Lockheed Martin Corporation — Q3 2015 Form 10-Q
Reporting period: Quarter ended September 27, 2015; comparisons are with the quarter ended September 28, 2014. Nine-month comparisons are for the corresponding periods. Dollar amounts are in millions unless stated otherwise. Financial statements are unaudited; Ernst & Young performed an interim review, not an audit.
Business context
Lockheed Martin is a security and aerospace contractor with five reporting segments: Aeronautics, Information Systems & Global Solutions (IS&GS), Missiles and Fire Control (MFC), Mission Systems and Training (MST), and Space Systems. The U.S. Government is its principal customer. The F-35 represented about 20% of consolidated sales in both Q3 and the first nine months of 2015.
Financial performance and position
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $11,461 | $11,114 | $33,215 | $33,070 |
| Operating profit | $1,354 | $1,392 | $4,155 | $4,250 |
| Net earnings | $865 | $888 | $2,672 | $2,710 |
| Diluted EPS | $2.77 | $2.76 | $8.45 | $8.39 |
| Operating margin | 11.8% | 12.5% | 12.5% | 12.9% |
- Sales increased 3% in Q3 and were essentially flat for the nine months. Q3 growth reflected higher F-35 production and sustainment, among other program increases.
- Gross profit was $1,256 in Q3 versus $1,275, and $3,890 for nine months versus $3,987. Gross margin was approximately 11.0% and 11.7%, respectively.
- Operating cash flow was $3,737 for nine months, down from $4,067. The company attributed the decline mainly to working-capital movements, including receivables and customer billing/payment timing; no qualified defined-benefit pension contributions were made, compared with $1.0 billion in the prior-year period.
- Cash and equivalents were $3,300 at September 27, versus $1,446 at year-end 2014. Current assets were $15,055 and current liabilities $12,980. Total debt on the balance sheet was about $8,412, including $952 current and $7,460 long-term; cash less debt was approximately negative $5.1 billion.
- For nine months, capital expenditures were $500; share repurchases were $2,364 and dividends paid were $1,427. The company repurchased 12.0 million shares and declared dividends of $6.15 per share. Remaining repurchase authorization was about $4.3 billion at quarter-end.
Material changes and notable items
- Q3 segment sales rose at Aeronautics, MST and MFC, but declined at IS&GS and Space Systems. For nine months, Aeronautics and MST grew, while MFC sales fell 8% and IS&GS sales fell 3%. IS&GS nine-month operating profit declined 12%; MFC declined 10%.
- Consolidated operating profit fell despite higher Q3 sales. Higher interest expense followed the February 2015 issuance of $2.25 billion of long-term notes. The effective tax rate was 30.9% in Q3 and 30.8% year to date, below 32.3% in the 2014 comparable periods.
- Net contract-estimate and other adjustments not related to volume increased segment operating profit by $435 in Q3 and $1.5 billion year to date, compared with $400 and $1.4 billion in 2014. The year-to-date adjustments added $960 to net earnings ($3.03 per diluted share). These estimates can change as contract costs, schedules and risks are reassessed.
- The company recorded $35 of IS&GS severance charges in Q3, reducing net earnings by $24, or $0.08 per share. It also continued a workforce and facility restructuring plan.
- Stockholders’ equity declined to $2,813 from $3,400 at year-end 2014, mainly reflecting repurchases and declared dividends, partly offset by earnings and postretirement-benefit accounting items. Accrued pension liabilities were $11,374.
Outlook, risks and contingencies
- Preliminary 2016 outlook: net sales and cash from operations expected to be comparable with 2015; total business-segment operating margin expected at 11.0%–11.5%. This outlook excludes the pending Sikorsky acquisition and strategic review outcomes and assumes timely GFY 2016 budget legislation. Segment-specific 2015 expectations included declining sales/profit at IS&GS and MFC, and broadly comparable sales at Aeronautics, MST and Space Systems.
- Lockheed agreed to acquire Sikorsky for $9.0 billion cash, subject to adjustments, and expected closing in Q4 2015, pending approvals and other conditions. A tax election was expected to provide an estimated $1.9 billion net-present-value cash tax benefit. October 9 credit facilities included $7.0 billion of 364-day capacity intended in part to fund the acquisition, plus a $2.5 billion five-year facility.
- A strategic review covered government IT infrastructure and technical-services businesses representing about $5.5 billion of estimated 2015 sales and 16,500 employees. Possible outcomes included a spin-off, Reverse Morris Trust or sale; no outcome was assured.
- Potential cost and termination exposure on C-130J and F-35 LRIP 9/10 production contracts was $2.4 billion while final terms and funding were being negotiated. Management expected additional funding by year-end; up to $750 million of expected 2015 cash collections could be delayed into 2016.
- Key risks included U.S. budget uncertainty and continuing-resolution funding, F-35 technical/schedule/cost and funding risks, acquisition financing and integration, competition and contract fragmentation, cyber threats, and potential goodwill impairment. The Civil reporting unit had $2.0 billion of goodwill and was identified as at risk if projected cash flows or market assumptions deteriorated.
- Environmental liabilities were $976, partly offset by $847 of estimated recoveries. The company could not estimate reasonably possible losses for certain legal proceedings, including an MTA dispute in which the MTA sought about $190 million and Lockheed asserted approximately $95 million in claims. It said an unfavorable resolution could materially affect an individual interim period, though it considered a material adverse effect on the company as a whole remote.
- ULA faced uncertainty over access to Russian RD-180 engines after the DoD denied a waiver request; management said this could impair ULA’s competitiveness in future national-security launch procurements.
Important facts for investors to verify
- Whether cash flow and working capital normalize, particularly F-35 receivable collections and production-contract funding.
- Final Sikorsky closing conditions, purchase financing, realized tax benefits, leverage and integration performance.
- Outcome and financial treatment of the strategic review, and whether retained IS&GS operations face further pricing or margin pressure.
- Sustainability of contract-estimate adjustments and segment margins, especially given the substantial year-to-date earnings contribution from non-volume adjustments.
- F-35 execution, future funding and contract terms; budget decisions; and any changes to pension assumptions, goodwill impairment assessments or environmental standards.