Lockheed Martin Corporation — Q3 2012 Form 10-Q
Reporting period: Quarter ended September 30, 2012; year-to-date results cover the nine months ended September 30, 2012. Comparatives are the quarter and nine months ended September 25, 2011. Dollar amounts below are in millions unless noted.
Business context and results
Lockheed Martin is a global aerospace and security company with four reported segments: Aeronautics, Electronic Systems, Information Systems & Global Solutions (IS&GS), and Space Systems. U.S. Government agencies are its principal customers; in 2011, 82% of sales came from the U.S. Government, including 61% from the Department of Defense. The company announced that Electronic Systems would be reorganized into Missiles and Fire Control and Mission Systems and Training effective December 31, 2012.
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $11,869 | $12,119 | $35,083 | $34,288 |
| Operating profit | $1,098 | $1,041 | $3,310 | $2,898 |
| Net earnings from continuing operations | $727 | $665 | $2,176 | $1,969 |
| Diluted EPS from continuing operations | $2.21 | $1.99 | $6.62 | $5.72 |
| Operating margin | 9.3% | 8.6% | 9.4% | 8.5% |
Quarterly sales fell 2%, while year-to-date sales rose 2%. Operating profit increased 5% for the quarter and 14% year to date. Product cost as a share of product sales improved to 88.6% from 89.5% in the quarter and to 88.1% from 89.3% year to date; service cost as a share of service sales increased to 90.7% from 87.7% in the quarter and to 89.7% from 89.2% year to date.
Segment performance
| Segment | Q3 sales / operating profit | Nine-month sales / operating profit | Notable comparison |
|---|---|---|---|
| Aeronautics | $3,698 / $415 | $10,812 / $1,254 | Quarter sales and profit declined; year-to-date sales and profit increased. F-35 production gains were partly offset by lower F-22 and C-130 activity. |
| Electronic Systems | $3,818 / $509 | $11,293 / $1,576 | Sales and profit increased in both periods, with higher volume and contract performance. |
| IS&GS | $2,292 / $209 | $6,645 / $605 | Sales and profit declined, reflecting completed or ended programs including U.K. Census and AMF JTRS; cyber security activity partly offset declines. |
| Space Systems | $2,061 / $301 | $6,333 / $809 | Quarter sales declined but profit rose; year-to-date sales and profit increased. Quarterly profit included higher ULA and USA equity earnings. |
Cash flow, liquidity and debt
- Nine-month operating cash flow was $2,876, down from $3,164. The company attributed the decline mainly to working-capital outflows and higher tax payments; working capital used $841 versus providing $87 in the prior period.
- Capital expenditures were $514. Investing cash flow was a $547 outflow; financing cash flow was a $1,259 outflow. Cash increased $1,070 to $4,652 from $3,582 at year-end 2011.
- At September 30, 2012, current assets were $15,791 and current liabilities $12,668. Long-term debt was $6,374, with another $150 current portion; total debt was approximately $6,524. The company reported compliance with debt covenants.
- A $1.5 billion revolving credit facility, expiring August 2016, had no borrowings outstanding; there were also no commercial paper borrowings. Estimated fair value of debt was $8.3 billion versus $6.5 billion carrying value.
- Nine-month dividends paid were $979 ($3.00 per share); share repurchases were $708. The company declared a fourth-quarter dividend of $1.15 per share, 15% above the third-quarter dividend.
Material changes, outlook and risks
- Management expected a slight decline in 2012 consolidated sales, slightly higher segment operating profit, and segment operating margin above 11% for the full year. For 2013, its preliminary outlook anticipated low-single-digit sales decline and segment margin above 11%, assuming sequestration did not occur and government funding continued.
- Management warned sequestration or substitute budget cuts could materially reduce sales, earnings and cash flow. It estimated potential cuts of more than $50 billion, or about 9% or more, to the FY2013 base defense budget; expected impacts could lag because of previously funded backlog. The continuing resolution funded government activities through March 27, 2013, but could delay procurement.
- F-35 development contract estimates were revised in Q2, reducing profit by approximately $85 million year to date. The filing cites unresolved incentive-fee milestones, supplier and software risks, schedule and testing challenges, and delayed funding for LRIP Lot 6. Potential termination-liability exposure was about $400 million at quarter-end, potentially rising to $1.1 billion without additional funding by year-end, with estimated company cash exposure of $250 million.
- Net contract-estimate adjustments and other non-volume items increased operating profit by approximately $430 million in Q3 and $1.5 billion year to date, versus $410 million and $1.2 billion in 2011. These items increased year-to-date net earnings by about $980 million ($2.98 per share). The filing says higher Electronic Systems profit-rate adjustments were a primary driver; significant profit reductions also occurred on certain Aeronautics and Electronic Systems programs.
- Defined-benefit pension liabilities were $12,967, down from $13,502 at year-end. The company had contributed $1.1 billion to qualified pension plans, completing required 2012 funding. It warned that a modeled year-end discount-rate decline could cause an approximately $3.0 billion after-tax, non-cash reduction in equity and potentially a stockholders’ deficit; actual assumptions and returns could differ.
- Environmental liabilities were $959, with $832 of related expected-recovery receivables. Management said lower proposed standards for perchlorate or hexavalent chromium could materially increase estimated environmental liabilities and related recoveries; unrecoverable costs could affect earnings.
- Other contingencies include securities, 401(k), MTA contract and environmental proceedings, as well as guarantees. Management assessed a material adverse effect on the Corporation overall as remote, but said individual matters could materially affect interim earnings; some loss ranges could not be estimated.
- Severance charges were $23 in 2012, versus $136 for the first nine months of 2011. Other unusual items included 2011 discontinued-operation earnings and tax benefits; 2012 discontinued-operation amounts were not significant. The interim statements received an independent accountant’s review, not an audit.
Key investor verification points
- Confirm whether sequestration or other budget actions occurred and how they affected contract funding, backlog, procurement and the company’s 2013 outlook.
- Track F-35 development-contract fee negotiations, LRIP Lot 6 funding, termination exposure, deliveries, and remaining schedule, software and supplier risks.
- Assess the size, sustainability and program concentration of contract-estimate adjustments, especially the $1.5 billion year-to-date operating-profit benefit.
- Review pension valuation assumptions, year-end funded status, potential equity effects and future cash contributions.
- Monitor IS&GS sales trends, segment reorganization costs, environmental remediation estimates and material legal or guarantee developments.
- Compare operating cash generation with dividends and repurchases, and verify debt, liquidity and funding needs as government budgets evolve.