Interesting Takeaways

1. Ukraine’s War has not lead to sales

Lockheed Martin does not anticipate increased sales in 2023 due to the war in Ukraine. There appears to be more interest in some products as a result of the war, but no actual new orders. This interest might lead to more sales in the future but the lack of extra production capacity needed to build products means that there is a long lead time needed before Lockheed Martin would be able to begin to sign new sales contracts.

2. US Congress is a mess

There is a good summary of the United States’ Congress recent machinations and struggles in regards to defense spending and appropriations. I have not been following Washington’s budget debates so this was all new information to me. Lockheed Martin believes that current projects will not be disrupted but they are prepared to see delays in approval for future projects if all the appropriation bills are not passed by the end of the year.

74% of business was with the US government. 24% of sales were with foreign governments.

3. F-35

The F-35 aircraft represents 26% of the total net sales for the entire company. They believe that international demand for this plane is strong and will continue in the future. They currently have a backlog of 391 aircrafts yet to be made. They managed to deliver 80 so far this year. If they keep this manufacturing rate and get no new orders, it will lead the current backlog to last over 3.66 years.

4. Cost-reimbursable contracts

41% of their contracts are “cost plus”. This means, they provide the customers a detailed breakdown of their costs associated with fulfilling the contract and the customer reimburses them for those costs plus a predetermined percentage giving them almost guaranteed profit. Lockheed Martin then adjusts their net profit booking rates up or down depending on how the contract work is going. They booked adjustments to operating profit of approximately $1.3 billion in the nine months reported ended September 24, 2023. Amazing!

This doesn’t mean there is no risk. The company still has to deliver on their end of the contract. Lockheed Martin recorded a $100 million loss on a contract to develop a helicopter for the Canadian Coast Guard. The helicopter design project is apparently not going well and it is doubtful the Canadians will record enough flight hours in the new helicopter to complete the contract.

International relations is also a risk that can derail a cost plus contract. Lockheed Martin had a number of long established helicopter contracts with a company located in Turkey. In 2020, the US Government imposed sanctions on that Turkish company thus making the established contracts unenforceable.

5. Estimates and Accounting

Lockheed Martin uses so many estimates there is a long section in the 10-Q titled “Contract Estimates”. They estimate when they bid on contracts, how far contracts are away from completion, if a R&D project will be successful, and much much more. 

A major accounting estimate they use is the “percentage-of-completion cost-to-cost method”. They use this to calculate both net sales and costs of sales for each contract they are working on. This means they record net sales and their corresponding costs on contracts over time based upon their progress toward completion on a particular contract. This makes sense, I guess, but it makes me wonder who is measuring “progress toward completion.” DISCLAIMER: I AM NOT ASSERTING ANYTHING UNETHICAL IS OCCURING. It would be mighty convenient to be able to tweak a project’s percentage of completion slightly to hit your numbers if your division needed a few more sales in order to show growth. I think it would be prudent to focus financial analysis on cash flows which are much harder to manipulate than accounting numbers like net sales.

There was a significant amount of talk about pension income and costs. There are lots of acronyms and accounting jargon in these sections leading me to have a hard time following it. As a result, I am unsure if pensions are material for investors to pay attention to.

MUST KNOW FOR INVESTORS

Lockheed Martin’s buyback program has been active in the previous quarter. The company bought a little more than 4 million shares at an average price of $449.29. This would help explain why this stock has had a solid floor around that average price over this same period. This does not mean they will continue this policy going forward, but we do know that $449.29 is a price at which they feel comfortable buying.