DEFENSIVE

CONTRACTOR INDUSTRY

ANALYSIS An analysis of the financial climate of Boeing,

General Dynamics, Lockheed Martin, and Raytheon

Siddharth Aggarwal, Kelsey A. Mastin, Adina A. Phillips, and Russell Young

Abstract Investigation and financial analysis of military defensive companies industry Raytheon, Lockheed

Martin, Boeing, General Dynamics, and the industry overall

Table of Contents I. Introduction ..........................................................................................................................2

II. Boeing ..................................................................................................................................2

A. Profitability.....................................................................................................................2

B. Short-Term Liquidity Risk .............................................................................................4

C. Long Term Solvency Risk..............................................................................................5

D. Prediction and Analysis..................................................................................................7

III. General Dynamics................................................................................................................8

A. Segment Data .................................................................................................................8

B. Profitability and Risk Analysis ......................................................................................8

C. Short Term Liquidity Risk ...........................................................................................11

D. Long-Term Solvency Risk ...........................................................................................12

E. Forecast and Analysis...................................................................................................12

IV. Lockheed Martin ................................................................................................................12

A. Profitability...................................................................................................................12

B. Short Term Liquidity....................................................................................................14

C. Long Term Solvency ....................................................................................................15

D. Analysis ........................................................................................................................16

V. Raytheon ............................................................................................................................17

A. Segment Data ...............................................................................................................17

B. Profitability and Risk Analysis ....................................................................................18

C. Short-Term Liquidity Risk ...........................................................................................19

D. Long-Term Solvency Risk ...........................................................................................19

E. Forecast and Analysis of results...................................................................................20

VI. Industry Analysis ...............................................................................................................20

VII. Conclusion .........................................................................................................................21

Works Cited ................................................................................................................................22

I. Introduction

In light of recent political priority shifts and events affecting global diplomacy and their

oil markets, both the United States and other federal governments around the globe are taking

sequestration law into consideration in an effort to offset federal government budget deficits.

In addition to potential tax policy changes, it’s possible the US government may change their

views on national security, intelligence, foreign tangible threats, economic variables, cost of

goods sold, and wartime defense. Such a global focal shift insinuates change and long-term

effects within the defensive contractor industry. The favorability of these changes to the

industry’s bottom line is one without much optimism.

The following outlines the financial analysis of the defense industry, constituted by

conglomerate of firms providing products and services to different governments. The four

firms that will be analyzed are Raytheon, Lockheed Martin, Boeing, and General Dynamics,

and we will be looking at profitability, short term liquidity, and long term solvency ratios.

Based off of these figures we will take a look at the defense industry, compare the firms, and

make projections.

II. Boeing

The Boeing Company, New York stock exchange ticker BA, was founded in 1913 and

today is the world’s largest aerospace manufacturer as well as being the second largest

defense contractor in the world. With its corporate office in Chicago, and approximately

174,000 employees, Boeing provides products to more than 150 countries and various

governments. The section of Boeing operating in the defense industry is Boeing, Defense,

Space, & Security and brought in around 47percent of company revenues for 2011.

A. Profitability

Altogether, Boeing had a respectable ROA percentage for most of the period. The

exception to this is for 2009 where although total asset turnover was above average, the

12/31/2011 12/31/2010 12/31/2009 12/31/2008

ROA (percent) 5.41 5.06 2.27 4.73

profit margin for ROA took a significant downward turn, resulting in the ROA dropping

by more than half its value.

Return on Common Equity is far above industry figures, due to the company having such

a low shareholders’ equity. While the number stabilized at around 130percent in 2010

and 2011, it went up over 400 percent from 2008 to 2009. A deviation this large is a point

of concern.

Inventory Turnover

2011 2010 2009 2008

1.98 2.51 3.47 4

The inventory turnover for the period has decrease rapidly over the period, ending with

2011 being less than half of the figure in 2008. This is a potential problem as low

inventory turnover is often a sign of inefficiency in the process of stocking and selling

inventory.

Accounts Receivable Turnover

2011 2010 2009 2008

11.48 10.84 11.21 10.04

Boeing has a stable Accounts Receivable turnover, with an average day’s receivable for

the company being between 30 and 35 days. These points to Boeing do a good job of

collecting revenue from customers.

