Lockheed Martin Corporation (NYSE:LMT) Q3 2023 Earnings Call Transcript

Lockheed Martin Corporation (NYSE:LMT) Q3 2023 Earnings Call Transcript October 17, 2023

Lockheed Martin Corporation misses on earnings expectations. Reported EPS is $ EPS, expectations were $6.66.

Operator: Good day, and welcome, everyone, to the Lockheed Martin Third Quarter 2023 Earnings Results Conference Call. Today’s call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to Maria Ricciardone Lee, Vice President of Investor Relations. Please go ahead.

Maria Ricciardone Lee: Thank you, Lois, and good morning. I’d like to welcome everyone to our third quarter 2023 earnings conference call. Joining me today on the call are Jim Taiclet, our Chairman, President and Chief Executive Officer; and Jay Malave, our Chief Financial Officer. Statements made in today’s call that are not historical fact are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities laws. Actual results may differ materially from those projected in the forward-looking statements. Please see today’s press release and our SEC filings for a description of some of the factors that may cause actual results to differ materially from those in the forward-looking statements.

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We posted charts on our website today that we plan to address during the call to supplement our comments. These charts also include information regarding non-GAAP measures that may be used in today’s call. Please access our website at www.lockheedmartin.com and click on the Investor Relations link to view and follow the charts. With that, I’d like to turn the call over to Jim.

Jim Taiclet: Thanks, Maria, and good morning, everyone. Thank you all for joining us on our third quarter 2023 earnings call. All of us on the line today are well aware that since our last call, the world is now seeing yet another terrible conflict. Everyone in our company remains dedicated to fully supporting the United States government’s policy and efforts to deter aggression, restore security and achieve peace. Today, I will first highlight our third quarter results as we pursue our vision of 21st Century Security, designed to support the U.S. Department of Defense Strategy of Integrated deterrents and then I’ll turn it over to Jay to provide additional detail before taking your questions. Starting on Page 3 of the slides.

Sales increased 2% year-over-year to $16.9 billion and backlog remains at historically high levels at $156 million. EPS of $6.73 exceeded prior year and free cash flow was a strong $2.5 billion. We returned approximately 100% of free cash flow to shareholders through dividends and share repurchases during the quarter. Earlier in October, we announced a $0.15 increase in our dividend which reflects 5% growth and is the 21st consecutive year of dividend increases for Lockheed Martin. At the same time, our Board also approved a $6 billion increase in our share repurchase authorization, bringing our total authorization to $13 billion, reconfirming our continued commitment to returning capital to shareholders. We are also reaffirming our full year 2023 financial outlook for sales, profit, EPS and free cash flow.

Given the current status of the 2024 U.S. defense budget, global geopolitical tensions and the macroeconomic environment, we will provide our expectations for our 2024 financial outlook during our full year 2023 earnings call in January. On the U.S. budget, though the specific trajectory of the future U.S. defense budget is still in process between the administration and Congress, the global threat landscape is increasingly elevated. Our robust backlog reflects the relevance and importance of the Lockheed Martin portfolio and elevating deterrence to great power conflict involving the United States and its allies and the solid positioning of our business to serve our domestic and international customers. From a process standpoint and government, the current continuing resolution or CR is in place through November 17.

At that point, one of the following could occur. FY ’24 appropriations bills will be enacted, Congress will enact another partial or whole CR or there could be a partial or full government shutdown. In any of these scenarios, there continues to be the option also for supplemental requests related to support Ukraine, Israel and potentially Taiwan. As Congress continues to work through the FY ’24 appropriations bills, we are optimistic that there will be consistent support for the National Defense strategy and funding for its priorities. In the meantime, we will continue to work with our customers and suppliers to minimize any potential disruptions due to the process. And we will press on with executing our 21st Century security strategy of building capacity, efficiency and resilience into our production operations, driving advanced digital technologies to enhance integrated deterrents and expanding our international business and operations.

Turning to the F-35 program. We delivered 30 F-35 aircraft in the third quarter, bringing the year-to-date total to 80 jets. Consistent with our announcement in September, we continue to expect to deliver a total of 97 aircraft this year, all in the Technology Refresh 2 or TR2 configuration. We are producing F-35s at a rate of 156 per year, and expect to continue at that pace while simultaneously working to finalize TR3 software development testing. And we recently began flight test evaluations of the next software release that encompasses major systems upgrades such as improved RADAR, next-gen distributed aperture system and weapons capability. As previously announced, we continue to expect to deliver the first TR3 configured aircraft between April and June of 2024.

