Business context and reporting period
Lockheed Martin Corporation’s Form 10-K covers the fiscal year ended December 31, 2017; it is an annual report, not a standalone fourth-quarter filing. The company sells defense, aerospace, space and related services through Aeronautics, Missiles and Fire Control (MFC), Rotary and Mission Systems (RMS), and Space. The U.S. Government generated 69% of 2017 sales, including 58% from the Department of Defense; international customers contributed 30%.
Financial performance and position
| Metric | 2017 | 2016 |
|---|---|---|
| Net sales | $51.05 billion | $47.25 billion |
| Operating profit | $5.92 billion | $5.55 billion |
| Net earnings from continuing operations | $1.93 billion | $3.75 billion |
| Total net earnings | $2.00 billion | $5.30 billion |
| Diluted EPS | $6.89 | $17.49 |
| Operating cash flow | $6.48 billion | $5.19 billion |
| Capital expenditures | $1.18 billion | $1.06 billion |
| Cash and cash equivalents | $2.86 billion | $1.84 billion |
| Total debt, net | $14.26 billion | $14.28 billion |
Operating cash flow less capital expenditures was approximately $5.30 billion. Gross margin was about 10.9% versus 10.7% in 2016; operating margin was about 11.6% versus 11.7%. Current assets were $17.46 billion and current liabilities $12.64 billion. Total equity was a deficit of $609 million, compared with positive equity of $1.61 billion a year earlier. Backlog rose to $99.94 billion, including $73.6 billion funded; approximately $31 billion was expected to convert to sales in 2018.
Material changes versus the prior comparable period
- Sales increased 8%, led principally by higher F-35 production and sustainment at Aeronautics, along with growth in MFC and RMS. Aeronautics sales rose 13%; MFC rose 9%; RMS rose 6%; Space was approximately flat.
- Operating profit increased 7%, but continuing-operations earnings fell 49%, chiefly because of a $1.9 billion one-time tax charge, substantially non-cash, following U.S. tax reform. The effective tax rate was 63.4%, compared with 23.2% in 2016.
- 2016 total earnings included a $1.2 billion gain on the IS&GS divestiture; 2017 included only $73 million of post-closing divestiture gain in discontinued operations. Thus, total net earnings and EPS fell sharply year over year.
- Segment profit was mixed: Aeronautics operating profit increased to $2.16 billion; MFC increased slightly to $1.05 billion while margin declined to 14.6%; RMS was essentially flat at $905 million; Space fell 23% to $993 million, partly reflecting lower ULA equity earnings and the absence of the 2016 AWE acquisition gain.
- Operating cash flow increased by $1.29 billion, primarily due to working-capital timing and lower cash income-tax payments. Dividends paid rose to $2.16 billion; share repurchases were $2.00 billion.
Outlook, commentary, risks and unusual items
- Management expected 2018 sales to grow in the low-single-digit range from reported 2017 levels and segment operating profit to rise in the mid-single-digit range, with segment margin slightly above 2017’s 10.2%. The outlook assumed U.S. Government support and funding consistent with the FY2018 budget.
- 2018 segment outlook: Aeronautics sales up mid-single digits; MFC sales up mid-single digits; RMS sales down low-single digits but profit up low-double digits; Space sales down mid-single digits with profit expected to be comparable to 2017.
- Management planned $5.0 billion of qualified pension contributions in 2018, funded with cash and commercial paper, and did not expect material qualified-plan cash funding again until 2021. Pension assumptions and market returns remain important sources of earnings and balance-sheet volatility.
- F-35 represented 25% of 2017 sales. The development and demonstration phase was substantially complete, but testing, software, supplier performance, production capacity, sustainment costs, warranties and timely contract funding remained risks. The company delivered 66 aircraft in 2017 and reported 235 production aircraft in backlog.
- Two commercial satellite programs had cumulative losses of about $305 million, including $135 million in 2017; management did not expect to meet the delivery schedule and warned further reserves or customer termination and penalties were possible. RMS’s EADGE-T program had cumulative losses of about $260 million after a $120 million 2017 charge; additional charges remained possible.
- U.S. FY2018 appropriations were unresolved when the report was filed, and continuing resolutions and a brief government shutdown created potential procurement delays. Sequestration and changing defense priorities could affect awards and funding.
- Other exposures include government-contract audits and termination rights, cost overruns and fixed-price performance, supply-chain and cybersecurity threats, international export and offset obligations, environmental remediation, and litigation. Environmental liabilities were $920 million, partly offset by $799 million of estimated recoverable receivables. The filing states the MTA dispute seeks approximately $190 million; the government’s False Claims Act claims involving Sikorsky seek about $52 million, subject to trebling and statutory penalties. Management considered a material loss from the latter not probable.
- The auditor issued unqualified opinions on the financial statements and internal controls. A material weakness identified at Sikorsky in 2016 was reported as remediated by year-end 2017.
Important facts for investors to verify
- How 2018 results compare with management’s sales, segment-profit and margin outlook, accounting for adoption of ASC 606 and the pension-cost presentation change.
- Whether the $5.0 billion pension contribution was funded as planned and how pension assumptions affect future cash flow, earnings and equity.
- F-35 production, sustainment economics, testing progress, contract awards and customer funding.
- Progress, delivery schedules and any additional charges or termination developments for the commercial satellite programs and EADGE-T.
- Final tax-reform measurement-period adjustments and the effect of the lower tax rate on ongoing cash taxes and earnings.
- Changes in U.S. defense appropriations, funded backlog conversion, debt and capital returns, and developments in material legal and environmental exposures.