Lockheed Martin Corporation — Q1 2020 Form 10-Q
Reporting period: Quarter ended March 29, 2020; comparisons are with the quarter ended March 31, 2019. Amounts are in U.S. dollars. Lockheed Martin is a global aerospace and defense contractor operating Aeronautics, Missiles and Fire Control (MFC), Rotary and Mission Systems (RMS), and Space. The U.S. Government represented 72% of quarterly sales, including 61% from the Department of Defense.
Financial performance and position
| Metric | Q1 2020 | Q1 2019 / comparison |
|---|---|---|
| Net sales | $15.651 billion | $14.336 billion; up 9% |
| Gross profit / margin | $2.091 billion / 13.4% | $2.188 billion / 15.3% |
| Operating profit / margin | $2.122 billion / 13.6% | $2.283 billion / 15.9% |
| Net earnings | $1.717 billion | $1.704 billion |
| Diluted EPS | $6.08 | $5.99 |
| Operating cash flow | $2.314 billion | $1.663 billion |
| Capital expenditures | $293 million | $284 million |
| Cash and cash equivalents | $1.988 billion | $1.514 billion at Dec. 31, 2019 |
| Debt, net of discounts and issuance costs | $12.7 billion | $12.7 billion at Dec. 31, 2019 |
Sales growth was led by Aeronautics, MFC and Space; RMS sales were broadly unchanged. Product sales rose 10% and service sales 5%. Despite higher revenue, gross and operating margins declined. Cost of sales increased faster than sales, while consolidated operating profit fell 7%. Net earnings were nearly flat; lower interest expense and a swing to non-operating pension income helped offset lower operating profit and higher tax expense. The effective tax rate was 15.4%, versus 12.4% a year earlier.
Cash from operations increased $651 million, primarily due to a $1.1 billion year-over-year improvement in working capital, particularly the timing of accounts-payable payments. Contract assets rose $1.1 billion to $10.2 billion, reflecting revenue recognized ahead of customer billing. The company had $15.7 billion of current assets and $15.7 billion of current liabilities. Its $2.5 billion revolving credit facility was undrawn; there were no commercial-paper borrowings at quarter-end. Long-term debt maturities included $1.3 billion due in November 2020.
Financing cash outflow was $1.545 billion, including $693 million of dividends paid and $756 million of share repurchases. The quarterly dividend was $2.40 per share, compared with $2.20. The company reported $2.0 billion remaining under its share-repurchase authorization. Total backlog was $144.1 billion; management expected to recognize approximately 37% within 12 months and 62% within 24 months.
Material changes and segment results
- Aeronautics: Sales increased 14% to $6.369 billion and operating profit rose 15% to $672 million, mainly on higher F-35 production, sustainment and development activity. F-35 sales were approximately 28% of consolidated sales.
- MFC: Sales increased 11% to $2.619 billion, while operating profit declined 5% to $396 million. Higher missile and air-defense volumes were offset in profit by lower risk retirements on international contracts.
- RMS: Sales were $3.746 billion and operating profit was $376 million, both broadly comparable with the prior year.
- Space: Sales increased 10% to $2.917 billion, but operating profit declined 16% to $281 million, reflecting lower risk retirements and reduced equity earnings, primarily from United Launch Alliance.
Consolidated results included approximately $465 million of net non-volume adjustments that increased segment operating profit, down from $565 million in Q1 2019. These adjustments increased net earnings by about $367 million, or $1.30 per diluted share, versus $446 million, or $1.57 per share, a year earlier. The company also recognized $530 million of sales from performance obligations satisfied in prior periods, primarily from changes in contract profit estimates. Such estimates can change and affect reported results.
Outlook, management commentary and risks
Management maintained its 2020 outlook for mid-single-digit sales growth over 2019, business-segment operating margin of approximately 10.9%, and operating cash flow of at least $7.6 billion. Segment expectations included mid-single-digit sales growth at Aeronautics, RMS and Space, and high-single- to low-double-digit growth at MFC. Space operating profit was expected to decline in the low-single-digit range. These forecasts assume continued facility operations, manageable supplier disruption, cost recovery under contracts and no change in government funding priorities.
COVID-19 had no material effect on Q1 results, but the company reported supplier-delivery delays, access restrictions, reduced staffing, travel and flight-test disruption, and brief pauses at F-35 assembly facilities in Italy and Japan. The duration and financial effect remained uncertain. Extended disruption could delay deliveries, raise costs, affect cash collection and hinder performance, particularly under fixed-price contracts. Government actions could also change funding, payment policies or acquisition priorities. Management said U.S. production facilities continued operating as critical infrastructure and described accelerated supplier payments.
After quarter-end, an AMMROC customer announced an intent to award its major maintenance contract to a competitor. Lockheed Martin’s equity-method investment had a $435 million carrying value; the company could not yet estimate a potential impairment, which could be significant and occur as early as Q2 2020.
Other notable exposures include continued performance risks on several programs with cumulative losses: approximately $225 million on a ground-based radar program, $260 million on EADGE-T, $410 million on two commercial satellite programs, and $140 million on the Warrior turret program. Management did not anticipate additional losses on these programs that would be material, but noted some could require further charges. The F-35 program faces potential schedule, supplier, testing and cost risks, including the transition from Turkish suppliers and uncertainty around possible Turkey-related sanctions. Full-rate production timing depended on completion of government testing.
Environmental liabilities were $812 million, substantially offset by $705 million of assets for costs considered probable of future recovery. Potentially stricter regulation of chromium, perchlorate or PFAS could increase remediation estimates. Legal matters include False Claims Act litigation, an MTA contract dispute in which the MTA seeks approximately $190 million and Lockheed Martin seeks approximately $95 million, and possible indemnification exposure related to another government lawsuit; the company stated it did not currently consider a material loss probable in the described matters. The auditor performed an interim review, not a full audit, and reported no material modifications it believed necessary.
Most important facts for investors to verify
- Whether COVID-19-related supplier, staffing, testing and customer-payment disruptions alter the 2020 sales, margin or cash-flow outlook.
- Whether AMMROC loses the contract, its transition arrangements, and the resulting impairment, if any, on the $435 million investment.
- Whether contract-estimate adjustments remain a substantial contributor to earnings, and whether margins recover as sales grow.
- Progress on F-35 testing, production transition, Turkish supplier replacements and any related sanctions or cost-recovery effects.
- Working-capital conversion, especially contract-asset growth and the timing of accounts-payable payments, alongside the $7.6 billion-plus cash-flow target.
- Developments in the identified loss-making programs, environmental remediation estimates and material legal contingencies.