Capital Structure Leverage

2011 2010 2009 2008

23.65 26.15 138.89 14.63

2011 2010 2009 2008

ROCE (percent) 127.94 135.15 314.63 69.12

Because this factor is based off of shareholders’ equity, the number cannot be relied upon

because it produces inordinately high capital structure leverage, particularly in the year

2009. Such high numbers indicate an issue within the company.

Total Asset Turnover

Total Asset Turnover measures a firm efficiency in earning sales by using its

assets and is inversely related. Industry average for 2011 was around 1.0.

2011 2010 2009 2008

0.93 0.98 1.18 1.08

Total Assets turnover oscillates somewhat throughout the period, resulting in .15 drop

from 2008 to 2011. This change is not very significant and the company is maintaining a

respectable total asset turnover for the period.

B. Short-Term Liquidity Risk

As the name suggests, short-term solvency ratios as a group are intended to

provide information about a firm’s liquidity. For obvious reasons, liquidity ratios are

particularly interesting to short-term creditors. One advantage of looking at current assets

and liabilities is that their book values and market values are likely to be similar.

Current Ratio

2011 2010 2009 2008

1.21 1.15 1.07 0.84

The current ratio indicates the amount of cash available at the balance sheet plus amount

of other current assets the firm expects to turn into cash within one year of the balance

sheet reporting date. Larger ratios mean more cash available to repay debts and expenses

in the current year. Most industries are above 1.0 and the defense industry is around 2.0

but now around 1.0 is common. Boeing has a steadily rising current ratio throughout the

period has good coverage of current ratios over current liabilit ies. However in 2008, the

figure is .84, indicating a problem, but the firm was able to bounce back from it.

Quick Ratio

2011 2010 2009 2008

0.42 0.46 0.53 0.3

The quick ratios for the company are relatively low for the period, especially in 2008.

However this is not an area of concern for the company as it is inventory intensive.

Operating Cash Flow to Current Liability

2011 2010 2009 2008

8.08 7.28 15.88 -1.54

The operating cash flow to current liability ratio is low for all years except 2009. The

number is negative in 2008, displaying an issue with paying off current liabilities.

Though substandard in 2010 and 2011, the figure is not too low as to cause a problem.

C. Long Term Solvency Risk

Long-term solvency ratios are intended to address the firm’s long-run ability to meet its

obligations, or, more generally, its financial leverage.

LT Debt to Equity

2011 2010 2009 2008

2.85 4.15 5.74 Equity<0

Due to such low shareholder equity, the long-term debt to shareholders’ equity is

extremely high throughout the period and is in fact immeasurable in 2008 as a result of a

negative shareholders’ equity. This is a serious point of concern for the firm as the figure

is far too high.

Interest Coverage

This ratio shows that a firm’s income or cash flows can cover interest expenses. Analysts

view this ratio as risky if 2.0 or less. Thus Lockheed was at 11.24 and has very low long-

term solvency risk according to this ratio. It is strange to note that. The defense industry

is 1.087, so an analyst should maybe use cash flows from operations before interest and

2011 2010 2009 2008

11.13 9.1 5.52 18.34

income taxes to calculate actual coverage ratios. Significant interest capitalization may be

accrued in the denominator cause this spike in the numerator of this ratio. Throughout the

four years, the net income is more than sufficient to pay off interest expense. Compared

to industry figures, Boeing is doing a good job of covering interest.

Liabilities to Assets

2011 2010 2009 2008

0.95 0.96 0.96 1.02

Liabilities are incredible high in proportion for the four years. This is a problem and in

fact Liabilities exceed Assets in 2008 displaying a major area of concern for the

company.

Liabilities to Shareholders Equity

2011 2010 2009 2008

21.17 22.96 26.95 Equity<0

This is the Debt to Equity Ratio. A higher number means a company has been

aggressive in getting growth for its debt. Capital intensive industries like auto

manufacturing prefer 2.0 whereas defense is 0.808. Due to such low shareholder equity,

liabilities to shareholders’ equity are disgustingly high for the period and it is in fact

immeasurable in 2008 as a result of a negative shareholders’ equity. This signifies there

is a huge issue with the structure of the company.

Long term debt to Long term capital

2011 2010 2009 2008

0.74 0.80 0.85 1.23

Based off the extremely low shareholder equity, the long-term debt to long-term

capital ratio is far too high from 2008 to 2011. While the number decreases by .49

throughout the period, it is still way too large.

Operating Cash Flow to Liabilities

As the name suggests, short-term solvency ratios as a group are intended to

provide information about a firm’s liquidity. For obvious reasons, liquidity ratios are

particularly interesting to short-term creditors. One advantage of looking at current assets

and liabilities is that their book values and market values are likely to be similar.

