LMT
#Good morning, everyone
I'll be making remarks based on the web charts that we included with our earnings release today
Let's begin with chart 3 and an overview of our results
We're pleased with our performance in the quarter
Sales of $12.2 billion and segment operating profit of $1.2 billion were slightly lower than our expectations, but we expect this timing-related shortfall will be more than made up for during the fourth quarter, as we will discuss later
Our earnings per share of $3.24 were in line with our expectations, even with the lower sales and profit levels, and were aided by the favorable resolution of several contractual matters that improved our unallocated expense amounts
Cash from operations was very strong at $1.8 billion for the quarter, and we continued to return a significant amount of that cash to our stockholders with $1 billion returned in the quarter
In addition, and as expected, we had a very strong quarter of capturing new business, achieving a record backlog level of $104 billion
We are increasing our outlook for sales, operating profit, earnings per share and cash from operations, reflecting our growing confidence as we progress through this year
So I'd characterize the quarter as one with solid performance and improving prospects for the rest of the year and beyond
On chart 4, we compare our sales and segment operating profit in the third quarter of this year with last year's results
Sales grew 5% compared with last year to $12.2 billion, with most of that growth coming in the Aeronautics business area which grew 14% in the quarter, driven by F-35 volume
Segment operating profit was slightly lower this year after adjusting for the large gain we recognized last year when we obtained a controlling interest in the Atomic Weapons Establishment joint venture in the UK
And as I said on the prior chart, we're increasing our full year outlook for both sales and segment operating profit
Turning to chart 5, we'll discuss our earnings per share in the quarter
EPS from continuing operations of $3.24 was lower than last year's amount
But after adjusting for the AWE gain that we recognized last year, our EPS was relatively flat
On chart 6, we'll compare our cash from operations this quarter versus our results from 2016. We generated nearly $1.8 billion of cash in the quarter, almost one-third more than we did in the third quarter of last year
On a year-to-date basis, we have generated almost $5 billion in cash from operations, well on our way to achieving our increased outlook for the year
Chart 7 shows the cash returned to stockholders through the third quarter
After deducting year-to-date capital expenditures from cash from operations, our free cash flow is almost $4.3 billion through the first three quarters
And we returned about $3.1 billion in cash to stockholders, or 72% of free cash flow, fairly evenly divided between dividends and share repurchases
Chart 8 shows the increase in backlog this year to a record level of $104 billion
You may recall from last quarter's call that we had received both an F-35 LRIP 11 UCA as well as the Multi-Year IX buy of Black Hawk helicopters shortly after the second quarter ended
I'm very pleased that with these awards as well as others in the quarter, our backlog increased above the $100 billion mark for the first time
And importantly, our $104 billion backlog level includes only a minimal amount of orders for the potential $8 billion SOF GLSS contract we received in the quarter as we will recognize orders under this IDIQ vehicle only when incrementally added to the contract
Chart 9 provides our updated outlook for the year
We're increasing our outlook for every metric other than the FAS/CAS adjustment
We're increasing our sales outlook by $200 million, and our segment operating profit outlook by $20 million
In our unallocated items, we expect to resolve certain conditions related to a prior year's property sale in the fourth quarter, which will allow us to recognize a previously deferred $200 million gain
And we're recognizing a $20 million improvement in other expenses for the favorable contract resolutions I mentioned earlier
Our operating profit outlook increased by $240 million, reflecting both the increase in segment operating profit and the improvement in unallocated items
With these improvements in our operating profit, we increased our earnings per share outlook by $0.55 to a new outlook of $12.85 to $13.15 per share
Lastly, we are increasing our cash from operations outlook by $200 million to be equal to or greater than $6.2 billion
Chart 10 shows our revised outlook by business area for sales
We're increasing our sales outlook for Space Systems, RMS and Missiles and Fire Control by a collective $550 million due to higher volume expected in all three business areas, while we're lowering our outlook for the Aeronautics business by $350 million based on an updated forecast of subcontractor production cost that will be incurred in 2017. The net result of these changes is the overall increase in sales of $200 million
Turning to chart 11, we show the changes in our segment operating profit outlook for the year
We're increasing our outlook for profit for Aeronautics, Space Systems and Missiles and Fire Control by a collective $35 million, reflecting both improved performance and higher volumes
We're lowering our outlook for profit at RMS, primarily to recognize the performance issue we discussed in our earnings release
The net of these changes is an overall increase of $20 million in our segment operating profit outlook
Chart 12 provides a view of how the new revenue recognition methodology, ASC 606, is expected to affect our 2017 results when that standard becomes effective next year
We expect 2017 sales under the new methodology will be about 2%, or $1 billion lower than the current methodology, while segment operating profit will be comparable under both the old and new methodologies
