WASHINGTON — Second quarter earnings results for US companies arrived this week, and while there was variation, the numbers were quite good, with year-end projections to match.
The backbone of those numbers was a heavy emphasis on share repurchasing, a process that increases the earnings per share (EPS) by reducing the number of outstanding shares. Nearly every major contractor spent big on retiring shares.
But the other major theme was the emphasis on cost-cutting efforts. The major primes are busy squeezing those lower in the supply chain, while cutting employee headcount and even consolidating divisions to save money. The effect is that while revenue was fairly stagnant if slightly up, margins improved and companies reported fairly rosy outlooks.
Lockheed Martin’s report showed revenue down, but EPS up. Much of that difference can be attributed to a massive share repurchasing effort that resulted in the purchase of 4.5 million shares at a cost of $465 million. Following Q1 purchases of 5.1 million shares at $461 million, the company has already blown past its projected $700 in repurchase spending for all of 2013 that was mentioned by company CFO Bruce Tanner in January.
That companies are leaning on repurchases isn’t new, but the magnitude of the repurchasing program is astounding. In 2005, Lockheed martin had 445.7 million common shares outstanding. By 2012 that number had dropped to 328 million, or a 26 percent drop as a result of continued repurchasing.
Tanner, speaking to analysts as part of the company’s earnings call, said part of the reason for the spike in repurchases has been the fact that stock options are being exercised at a tremendous rate. Q2 2012 saw 1 million options exercised. Q2 2013 saw roughly quadruple the number of options exercised, largely driven by a stock price that is over $100.
Typically that kind of rush on exercising options says two things: 1) the stock price is high, and 2) there are questions about the stock price going any higher.
Tanner said the company, looking to avoid the dilution of shares as a result of the influx of stock issued, has increased its repurchasing program to keep pace.
But the rate of options being exercised may not continue. Most of the options exercised were at a price closer to $80 per share, a price point that the remaining options cannot touch. Of the 15 million outstanding options, about 12.5 million are fully vested, but it’s unlikely that there would be a repeat of Q2 and a third of those would be exercised.
“We’ve sorted out the low-dollar option amounts,” Tanner said.
As a result of the reduced denominator in the EPS equation, Q2 2013 saw an 11 percent increase over Q2 2012 at $2.64 per share.
Another interesting note in the stock option equation: Lockheed has cut off its awarding of stock options to executives.
“At the start of this year we eliminated options as a component of our executive compensation component,” Tanner said.
That doesn’t mean that executives aren’t getting stock, but by removing the stock option approach it reduces uncertainty as to when stock has to be issued.
Much of Boeing’s earnings week was focused on the performance of commercial aircraft and the recent 787 Dreamliner incident, in which a battery burst into flames on the tarmac at Heathrow. Yet there was one significant development for the company’s defense sector.
Q2 2013 revenue was flat for the company compared to Q2 2012, at $8.2 billion. But like most of the industry, Boeing has been focused on cost-saving measures in light of the defense downturn.
The result is that Boeing saw its margin on that revenue increase, from 9.1 percent in 2012 to 9.5 percent in 2013. That means an extra $32.8 million dollars on flat revenue.
Much of that improvement came from squeezing suppliers further down in the supply chain, an area in which Boeing has been aggressive in the pasts couple of years.
“Our focus on affordability continues as we remain committed to our market-based affordability efforts where we’ve already captured $3 billion in savings,” Greg Smith, Boeing CFO, said on the company’s earnings call. “We’re on track for further lowering our cost structure, in an effort to [increase] productivity and strengthen our competitive position in this challenging environment.”
Boeing was also bullish for its full 2013 defense revenue projections. The company is predicting $31.5 to $32.5 billion in defense revenue. In 2012, the company made $31.4 billion, meaning the company is expecting further growth despite questions surrounding the defense market and defense spending.
Part of that is coming from an increase in international sales, but the cost-saving efforts are critical, said Jim McNerney, Boeing CEO.
