Lockheed Martin Corporation — Q3 2013 Form 10-Q
Reporting period: Quarter ended September 29, 2013; comparisons are with the quarter ended September 30, 2012. Year-to-date figures cover nine months. Dollar amounts are in millions unless noted. 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 contractor whose principal customer is the U.S. Government. Its five segments are Aeronautics, Information Systems & Global Solutions (IS&GS), Missiles and Fire Control (MFC), Mission Systems and Training (MST), and Space Systems. The F-35 accounted for approximately 16% of Q3 sales and 15% of nine-month sales.
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net sales | $11,347 | $11,869 | $33,825 | $35,083 |
| Operating profit | $1,254 | $1,137 | $3,671 | $3,373 |
| Operating margin | 11.1% | 9.6% | 10.9% | 9.6% |
| Net earnings | $873 | $727 | $2,493 | $2,176 |
| Diluted EPS | $2.66 | $2.21 | $7.63 | $6.62 |
| Operating cash flow | — | — | $3,608 | $2,876 |
Products sales fell 7% in Q3 and 6% year to date, while services sales rose 5% in both periods. Gross profit was $1,184 in Q3 versus $1,020, and $3,449 year to date versus $3,201. Product cost as a percentage of product sales improved to 87.6% from 88.6% in Q3 and to 87.5% from 88.1% year to date; service cost ratios also improved. Q3 diluted EPS includes $0.09 from discontinued operations, a $31 tax-resolution benefit; year-to-date discontinued operations also contributed $31.
Material changes and segment performance
- Overall sales declined 4% in Q3 and 4% year to date. Lower volume and deliveries were the main drivers, including declines in IS&GS, MST, Aeronautics, and Space Systems; MFC sales increased.
- MFC was a relative strength: nine-month sales rose 9% and operating profit rose 10%, supported by air and missile defense and tactical missile programs.
- MST nine-month sales fell 7%, but operating profit increased 26%, including approximately $75 of contract-cost settlements and stronger risk retirements. These items contributed to improved margins.
- IS&GS nine-month sales and operating profit declined 6%, principally due to lower volume and completed programs. Aeronautics nine-month sales declined 5% and operating profit 4%, with F-35 production gains partly offset by fewer F-16, C-130, and F-22 deliveries and lower profit on C-5.
- Space Systems nine-month sales fell 5% and operating profit 7%, reflecting lower commercial satellite deliveries and Orion volume, partly offset by government satellite and strategic missile work.
Consolidated net adjustments unrelated to volume, including contract profit-booking changes and other matters, increased segment operating profit by $510 in Q3 and $1.6 billion year to date, compared with $430 and $1.5 billion in 2012. Management said these adjustments increased net earnings by $330 ($1.01 per diluted share) in Q3 and $1.0 billion ($3.12 per share) year to date. They include significant F-35 development contract profit reductions in both year-to-date periods and a C-5 profit-rate reduction in 2013.
Cash flow, liquidity, debt, and capital returns
- Year-to-date operating cash flow was $3,608, up $732. Capital expenditures were $491, giving approximate operating cash flow less capital expenditures of $3,117. Investing cash use was $784, including $266 for acquisitions and affiliate investments.
- Financing cash use was $2,061, including $1,533 of share repurchases, $1,112 of dividends paid, and $150 of debt repayments. Cash rose $763 from year-end 2012 to $2,661; the comparable prior-year-end cash balance was $4,652.
- At September 29, cash was $2,661; current assets were $14,119 and current liabilities $12,293 (current ratio approximately 1.15). Long-term debt, net, was $6,156, with no current debt shown; outstanding debt principal was approximately $7.0 billion. The company reported compliance with debt covenants and no borrowings under its $1.5 billion revolving credit facility or commercial paper arrangements.
- Stockholders’ equity was $1,277, up from $39 at December 31, 2012. Pension-related comprehensive income and employee stock activity contributed to the increase, partly offset by repurchases and declared dividends. The board authorized an additional $3.0 billion of repurchases; remaining authorization was $3.8 billion at quarter-end.
- Cash dividends paid were $3.45 per share year to date, versus $3.00. The declared Q4 2013 dividend was $1.33 per share, a 16% increase over the Q3 dividend.
Outlook, management commentary, and risks
- Management expected 2013 sales to decline at a mid-single-digit rate from 2012, with segment operating profit comparable to 2012 and segment margin slightly higher. Its preliminary 2014 outlook was for slightly lower sales than 2013 and segment operating margin above 11.5%.
- The 2014 outlook assumes known sequestration impacts, continued U.S. Government support and funding for key programs, and timely GFY 2014 budget legislation. The estimates exclude potential collateral costs such as supplier disruption, contract terminations, severance, facility closures, and asset impairments.
- Sequestration and federal budget uncertainty remain central risks. The 2013 government shutdown temporarily placed some employees on directed vacation; a continuing resolution funded government activities through January 15, 2014. Management warned that future funding reductions could delay procurement and payment, reduce or terminate programs, raise unit costs, and impair goodwill.
- The F-35 development contract’s profit booking rate was reduced in June, lowering profit by $85 year to date. The company delivered 10 aircraft in Q3 and had 60 cumulative production deliveries and 106 aircraft in backlog. Identified challenges include software development, suppliers and partners, funding timing, contractual withholds, flight testing, and test findings.
- Management expected 2014 non-cash FAS/CAS pension income of approximately $150, and pension contributions of approximately $1.0 billion in 2014. These estimates depend on actuarial assumptions; a 25-basis-point discount-rate change could alter projected year-end equity by approximately $1.0 billion and projected pension income by approximately $135.
- Environmental liabilities were $982, offset by $849 of probable future recovery receivables. Potentially lower drinking-water standards for chromium or perchlorate could increase estimated liabilities and affect earnings. Outstanding letters of credit, surety bonds, and third-party guarantees totaled $2.4 billion.
- The company reported MTA contract litigation and DOJ claims concerning the Paducah plant; it disputes the allegations and could not estimate reasonably possible losses. Management considered a material adverse effect on the company as a whole remote, while acknowledging individual matters could materially affect an interim period.
Important facts for investors to verify
- Whether future U.S. defense appropriations, sequestration, and program funding support the 2014 outlook, and how much shutdown or budget delays affect orders, collections, and suppliers.
- How much of earnings growth depends on non-volume contract estimate adjustments, including the MST settlements, F-35 development revisions, and C-5 profit-rate changes.
- Whether improved margins and cash generation persist as product sales decline, and whether the $1.6 billion year-to-date pension contribution and planned 2014 contribution affect cash deployment.
- Execution, cost, schedule, and funding progress on F-35 development and production, including the backlog and identified technical and supplier risks.
- Potential environmental liability changes, legal outcomes, and exposure under guarantees; the filing does not provide estimable loss ranges for certain legal matters.
- How share repurchases and dividends are balanced against investment needs, debt, and the company’s low reported stockholders’ equity.