Boeing’s disproportionately high liabilities make the operating cash flow to total

liabilities below a healthy firm should be for the industry it is in.

D. Prediction and

Analysis

The profitability ratios are good for the firm and show that Boeing is adept at

generating revenue. Furthermore, short-term liquidity for the firm is adequate to pay off

short term debt in the case if an emergency. However, the firm’s long-term solvency risk

is very large based off the ratios computed. The reason for such high risk most stems the

company’s shareholders’ equity being so devalued as a result of its pension &

postretirement adjustments and accumulated other comprehensive income losses.

Although these numbers display a company who is far too thinly capitalized with way too

much debt in comparison to equity, Boeing still continues to accrue high net incomes and

pay out dividends making it the leader in the defense and aerospace industry. While with

another company, it would be a major indication of a future economic downturn, Boeing

is performing stably though the risk does pose the risk that the company may become a

going concern.

Based on their prior performance, Boeing should perform well in 2012, and pay

dividends of around 1.76 per share for the year based off the fourth quarter payment of

.44 in the final quarter. The dividend amount for 2013 is expected to be the same as 2012.

Also the corresponding net incomes are expected to be approximately 4,100, 4,200, 4,400

million for 2012, 2013, 2014 respectively. This would equate to approximately a 32-33%

dividend payout ratio for the period. The pattern is for a diminutive Shareholders Equity

due to high pension and post-retirement costs, which will also continue for 2012.

2011 2010 2009 2008

0.05 0.04 0.09 -0.01

While this far too high debt to equity structure will not cause any major problems

in 2012, it is likely that it will affect the interest rate that Boeing borrows money to

finance its operations. While defense as a percentage of sales revenue will fall somewhat

Boeing is projected to see an increase in aero plane sales to more than compensate for

this drop. The company’s stock price has steadily risen throughout the period, aside from

the drop in 2008 when the Shareholders’ equity was negative. As a result, investment in

Boeing would be encouraged despite the potential liquidity issues, as the firm as shown a

strong earning potential and ability for capital appreciation.

III. General Dynamics

A. Segment Data

General Dynamics has three major segments Aerospace, Combat Systems and

Marine Systems. The Aerospace was the company’s growth engine in 2011. The

group’s revenue were $6 billon, up 13 percent from 2010, while operating earnings were

$729 million, Initial G650 deliveries and robust demand for aircraft services across their

global network propelled this revenue growth. The Combat Systems group performed

very well in 2011, this was the firms leading operating earnings. These group sales were

$8.8 billion while earnings were $1.3 billion. This represents a modest decline in sales

from the year before. The Marine Systems group delivered a strong performance for 2011

with sales totaling $ 6.6 billion and earnings improved at least 2.5 percent. This group

had a 10.4 percent operating margin that reflected in manufacturing.

B. Profitability and Risk Analysis

Rate of Return on Assets (ROA)

Studying the changes in ROA and its components, one is struck with the overall relatively

minor changes in the ratios. We explore possible reasons for the minor changes next.

Segment Sales Mix change 2011 Sales Mix

Change

2008 Sales Mix

changes ROA 7.49 8.05 9.06

Profit Margin 7.73percent 7.49percent 8.39percent

2011 2010 2009 2008

ROA 7.49 8.25 8.05 9.06

Profit Margin 7.73percent 8.08percent 7.49percent 8.39percent

The ROA of General Dynamics fluctuated over a four-year period from 2008 to 2011.

This same fluctuation is reflected in the profit margin across the same four years. These

variations could be caused by the flux in net income as well as decreasing asset turnover

ratio.

The decline in profit margin for ROA is most easily examined with common-size

income statements. The operating costs & expenses for products shows a steady decrease

over the four periods, while the operating costs & expenses for services and general &

administrative expenses increased.

Operating Costs & Expenses/Sales/Products

The decreasing cost of goods sold to sales percentage might be due to several

different factors. The first is that General Dynamics depends on suppliers and

subcontractors for raw materials and components. These supply networks can experience

price fluctuations and capacity constraints, which put pressure on pricing. In order to

mitigate risks they use long-term agreements. Also, the timing of contract awards,

availability of funding from customers and contract costs impact revenue recognition.

These factors are also influenced by federal government’s fiscal years. Finally,

International sales are subject to the applicable foreign government regulations and

procurement policies and practices, as well as certain US policies and regulations,

including Foreign Corrupt Practices Act. They are subject to governing investments,

exchanges controls, repatriation of earnings and import-export control, including the

International Traffic in Arms Regulations.

