Earnings Call Transcript - LMT Q1 2023

Maria Ricciardone Lee, Vice President of Investor Relations

Thank you, Lois, and good morning. I'd like to welcome everyone to Lockheed Martin’s first 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. We have 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, Chairman, President and CEO

Thanks, Maria. Good morning, everyone, and thank you for joining us on our first quarter 2023 earnings call. I'd like to begin today with a few highlights from the quarter, as well as an overview of the Presidential Budget Request, and then Jay will discuss our financial results and full-year 2023 outlook in detail. We had a solid start to the year with first quarter sales of $15.1 billion led by 16% year-over-year growth at space. Segment operating margin was 11.1% led by MFC at 15.8%. Free cash flow grew 11% to $1.3 billion and combined with the lower share count contributed to a strong free cash flow for share growth year-over-year. We remain on track to meet our financial expectations for the full year and the return to growth in 2024 as we laid out in January. In terms of capital deployment, we returned $1.3 billion, or 101% of our free cash flow to shareholders in the quarter. We remain focused on our long-term strategy of growing free cash flow per share and continue to plan to deliver approximately 110% of our free cash flow to stockholders in 2023 through dividends and buybacks. Turning to the budget. The administration released preliminary details of the FY ‘24 President's Budget Request or PBR in early March. This budget proposal reflects a heightened emphasis on defense and security cooperation with allies. The FY ‘24 DoD budget request is $842 billion, an increase of $25 billion, or 3% over the FY ‘23 enacted funding. The near-peer threats posed by China and the Russian invasion of Ukraine are driving the national defense strategy and have created added demand for Lockheed Martin's advanced solutions. Key highlights include the procurement of 83 F-35 aircraft, continued expansion in classified programs, and an increase in requested funding for munitions. The PBR also includes facilitation investment and advanced funding for long lead-time parts in support of multi-year procurement of JASSM and LRASM. We're also engaged with DoD on multi-year procurement proposals for PAC-3 MSE and guided multiple launch rocket systems. These proposals are subject to congressional approval during the course of the FY ’24 defense authorization and appropriations process. The PBR also includes continued investments in key technology development efforts such as conventional prompt strike, long-range Hypersonic weapon, next-generation interceptor, hypersonic defense, bomb defense system, and other space programs. Furthermore, key technology areas aligned with Lockheed Martin investment priorities received increased funding, including microelectronics, 5G technologies, and joint all-domain operations. We are encouraged by this initial request and look forward to its progression through the authorization and appropriations process. We also anticipate heightened emphasis on national security prioritization from Congress, supplemental spending requests including Ukraine, and elevated demand from allies and partners. Turning to the F-35 program, the 83 F-35 Lightning II aircraft included in the PBR signal strong support from the services and the administration. Moreover, the Canadian government's January announcement that it will procure 88 F-35s marks another milestone in continued international demand for the aircraft. As for production, deliveries of F-35 engines, which are government-furnished equipment, resumed in February. And then flight operations and deliveries resumed in March. However, we do expect a fraction of total expected 2023 deliveries to be impacted later this year, due to both software maturation related to Technology Refresh 3, or TR3, and hardware delivery timing. However, we anticipate little to no revenue impact from any potential delivery delay and therefore no material adverse effect on our 2023 P&L. Jay will provide some more context on this in a moment. In addition, at Aeronautics, the first Greenville-built F-16 Block 70 took flight and was delivered to Bahrain. Along with the Bahrain customer, six countries have selected Block 70 or 72 aircraft, and Jordan and Bulgaria have signed letters of agreement for additional jets. Further related to the F-16 in the quarter, while I was at the U.S.