The superior technological capabilities of the F-35 continue to generate strong interest both domestically and internationally. In September, Denmark’s first four locally based F-35 aircraft arrived on their home soil. Denmark’s program of record calls for 27 F-35A aircraft. Also in September, the Czech Republic chose to become part of the global F-35 Lightning II program, and the U.S. State Department approved a possible $5 billion foreign military sale to South Korea for up to 25 F-35 Joint Strike Fighters. Earlier in the quarter, Israel announced that we’ll buy an additional 25 F-35, which will add a third squadron and increased its F-35 fleet to 75 aircraft. Additionally, in August, Lockheed Martin was selected by the Australian Department of Defense, as their strategic partner for their Air 6500 program Phase 1.

This transformational Pathfinder program will deliver the broadest scope of Joint All Domain Operations, JADO in the free world, and will completely revolutionize the way the Australian defense force operates. By connecting Australian systems and platforms that operate across air, space, land, sea and cyber domains, we expect that Air 6500 will set the blueprint for future military operations worldwide. This proven technology will provide greater situational awareness and defense against increasingly advanced air and missile threats and enables significantly greater interoperability between Australia and allied nations. Lockheed Martin will lead this first phase which will provide the core architecture and multi-domain integration for the program.

This is just one recent win that demonstrates the business success of our 21st Century security cornerstone, trusted and reliable battle management and command and control systems that integrate across multiple domains, military services and allied forces. Late last year, Lockheed Martin also won the $500 million Defense of Guam award. And in late September, we were also awarded a potential seven-year, over $1 billion contract for systems engineering and software integration to the integrated combat system across the surface force portfolio of the U.S. Navy and Coast Guard. This will link together systems and software across the services and a JADO construct and it not only enables faster decision-making and better capabilities but also serves as a much more effective global deterrent strategy.

Beyond these awards, we continue to develop 21st Century security technologies to advance interoperability between Lockheed Martin product lines. The 5G.MIL hybrid base station that our engineers invented is the 1 LM initiative that includes teams at MFC and Aeronautics. We recently transferred data from a sniper targeting pod that was set up in Orlando, Florida to the Tactical Missile Simulation Lab in Grand Prairie, Texas to provide real-time updates to a simulated missile in-flight. This event significantly advanced efforts towards upcoming live fire demonstrations across the main platforms operating in a joint environment that will use data from multiple sources across an open architecture. Also, Skunk Works partnered with the University of Iowa’s Operator Performance Laboratory to demonstrate an AI commanded jamming capability.

In this, we successfully used artificial intelligence on two air systems to provide jamming support to a simulated strike against enemy air defenses. This demonstration showed how AI agents with high performance and reliable behavior can operate in close coordination with and be controlled by human crude aircraft. We also conducted a successful test of the prototype radio for the PAC-3 MSC missile that will enable communications with the SPY-1 radar, the key sensor in the Aegis Weapon System. This test performed by a 1 LM team across MFC and RMS paves the way for the design of a multifrequency radio data link for PAC-3 MSC. In turn, that will enable the U.S. Navy for the first time to have the ability to integrate the state-of-the-art PAC-3 missile onto its warships and open up another opportunity for Lockheed Martin in the future.

International interest in PAC-3 also remains strong. As demonstrated by our deepening partnership with Poland, which signed a letter of offer and acceptance for 644 PAC-3 MSCs and related equipment in the quarter. In our RMS business, Sikorsky CH-53K helicopter is expected to grow meaningfully also over the coming years. In August, we won a $2.7 billion contract to build and deliver 35 additional CH-53K helicopters and it’s the largest procurement to date for this multi-mission aircraft. Another longstanding major Lockheed Martin program, this one is space is also poised for significant growth ramp. In late September, the Fleet Ballistic Missile program won a $1.2 billion contract for the Navy’s Trident II D5 life extension. For nearly seven decades, Lockheed Martin has supported the U.S. Navy as a critical partner for its mission to provide sea-based strategic deterrents.