“The upside that we’ve seen this year is for two reasons,” he said. “One, we’ve gotten after our costs very aggressively and very early. Our market-based affordability initiative that Dennis [Muilenburg, CEO of Boeing Defense] has been driving over the last couple of years. And secondly, mixing up on international orders, which our company is in many ways uniquely positioned to do given our global footprint.”
On sequestration, McNerney described real risks, but voiced optimism that Boeing can weather them.
“I think we’ve seen some impact of sequestration, but we have not begun to see most of it yet, and so we remain cautious. We believe there is more to come on sequestration, more than we’ve seen so far. We are prepared for it margin-wise.”
While making similar moves to most other contractors to reduce costs through supplier pressures, Raytheon has also been one of the leaders of a trend picking up steam: internal consolidation. The company is completing its move to go from six divisions to four.
The result was that, along with increased revenue, the company also is seeing better margins at 12.3 percent year-to-date in 2013 vs. 12.1 percent at the same point in 2012.
The consolidation move wasn’t expected to yield clear savings just yet, because of the cost of implementation, said company CFO David Wajsgras on Raytheon’s earnings call.
“When I initially looked to 2013, I suggested that, from a financial performance perspective, the cost of implementation would essentially offset the financial benefits, the savings,” he said.
But that hasn’t been the case as the consolidation has already saved the company.
“Our overall gross savings from the program, we had initially set up a target of about $85 million, and we are now well in excess of that number,” Wajsgras said.
Those savings will likely increase for a time, yielding the company greater savings, and will be helpful with fixed-price contracts. But because of the fact that new overhead rates will be considered for future deals, those savings will reap lesser rewards down the road, he said.
“There’s a wear-away as old contracts expire and new contracts need to be negotiated with our new cost structure,” he said.
“Much of that, at some point all of that goes back to our customer. That’s the way this business works, that’s the way this industry works. It does make us more competitive as we go forward.”
Raytheon also reaped rewards from international sales, which were up 10 percent compared to Q2 of 2012, and accounted for 27 percent of sales. That boom more than offset the 1 percent domestic decline the company reported.
And like many contractors, aggressive share repurchasing helped improve the company’s EPS. Thus far in 2013, Raytheon has bought back 7.6 million shares at a cost of $450 million. As a result EPS was up 4 percent.
Although many contractors are being aggressive about stock repurchasing and dividend increase, Northrop Grumman might be the most aggressive of all, announcing this year that the company would spend roughly $4 billion on share repurchases in the next few years in an attempt to buy back 25 percent of the company’s stock.
That’s led to speculation that the company is going to go private, although thus far there has been no evidence to that effect.
With the company increasing divided payouts by 11 percent and acquiring 12.6 millions shares so far this year, it’s betting a lot of money on the value proposition of returning cash to shareholders.
Northrop CEO Wes Bush described on the company’s earnings call that Northrop’s clear guidance on share repurchases is an effort to settle questions about company direction.
“We often get the question of, ‘gee, is this just something that you guys are doing right now, or do you see it as a continuing part of your strategy,’ ” he said. “We developed a great degree of, I wouldn’t say comfort, you can never be comfortable in running a business, but I would say that we developed a great degree of confidence that the cash flows in our business supported taking the action that we took, which was to be clear about where we see ourselves going so that there wasn’t this constant question about what we are going to be doing.”
While executives for most defense companies with earnings calls this week described the horrors of sequestration as a general threat to security and company opportunity, Northrop executives were far more specific, focused on the threat of furloughs.
“What we’re all worried about in different ways is what the real impact will be of this furloughing of the civilian workforce,” Bush said. “If anybody thinks that that has no impact, they’re not thinking about it with a clear head.”
Bush emphasized the important roles civilians play, and while voicing concern about how furloughs will impact Defense Department operations, stressed that in the end the furloughs will not stop payment on contracts. “Ultimately it’s a matter of timing, it’s not a matter of do we get paid or not.”