-India CEO forum in March, I had the privilege to announce the memorandum of understanding with the Tata Lockheed Martin Aero Structure Limited joint venture to produce F-16 wing structures in India, demonstrating our commitment to India as an industry partner and customer while bolstering our supply chain. Turning to Hypersonics, it is encouraging to see the continued investment outlined in the PBR for the conventional prompt strike weapon system or CPS as it begins integration and testing for Zumwalt Class Ships, recognizing our advancements in this critical technology. In February, the U.S. Navy awarded Lockheed Martin an initial contract for CPS, the first sea-based hypersonic strike capability for the United States, enabling long-range missile flight at speeds greater than Mach 5. The first delivery is expected by the mid-2020s. Regarding our Air Launch Rapid Response weapon, also known as Aero, we are continuing testing of the system at hypersonic speeds to advance technical maturation of the missile and glide body and to ensure the final product is safe, reliable, and supportive of our customers' missions and future plans. In January, we also completed the second flight test of the hypersonic air-breathing weapons concept, also known as Hawk, in partnership with DARPA and the Air Force Research Lab. We accomplished all the test objectives during the second flight test, including affordable rapid development and performance requirements. And in late March, the U.S. Navy announced its support of the hypersonic air-launched offensive anti-surface strike weapon or HALO. Lockheed Martin was downselected and awarded a contract for the first step to fielding a critical capability over the next decade and begin the design and development of a carrier-based air-breathing hypersonic strike capability for the Navy's fleet. As a company, we remain fully committed to developing hypersonic technology on accelerated timelines to meet this critical national security need and establish a solid deterrent posture in this area for the U.S. and its allies. The hypersonic solutions are just one element in our vision of 21st Century security. We advanced several additional aspects of this strategy during the quarter, including announcing a memorandum of understanding with Juniper Networks to jointly develop integrated hybrid software-defined wide area network solutions and to demonstrate that with our customers in the future. This technology enables Mission Aware Dynamic Routing, a foundational capability for resilient joint all-domain operations. This mission-aware dynamic routing shifts the movement of data and communications in real-time across a mix of military and commercial infrastructure according to evolving conditions. Our solutions give customers the flexibility to rapidly adapt to maintain the flow of crucial data and information as their assets operate in contested environments. We also led simulations of technologies to the U.S. Army, Air Force, and Navy to demonstrate the impacts of 5G communications and advanced analytics to significantly improve operations and maintenance performance for a variety of aircraft, as well as for unmanned platforms in operationally challenging environments. At the Mobile World Congress in Barcelona, I had the opportunity to deliver a keynote address and meet with CEOs across the digital technology, mobile, and networking industries to encourage working together to promote innovative solutions to protect our countries and advance our space exploration capabilities. Another example of our leadership in accelerating advanced 21st Century technologies to improve national defense and deterrence of conflict is in the arena of directed energy. Recently, our RMS unit achieved success in our initial test of our demonstration high-energy laser, which verifies that the laser's optical performance meets the system's targeted design parameters. This 50-kilowatt class laser weapon system aligns with the Army's directed energy, short-range air defense mission. In addition to delivering on absolutely cutting-edge technologies, demand for many of our well-known and long-time high-performing systems continues to be strong. For example, in January, the Australian government announced the purchase of 20 Lockheed Martin high mobility artillery rocket systems or the now-familiar High Mars, providing Australian defense forces with a reliable, well-proven capability. We continue to grow our significant partnership with Australia beyond High Mars. In February, an agreement was announced between the Australian and United States governments for a foreign military sale of 40 UH-60M Black Hawks for the Australian Army, and deliveries are slated to begin early this year. The Black Hawk remains unmatched as an all-around, multi-role durable military helicopter for Australia and for the 34 other countries around the globe that use it. We are excited to work with the ADF and Australian industry to develop their sovereign satellite communications component, otherwise known as joint Project 9102. The Commonwealth of Australia announced in April that Lockheed Martin was selected as the preferred bidder for JP-9102. This multibillion-dollar project will provide the ADF with a robust solution for military satellite communications defined by its versatility and its resilience. With that, I'll turn the call over to Jay and join you later for questions.