The TRIDENT II D5 LE missile will be in service through the 2040s, maintaining the proven performance of the D5 system for significantly less cost to the government than of designing a new missile. Also in our Space business, Lockheed Martin’s Next Generation Interceptor or NGI program, executed its digital preliminary design review in partnership with the Missile Defense Agency customer. That happened on September 29. During this review, the MDA assessed the NGI program’s readiness and maturity to continue into the detailed design phase, confirming that our solution continues to meet the requirements for this crucial and demanding mission. Finally, the OSIRIS-REx Sample Return Capsule touched down in the Utah Desert on September 24, returning NASA’s first ever sample from an asteroid.

After a seven-year mission traveling approximately, I believe is 4 billion miles in space. The capsule holds material from Bennu, a carbon-rich asteroid and scientists hope it will teach us more about the origins of organics that led to life on earth, plus the mechanics behind overall planet formation After release of the capsule, the spacecraft was set on a new course to investigate the asteroid Apophis under the mission name OSIRIS-REx. So with that interesting and exciting news, I’ll turn it over the call to Jay and join you later for questions. Jay?

Jay Malave: Thanks, Jim, and good morning, everyone. Today, I will walk you through our third quarter 2023 financial results. I’ll also provide an update to our full year 2023 guidance, and offer a few comments on 2024. As I describe our results, please follow along with the web charts we have posted with our earnings release today. Starting on Chart 4, with consolidated sales and segment operating profit. Third quarter sales increased 2% year-over-year with three of the four business areas delivering growth. Segment operating profit was down 6% year-over-year due to lower net favorable profit adjustments and lower equity earnings, resulting in segment margins of 10.7%. Moving to earnings per share on Chart 5. GAAP EPS was comparable year-over-year, with lower segment profit and higher net interest expense offset by favorable below-the-line items, including lower share count, lower tax rate and fewer mark-to-market losses.

On an adjusted basis, EPS was down $0.10 year-over-year, primarily due to the lower profit. Moving to cash flow on Chart 6. Our free cash flow was strong at over $2.5 billion in the quarter or 150% of net income, helped in part by our focus on working capital, primarily due to better collections at the end of the government fiscal year. Once again, we demonstrated our commitment to shareholders by returning 99% of our free cash flow through dividends and share repurchases this quarter. On a year-to-date basis, we’ve returned almost $5.3 billion or 116% of free cash flow. As Jim mentioned, our Board approved a 5% increase to the quarterly dividend and an additional $6 billion in share repurchase authorization. These tools remain a key part of our total shareholder return strategy.

Okay. Moving to segment results and starting with Aeronautics on Chart 7. Third quarter sales at Aero decreased 5% driven by lower volume on F-35, partially offset by higher volume at Skunk Works. F-35 production was down due to the previously mentioned Lot 15 through 17 sales catch up in the third quarter of 2022, and an overall more linear throughput this year. Both development and sustainment saw solid year-over-year growth in the quarter. Operating profit decreased 12% from the prior year due to the lower volume and lower net profit adjustments. On the F-16 program, international interest remains strong. We delivered the second Block 70 aircraft to Bahrain in July and in September, the first Block 70 aircraft for the Slovak Republic was unveiled at our facility in Greenville, South Carolina.

The Slovak Republic will be the first European country to receive this newest and most capable version of the Fighting Falcon. Today’s latest version, the Block 772 will be flown by six countries and counting. With a backlog of 126 aircraft as of the third quarter, the F-16 program continues to play a crucial role in 21st Century security missions for international allies. It will be a key contributor to growth over the coming years. Shifting to Missiles and Fire Control on Page 8. Sales increased 4% year-over-year driven by higher sales volumes on munitions programs within tactical strike missiles, partially offset by lower volume within integrated air and missile defense. Segment operating profit also increased 4% year-over-year due to the higher net profit adjustments.

Margins were comparable at 13.5%. MSC has built a strong backlog and we continue to see strong demand for our missiles and munitions with allied nations seeking to improve the security posture amidst today’s complex threat environment. This backlog provides a foundation for growth over the coming years across several of our product lines, including PAC-3, GMLRS, HIMARS, Javelin and JASSM and LRASM. Turning to Rotary and Mission Systems on Page 9. Sales were up 9% in the quarter, driven by higher volume across a handful of programs within our integrated warfare systems and sensors and C6ISR lines of business. Operating profit increased 2% due to higher sales volume and was partially offset by lower net profit adjustments. RMS backlog increased in the quarter, primarily due to the $2.7 billion CH-53K award, which is pictured for Lot 7 and 8, the first full rate production launch as part of the U.S. Marine Corps 200 aircraft program of record.

