support and funding consistent with the FY2018 budget.
  • The company contributed $3.5B to qualified pension plans in the first half and planned another $1.5B by September 15, 2018, funded with cash and commercial paper. Management did not expect material qualified-plan cash funding in 2019 or 2020; elsewhere it stated no material funding was expected until 2021.
  • Unusual program costs included $96M of RMS severance and restructuring charges; $85M of first-half Warrior turret reserves, with approximately $140M cumulative losses; and $75M of first-half losses on two developmental commercial satellite programs, with approximately $380M cumulative losses. One satellite missed its July delivery requirement. Further delays, rework, penalties or customer termination could cause material additional losses, although management considered termination on the missed delivery program remote.
  • EADGE-T cumulative losses remained approximately $260M; management did not anticipate additional material charges. The company’s investment in AMMROC was approximately $560M and remained subject to potential impairment.
  • Legal matters include a government False Claims Act case with approximately $52M of alleged damages before possible trebling; the court dismissed Anti-Kickback Act claims and one relator after quarter-end, and the remaining claims continue. In a separate MTA dispute, the customer sought approximately $190M; Lockheed Martin also asserted approximately $95M in claims. The company said it could not estimate the outcome of the MTA case.
  • Environmental liabilities were $910M, with $789M of estimated recoveries recorded. Changes to environmental standards could increase liabilities and, for costs not recoverable through U.S. Government contract pricing, could affect earnings. Outstanding letters of credit, surety bonds and third-party guarantees totaled $3.5B.
  • Management cited U.S. budget and sequestration uncertainty, program execution and funding, supplier performance, contract cost estimates, and pension assumptions among key risks. Sikorsky goodwill and intangible assets were identified as at risk of impairment if business performance or market factors deteriorate.
  • The company adopted ASC 606 and updated pension-cost presentation retrospectively; prior periods shown were adjusted. Management reported effective disclosure controls, and the independent accountant’s interim review found no material modifications needed for GAAP conformity.

Important facts for investors to verify

  • Whether FY2018 sales, segment-profit and margin guidance is achieved, particularly through F-35 volume and RMS performance.
  • Cash conversion, contract-asset growth and collections, alongside the remaining $1.5B pension contribution and the effect on liquidity.
  • Progress, delivery timing, penalties and any further loss reserves for the commercial satellite and Warrior turret programs.
  • U.S. defense appropriations and F-35 production funding, including whether budget uncertainty affects backlog conversion.
  • Developments in the False Claims Act and MTA litigation, environmental recovery assumptions, and impairment indicators for Sikorsky and AMMROC.