Jay Malave, CFO

Thanks, Jim, and good morning, everyone. Today, I will walk you through our consolidated and business area results for the first quarter and cover our 2023 outlook. As I highlight our results, please follow along with the web charts we have posted with our earnings release today. Let's begin with chart three and an overview of consolidated financial results. Overall, 2023 is off to a solid start, positioning us well to meet our commitments for the year. We delivered just over $15 billion in sales with $1.7 billion in segment operating profit, resulting in an 11.1% segment operating margin. Earnings per share was $6.61, and we generated $1.3 billion of free cash flow, enabling a solid return to shareholders through repurchases and dividends. Our book-to-bill ratio for the first quarter was 0.7, as anticipated. With backlog expected to increase in the second quarter, from the upcoming order for F-35 Lot 17 production. We continue to strategically invest in our growth strategy with $600 million of capital expenditures and independent research and development this quarter. These financial results are on track with our expectations for the year. Taking a closer look at the quarter's results with consolidated sales and segment operating profit on chart four, first quarter sales increased year-over-year by 1%, as space led the way with 16% growth. Segment operating profit was down 2%, as lower ULA equity earnings and contract mix more than offset the benefits from slightly higher volume and step-ups. As expected, margins contracted mostly due to the lower equity earnings from ULA. Moving to earnings per share on chart five. GAAP earnings per share were up $0.17, or 3% over 2022. Adjusted for mark-to-market investment gains, EPS was flat. On an adjusted basis, the unfavorable year-over-year impacts from segment operating profit, interest expense, and FAS/CAS pension income were offset by the lower share count. Moving to cash flow on chart six, we generated nearly $1.3 billion of free cash flow in the quarter, including nearly $300 million of capital expenditures, as well as over $600 million of accelerated payments in continued support of the supply chain. Our cash deployment plan is on track, which we expect to accelerate throughout the year. In the quarter, we had $500 million of share repurchases and paid almost $800 million in quarterly dividends. Total cash return to shareholders in the quarter was 101% of free cash flow. Moving to segment results and starting with Aeronautics on chart seven. First quarter sales at Aero decreased 2% year-over-year. Lower F-35 production sales were partially offset by higher F-16 and classified program volumes. Operating profit was slightly lower than the prior year as the impact from lower net profit adjustments and sales volume was partially offset by favorable contract mix. For the year, we expect F-35 deliveries to be lower than previously anticipated due to software maturation with the Tech Refresh 3 program and hardware delivery timing. We will refine the impact as the year progresses but do not expect the change to Aero’s 2023 sales and profit ranges that we had previously communicated in January, as we maintain our production cost throughput profile for the year. Looking at Missiles and Fire Control on page eight, sales decreased 3% as lower sales volume on sensors and global sustainment, as well as our tactical strike missile programs were partially offset by growth in integrated air and missile defense. Segment operating profit was down 2%, driven by lower sales volumes and net profit adjustments, partially offset by favorable contract mix. At Rotary and Mission Systems on page nine, sales were down 1% from 2022, driven by lower volume on Black Hawk production and our C6 ISR programs. These declines were partially offset by favorable volume on radar programs and integrated warfare systems and sensors, including Defense of Guam, an important growth area for RMS that was won in 2022. Operating profit decreased 14%, due to lower sales volume and timing of net profit adjustments. Turning to chart 10 and our space business area. Sales were up 16% in the quarter driven by strong growth on the next-gen interceptor and classified programs, further boosted by favorable program lifecycle timing on Orion, protective communications, and fleet ballistic missile programs. Operating profit was up 13%, driven by the increase in volume and favorable profit adjustments, partially offset by the lower equity earnings from United Launch Alliance. Now shifting to the outlook for 2023 on page 11. For the year, we are reaffirming guidance for all key metrics. We continue to expect sales to be in the range of $65 billion to $66 billion with segment operating margin at 11.2% at the midpoint. We also still expect to deliver free cash flow at or above $6.2 billion while repurchasing $4 billion of outstanding shares. We believe our first quarter results position us to achieve these expectations as we continue to add orders, fulfill program execution commitments, and pursue new opportunities throughout the year. Let’s close on page 12 to summarize with the comments. As noted, the first quarter represents a solid start to 2023. We reaffirm key financial metrics as previously guided and continue to expect a return to growth in 2024 and beyond, with consistent free cash flow per share growth. Looking ahead, our strategic focus on 21st Century Security Solutions aligns with expected increases to defense and security spending. With our continued discipline and focus on execution, we are on track to meet our expectations for long-term growth and value creation for our shareholders. With that, Lois, let's open up the call for Q&A.

Seth Seifman, Analyst

Hey, thanks very much. Good morning, everyone. I apologize, I'm losing my voice a little bit here. But Jay, I wonder if you could talk a little bit about the GAO report which indicated that Sikorsky’s bid for FLRAA was about 45% of that of Bell? It seems like investors are kind of fortunate that Sikorsky did not win that competition. What can you say to investors? You talked about some of the classified missile profitability headwinds. There was a charge on CH-53K, some ULA development; is the bid process consistent with generating adequate returns on new work?

Jay Malave, CFO

Great question, Seth. Let me just say on FLRAA, we're obviously disappointed. We believe that our offering was the best technology to support the multi-mission requirements at the best value. While we'll acknowledge that the proposal included aggressive pricing, a significant amount of our offering included efficiencies made possible by the benefits of 1LMX. Our adoption of 1LMX model-based and digital thread enhancements significantly improved our cost competitiveness, and we expect that to continue in the future. The business case itself was favorable, which enabled the pricing that we were able to offer. In terms of competition, we analyze these proposals using various metrics, including NPV and IRR, and we consider current affordability. I've mentioned at your conference, Seth, we often face short-term pain for long-term gain in classified programs at MFC. However, the business case does provide that long-term gain for us. We consider all of these factors as part of our management decision-making; we have leverage and the capabilities necessary to provide competitive pricing without sacrificing financial returns. Regarding CH-53K, there was a small adjustment related to an older development contract, but there were no adjustments taken on the forward production agreements we are currently working on.