As a result, we expect our segment operating margin will increase to around 10.3%
We explained the reasons for the changes we expect for 2017 in the bullets on the chart
Under the current revenue recognition standard, about 70% of our sales are already recorded using the cost-to-cost methodology, and we'll have minimal if any change under the new standard
About 30% of our sales are recorded as deliveries occur, and this is where almost all of the impact of the change to the new standard will occur
The main drivers behind the lower sales in 2017 under the new standard are programs where the quantities of deliveries in 2018 will be lower than the quantities of deliveries in 2017. And this occurs primarily with our aircraft programs like the F-16, C-5 and Black Hawk programs
Profit, on the other hand, is comparable under the two standards
We record our profit step-ups based on the same risk retirement events regardless of revenue recognition method, meaning the timing of those step-ups does not change between the two standards
While the timing of the step-ups does not change, the amount of inception to-date cost incurred or cost of goods sold when the step-ups occur does change between those two standards
The effect on our delivery base sales contracts is always to shift sales to the left, as we always incur significant costs before we begin to deliver our products
As a result, some step-ups in 2017 will be applied to higher inception to-date cost, which helps to offset other contracts that had sales and profit shift to prior periods
The combination of all these unique impacts combined to create essentially no change to our profit in 2017 under either methodology
The important takeaway of the chart is that there is no change to the economics of our programs or cash from operations
The only change is to the phasing of sales and earnings recognized under GAAP
We provide our preliminary trend information for 2018 under the new revenue recognition methodology on chart 13. We expect our sales in 2018 will increase about 2% over the restated 2017 level
Segment operating margin is expected to increase to a range of 10.3% to 10.5% next year
Our cash from operations is expected to be equal to or greater than $5 billion after making required pension contributions of $1.6 billion, meaning our cash from operations before making pension contributions is expected to be $400 million higher than it was in 2017. We expect to have share repurchases of equal to or greater than $1 billion, and we expect to retire about $750 million of debt that is maturing next year
Our FAS/CAS outlook for next year is essentially comparable to this year at $860 million
And this outlook is based on interest rates remaining at their current level through year end, which would be 25 basis points lower than when we began this year
It also assumes a 9% return on our plan assets in 2017, holding to the performance we've experienced through the first three quarters, and it maintains our long-term return on assets assumption of a 7.5% return
Turning to chart 14, we've provided an update to both the original and new three-year goals for cash from operations
Our original goal in October of 2014 was to generate $15 billion or more over the years 2015 to 2017 while we experienced what we called a pension funding holiday over those years
I'm pleased that we now expect to generate $16.5 billion over this time period, while absorbing $100 million of pension contributions for Sikorsky that were not envisioned when we developed this goal
In October of last year, we said that our new goal was to generate more than $15 billion for the years 2017 to 2019, even though we expect to have significantly higher required pension contributions over this timeframe than we had during the pension funding holiday timeframe
Based on our expected 2017 cash from operations of $6.2 billion, we now expect to generate more than $16 billion over the 2017 to 2019 timeframe, while contributing a total of $3.3 billion to our pension trust over 2018 and 2019. Finally, we have our summary on chart 15. We're increasing our full year outlook for all key financial metrics
Our record backlog positions us for sustained long-term growth
We'll continue to have robust cash flow even with the higher pension contributions in the future
We'll maintain our balanced approach to cash deployment
And during our earnings call next quarter, we will provide our full year 2018 outlook under the new revenue recognition standard, which is effective for us on January 1. With that, we're ready for your questions
John? Question-and-Answer Session
Hi, Rich
Let me take a shot at both of those, I think
So I think the first part of your two-parter was – and good on you to get a two-parter in, by the way
But your first part was cash from operations, $16 billion, is that considered the restart of Greece and Bahrain and maybe Saudi THAAD, if I caught the question right
So I think the short answer is it includes the effect of all those in our cash from operations outlook
And I think maybe the heart of your question is whether or not there could be some upside
For instance, if THAAD were to happen sooner than maybe we have it planned or not, or if Greece and Bahrain might happen sooner
I think the short answer to that is I wouldn't expect to see a lot of upside improvement, because none of those are on a DCS or direct commercial sale basis
So there is no sort of down payment associated with that
All those will be FMS payments
And at least for the start of those contracts, I would expect most if not all of those to be under progress payments
So, if anything, we've probably got a little cash usage in the near-term associated with winning those new orders as opposed to cash benefit