General and Administrative Expense to Sales

The general and administrative expense to sales costs increased between 2008 and

2011. Two possible reasons for the increase exist. The first is the fact that General

Dynamics applies earnings rates to all contract costs, including general and

administrative expenses on government contracts, to determine revenues and operating

expenses. An alternative explanation is that the company also includes general and

administrative expenses in pretax stock based compensation expense.

Total Assets Turnover

The total assets turnover remained the same between 2008 and 2009 (at 1.08) and

then decreased slightly in 2010 and 2011 (to 1.02 and 0.97). The flat total assets turnover

between 2008 and 2009 actually reflects a combination of decreasing accounts receivable

turnover, increasing inventory turnover, and a decreasing fixed assets turnover. Accounts

receivable is a relatively small fraction of the total assets, so the decreasing accounts

receivable turnover had little effect on the total assets turnover. However, fixed assets and

inventory represent the bulk of total assets. Thus, despite a slight increase in fixed assets

turnover (from 10.97 to 11.04), the increase in inventory turnover (from 4.18 to 6.08)

offset the fixed assets turnover decrease (and accounts receivable decrease).

The slight increase in total assets turnover between 2008 and 2009 is also due to a

combination of changing turnovers of individual assets. Whereas accounts receivable

turnover continued to decline until 2011, inventory turnover doubled in 2011, and fixed

assets began to decline. The increase in inventory turnover between 2010 and 2011 is

offset the decline in fixed assets turnover over the same two years.

In the investing section of the statement of cash flows there is a noticeable item

was capital expenditures, which fell to approximately $385 million, down from

approximately $490 million in 2008. According to the 10-K General Dynamics, the

decrease in 2009 compared with 2008 resulted from the completion of several major

facility improvement projects in the aerospace and Marine Systems groups.

It is of interest to observe that the accounts receivable turnover continually

decreased during the four years. From 2009 to 2010, the receivable from non-US

government customers relate primarily to long-term production programs for the Spanish

government, the scheduled payment terms extended beyond those years.

Return on Equity (ROE)

*

N

o

Preferred Stock – Used ROE instead of ROCE

General Dynamic’s earnings and margins depend on many factors, including

performance under contracts, performance of their subcontractors, research and

development of new products, as well as international sales and operations. In 2009, the

aviation market was plagued by economic risk and negative public opinion about

business aircrafts. Sales were $5.2 billion, down from 6% from 2008, due to fewer new

aircrafts being made. The decrease in Debt to equity from 2008 to 2009 may have been

due to increase in cash and cash equivalents, and paying down long-term debt. They also

acquire a company named AxleTech International in December 2008. ROE grew 7

percent from operating earnings in 2010. The Aerospace segment has a 22 percent alone,

while the other Systems had a $ 1 billion increase also. The following year, 2011,

exhibited continued growth of 19 percent in Aerospace, a 27 percent growth in Combat

Systems, and a 20 percent growth in Marine Systems.

C. Short Term Liquidity Risk

G

e

n

e

r

al Dynamics’ short liquidity ratios have decreased slightly over the four-year period. A

current ration decreasing from 1.15 in 2008 to 1.38 in 2011 and a quick ratio of

decreasing from 0.64, which is shows decline in the health of the firm. This firm has

long-term contracts with its customers so receivables turnover is on average around 91

days. Its cash flow from operations has also decreased. However, in 2011, General

2011 2010 2009 2008

ROE 2.82 2.50 2.44 2.64

Debt to Equity 0.31 0.25 0.18 0.30

2011 2010 2009 2008

Current Ratio 1.38 1.27 1.27 1.15

Quick Ratio 0.64 0.58 0.57 0.49

OCF to Current Liabilities 29.01 27.71 27.54 31.86

Dynamics ended the year with commercial paper outstanding. They had $2 billion in

bank credit facilities that remained available.

D. Long-Term Solvency Risk

General Dynamics’s total liabilities to total assets ratio fluctuated between 2008

and fiscal 2011, with a decline in 2009 and 2010, and increase in 2011 to 64.57. The

long-term debt ratio runs concurrent with above-mentioned ratio, consistent with the shift

in GD’s capital structure toward long-term borrowings.

