Lockheed Martin Corporation — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 28, 2015; comparisons are with the periods ended June 29, 2014. Financial amounts below are in millions of dollars, except per-share data. The interim financial statements are unaudited; Ernst & Young performed a review, not an audit.
Business context and financial performance
Lockheed Martin is a global aerospace and defense 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. F-35 sales accounted for approximately 20% of consolidated sales in Q2 and 19% in the first half of 2015.
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $11,643 | $11,306 | $21,754 | $21,956 |
| Gross profit | $1,371 | $1,341 | $2,634 | $2,712 |
| Operating profit | $1,445 | $1,426 | $2,801 | $2,858 |
| Net earnings | $929 | $889 | $1,807 | $1,822 |
| Diluted EPS | $2.94 | $2.76 | $5.68 | $5.63 |
| Operating cash flow | Not separately reported | Not separately reported | $2,220 | $3,077 |
- Q2 sales grew 3%; first-half sales declined 1%. First-half product sales fell $380 (2%), while service sales rose $178 (4%).
- Q2 diluted EPS increased 7%; first-half EPS rose 1% despite lower net earnings, benefiting from a reduced share count. Interest expense rose to $197 for the first half from $171, primarily following the February debt issuance.
- First-half product cost was 88.5% of product sales versus 87.8% a year earlier; service cost was 87.8% versus 87.9%. Gross profit declined 3% for the first half.
Segments and material changes
- Aeronautics: First-half sales were essentially flat at $7,265; operating profit declined to $815 from $846. F-35 production and sustainment gains were offset by lower C-130, F-16 and F-22 activity; margins also reflected a less favorable program mix.
- IS&GS: First-half sales declined 2% to $3,767 and operating profit fell 15% to $296. The company cited reduced in-theater activity and customer funding, greater competition and contract fragmentation, and approximately $70 of lower profit from performance matters on an international program.
- MFC: First-half sales fell 13% to $3,280 and operating profit declined 15% to $595, largely due to fewer air-defense, tactical-missile and fire-control deliveries and lower risk retirements.
- MST: First-half sales increased 2% to $3,459 and operating profit rose 4% to $453. New-program activity helped; the comparison also benefited from 2014 reserves on certain training and logistics programs not recurring.
- Space Systems: First-half sales increased 7% to $3,983 and operating profit rose 9% to $547, supported by Orion volume, acquisitions and risk retirements. Equity earnings, primarily ULA, contributed about $115, or 21%, of first-half segment operating profit, down from $150, or 30%.
Consolidated net adjustments unrelated to volume—including contract profit-booking-rate adjustments and other matters—increased segment operating profit by approximately $550 in Q2 and $1.0 billion in the first half of 2015. The comparable 2014 amounts were $440 and $965. Management said these adjustments increased first-half 2015 net earnings by $675, or $2.12 per share; the measure includes estimates and contract-related items and is important to assessing underlying comparability.
Cash, debt and liquidity
- Cash and cash equivalents were $3,202 at June 28, up from $1,446 at year-end 2014. Current assets were $15,287 and current liabilities $12,624.
- First-half operating cash flow was $2,220, down $857 year over year. Management attributed the decline mainly to working-capital movements, including higher receivables related in part to F-35 collections; no qualified defined-benefit pension contributions were made, compared with $515 in the prior-year period.
- Investing cash outflow was $218, including $309 of capital expenditures; financing cash outflow was $246 after $2,213 of net debt proceeds, $1,541 of share repurchases and $965 of dividends paid.
- Outstanding debt was $8.4 billion net of unamortized discounts; principal was $9.3 billion. The company issued $2.25 billion of fixed-rate notes in February, with maturities in 2025, 2035 and 2045. Long-term debt on the balance sheet was $7,950, with $452 classified as current. The company reported compliance with debt covenants and no borrowings under its $1.5 billion revolving facility or commercial-paper arrangements.
- Stockholders’ equity was $2,982, down from $3,400 at year-end, mainly due to buybacks and declared dividends. The company repurchased 7.9 million shares for $1.5 billion in the first half and had $2.1 billion of authorization remaining at quarter-end.
Outlook, strategic actions and risks
- Management’s 2015 segment outlook: Aeronautics sales and profit comparable to or slightly below 2014; IS&GS sales down mid-single digits and profit down low-to-mid teens; MFC sales down mid-single digits and profit down high-single digits; MST sales, profit and margins comparable; Space Systems sales down low-single digits and profit down mid-to-high single digits. No consolidated full-year guidance is stated in the provided filing text.
- On July 20, 2015, after quarter-end, the company announced a definitive agreement to acquire Sikorsky for $9.0 billion cash, subject to adjustments and approvals. It expected to fund the purchase with new debt and cash, and estimated a $1.9 billion net-present-value tax benefit from a planned Section 338(h)(10) election. Closing was expected in Q4 2015 or Q1 2016; Sikorsky results were not included in this filing.
- Also after quarter-end, the company announced a strategic review of government IT infrastructure and technical-services businesses representing approximately $6.0 billion of estimated 2015 sales and 17,000 employees. A sale or spin-off was contemplated; no transaction was assured. The businesses remained in continuing operations during the review.
- Risks include constrained U.S. Government budgets, sequestration and funding delays; competition and contract fragmentation in services; execution, cost, schedule and testing risks in complex programs such as F-35; supplier and cyber-security risks; and acquisition financing, regulatory, integration and synergy risks.
- Environmental liabilities were $955, with $827 of related receivables recorded for probable recovery. Potentially lower standards for perchlorate or hexavalent chromium could increase estimates and affect earnings. The filing also describes MTA litigation, with approximately $190 in damages sought by the MTA and approximately $95 in company claims; and a False Claims Act/environmental case for which a reasonably possible loss could not be estimated. Management said an adverse resolution of individual matters could affect a particular interim period, while considering a material adverse effect on the company as a whole remote.
- The Civil reporting unit had $2.2 billion of goodwill and was identified as at risk of future impairment if projected cash flows or valuation assumptions deteriorate. U.S. Government spending and contract competition were cited as pressures.
- The U.S. R&D tax credit had expired, and the filing notes possible tax-law effects: a hypothetical reduction of the federal rate to 25% would have reduced net deferred tax assets by $1.6 billion and caused a one-time noncash tax expense of the same amount.
Important facts for investors to verify
- Whether operating cash flow recovers as F-35 receivables and other working-capital timing effects normalize.
- Progress and final financing, approvals, tax treatment and integration economics for the Sikorsky acquisition.
- Outcome and structure of the review of the government IT and technical-services businesses.
- Whether segment outlooks and contract profit-booking adjustments are supported by delivery, performance and funding trends, particularly in IS&GS, MFC and F-35.
- Developments in environmental standards, the cited legal proceedings, and Civil reporting-unit goodwill impairment indicators.
- Effects of U.S. defense appropriations, sequestration, debt-limit actions and cyber-security incidents on program funding and execution.