Kristine Liwag, Analyst

Thanks, good morning, Jim and Jay. On the F-35, the discussion around the performance-based logistics deal has been ongoing for some time. It seems like a deal could be reached this year. Could you provide an update on where you stand in transitioning to a PBL contract in the program? Assuming that PBL meets conditions set by the 2022 NDAA, how could this impact sustainment work and the overall program profile in the coming years?

Jim Taiclet, Chairman, President and CEO

Thanks, Kristine. It's an excellent question. We have estimated a proposal, and we expect that to be decided by the end of the year and awarded. We believe this is the best solution for the customer not only over the next five years but throughout the life of the program. This offers a win-win solution, allowing us to leverage our proprietary modeling for material requirements to use inventory most efficiently and provide real-time availability of materials to our customers as they need it, relieving them of that responsibility while maintaining readiness levels.

Rob Stallard, Analyst

Thanks so much. Good morning.

Jay Malave, CFO

Yes, it's a good question. Rob. Our visibility is growing throughout the year, and I've made a few comments previously about potential shortcomings caused partly by the strong performance we saw in the fourth quarter. Overall, supply chain delivery for the most part remains challenging, especially in MFC and RMS, which have continuing lingering issues. On-time delivery performance has not improved since Q4, as expected. We've been managing expectations since resetting them in the second quarter of 2022, and we don't anticipate a significant recovery until the end of the year or into 2024. Essentially, more of the same in the first quarter compared to previous quarters.

Jim Taiclet, Chairman, President and CEO

And Rob, it's Jim. We are on the verge of fully implementing best practices in supply chain across our new Lockheed Martin concept. Previously, each business unit managed its supply chain narrowly. We are now aggregating demand for each supplier across all of Lockheed Martin, synchronizing requirements and taking advantage of bulk buys of raw materials and components. We are implementing these best practices to strengthen the supply chain.

Cai von Rumohr, Analyst

Yes, thanks so much. So, Jay, you had very strong profitability at MFC; 15.8% was up, yet you talked about this classified missile program hitting margins by 50 to 100 bps. Can you update us on whether that number holds, given the strength in the first quarter and how far into the future does that extend? Also, are there other programs we should watch for potential fixed-price exposure looking ahead?

Jay Malave, CFO

Okay, thanks, Cai, for the question. Let me address specifically MFC; they indeed had a strong quarter. However, looking at the year ahead, while they achieved the highest profit adjustment quarter within Q1, we expect a step-down in the margins for the remainder of the year. This impact from the dilutive margins associated with the classified program will become more pronounced in the back half of the year. I would expect margins to step down to around 13% in Q2 and continue from there. Despite pressures, we expect MFC profit to grow over the next four to five years.

Ron Epstein, Analyst

Hey, good morning, guys. A question for you—maybe a bigger-picture question. Secretary Kendall recently discussed NGAD, talking about restructuring the program to ensure more IP is owned by the DoD and a constant re-competition of contractors. How does this factor into your business model? Does it change anything?

Jim Taiclet, Chairman, President and CEO

Ron, it's Jim. We've been working with the government on intellectual property management rights for years. NGAD is still in progress, defining what it looks like, which involves a mix of potential crewed and uncrewed vehicles. We are collaborating with the government through our Skunk Works operation to discuss options. Our focus remains on advocating for a more open architecture approach while ensuring we protect our intellectual property rights.

Pete Skibitski, Analyst

Hey, good morning, everyone. Jim, could you provide more color on Lockheed’s position with Hypersonics, especially regarding the changes to Aero and your Hawk variant? Could you discuss where things stand today in Hypersonics and potential size of this business?

Jim Taiclet, Chairman, President and CEO

Sure, I'll outline the positioning, and then I'll let Jay provide some revenue growth context. Hypersonics is a complex endeavor involving both air-breathing propulsion systems and boost glide technologies. The government is expressing interest in the long-range hypersonic weapon and CPS as primary thrusts for future programs. Air-launched vehicles present size concerns, such as which aircraft can carry the hypersonic weapons. We're supporting all these development programs including Aero and production programs like CPS. As for potential scale, I'll turn it over to Jay.

Jay Malave, CFO

Today, hypersonics represents about a $1.5 billion business for us across all mentioned programs. We expect it to grow and be a contributor to our growth pillars, with additional upside related to hypersonic defense capabilities.

Rich Safran, Analyst

Thank you, Jim, Jay, Maria, good morning.

