Lockheed Martin Earnings Call Insights: Cash Deployment and Margin Pressure
Jason Gursky – Citi Investment Research: Bruce, I wanted to, if it’s okay, target this question to you, and talk a little bit about cash deployment. I think this big pension contribution that you made here during the quarter may have caught a few of us by surprise. And I was wondering if you could just talk a little bit about whether you contemplated letting us know that this was going to be coming and perhaps why you didn’t. And then also maybe just talk a little bit about long-term capital deployment. And what you see on the horizon with regard to the mix? We just now had a big pension contribution. Does that take that off the table now for a number of years so we can get a much more steady stream of operating cash flow that can be used to deploy either back into the business or back into shareholders through repurchases and dividends?
Bruce L. Tanner – EVP and CFO: Thanks, Jason. I think you got your money’s worth on that question. So, let’s say where do I start. As for why we did at the end of the year and why we didn’t tell you and did we contemplate it on you, we did a fairly comprehensive study as far as pension analysis are concerned relative to our funding requirements, the expectations in the future, the sensitivity of our plans to asset returns, discount rate changes and the like. You may or may not be aware, we actually sent out in the fourth quarter an offering to our terminated but vested participants in the plan offering to essentially give them lump sum payments in lieu of the pension payments over periods of time when they retired. We got a fairly good return on that, actually reducing some of the volatility and our liability associated with those individuals going forward. We were studying this issue right up until literally the end of the fourth quarter, Jason, and we were studying at the same time the prospects of what was going on in Washington relative to corporate tax reform, and we were speaking to the Board at that time, saying, we think this might be sort of the confluence of a lot of different actions that should result in us potentially making a larger contribution for the pension plan in 2012 in order to, in my words, lock in the deduction at 35%. We do feel there is a strong possibility for corporate tax reform going forward. We think that number could be anywhere from a 25% to 28% rate as opposed to the current 35% and we very much wanted to, as I said earlier, lock in that rate.
I’ll walk through the very dynamics that I said in the prepared remarks relative to – we thinking that this is a very quick payback and the interest that we are earning on the cash on the balance sheet is probably about 20 basis points as we sit here today. So, the acceleration occurs within a low interest rate period of time and we are getting low interest on the cash that sits on the balance sheet currently. It did accelerate the tax deduction as we talked about earlier, and I like the fact that it also reduces the gap between pension-adjusted and reported earnings as I mentioned earlier as well. We look at this Jason, and I’ll just give you some stats here.
So, taking a look at 2013, one of the reasons we did the $2.5 billion is we looked at how much cash did we want to have left on the balance sheet and how much flexibility did we want to have going into 2013 to enable us to do these sorts of cash deployment activities we’ve done in years passed. So, in 2013, we are looking at $4 billion of operating cash. We are looking at roughly $1 billion or so of capital expenditures, so $3 billion of free cash flow. We do have about $150 million debt retirement that we are going to do in the year 2013. So think of that as contributing $850 million sort of unencumbered of our free cash flow, and we felt that that $850 million plus the $1.9 billion on the balance sheet, so almost $2.8 billion was very adequate to continue to do the kind of cash deployment that we’ve done in the past. I think a fair question would be, so you guys have said, you are not going to have share count increase, what’s that level of share repurchase that you are counting on there and at least for our planning purposes, we are expecting about $700 million of share repurchase activity in order to affect that.
That’s our estimate of how many options will be exercised in the year and also how many newish ones as the stock will occur for executive compensation matching of our retirement plans and the like. So collectively we think from a cash deployment, between the current dividend contributions that we will have in 2013, of roughly $1.5 billion plus the $700 million of share repurchase embedded in our guidance, that’s $2.2 billion. As I said I think we still have adequate flexibility on the balance sheet and unencumbered cash flow to remain opportunistic to do additional share repurchases or mergers in our acquisition candidates if in fact they looked fine for us to make those acquisitions.
So kind of a long winded answer, I think the other side of it is, we don’t see this as a change and I think Marillyn made those comments in her prepared remarks relative to our longstanding cash deployment practice of contributing at least 50% or more free cash flow to our shareholders. That is still our intent and I think I said it earlier but I will close again. The reasons for the timing, was we literally we didn’t have this discussion until late in December with our Board of Directors before making this contribution. Kind of a long winded answer, Jason, sorry about that.
Richard Safran – Buckingham Research Group: I had a question on IS&GS. You’re guiding to 9% margins for the year. Given the margin pressure in this environment right now, can you discuss a little bit about what gives you the ability and confidence that you can sustain 9% margins, and also maybe if you could comment if this is being driven by your cyber and intelligence business?
Bruce L. Tanner – EVP and CFO: As we look at IS&GS, I think we’ve made a very conscious decision and I discussed this on previous calls. We try to differentiate ourselves somewhat in this market by focusing on what I’ll call mission IT, where we’re literally sort of providing the embedded capabilities in large measure for our customers, as opposed to what I’ll call commodity IT, and you think of that as sort of back shop processing and the like, help desks, those sorts of things. Where really we didn’t see, we’ve done that work in the past, but really we didn’t see sort of a discriminator or a differentiator for Lockheed Martin in doing that work.
So, we focus much more on the mission part of the IT service. That tends to be a higher margin part of the service activity in the IT world. So, that’s one thing that gives me the confidence that we can continue to do that. As I look back, Rich, over the last, probably eight or nine quarters, IS&GS has been 9% or the low 9% return on sales, consecutively for those eight or nine quarters. So, that gives me confidence again going into 2013 that we can continue to do that. You asked about the cyber. We’re very excited about the cyber activity within IS&GS. We’ve had some very successful wins, including taking some business away from some of our competitors within cyber. I believe we are the largest federal cyber provider in the industry. That work is very valued, that’s very much in line with that mission IT that I talked about, and that work as you would suspect supports that 9% margin as well.
A Closer Look: Lockheed Martin Earnings Cheat Sheet>>