Lockheed Martin Corporation — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013; comparative periods ended June 24, 2012. Amounts below are in U.S. dollars, generally millions, except per-share data. 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 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net sales | $11,408 | $11,921 | $22,478 | $23,214 |
| Gross profit | $1,224 | $1,172 | $2,265 | $2,181 |
| Operating profit | $1,298 | $1,192 | $2,417 | $2,236 |
| Net earnings | $859 | $781 | $1,620 | $1,449 |
| Diluted EPS | $2.64 | $2.38 | $4.97 | $4.41 |
Sales declined 4% in Q2 and 3% year to date, as lower product volume and deliveries outweighed modest services growth. Operating profit increased 9% and 8%, respectively; diluted EPS rose 11% and 13%. Gross margin was approximately 10.7% in Q2 versus 9.8% and 10.1% year to date versus 9.4%; operating margin was approximately 11.4% versus 10.0% and 10.8% versus 9.6%.
Cash flow, financial position and capital returns
- First-half operating cash flow was $2,708, up from $1,303; capital expenditures were $282, giving approximately $2,426 of operating cash flow less capital expenditures.
- Cash and equivalents were $2,845 at June 30, up from $1,898 at year-end. Current assets were $14,379 and current liabilities $12,253.
- Long-term debt, net, was $6,140, with no current debt shown at quarter-end; outstanding principal was $7.0 billion. The company repaid $150 of notes at maturity and reported compliance with debt covenants. Its $1.5 billion revolving facility had no borrowings outstanding.
- Stockholders’ equity was $694, up from $39 at year-end, but remained low relative to total assets of $38,947. Accrued pension liabilities were $14,766.
- First-half cash uses included $926 of share repurchases and $742 of dividends paid. The company had $1.4 billion remaining under its $6.5 billion repurchase authorization. Cash dividends paid were $2.30 per share for the first half.
Material changes and segment performance
- Aeronautics: First-half sales fell 7% and operating profit fell 6%, principally from fewer F-16, C-130 and F-22 deliveries; higher F-35 activity partly offset declines.
- IS&GS: First-half sales declined 3% and operating profit 3%, reflecting lower volume and completed programs, partly offset by new program start-ups.
- MFC: First-half sales rose 12% and operating profit 6%, led by air and missile defense and tactical missile programs.
- MST: First-half sales fell 7%, largely following completion of PTDS deliveries; operating profit rose 35%, helped by contract cost settlements and higher risk retirements.
- Space Systems: First-half sales fell 5% and operating profit 6%, with fewer commercial satellite deliveries and lower Orion activity partly offset by government satellite volume and higher ULA equity earnings.
- Consolidated non-volume adjustments, including contract profit-rate revisions and other matters, added $585 to segment operating profit in Q2 and $1.1 billion in the first half. The company said these adjustments increased net earnings by $380 ($1.17 per diluted share) and $685 ($2.10 per diluted share), respectively. These estimates and contract judgments materially affect period results.
Outlook, commentary and risks
- Management estimated 2013 sales would decline by a mid-single-digit percentage from 2012, inclusive of the estimated sequestration impact. It expected 2013 operating profit and cash flow not to decline at the same rate as sales, assuming no significant sequestration-related restructuring charges. No specific EPS guidance is provided in the supplied filing text.
- Management reported minimal sequestration impacts to date, but expected program-level budget reductions and potential material negative effects. It cited risks of program reductions, delays or terminations, lower production volumes, supplier disruption, workforce reductions, and restructuring costs. Longer-cycle businesses could feel effects later.
- For 2013, the company anticipated $1.5 billion of qualified pension contributions; $750 million had been contributed by June 30 and a further $750 million early in Q3 completed the anticipated amount.
- F-35 development contract estimates were revised, reducing profit by $85 in Q2 and the first half. The amended contract had $350 of remaining available incentive fees. At quarter-end, 50 production aircraft had been delivered, 76 were in backlog, and 12 were delivered during Q2. Management cited supplier and partner performance, software, funding timing, contractual withholds, and testing as continuing challenges.
- Environmental liabilities were $978, partly offset by $846 of estimated recoveries; remediation estimates could rise if proposed water-quality standards become stricter. Litigation includes the MTA contract dispute and Paducah environmental and False Claims Act allegations; the company said certain potential losses could not be estimated. Outstanding letters of credit, surety bonds and third-party guarantees totaled $2.4 billion.
- The effective tax rate was 27.5% for the first half, benefiting in part from reinstatement of the R&D tax credit; a $37 benefit attributable to 2012 was recorded in Q1.
Important facts for investors to verify
- Whether sequestration, appropriations decisions or other federal budget actions change the sales outlook, contract funding, or restructuring requirements.
- Whether the $85 F-35 development-contract profit reduction and remaining incentive fees adequately reflect final cost, schedule, testing and performance risks.
- How much reported profit depends on contract estimates and non-volume adjustments, and whether such benefits recur.
- Whether operating cash flow remains strong after the effects of tax refunds, pension funding and working-capital timing; confirm planned pension contributions and capital returns.
- Potential changes in pension obligations, environmental liabilities and recoveries, and outcomes of significant legal proceedings and guarantees.
- Segment trends, particularly continued strength in MFC versus delivery-related declines in Aeronautics, MST and Space Systems.