This significant contract bolsters Sikorsky and its partners creates additional production efficiencies and provides the U.S. Marine Corps with transformative capabilities. On Chart 10, we continue to see strong growth across our space portfolio with sales increasing 8% year-over-year driven by higher volume on NGI, fleet ballistic missile, GPS and Orion programs. Operating profit decreased 15%, as the benefit from higher sales volume was more than offset by lower net profit adjustments and lower equity earnings from United Launch Alliance. Space backlog grew slightly to over $30 billion at the end of the third quarter helped by the $800 million transport layer tranche two award for 36 beta satellites. Transport Layer is part of the proliferated space architecture and will strengthen deterrents with more resilient space architectures for beyond line of sight targeting, data transport and advanced missile detection and tracking.

With this award, we will build and deliver a total of 88 data communication satellites to the Space Development Agency in support of their low-earth orbit constellations. Okay, now shifting to our 2023 expectations on Page 11. For the full year, we’re holding the outlook for sales, segment operating profit, earnings per share and free cash flow. We’ve successfully driven and delivered more linear results in 2023 than prior years, which enables more efficient use of our capacity, but sets up for a difficult compares to last year’s fourth quarter. In conjunction with our recent announcement of increased share repurchase authorization, we’re increasing our share repurchase forecast for 2023 to $6 billion, provided there is not an extended shutdown scenario.

These repurchases along with dividends, are expected to return nearly 150% of our free cash flow to shareholders for the year. And between 2022 and 2023, we are on track to repurchase nearly 13% of our current market cap. We’re also set to deliver mid-single-digit free cash flow per share growth in 2023, and we’re positioning the company to continue that level of growth in the future. Okay. A few comments on 2024. While we don’t have a formal outlook to share, I’ll provide a few directional markers as we see them today, barring any environmental setbacks. We still anticipate low single-digit sales growth as we convert our strong backlog position. As I previously mentioned, the backlog supports a higher growth rate, but the value chain remains constrained by extended lead times that have yet to compress.

On segment margins, we expect the underlying business to be relatively flat year-over-year, but anticipate variability caused by the timing of impacts from the MFC classified program. And at free cash flow, we’re following the budget process to determine whether it will have an impact on the timing of our program schedules and milestones but are continuing to set internal targets that deliver mid-single-digit growth and free cash flow per share. Okay. Let’s wrap it up. Results through the first three quarters have been solid with a long-term demand environment that is favorable to Lockheed Martin’s 21st Century security capabilities. Our focus on linearity and working capital is helping to drive more consistent sales and improved cash flow.

We’re maintaining our full year outlook while increasing our planned share repurchases, further demonstrating our commitment to shareholder returns. And finally, we’re executing our 21st Century security strategy through improving capacity and resilience in the defense enterprise, accelerating the adoption and insertion of 21st Century digital technologies, and collaborating more closely with international partners and allies to improve security solutions. With that, Lois, let’s open up the call for Q&A.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question will come from the line of Doug Harned from Bernstein. Please go ahead.

Doug Harned: Good morning. Thank you.

Jim Taiclet: Good morning, Doug.

Doug Harned: I wanted to see if – just could I understand the F-35 situation a little bit more. Now the TR3 deliveries of F-35, those are now expected at some point in Q2 next year. But I think it’s difficult for us to have like total confidence in that time frame. And what I’m trying to understand is as you continue to produce F-35s, which will need software upgrades before delivery, you’re recognizing revenues on percent completion, so revenue should continue to be solid. But when you look at, say, a June delivery date, what’s the impact on your production recognition of revenues, earnings and cash flow, should that date move around, how should we think about the timing here?

Jay Malave: So Doug, the timing on sales and the profits associated with the sales, the booking margin, I really shouldn’t expect much variability with that. As we’ve mentioned, that really doesn’t get impacted. What you could see and what we are seeing today is that our risk retirements are obviously dependent upon successful completion of the test program. And so that will – could limit our ability to take profit adjustments on a Lot 15 to 17 program. But as I’ve said in the past, we are performing and expect to continue to perform profitability stronger on Lot 15 to 17 than we did on Lot 12 through 14. And so we might see some short-term limitations on our ability to take profit rate adjustments, we still expect and have confidence will drive higher profitability on this contract lot than the prior one.