E. Forecast and Analysis

General Dynamic’s profitability ratios have steadily declined over the last four years,

although they have continued to revenue increase throughout all there business

segments. There short-term liquidity is suitable to pay off short-term debt. They have

also continued to reduce their short and long-term debt.

General Dynamics' has a payout ratio is 24.85% and they have continued to

generate enough income to support a dividend payout of 2.90%. They have coverage ratio

is 4.00, which is more than enough cash to continue to pay a 2.90% yield. General

Dynamics' payout ratio compared to the industry average has a lower percentage, which

illustrates that its dividend is probably more maintainable. The defense market has a lot of

uncertainty to the foreseen defense spending cuts over the next nine years. They also have

a 6% capital appreciation, which means that investors will have expected capital gains.

IV. Lockheed Martin

A. Profitability

Accounts Payable Turnover

Lockheed does a good job of paying its suppliers at 23.87. A small increase

happened since the recession began in 2008 from 20.33 to 23.87 over a period of four

2011 2010 2009 2008

Liabilities to Asset 64.57 60.03 59.08 62.07

LT Debt to SE 0.3 0.28 0.25 0.31

Interest Coverage 27.13 25.13 22.97 55.35

OCF to Total Liabilities 13.15percent 17.09percent 16.15percent 15.58percent

years. Lockheed pays more attention to paying off its vendors since the budget cuts

started and the economy contracted.

Total Asset Turnover

2011 2010 2009 2008

Total Asset Turnover 1.27 1.31 1.32 1.37

The total asset turnover stays consistent over the past four years and that means

Lockheed is keep sales revenues respectably above total assets. The industry is at 1.16

and Lockheed is well above at 1.27. This is a small difference in terms of ratio percentage

but extremely measurable and significant because net sales for Lockheed in 2011 were at

46.5 billion US Dollars and total assets were measured at 37.9 Billion Dollars.

Property Plant and Equipment Turnover

The industry average is slightly lower at 7. The average PPE turnovers for other

“Big Five” firms were Boeing: 8.6, Raytheon 12.7, General Dynamics 9.5, Northrop

Grumman 8.8. It was concluded that a healthy FA ratio for the defense industry is about

8.0 whereas other firms like BAE Systems of the UK were at 7.1 and EADS of the

European Union (Airbus) were at a dismal 3.9. Both were below the 8.0 threshold.

The fact that the ratio is fluctuating is a cause for concern because it’s not

consistent. The issue here is that in 2011 the Shareholders equity was at a low of 1,001

million versus previous years which were around 3 to 4 billion dollars. Yet, Total Assets

remained about the same, yielding a CSL ratio of about 37.87. The Shareholders equity

was very low due to several reasons, mainly due to Lockheed paying out retirement

obligations from 2011 onwards.

The reason the shareholders equity is so low is because US GAAP impact on

retirement plan benefits paid by Lockheed is volatile year to year. Other measures

considered are interest rates, rates of return on plan assets, and future salary levels and all

these measures affect shareholder’s equity. The increase in total assets and decreases in

shareholders’ equity in 2010 and 2011 is from the annual measurement of the

governments funding status of postretirement benefits for those two years. Thus CSL is

much higher due to that. The average for the industry is about 2 to 2.577 and Lockheed is

from 8.5 to 37.87.

Return on Common Shareholder Equity (ROCE)

Going forward as of 2011, the defense industry has had an average of 0.10 ROCE

for the past decade and a half (Since 1998), and Lockheed’s was 0.377 in 2011 as

opposed to the industry average of 0.13 which means Lockheed’s ROCE is decreasing

the past four years but leveling out with the industry. Lockheed’s ROCE is still higher

than the industry average and that means that with no preferred dividends, Lockheed’s

ROCE numerator component will be higher because there are no “senior claimants” for

dividends. ROCE incorporates the results of a firm’s operating, investing, and financing

decisions. Most public firms in the United States are around 10 to 12 percent and

Lockheed is about 37 percent while the defense industry is around 13percent.

Whether this is good or bad depends on how you look at it. ROCE will exceed

ROA when ROA exceeds the cost of capital provided by creditors and senior

shareholders. If a firm gets higher capital returns than the costs of those sources of

capital, the excess return belongs to common shareholders. The ROA for 2011 was 7

percent for Lockheed. ROA of Lockheed is higher than the industry because Lockheed’s

Profits are higher meaning its higher profit margin for ROA in its disaggregation of asset

turnover and profit margin (Net income over sales). From the previous analysis of total

asset turnover we know that it’s been similar for the past 4 years at around 1.27 but ROA

is slightly smaller at 7percent meaning average total assets has increased in greater

proportion to total net income.