Jim Taiclet, Chairman, President and CEO

Good morning.

Jay Malave, CFO

For us over the next five years, we expect international sales to be a significant contributor. We project high single-digit growth. Most of these programs, particularly regarding munitions, will be through Foreign Military Sales (FMS), along with the F-35 program. The Australian military satellite communications program is a multibillion-dollar opportunity that creates new prospects for our space business.

Jim Taiclet, Chairman, President and CEO

We've seen incredible demand for our F-35 and F-16 programs. We're anticipating increased production rates to meet the international demand. Overall, opportunities across various sectors contribute to our growth estimates, but contracting through the FMS process can take time.

Myles Walton, Analyst

Thanks, good morning. On RMS, could you address drivers for margins implied in your guidance? Also, in light of FLRAA’s decision, what should we expect from Sikorsky to remain competitive?

Jay Malave, CFO

On RMS margins, first quarter was 10%. With guidance near 12% for the year, we expect profit adjustments to be a significant driver, stepping from 20% of profit to about 30%. We anticipate growth despite some production declines, particularly due to adjustments.

Matt Akers, Analyst

Hey, good morning, guys. I wanted to discuss missiles and fire control. When should we think about transitioning from flat sales this year to mid-single-digit growth, and what investments are needed to scale capacity?

Jay Malave, CFO

Over the next five years, MFC has significant growth potential. Capacity investments are ongoing. We've committed to increasing production for multiple programs in response to strong demand, and we have expectations for achieving certain capacity levels by 2025-2027.

Jim Taiclet, Chairman, President and CEO

For PAC-3, we are working towards increasing the capacity from 450 in 2022 to 550 by 2026. Similarly, the Javelin will ramp from 2,000 to 4,000 per year. We are pushing to fill the demand and ensure timely delivery.

Jason Gursky, Analyst

I have a bookkeeping question for you. What kind of book-to-bill do you need this year to support returning to growth in ‘24? Is the timing of the awards important?

Jay Malave, CFO

Essentially, we need a book-to-bill ratio of around 1. We expect our backlog to remain stable, aiming to maintain our position to lead to growth resumption in 2024.

Jim Taiclet, Chairman, President and CEO

The Evolve initiative and partnership with Crescent are part of our strategy to address fragility in the production system and widen our collaborative capabilities across sectors. We'll invest creatively while managing the contribution of these initiatives carefully...

Jay Malave, CFO

By breaking Evolve and Crescent out of the traditional structure, we can operate with greater speed and flexibility, allowing us to pursue innovative opportunities without traditional constraints.

Scott Deuschle, Analyst

Good morning. Jay, if I model Q2 through Q4 space systems sales based off of Q1, I get about $12.8 billion in space segment sales, which is significantly higher than your guidance of $11.6 billion. What prevents that kind of upside, and what volume headwinds do you anticipate?

Jay Malave, CFO

While we saw substantial growth driven by cycles and programs within Q1, we identify potential normalization for the rest of the year based on expected performance of ongoing contracts. The higher growth numbers were results of timing that we don't anticipate sustaining through the year.

George Shapiro, Analyst

Could you clarify the big part of the earnings beat from other income? If you kept the guidance of minus $3.25 million for the year, does it imply subsequent quarters will be minus 100 plus, or is there some quarters that will be abnormally high?

Jay Malave, CFO

We will reassess midway through the year based on performance. As for non-operating income, I'll provide more clarification on the figures in subsequent discussions and ensure we track these effectively throughout the year.

Ken Herbert, Analyst

I wanted to see if you could provide granularity on the TR3 and the F-35 program. What is impacting deliveries this year, and how do you see timing getting back on track?

Jim Taiclet, Chairman, President and CEO

We are in the final stages of implementing TR3, which enhances F-35 capabilities. We are currently flight testing and working closely with the joint program office to define rollout timelines. There's been some delays due to complexity, but we are committed to ensuring proper execution.

Maria Ricciardone Lee, Vice President of Investor Relations

All right, Lois, this is Maria. I think we've come to the top of the hour. So I'm just going to quickly turn it back to Jim for any final thoughts.

Jim Taiclet, Chairman, President and CEO

Thanks, Maria. As we conclude, I'd like to say thank you to our 116,000 employees here at Lockheed Martin for their commitment to providing 21st Century Digital and Physical Technologies that will help deter conflict and win if needed. Thank you all again for joining us today. We look forward to speaking with you on our next earnings call in July. Lois, that concludes our call today.

Operator, Operator

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T teleconference service. You may now disconnect.