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Lockheed Martin today reported third quarter 2016 net sales from continuing operations of $11.6 billion, compared to $10.1 billion in the third quarter of 2015. Net earnings from continuing operations in the third quarter of 2016 were $1.1 billion, or $3.61 per share, compared to $756 million, or $2.42 per share, in the third quarter of 2015. Cash from operations in the third quarter of 2016 was $1.3 billion, compared to $1.5 billion in the third quarter of 2015.
“The corporation achieved a quarter of strong operational and financial results, while also completing our strategic disposition of IS&GS,” said Lockheed Martin Chairman, President and CEO Marillyn Hewson. “Looking ahead to 2017, we are focused on providing innovative solutions to our customers, while executing on our realigned business portfolio to generate growth and value to shareholders.”
Divestiture of Information Systems & Global Solutions
On Aug. 16, 2016, the Corporation completed the previously announced divestiture of its Information Systems & Global Solutions (IS&GS) business segment, which merged with Leidos Holdings, Inc. (Leidos) in a Reverse Morris Trust transaction (the Transactions). The Transactions were the culmination of the Corporation’s strategic review of its government information technology (IT) business and its technical services business performed in 2015 to explore whether these businesses could achieve greater growth and create more value for customers and stockholders outside of Lockheed Martin. As part of the Transactions, the Corporation also completed an exchange offer that resulted in a reduction of Lockheed Martin common stock outstanding by approximately 9.4 million shares (approximately three percent). Both the exchange offer and merger qualified as tax-free transactions to the Corporation and its stockholders, except to the extent that cash was paid to the Corporation’s stockholders in lieu of fractional shares. Additionally, Lockheed Martin received a one-time special cash payment of $1.8 billion, which is reported under financing activities in the consolidated statements of cash flows.
The Corporation recognized a $1.2 billion gain as a result of the Transactions, which represents the $2.5 billion fair value of the shares of Lockheed Martin common stock tendered and retired as part of the exchange offer, plus the $1.8 billion one-time special cash payment, less the $3.0 billion net book value of the IS&GS business segment at Aug. 16, 2016 and other adjustments of $100 million. The final gain is subject to certain post-closing adjustments, including final working capital and tax adjustments, which the Corporation expects to complete in the fourth quarter of 2016 or the first quarter of 2017. The operating results of the IS&GS business segment and the gain on the Transactions have been classified as discontinued operations. However, the cash flows of the IS&GS business segment have not been classified as discontinued operations, as the Corporation retained the cash as part of the Transactions.
Consolidation of Atomic Weapons Establishment Venture
On Aug. 24, 2016, the Corporation’s ownership interest in the AWE Management Limited (AWE) venture, which operates the United Kingdom’s nuclear deterrent program, increased by 18%. As a result of the increase in ownership interest, the Corporation now holds a 51% controlling interest in the AWE venture. The operating results and cash flows of AWE have been included in the Corporation’s consolidated results since Aug. 24, 2016, the date it obtained a controlling interest. AWE has been aligned under the Corporation’s Space Systems business segment. Previously, the Corporation accounted for its investment in AWE using the equity method of accounting. The Corporation recognized a $127 million non-cash gain as a result of this transaction, which represents the fair value of the Corporation’s 51% interest in AWE, less the net book value of the previously held investment in AWE. The gain increased net earnings from continuing operations $104 million ($0.34 per share) in the third quarter of 2016.
2016 Financial Outlook
The Corporation’s 2016 financial outlook for sales, operating profit, and earnings per share have been updated to exclude the operating results of the IS&GS business segment for the full year, which was divested on Aug. 16, 2016. However, the 2016 financial outlook for cash from operations includes cash flows generated by the IS&GS business segment through the closing of the divestiture on Aug. 16, 2016, as the Corporation retained this cash as part of the divestiture.
The Corporation also adjusted its 2016 financial outlook to include sales of $400 million from the AWE venture, which has been consolidated since Aug. 24, 2016 as a result of obtaining a controlling interest, and the $127 million gain recognized in operating profit of the Corporation’s Space Systems business segment in the third quarter of 2016 as a result of the AWE transaction. The AWE venture has been aligned under the Corporation’s Space Systems business segment.
The financial outlook for cash from operations is likely to be impacted by a delay in collections on the F-35 program. Any delay in 2016 customer payments on the F-35 program will increase the Corporation’s cash from operations in 2017.
The Corporation may determine to fund customer programs itself pending government appropriations. If the Corporation incurs costs in excess of funds obligated on a contract, it is at risk for reimbursement of the excess costs. In 2014 and 2015, the Corporation received customer authorization and initial funding to begin producing F-35 aircraft to be acquired under low-rate initial production (LRIP) 9 and 10 contracts, respectively. The Corporation continues to negotiate these contracts with its customer. Throughout the negotiation process, the Corporation has incurred costs in excess of funds obligated and has provided multiple notifications to its customer that current funding is insufficient to cover the production process. Despite not yet receiving funding sufficient to cover its costs, the Corporation continued work in an effort to meet the customer’s desired aircraft delivery dates. Currently, the Corporation has approximately $950 million of potential cash exposure and $2.3 billion in termination liability exposure related to the F-35 LRIP 9 and 10 contracts.
2017 Financial Trends
The Corporation expects its 2017 net sales to increase by approximately 7 percent as compared to 2016. Total business segment operating margin is expected to be in the 10.0 percent to 10.5 percent range. Depending on the timing of F-35 collections, 2017 cash from operations will be greater than or equal to $5.0 billion or greater than or equal to $5.7 billion. The preliminary outlook for 2017 assumes the U.S. Government continues to support and fund the Corporation’s key programs, consistent with the continuing resolution funding measure through Dec. 9, 2016, and Congress approves budget legislation for government fiscal year 2017 soon. Changes in circumstances may require the Corporation to revise its assumptions, which could materially change its current estimate of 2017 net sales, operating margin and cash flows.
The Corporation expects the 2017 FAS/CAS pension benefit to be approximately $800 million assuming a 3.625 percent discount rate, a 75 basis point decrease from the end of 2015, a 5.0 percent return on plan assets in 2016, revised longevity assumptions (described below), and other assumptions. The Corporation does not expect to make contributions to its legacy qualified defined benefit pension plans in 2017. A change of plus or minus 25 basis points to the assumed discount rate, with all other assumptions held constant, would result in an incremental increase or decrease of approximately $125 million to the estimated 2017 FAS/CAS pension benefit. On Oct. 20, 2016, the Society of Actuaries published revised longevity assumptions that are used to estimate the life expectancy of plan participants during which they are expected to receive benefit payments. Actuarial studies have recently been updated and would have the resultant impact of decreasing the total number of benefit payments to plan participants. These actuarial studies have not yet been reflected or incorporated in the postretirement benefit plan obligation recognized at Sept. 25, 2016 or the FAS expense and CAS cost for 2016. The new longevity assumptions, which the Corporation expects to adopt at the Dec. 31, 2016 measurement date, currently are expected to decrease the amount of the Corporation’s postretirement benefit plan obligation and increase the Corporation’s 2017 net earnings. The Corporation will finalize the postretirement benefit plan assumptions and determine the 2016 actual return on plan assets on Dec. 31, 2016. The final assumptions and actual investment return for 2016 may differ materially from those discussed above.