Lockheed Martin Corporation — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; comparisons are to periods ended September 24, 2017. Amounts are in U.S. dollars. The filing is unaudited. Prior periods were retrospectively adjusted for ASC 606 revenue recognition and the pension-cost presentation standard.
Business context and results
Lockheed Martin is a defense and aerospace contractor operating Aeronautics, Missiles and Fire Control (MFC), Rotary and Mission Systems (RMS), and Space. For the first nine months, 71% of sales were to the U.S. Government, including 60% to the Department of Defense; 27% were international and 2% U.S. commercial and other. The F-35 accounted for about 27% of Q3 sales and 26% of nine-month sales.
Key financial metrics
- Q3 revenue: $14.318 billion, up 16% from $12.341 billion. Product sales were $11.918 billion and services $2.400 billion.
- Q3 earnings: Gross profit was $1.921 billion, operating profit $1.963 billion and net earnings $1.473 billion, versus $1.600 billion, $1.677 billion and $963 million, respectively, a year earlier. Diluted EPS was $5.14 versus $3.32.
- Q3 margins: Gross margin was about 13.4% versus 13.0%; operating margin about 13.7% versus 13.6%; net margin about 10.3% versus 7.8%.
- First nine months: Revenue was $39.351 billion, up 9%; operating profit was $5.483 billion, up 14%; net earnings were $3.793 billion, up 40%; diluted EPS was $13.21 versus $9.29. Operating margin was about 13.9% versus 13.3%.
- Segment results, nine months: Aeronautics sales/profit were $15.361/$1.646 billion; MFC $6.035/$872 million; RMS $10.637/$1.013 billion; Space $7.318/$831 million. Sales and profit increased in each segment; RMS profit growth was particularly strong, partly reflecting prior-year charges that did not recur.
- Cash flow: Nine-month operating cash flow was $921 million, down from $4.964 billion. The company attributed the decline principally to $5.0 billion of pension contributions and increased working-capital use, including revenue recognized ahead of cash collections. Capital expenditures were $819 million.
- Capital returns: Nine-month dividends paid were $1.725 billion ($6.00 per share); share repurchases were $826 million. Remaining repurchase authorization was $3.7 billion at September 30.
- Liquidity and debt: Cash was $897 million, down from $2.861 billion at year-end 2017. Current assets were $16.859 billion and current liabilities $15.204 billion. Debt and commercial paper principal totaled $15.9 billion, including $1.2 billion due within one year; the balance-sheet carrying amount of debt was $14.7 billion. A $2.5 billion revolving credit facility was undrawn, and the company reported compliance with debt covenants.
- Equity: Total equity was $1.002 billion, compared with a deficit of $776 million at year-end 2017. Pension-related accounting and net earnings contributed to the improvement, partly offset by dividends and repurchases.
Material changes and unusual items
- Revenue growth reflected higher F-35 production and sustainment, missile volume, RMS systems and services, and other program activity. The company’s consolidated net adjustments not related to volume, including profit-booking-rate adjustments and other matters, increased segment operating profit by approximately $545 million in Q3 and $1.4 billion year to date; these adjustments are estimates and can change as contract risks evolve.
- The effective tax rate was 6.5% for Q3 and 12.9% for the first nine months, versus 25.8% and 26.3% in 2017. The lower 2018 rates chiefly reflected the Tax Act, with Q3 also benefiting from a discrete tax-accounting-method change.
- RMS recorded $96 million of severance and restructuring charges in the first half, including $75 million severance and $21 million asset impairment. Most severance payments are expected by the end of 2019.
- Contract assets rose $1.8 billion to $9.769 billion, mainly because recognized revenue exceeded the amount billable; contract liabilities decreased $539 million to $6.489 billion. Backlog was $109 billion, with about 40% expected to be recognized within 12 months and 65% within 24 months.
- Q3 adoption of ASC 606 did not create a new transition in the quarter, but the standard changed revenue timing for certain contracts; substantially all revenue is recognized over time using cost-to-cost progress measurement. Comparisons use retrospectively adjusted prior periods.
Guidance, outlook and risks
- 2018 outlook: Net sales expected to grow about 6% from 2017; segment operating profit expected to increase in the low-double-digit range; segment operating margin expected to exceed 2017’s 10.2%; operating cash flow expected to be at least $3.4 billion.
- 2019 preliminary outlook: Sales growth of 5%–6% over the 2018 outlook, segment operating margin of 10.5%–10.8%, and operating cash flow of at least $7.0 billion. These expectations assume continued U.S. Government support and funding. The company did not expect qualified defined-benefit pension contributions in 2019.
- Management cited U.S. defense funding uncertainty beyond FY2019, potential sequestration or budget cuts, contract funding and termination risks, and the technical, cost, schedule and sustainment challenges of complex programs, especially the F-35.
- The F-35 LRIP 11 production contract was finalized at $11.5 billion for 141 aircraft. The company reported 325 production aircraft delivered and 176 in backlog at September 30. Program risks include supplier performance, software, testing, sustainment costs, funding timing and customer requirements.
- Two developmental commercial satellite programs had cumulative losses of about $380 million; further technical, integration or schedule problems could require material additional reserves. One missed a July 2018 delivery requirement; management said termination was remote but noted possible refunds and penalties if the customer successfully terminated. The Warrior turret program had cumulative losses of about $140 million; management did not expect further losses, if any, to be material. EADGE-T cumulative losses remained about $260 million, with no material additional charge anticipated at this time.
- Environmental liabilities were $899 million, with $781 million of estimated recoveries recorded. The company warned that stricter standards for certain contaminants could increase estimates and affect earnings. Other matters include a government False Claims Act case seeking about $52 million before potential trebling and a dispute with the New York MTA seeking approximately $190 million against the company; outcomes and reasonably possible losses may be uncertain.
- Sikorsky goodwill and intangible assets were identified as potentially at risk if projected business deteriorates, contracts are cancelled or market assumptions worsen. The company also monitored its AMMROC investment for possible further impairment.
Most important facts for investors to verify
- Whether operating cash flow recovers as pension funding subsides and contract assets convert to billings and collections.
- Whether 2018 and preliminary 2019 sales, margin and cash-flow outlooks are achieved, including the assumptions for U.S. Government funding.
- Whether large profit-booking adjustments and contract estimates are sustainable, and whether the satellite and Warrior programs incur additional losses or penalties.
- F-35 production, sustainment, delivery and funding developments, including any effect of program challenges or government negotiations.
- Changes in debt, commercial-paper use, pension obligations, environmental recovery estimates, litigation exposure, and potential Sikorsky or AMMROC impairments.