B. Short Term Liquidity

Current Ratio

Inventory represents around 8 percent of Current Assets, which is a reasonable

number. We still have Current Liabilities covered 1.25 times over. Some businesses can

convert their inventory but inventory is not recorded in this ratio because it cannot be

converted quickly.

Quick Ratio

The quick ratio is also called the acid test ratio and more diversified portfolios

typically have lower quick ratios because the numbers of current assets that can be

converted to cash quickly are more thinly widespread such as Boeing’s Quick Ratio was

0.4. The industry average is 0.3 so Lockheed can convert current assets to cash almost 3

times quicker than the industry.

C. Long Term Solvency

Liabilities to Assets

Lockheed Martin Nextel Corp. (S) has $0.97 in debt for every $1 in assets.

Therefore, there is $0.03 in Equity (=$1 – 0.97) for every $0.97 in Debt. It’s a very broad

ratio and liabilities are very high proportional to assets. Boeing for 2011 was 0.95

whereas Lockheed was 0.97. Firms should be between 0.4 and 0.6 to remain in good

solvency standing.

Long Term Debt to Equity

This number is very high for 2011 compared to 2008-2010. This is mainly

because Long-Term Debt of Lockheed has increased significantly. In 2008, Long term

debt was only 3.5 billion but in 2011 it is 6.4 billion. The increase in long term debt by

so much was due to the issuance of over 2 billion dollars in debt notes in 2011 with an

addition of another 1.5 billion dollars previously in 2009. Yet shareholders equity has

measurably decreased from 2.7 billion in 2008 and 4 billion in 2009 to only 1.001 billion

in 2011 creating a very skewed LT Debt to Equity ratio. The industry average is only

.315 and Lockheed is well above 1 even on a normal year. This number is also very high

for 2011 like the LTD to Equity ratio compared to 2008-2010. This is mainly because

Long-Term Debt of Lockheed has increased significantly. In 2008, Long term debt was

only 3.5 billion but in 2011 it is 6.4 billion. The increase in long term debt by so much

was due to the issuance of over 2 billion dollars in debt notes in 2011 with an addition of

another 1.5 billion dollars previously in 2009. Yet shareholders equity has measurably

decreased from 2.7 billion in 2008 and 4 billion in 2009 to only 1.001 billion in 2011.

This is why the Total debt to equity ratio went up to 36.87.

Interest Coverage

Analysts view this ratio as risky if 2.0 or less. Thus Lockheed was at 11.24 and

has very low long-term solvency risk according to this ratio. It is strange to note that. The

defense industry is 1.087, so an analyst should maybe use cash flows from operations

before interest and income taxes to calculate actual coverage ratios. Significant interest

capitalization may be accrued in the denominator cause this spike in the numerator of this

ratio. Lockheed does a good job however of paying off its interest charges.

D. Analysis

As of 2012, Lockheed Martin’s risks are a combination of large processes, work

in progresses, and short-term risks. Contracts are awarded through bidding between

contractors, leaving the firm to compete with new threats in its IT and cyber security

sector from non-defense industry players. Lockheed’s IT customers are themselves

fiscally constrained. The firm is making an effort to compensate for their budget cuts by

improving their own efficiency.

Globally, Lockheed sold 17 percent of its net sales non-US customers, namely

foreign governments. Half of those sales consisted of foreign military transactions, while

the other half were accounted for by commercial dealings. Dealing internationally,

Lockheed faces a multitude of rivals outside their domestic ones. The list of vendors

available to the foreign market includes international defense firms such as BAE Systems

and any respective domestic organizations. Lockheed is also faced with an assembly of

annual international contract stipulation costs, from governments seeking incentives to

EPA fines and environmental quality control. Some more areas of fiscal concern when

dealing internationally involve insurance liabilities and indemnities, post-retirement

medical and pension plans, cyber-attack threats, legal disputes, retaining skilled workers

and management, and costly equity investments where the firm has less control. In short,

any normal costs worthy of apprehension in domestic business are somewhat aggravated

when trading in foreign markets.

The analysis of Lockheed’s core revenues and expenses is based on human

opinion of financial the firm’s financial past and how it may translate into future financial

stature, as well as an assessment of the Lockheed’s many tangible and intangible

variables. For sales, using the completed percentage method, they make estimates on the

degree of completion of long-term contracts with cannot always be easily or readily

assessed.

