LOCKHEED MARTIN CORP quarterly report, Q2 FY2017

Full document

Lockheed Martin Corporation — Q2 2017 Form 10-Q

Reporting period: Quarter ended June 25, 2017; comparisons are with the quarter ended June 26, 2016. Six-month results are also summarized. Financial statements are unaudited and were reviewed, not audited, by Ernst & Young. Unless stated otherwise, amounts are in U.S. dollars.

Financial results and position

  • Revenue: Q2 net sales were $12.685 billion, up 9.6%; six-month sales were $23.742 billion, up 8.2%. Product sales drove most of the increase. Growth includes AWE sales consolidated following Lockheed Martin’s increase in ownership to 51% in August 2016; AWE sales were not included in the 2016 comparison.
  • Profit and margins: Q2 gross profit was $1.425 billion (11.2% gross margin) and operating profit was $1.485 billion (11.7% operating margin). Net earnings from continuing operations were $942 million, or $3.23 diluted EPS, versus $899 million and $2.93. Six-month continuing earnings were $1.705 billion, essentially unchanged; diluted EPS rose to $5.84 from $5.54.
  • Reported net income comparison: Q2 net earnings were $942 million versus $1.021 billion, and diluted EPS was $3.23 versus $3.32. The prior-year figures included discontinued IS&GS earnings of $122 million ($0.39 per diluted share). The six-month comparison similarly included $214 million ($0.69 per share) of prior-year discontinued earnings.
  • Cash flow: Six-month operating cash flow was $3.210 billion versus $3.140 billion. Capital expenditures were $448 million, implying operating cash flow less capital expenditures of about $2.762 billion. Cash increased $615 million to $2.452 billion.
  • Liquidity and debt: Current assets were $16.566 billion and current liabilities $13.641 billion (current ratio about 1.21). Long-term debt, net, was $14.283 billion; outstanding debt principal was $15.3 billion, excluding discounts and issuance costs. The company reported no borrowings under its $2.5 billion revolving facility or commercial paper program and said it was in compliance with debt covenants.
  • Shareholder returns: In the first half, the company repurchased $1.0 billion of shares and paid $1.069 billion of dividends. Remaining repurchase authorization was $2.5 billion. Cash dividends paid per share were $1.82 in Q2.

Material changes and segment performance

  • Q2 sales growth was strongest in Aeronautics (+19%), supported by F-35 production and sustainment, and Space Systems (+9%), largely reflecting newly consolidated AWE. MFC sales declined 3%; RMS sales rose 3%.
  • Q2 segment operating profit increased at Aeronautics ($550 million versus $478 million), MFC ($268 million versus $253 million) and RMS ($254 million versus $202 million), but declined at Space Systems ($256 million versus $340 million). Lower ULA equity earnings and higher commercial satellite program charges weighed on Space Systems.
  • For the first half, RMS operating profit fell to $362 million from $431 million, and Space Systems fell to $544 million from $584 million. Segment results include contract estimate changes and risk-retirement adjustments, which can make period comparisons less indicative of underlying trends.
  • Share count reduction supported EPS: diluted weighted-average shares fell to 291.2 million in Q2 from 307.1 million, reflecting repurchases and shares retired in the IS&GS divestiture, partly offset by stock-based issuance.

Outlook, commentary and risks

  • 2017 outlook: Management continued to expect net sales growth in the mid-single-digit percentage range from 2016 and segment operating margin just above 10%, down from 2016. The outlook assumes continued U.S. Government support and funding of key programs and no government shutdown.
  • Management expected Aeronautics sales to grow at a low-double-digit rate, led by F-35; MFC sales to grow mid-single digits with operating profit flat or slightly higher; RMS sales and operating profit to grow at low-single-digit rates; and Space Systems sales to decline low-single digits and operating profit low-double digits.
  • Program charges and estimates: EADGE-T incurred an additional $120 million charge in Q1; cumulative losses were about $260 million, with further charges possible. Commercial A2100 satellite programs had cumulative losses of about $260 million, including $90 million in the first half; additional reserves could be material. A $64 million share of an AMMROC investee impairment was also recorded in Q1.
  • Government and program risks: Defense appropriations, sequestration and debt-ceiling uncertainty could affect funding, schedules or program scope. The F-35 faces continuing oversight and execution challenges involving cost, schedule, software, suppliers, testing and sustainment. It represented about 25% of Q2 and first-half consolidated sales.
  • Legal and environmental matters: The company disclosed government False Claims Act-related claims against Sikorsky subsidiaries seeking about $52 million, subject to trebling and statutory penalties, and an MTA dispute in which the MTA seeks about $190 million while Lockheed Martin claims about $95 million. Environmental liabilities were $975 million, with $839 million of related recovery receivables recorded; estimates may change with remediation requirements and recovery assumptions.
  • Internal controls: Disclosure controls were deemed ineffective because of a previously reported material weakness at Sikorsky involving contract accounting and revenue recognition, inventory, payroll and IT controls. Remediation was ongoing; management expected completion by year-end 2017. No material errors or restatement had been identified.
  • Other watch items: Sikorsky goodwill of $2.7 billion had an estimated fair-value cushion of about 10% at the latest annual test, and its $887 million indefinite-lived trademark was close to carrying value; both were identified as at risk of impairment if performance or market conditions deteriorate. The company also said a 15% federal corporate tax rate, if enacted at the reporting date, would have reduced net deferred tax assets by $3.6 billion and caused a corresponding one-time noncash tax charge.

Most important facts for investors to verify

  1. Whether sales and margin guidance is achieved, especially given the expected Space Systems decline and mix effects from F-35 growth.
  2. Progress, remaining cost exposure and any further charges on EADGE-T and the A2100 commercial satellite programs.
  3. Whether Sikorsky’s control weakness is remediated by year-end and whether subsequent filings report any control-related errors.
  4. Federal budget and F-35 funding developments, including effects on production, sustainment and program schedules.
  5. Developments in the Sikorsky government claims, MTA litigation and environmental recovery assumptions.
  6. Cash generation and capital returns relative to debt, pension obligations and the company’s limited reported stockholders’ equity of $1.265 billion.