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Lockheed Strikes Better, Guides Up

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World’s largest stand-alone defense contractor,Lockheed Martin Corporation (LMT - Analyst Report) started fiscal 2011 with a bang. The company posted first-quarter 2011 operating earnings of $1.55 per share, beating both the Zacks Consensus Estimate of $1.51 and year-ago quarterly earnings of $1.38 by margins of 4 cents and 17 cents, respectively.

On a reported basis, Lockheed Martin clocked per share earnings of $1.50 versus $1.41 in the year-ago quarter. The variance of 5 cents between reported and operating earnings in the first-quarter 2011 cropped up on considering the discontinued operations. Discontinued operations include the operating results of Pacific Architects and Engineers Inc. (PAE). Lockheed Martin divested PAE to New York based private equity firm Lindsay Goldberg, LLC on April 4, 2011.

Earlier, Lockheed Martin acquired PAE in 2006, which provided services that enhanced military readiness, peacekeeping missions, personnel recruitment and training, and disaster relief services. The acquired unit then became a part of the Information & Technology Services segment of the company.

Post-acquisition, the company undertook numerous steps to improve the unit, build a team that leads and strengthen operations. However, following a thorough assessment, on June 2, 2010, the company decided to divest this unit. The divestiture emanated from the realization that the services demanded by PAE's consumers failed to resonate with the long-term business strategy of the company.

Operating Statistics

On the revenue front, Lockheed Martin reported quarterly net sales of $10.63 billion, marginally beating the Zacks Consensus estimate of $10.62 billion by $11 million. Also the company smoothly sailed past the year-ago quarterly revenue of $10.34 billion by $296 million. Earnings in the reported quarter were affected by a FAS/CAS pension charge of $231 million.

Similarly in the year-ago quarter the company digested a FAS/CAS pension charge of $110 million, and an unusual tax charge of $96 million resulting from legislation that eliminated the tax deduction for benefit costs, reimbursed under Medicare Part D. Overall the company clocked earnings of $548 million from continuing operations versus $519 million in the year-ago quarter. Lockheed Martin’s quarterly net earnings marginally dropped to $530 million from $533 million in the year-ago period.                                                

Lockheed Martin finished first-quarter 2011 with $80 billion of backlog versus $78.40 billion at fiscal-end 2010. Of this, $31.30 billion belonged to the Aeronautics segment and $22.60 billion to the Electronic Systems segment.

Segmental Performance

Aeronautics

Aeronautics quarterly sales increased 8% year over year to $3.18 billion in the reported quarter due to higher deliveries of C-130J and support activities, as well as an increase in volume on the F-35 low-rate initial production (LRIP) work. This increase was partially offset by lower volume of approximately $180 million on the F-22 program, and lower volume on the F-35 System Development and Demonstration contract.

The dwindling fortunes of the F-35 System Development and Demonstration contract are attributable to higher quantum of LRIP work. Segmental operating profit remained flat at $331 million while operating margin shrunk by 90 basis points to 10.4% in the reported quarter.

Electronic Systems

Electronic Systems’ quarterly sales increased 6% year over year to $3.46 billion due to higher volume on various radar system programs, air defense programs, such as Patriot Advanced Capability-3 (PAC-3), and logistics activities, such as Special Operations Forces Contractor Logistics Support Services program.

These increases partially were offset by lower volume on ship and aviation systems programs, such as the Persistent Threat Detection System. Segmental operating profit rose by 10% to $417 million while operating margin rose by 40 basis points to 12.1% in the reported quarter.

Information Systems & Global Solutions

Information Systems & Global Solutions segment’s quarterly sales decreased 4% to $2.12 billion. In the reported quarter sales decreased due to lower volume on the Decennial Response Integration System (DRIS 2010) program that supported the 2010 U.S. census. Segmental operating profit fell by 1.5% to $194 million while operating margin rose by 20 basis points to 9.0% in the reported quarter.

Space Systems

Space Systems’ segmental sales decreased by 4% to approximately $1.84 billion. In the reported quarter sales declined due to lower volume on the Orion program and the External Tank program for NASA’s space shuttle program. The downside was partially offset by higher volume in government satellite activities. Segmental operating profit rose by 5% to $217 million while operating margin rose by 100 basis points to 11.8% in the reported quarter.

Financial Condition

At the end of the first quarter 2011, cash and cash equivalents of Lockheed Martin were $3.36 billion versus $2.26 billion at fiscal-end 2010. Long-term debt remained flat at $5.02 billion versus fiscal-end 2010. Lockheed Martin generated $1.68 billion of cash in operating activities in the reported quarter, compared to $1.65 billion generated in the year-ago quarter. The company in the reported quarter repurchased 3.5 million shares for $281 million and distributed $266 million as cash dividend.

Guidance

Lockheed Martin raised its fiscal 2011 earnings per share guidance range to $6.95–7.25 versus its earlier guidance range of $6.70–$7.00. The company however reaffirmed its net sales for fiscal 2011 in the range of $45.75 billion–$47.25 billion.

Outlook

Lockheed Martin is the largest U.S. defense contractor with a platform-centric focus with a steady inflow of follow-on orders with a leveraged presence in the Army, Air Force, Navy and IT programs. However the ongoing trend of governmental delays in program decisions coupled with program cancellations has affected the fortunes of the defense industry in general and Lockheed Martin in particular.

Lockheed Martin currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we are maintaining our Neutral recommendation on the stock. Our sidelines strategy comes from headwinds concerning cutbacks on defense budgets for fiscals 2011–2012.

The cautious outlook is reflected across the board in the defense and aerospace industry. Of Lockheed Martin’s major peers, General Dynamics Corporation (GD - Analyst Report) and The Boeing Company (BA - Analyst Report) retain a short-term Zacks #3 Rank.

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