Lockheed Martin Corporation — Q2 2010 Form 10-Q
Reporting period: Quarter and six months ended June 27, 2010; comparisons are with periods ended June 28, 2009. Figures are in U.S. dollars unless noted. Interim results are unaudited and may not indicate full-year results.
Business context and results
Lockheed Martin is a defense, aerospace and government-services contractor whose principal customer is the U.S. Government. It reports four segments: Aeronautics, Electronic Systems, Information Systems & Global Solutions (IS&GS), and Space Systems.
| Metric | Q2 2010 | Q2 2009 | H1 2010 | H1 2009 |
|---|---|---|---|---|
| Net sales | $11.442B | $11.072B | $21.915B | $21.280B |
| Gross profit | $1.060B | $1.012B | $1.988B | $2.017B |
| Operating profit | $1.135B | $1.078B | $2.107B | $2.130B |
| Continuing-operations earnings | $727M | $731M | $1.268B | $1.397B |
| Net earnings, including discontinued operations | $825M | $734M | $1.372B | $1.400B |
| Diluted EPS | $2.22 | $1.88 | $3.66 | $3.55 |
| Cash dividends per share | $0.63 | $0.57 | $1.26 | $1.14 |
Approximate gross margin was 9.3% in Q2 (9.1% prior year) and 9.1% for H1 (9.5% prior year). Approximate operating margin was 9.9% in Q2 (9.7%) and 9.6% for H1 (10.0%).
Cash flow, debt and liquidity
- H1 operating cash flow was $2.874B, up $520M year over year; investing used $804M and financing used $1.720B. Cash increased $331M to $2.722B.
- At June 27, cash and cash equivalents were $2.722B and short-term investments were $877M. Current assets were $14.212B versus current liabilities of $11.859B (current ratio approximately 1.20).
- Long-term debt, net, was $5.019B. Debt-to-total capital was 57%, versus 55% at year-end 2009. The company had no borrowings under its $1.5B revolving facility or commercial-paper program.
- H1 share repurchases were $1.247B; dividends paid were $471M. The company declared a further $233M dividend for payment in September. Stockholders’ equity declined to $3.734B from $4.129B at year-end.
- Accrued pension liabilities were $11.194B. The company made $350M of discretionary qualified-pension contributions in H1 and expected to contribute another $1.050B in Q3.
Material changes and segment performance
- Sales increased 3% in both Q2 and H1, with increases reported in each segment. Q2 operating profit rose 5%; H1 operating profit declined 1% and continuing-operations earnings declined 9%.
- Aeronautics sales rose 2% in Q2 and 4% in H1, but operating profit fell 7% and 8%, respectively, mainly on lower F-16, F-22 and F-35 development activity and less favorable performance adjustments. Higher C-130J activity partly offset declines.
- Electronic Systems sales grew 4% in both periods; operating profit rose 2% in Q2 and 1% in H1. IS&GS sales rose 6% in Q2 and 3% in H1; operating profit rose 6% in Q2 but fell 1% in H1. Space Systems sales rose 1%; operating profit increased 9% in Q2 and 5% in H1.
- Q2 net earnings included $98M from discontinued operations, including a $96M tax benefit associated with the planned PAE sale. H1 discontinued-operations earnings were $104M, versus $3M a year earlier. Continuing-operations EPS increased in Q2 despite slightly lower earnings, partly reflecting fewer shares outstanding after repurchases.
- H1 operating cash flow benefited from a $325M federal tax refund and increased recovery of pension costs; these were partly offset by the $350M discretionary pension contribution.
Outlook, risks and unusual items
- The company expected operating cash flow to support operations and anticipated capital expenditures; annual capital expenditures were expected to be approximately $1.0B for the next few years. No specific full-year earnings guidance is provided in the supplied filing text.
- Lockheed Martin planned to divest PAE, with a sale considered probable around year-end 2010. Most of EIG was also planned for divestiture; the company was evaluating a sale versus a spin-off and expected a transaction around year-end. EIG remained in continuing operations.
- The DoD recertified the F-35 under the Nunn-McCurdy process but restructured its development schedule. The program faced schedule, cost, flight-testing, supplier and software challenges; the company’s ability to earn its share of the remaining $614M SDD fee depended on milestones. Further reviews could change requirements, schedules, costs or quantities.
- Environmental remediation liabilities were $879M, with $756M of related expected recovery assets recorded. The company noted that exposure at some sites could not be reasonably estimated. Outstanding letters of credit, surety bonds and similar arrangements totaled $3.7B.
- Material legal matters included disputes involving a U.K. defense contract, the New York MTA security-system contract, False Claims Act allegations and environmental claims. Management viewed a material adverse effect on the company as a whole as remote, while acknowledging that individual matters could affect quarterly earnings.
- Other notable items: a $96M Q1 charge to earnings from health-care legislation reducing deferred tax assets; a May debt exchange involving $728M of new 5.72% notes due 2040 for $611M principal of older notes, with a $158M premium; and higher pension expense. Management said market-risk exposures had not materially changed since year-end 2009.
- Risks cited include government funding and priority changes, contract awards or cancellations, cost and schedule performance, pension assumptions and asset returns, supplier performance, legal and environmental matters, and delays in the planned divestiture of EIG.
Important facts for investors to verify
- Whether PAE and EIG transactions close as anticipated, and the resulting proceeds, earnings effects and contract implications.
- F-35 schedule, cost and testing progress, and whether the company earns the remaining SDD fee.
- Cash generation after pension contributions, continued repurchases and dividends, and the trend in debt-to-capital and pension liabilities.
- Developments in the MTA and U.K. contract disputes, environmental remediation estimates and other legal contingencies.
- The filing reports an independent accountant’s interim review, not an audit; Ernst & Young stated it was not aware of material modifications needed for GAAP conformity.