Lockheed Martin Corporation — Q1 2017 Form 10-Q
Reporting period: Quarter ended March 26, 2017; unaudited. Comparative quarter ended March 27, 2016. Ernst & Young performed an interim review, not an audit.
Business context and results
Lockheed Martin operates in Aeronautics, Missiles and Fire Control (MFC), Rotary and Mission Systems (RMS), and Space Systems. Its principal customer is the U.S. Government. The company completed the IS&GS divestiture in August 2016; 2016 earnings comparisons classify that business as discontinued operations. Q1 2017 includes AWE sales consolidated after Lockheed Martin raised its ownership to 51% in 2016, whereas Q1 2016 included no AWE sales.
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Net sales | $11.057 billion | $10.368 billion |
| Gross profit | $1.153 billion | $1.095 billion |
| Operating profit | $1.149 billion | $1.158 billion |
| Continuing-operations net earnings | $763 million | $806 million |
| Net earnings, including discontinued operations | $763 million | $898 million |
| Diluted EPS, continuing operations | $2.61 | $2.61 |
| Diluted EPS, total | $2.61 | $2.91 |
| Operating cash flow | $1.666 billion | $1.667 billion |
- Sales rose about 6.6%, led by F-35 production and sustainment and AWE consolidation. Product sales increased 9%; service sales decreased 4%.
- Gross margin was approximately 10.4% versus 10.6%; consolidated operating margin was approximately 10.4% versus 11.2%. Higher revenue did not translate into higher consolidated operating profit.
- Continuing-operations earnings fell about 5%, while continuing-operations diluted EPS was unchanged. The 2016 comparison included $92 million of IS&GS discontinued-operations earnings and benefited from a $104 million employee-equity-award tax benefit recognized after an accounting-standard adoption.
Segments and material changes
| Segment | Sales, 2017 vs. 2016 | Operating profit, 2017 vs. 2016 |
|---|---|---|
| Aeronautics | $4.106B vs. $3.799B | $436M vs. $420M |
| MFC | $1.489B vs. $1.434B | $219M vs. $221M |
| RMS | $3.101B vs. $3.004B | $108M vs. $229M |
| Space Systems | $2.361B vs. $2.131B | $288M vs. $244M |
RMS profit declined sharply, principally due to a $120 million charge for the troubled international EADGE-T air-missile-defense program, plus lower risk retirements. Cumulative EADGE-T losses and reserves were approximately $260 million; further charges remain possible. Space Systems’ increase included AWE consolidation and higher ULA equity earnings. The company also recorded a $64 million noncash impairment charge representing its share of an international equity-method investee’s impairment.
Cash flow, balance sheet and capital returns
- Operating cash flow was $1.666 billion; capital expenditures were $170 million, implying approximately $1.496 billion of operating cash flow less capex. Investing cash use was $166 million.
- Financing cash use was $1.121 billion, including $500 million of share repurchases and $544 million of dividends paid. Cash increased $379 million to $2.216 billion.
- At March 26, cash was $2.216 billion, current assets $16.586 billion and current liabilities $13.597 billion (approximate current ratio 1.22). Total assets were $48.836 billion; total liabilities $47.251 billion; total equity $1.585 billion.
- Long-term debt, net, was $14.276 billion. Management reported $14.3 billion of debt net of discounts and issuance costs, $15.3 billion principal, and estimated fair value of $16.1 billion. No revolving-credit-facility or commercial-paper borrowings were outstanding; the $2.5 billion facility was available.
- Repurchased 1.9 million shares for $500 million; $3.0 billion remained authorized. Dividends declared were $1.82 per share. The company reported compliance with debt covenants.
- Qualified pension-plan contributions were not material in the quarter; management did not expect material contributions in 2017.
Outlook, risks and notable disclosures
- Management expected 2017 sales growth in the mid-single-digit percentage range and segment operating margin just above 10%, lower than 2016. Outlook assumed continued U.S. Government support and funding consistent with the FY2017 budget and no government shutdown.
- Segment outlook: Aeronautics sales expected to rise low double digits; MFC sales mid-single digits with profit flat or slightly higher; RMS sales and profit low-single digits higher; Space Systems sales expected to decline mid-single digits and profit low- to mid-double digits.
- Management cited continuing-resolution and shutdown risk, sequestration and budget uncertainty, and the approaching federal debt-limit constraint. Funding interruptions could delay procurement and adversely affect results and cash flows.
- F-35 remains the largest program: about 24% of Q1 sales. The filing notes cost, schedule, software, supplier, testing, sustainment and funding challenges, as well as potential pressure to reduce costs. At quarter-end, 215 aircraft had been delivered and 158 were in backlog.
- Disclosure controls and procedures were reported ineffective because of a previously identified material weakness in Sikorsky’s controls, including contract accounting/revenue recognition, inventory, payroll and IT controls. No material financial-statement errors or restatement were identified. Remediation was underway, with completion expected before year-end 2017.
- Environmental liabilities were $978 million and related recovery receivables $842 million at quarter-end. Lower future regulatory limits for certain contaminants could increase estimated remediation costs; the unrecoverable portion could affect earnings.
- Legal matters include a False Claims Act case seeking about $52 million, subject to trebling and statutory penalties, and an MTA dispute in which the authority seeks about $190 million. Management said it did not currently consider a material loss probable in the False Claims Act matter; outcomes and reasonably possible losses in some proceedings cannot be estimated clearly.
- Sikorsky goodwill and its indefinite-lived trademark were identified as exposed to possible future impairment if business performance or market assumptions deteriorate. The filing also described planned adoption of revenue-recognition changes in 2018; management expected earlier recognition on certain unit-of-delivery contracts but had not yet quantified the overall impact.
Investor verification priorities
- Track EADGE-T execution, cumulative losses, and any additional charges.
- Assess Sikorsky control-remediation progress and whether controls operate effectively long enough to clear the material weakness.
- Compare full-year sales and margin performance with management’s outlook, considering AWE consolidation and the 2016 IS&GS divestiture in comparisons.
- Monitor U.S. budget, continuing-resolution, shutdown and debt-limit developments and their program-funding effects.
- Review F-35 cost, schedule, delivery, backlog and sustainment developments, along with Sikorsky impairment indicators and environmental/legal exposures.