Operator: Thank you. And the next question is from the line of Cai von Rumohr from TD Cowen. Please go ahead.

Cai Von Rumohr: Yes. Thanks so much. So Jay, I think recently, you made a comment about gravity on margins, and you haven’t provided a guide for ’24. But I think one of the issues that kind of you mentioned has been the classified missile program at MFC, where you have some LRIP options coming up. Could you maybe give us some color in terms of the status of that and how that impacts could impact next year? And any other items we should be watchful of that might exert gravity on margins? Thank you.

Jay Malave: Sure, Cai. Thanks. So yes, I mean, that’s the question we’ve talked about. It’s been a headwind. It’s something that we’ve talked about for the upcoming number of years, including next year. And in fact, we are seeing some of the headwind this year, and it really – it’s dependent upon an analysis really the timing of recognition of these losses. And there are certain things that need to be met from a performance standpoint on the program. And then it becomes an assessment on the probability of an option being exercised. And so there’s just variability in that timing. It could be as early as, frankly, as this quarter, or into next quarter. What we could find ourselves in a situation is that we’re recording multiple lots in 2024, which would put some downward pressure on next year’s margins.

So we’ll have a better feel for that next year, and it could be in the range of anywhere between 25 to 50 basis points of headwind from where we are and where we end today or this year from a margin perspective. So hopefully, that provides a little bit of color on the impact of that program. Is that – as far as any others, look, we – if you look at this year, we had lower profit adjustments this year. We expect there to be in the low 20s in 2023. We’re evaluating what that means for 2024 in general. But again, I think, as I mentioned in my prepared remarks, we’re expecting the underlying business to be pretty much flattish, which would include recurring margins as well as profit rate adjustments in 2024.

Jim Taiclet: Yes. And Cai, it’s Jim. Just to add on the classified program. First of all, given my Air Force filed experience, I can tell you that this is a really important capability for the country. It should continue on as an important capability for many, many years and even decades, assuming the program is successful, which we think we’re on track to be and it will be massively NPV positive over that longer time frame. So we’re working our way through the schedule and the performance in the early phases of the contract, but at the end of the day, it will be worth it for the country and the company. But we will keep you all updated as Jay just did on the path to get there.

Operator: Thank you. And our next question is from the line of Kristine Liwag from Morgan Stanley. Please go ahead.

Kristine Liwag: Hi. Good morning, everyone. So maybe an F-35 question. We’ve seen a lot of new countries express interest in the F-35 and current partners like Israel, have indicated plans to add to existing orders. What are your thoughts on expanding capacity to meet all the international demand? And is there demand from the customers to potentially bring forward their deliveries? And should you increase capacity, what level of investments?

Jim Taiclet: So Kristine, it’s Jim. I’ll start off and Jay can maybe speak to the required investment level. We’re in sync with our Joint Program Office customer, which represents the international cohort indirectly of the F-35 customer base and directly the U.S. services. We’ve all settled on the 156 per year rate as the joint investment that we’re all willing to make, given the demand that’s out there. There is the annual sort of slotting priorities discussion that happens within the Joint Program Office and the international partners, and that will keep the line full for many, many years. If we were to get significantly more international orders that might motivate us jointly, and I mean us meaning the government and industry, including our suppliers, by the way to make an incremental investment. But I think that, that would have to be a significant increase in the order book above what we see today. So Jay, any other…

Jay Malave: Yes. I mean, the investments, it’s probably in the low hundreds of millions. It’s manageable. But again, to Jim’s point, it needs to be coordinated with the customer.

Operator: Thank you. Our next question is from the line of George Shapiro from Shapiro Research. Please go ahead.

George Shapiro: Yes. Jay, on the F-35, can you discuss a little bit where we stood in the quarter in terms of sustainment revenue versus production because the decremental margin on the production was pretty high at 22%? And I’ll sneak in one other one, which is in RMS, the implication is that you’d have a 14% margin in Q4 to meet your guide, yet revenues would be relatively flat. So if you can just kind of tell us what’s going on to cause that to occur? Thanks.