Over 27 percent of Lockheed’s projected 2012 total assets are accounted for by

the 10.4 billion dollars of goodwill built on its balance sheet. Because of the high amount,

this number is noted at its carrying value rather than the fair value. Should the carrying

value become higher than the fair value, there is impairment. In the current bear, or weak

post-recessionary, market, goodwill assets are to be reported realistically with a

significant SEC required asset write-off of related goodwill assets. Tax expenses may be

unrealistic, and could affect profits, so reducing net deferred taxes due to loss carryovers

is required.

V. Raytheon

Raytheon was founded in 1922 and has grown to be one of the largest technology

companies focused on defense and aerospace systems. Revenue earned is mainly through

fixed price government contracts, with more than 70 percent generated from various US

government agencies including Department of Defense, NASA, and Homeland Security.

A. Segment Data

Raytheon currently operates in six segments headquartered around the nation

including Intelligence and Information Systems (IIS) and Network Centric Systems

(NCS), which are located in Garland and McKinney respectively.

Because Raytheon generates more than 70 percent of its total revenue from the United

States government contracts, caution should be taken in spreading itself too thin

concerning available resources. Below is a table summarizing the six segments Raytheon

currently operates in, along with the sales mix for the 2008 & 2011, as well as the period

change.

Segment Sales Mix

Change

2011 Sales

Mix

2008 Sales

Mix

Integrated Defense Systems -10.1percent 18.6percent 20.48percent

Intelligence & Information

Systems -10.2percent 11.3percent 12.46percent

Missile Systems -2.0percent 21.0percent 21.39percent

Network Centric Systems -6.4percent 16.9percent 17.94percent

Space & Airborne Systems 11.7percent 19.7percent 17.39percent

Technical Services 17.7percent 12.6percent 10.35percent

B. Profitability and Risk Analysis

Rate of Return on Assets (ROA)

Over the four-year period, Raytheon’s return on assets varies more than should be

expected of a company with such large fixed assets. Between 2008 and 2009, the ratio

increased almost 15 percent. This is largely due to the increase in net income, which

increased over 18 percent from 2008 to 2009. Another encouraging sign is the increase in

percent of total assets, signaling the company is becoming more liquid due to debt or

equity. Cash and short-term investments, which have grown steadily with each year, can

be attributed to the increase in long-term debt in 2010 and 2011. Ironically, with every

year, the cash increases and the net PP&E decreases. This trend causes wariness about the

company’s move to liquidity.

Profit Margin for ROA:

The varied profit margin ratio can be partially be explained by the change in

Profit Margin. In 2008, when ROA was at its lowest for the 4 years (7.18), the profit

margin derived from the common size income statement was also 2nd highest. However,

the slight variations are mainly due to fluctuating costs between COGS, Selling, and

General and Administrative costs. With no material fluctuations, further analysis was not

pursued.

Rate of Return on Shareholders' Equity (ROE)

Raytheon, unlike the other companies analyzed has no preferred stock and therefore

its Return on Common Share is equal to its return on equity. Because Raytheon does

issue dividends, the ROE actually does provide some benefit for shareholders especially

Expense as percent of Sales 2008 2009 2010 2011

Cost of Goods Sold (COGS) 79.89 79.37 80.62 79.24

Selling and General Administrative 6.68 6.14 6.54 6.75

Total 86.57 85.51 87.16 85.99

2011 2010 2009 2008

20.81 18.79 20.46 15.46

those investing in the defense industry. Compared to Boeing and Lockheed which both

have almost zero ROE/ROCE, Raytheon’s modest growth is encouraging to investors

despite the high degree of leverage and small net income.

C. Short-Term Liquidity Risk

Current & Quick Ratio

2011 2010 2009 2008

Current Ratio 1.52 1.48 1.42 1.44

Quick Ratio 1.39 1.35 1.29 1.28

Raytheon’s steady cash ratio at first looks very enticing, however after delving a bit

further in one can infer that most of the cash was generated not from operations but

from extending the debt owed to creditors as far out as 30 years. While this does not

necessarily affect the short term, and Raytheon’s numbers are well above 1, care should

be taken so short term is not sacrificed for long term longevity.

D. Long-Term Solvency Risk

From 2008 to 2010, total liabilities stayed consistent. Averaging just over 60

percent, there was an indication that the company was incurring more long-term debt.

