Lockheed Martin Q3 Earnings: Business Set To Flourish On The Back Of F-35 Success And Increased International Sales

Lockheed Martin (NYSE: LMT) posted a solid earnings report this quarter with revenues and earnings beating consensus estimates by a significant margin. The world’s largest defense contractor increased revenues by almost 15% year over year on the back of increased sales at Sikorsky. Furthermore, the company’s F-35 Joint Striker Fighter program proved its worth driving sales in aerospace up almost 7%. From a continuing operations perspective, Lockheed booked  a $127 million gain associated with gaining a controlling interest in AWE that resulted in a $0.34 favorable impact on EPS in the quarter. Going forward, the management expects strong results spilling into the remainder of 2016 as well as all of 2017.

The F-35 Program Is Poised For Success:

This quarter witnessed a big win for the F-35 Joint Strike Fighter program. The F-35A conventional takeoff and landing model (CTOL) was declared combat-ready by the U.S. Air Force and has achieved initial operational capability (IOC). The IOC has enabled the U.S. Air Force to become the second branch of the military to field combat ready F-35 aircraft. As almost 70% of the more than 3,000 aircraft orders are for the CTOL variant, achievement of the IOC for the aircraft strengthens the foundation for future decades of  production for domestic and international customers.

Additionally, the F-35 also demonstrated the benefit of its unique fusion fused sensors in its first live fire missile intercept event. The fusion sensors will enable pilots to detect an 0ver-the-horizon missile threat, which can then be subsequently engaged and destroyed. The fusion fused sensors only begin to outline the potential enhanced war fighting capabilities and distributed lethality that F-35 aircraft will enable across military forces.

In the recent past, customer support and demand for the F-35 has increased tremendously. Key milestones included the rollout of the first F-35 aircraft for the Japan Air Self-Defense Force. At present, the company is on track to provide Japan with 42 aircraft for its national defense requirements. Further, Norway has stated its interest to participate in a multiyear, multinational block buy of the F-35. In its 2017 budget, the country has outlined a request to buy 12 F-35 fighters and remains on track to purchase a total of 52 aircraft for its national defense needs.

Therefore, given the developments above, it is safe to assume that Lockheed Martin will continue to benefit from its F-35 program for years to come as demand and deliveries remain strong, significantly driving the top-line.

International Business Set To Flourish In The Coming Quarters:

Over the past two years, Lockheed Martin has worked to try and improve its sales from international customers. The company had previously aimed to expand focus and footprint overseas in an attempt to achieve 25% of annual sales from international customers. Due to a change in its portfolio content, resulting from the acquisition of Sikorsky and the divesture of IS&GS, the company seems on track to exceed the goal later this year.

In general, international work across all segments is expanding. The increased sales of F-35 Joint Strike Fighter, missile defense systems, C-130J cargo planes and tactical missiles abroad are testament to this fact. The ageing equipment in allied countries, coupled with an expanding level of global security needs, are creating significant demand for the vast portfolio of products the company has to provide.

Specifically, the company has witnessed demand for its equipment, ranging from C-130J aircraft in France and Germany to helicopters in Poland to missile defense systems in the Asia-Pacific, Europe and Middle East theaters. This demand has greatly benefitted the company as the international portfolio continues to grow faster than the DOD budget. Additionally, increased international work is also providing Lockheed Martin with greater economies of scale that enhance the company’s ability to improve the affordability of platforms and services to both domestic and international customers. The company now expects to increase international sales to at least 30% of the total annual sales over the next few years.

Information Systems & Global Divestiture:

Within the quarter, Lockheed Martin finally managed to conclude the divesture of the IS&GS business to Leidos through a tax-efficient Reverse Morris Trust. The closure better positions the business to generate shareholder value and opportunities for employees as they move forward outside the corporation. The transaction generated highest value creation benefits to Lockheed’s shareholders while allowing the company to focus more intensely on the remaining core DOD portfolio.

As part of the transaction, Lockheed Martin also completed an exchange offer that resulted in a reduction of the corporation’s common stock outstanding by approximately 9.4 million shares (about 3% in value). The exchange offer and merger qualified as tax-free transactions to the company and its shareholders, except to the extent that cash was paid to the its shareholders in lieu of fractional shares. Additionally, the company received a one-time special cash payment of $1.8 billion, which is reported under financing activities in this quarter’s cash flow statement.

In total, the defense contractor recognized a $1.2 billion gain as a result of the transactions, which is subject to post-closing adjustments, including final working capital and tax adjustments. The company expects company expects to complete these adjustments in Q4 2016 and Q1 2017. The operating results of the IS&GS business segment and the gain have been classified under discontinued operations. That said, the cash flows from the IS&GS segment have not been classified as discontinued operations, as the Lockheed retained the cash as part of the transactions.

All in all, it seems like Lockheed Martin has positioned itself really well to optimise long-term growth. The company’s share closed about 7% up last evening embodying increased investor confidence.

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