This is apparent when comparing common-sized income statements, where liabilities

increased 49.8 percent from 2009 to 2010. This increase is also reflected in the LT debt

to SE ratio for the same period, which increased over 54 percent. Given the margin of

error for estimation of revenues of the company, and the fixed nature of the government

contracts, this is an area of concern.

Because of these changes, it is no surprise the company’s financial leverage

continued to climb from 2.56 to 3.16 - a 23 percent increase over the 4-year period. This

was mostly due to the company’s continued expansion, whose financing measures

included taking on more bonds and debt. Thanks to the increase in long term and total

debt, the company’s ability to cover interest was slightly reduced.

Ratios 2008 2009 2010 2011

Liabilities to Assets 60.99 58.37 60.06 68.36

Long Term Debt Refinanced

Because of the nature of the industry of fixed income contracts subject to

government spending that almost always gets cut, long term solvency is the largest area

of concern. Management must have also felt the tightening budget as a footnote explained

that Raytheon “entered into a [1.4 billion dollar] revolving credit facility maturing in 201,

replacing the previous $500,000,000 and $1.0 billion credit facilities, both schedule to

mature in November 2012.” This now means the company has debt of over 4.731 billion

dollars due between 2018 and 2041.

E. Forecast and Analysis of results

Although Raytheon remains profitable and continues to grow, caution should be taken

as the company’s long-term liquidity is starting to show a declining trend. The large

increase in long-term debt, in both percentage and amount for 2011, is a small red flag

given the change in the economic climate and the company’s dependence on U.S

government contracts. In 2010 and 2011, these contracts accounted for 76 and 74 percent,

respectively, of the net sales of the company. The defensive contractor industry benefited,

as a whole, with the recent military expenditures on international conflict. Consideration

should be given to the conclusion of these wars: Raytheon should be careful to diversify

its portfolio away from the heavy dependence of the U.S government.

VI. Industry Analysis

When Congress introduced the Budget Act of 2011, there was no consensus within

the government on where to apply required budget-cutting measures. Lockheed’s future

contract awards will be immediately and significantly reduced over the next ten years.

The cuts are annual and “across-the-board”, including overseas contingency operations

and some obligations already on the firm’s schedule. These yearly cuts begin with a 52

billion dollar cut in 2013, and almost 487 billion dollars’ worth of cuts over the 10

LT Debt to SE .25 .24 .37 .56

Interest Coverage 20.36 24.82 20.30 16.64

OCF to Total Liabilities 14.18 19.78 13.24 11.92

subsequent years. Aside from the obvious effects direct to the firm, these budget cuts will

also adversely affect the defense industry. . Because of the sheer size of the US defense

industry, looking forward, these cuts would create a domino effect in the way of job cuts

for skilled workers and potential US GDP and GNP losses. The main firms affected by

this change are Lockheed Martin, Boeing, General Dynamics, Raytheon, and Northrop

Gumman.

The government has the option in their contracts to cancel them at any time and if

reimbursement on these contracts is not fully met, or funding ceases altogether, another

long-term impact of the sequestration will be seen in substantial amounts. While the

firm’s presented have sufficient cash and short-term assets to handle operations under

contract, concern for future risk lies in the chance of the US government not providing

additional contracts or guarantees. Lastly, Lockheed and Boeing’s equity is too low in

comparisons, should the firm’s financial goals not be met. This is only exacerbated by

perceptions of non-defense and non-American customers, such the British and other

foreign governments. Without the US government being legally bound to give a more

detailed explanation than “fiscal management” for closing its contracts, any additional

liability will only tarnish the firm’s equity value.

VII. Conclusion

Defensive Contractors risks are a combination of large processes, work in

progresses, and short-term risks. Contracts are awarded through bidding between

contractors, leaving the firm to compete with new threats in its IT and cyber security

sector from non-defense industry players. The firms themselves are making an effort to

compensate for their budget cuts by improving their own efficiencies.

Dealing internationally, companies face a multitude of rivals outside their

domestic ones. The list of vendors available to the foreign market includes international

defense firms such as BAE Systems and any respective domestic organizations. The

industry is also faced with an assembly of annual international contract stipulation costs,

from governments seeking incentives to EPA fines and environmental quality control.

Some more areas of fiscal concern when dealing internationally involve insurance

liabilities and indemnities, post-retirement medical and pension plans, cyber-attack

threats, legal disputes, retaining skilled workers and management, and costly equity

investments where the firm has less control. In short, any normal costs worthy of

apprehension in domestic business are somewhat aggravated when trading in foreign

markets.

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