You talked about 2019. By that time, Rich, the cash should start to turn around, and we would start to expect to see some positive cash come out of those orders, I would expect, during that timeframe
And next I think was the question on F-35 sales and lowering the outlook for this year, and what does that portend for next year
I'm going to give you probably a longer than maybe even necessary response, Rich, to the question because I think that's an important question
I'm glad you asked it upfront there
So I think the very short answer is, no
I don't think that portends anything for 2018 sales for F-35. I think we're looking at about 16% sales growth in F-35 sales in 2017 over 2016. And as I look forward to 2018, there's still another mid-single-digit – or 13% probably to 15% growth range in F-35 sales in 2018. So still very, very significant growth
In fact, if you take a look at the F-35 growth in the quarter, it's up 20% over the third quarter of last year
So that program is growing at pretty good leaps and bounds
And so I think that sort of begs the question so why the lowering of the outlook for F-35? And it's a little bit of a complicated answer, so let me try to get into that
First off, we're not in a steady state on the F-35 program
As I just said, we are growing at a very, very significant rate
And I'll just tell you, it's a lot easier to forecast steady build programs where you're incurring the same costs year-to-year, the same number of deliveries year-to-year
It's much, much harder to forecast when you're either increasing rate or decreasing rate, as we are with the F-35. And at any given calendar year, we probably have at least three LRIPs with significant costs incurred in each of those LRIPs all at the same time
And, more importantly, our suppliers amount of probably 65% or 70% of the total cost in each LRIP
And you should think of that as hundreds of thousands of suppliers – hundreds to thousands, not hundreds of thousands, for each LRIP
And, frankly, we missed the phasing of this supplier cost this year
I think it's important to note that this does not impact the production of aircraft
It's just the timing of when we expected suppliers to incur their cost or bill their cost to us
We're actually not missing the phasing on our internal costs
We are just missing the phasing of our supplier cost
And this doesn't change our overall expectations of cost by LRIP or the profitability by LRIPs, simply the phasing of cost by year
And in a weird kind of way we actually know the at-completion cost for each LRIP probably better than we know when it's going to be phased by year
So, obviously, Rich, we've got to get this dialed in better with our supply chain costs going forward
We think we're going to do that
We think we have the process in place to do that
I will tell you there's a twist coming up this year and probably next year – or 2018 and probably 2019, though, which is the economic order quantity that we expect to start incurring costs on actually this year, and into next year, and 2019, and beyond
We're forecasting it's also going to present a bit of a challenge, because there we're actually buying for three LRIPs simultaneously versus three LRIPs uniquely, like our historical data represents
So not trying to over complicate things, hopefully, for you, Rich, but just to give you an appreciation for why we don't think that's a long-term issue with the F-35. It doesn't change the economics of the F-35 program
We simply missed the phasing in 2017 of our supplier cost
Hey, Rob
Let me correct you a little bit, Rich (sic) [Rob]
You should think of almost all the F-35 as fixed price incentive, firm contracts, not cost plus, but they're all recognized under a POC cost-to-cost if that might have been your question, method of sales recognition, versus a delivery based
That's exactly right, Rob
So most of it is coming from 2017, Rob
I'll say, with the improved performance that we've seen this year, I think, we're up, what, $500 million or so this year over what we initially guided towards
So when we came out with that guidance at the beginning of the year, I think, there was always some confusion, at least as I met with investors and talked to some of the analysts myself, as to was our cash going to sort of fall off the face of the earth when we started making some fairly large pension contributions
And there, I'm pleased to say that even with those, we still think we can stay at the $5 billion plus level in the years 2018 and 2019. So most of the change occurred in the upper first 2017 performance but I did want to give the indication that still strong cash performance, especially if you consider sort of pre-pension cash flow, our numbers are increasing every year, 2017, 2018, all the way through2019.
Yes
So I know it's a lot of moving parts and probably a lot of confusion, <UNK>, because we're basing our sales growth next year based on restated 2017 numbers where we've not given and you haven't seen that laid out by business area
So it's a little bit of explaining something kind of on faith at this point in time, frankly, because you don't have the data in front of you
We'll obviously provide some restated 2017 performance based under the new revenue recognition when we present our data in the January timeframe
But given that, what we're looking at is Arrow's probably going to be up in, I would think, high single-digits sales next year
And obviously most of that is driven by the F-35 program
That's helping to offset both lower F-35 development costs
Although the F-35 development program continues, it's dropping probably a $0.25 billion year-over-year
So that's a pretty good headwind for us
And, as you said, obviously, we've got the lower C-5. What you didn't mention is we've also got next year zero F-16 deliveries
We've just got to start on hopefully the Bahrain aircraft there, but actually lower F-16 volume next year for production aircraft than we have in 2017. Missiles and Fire Control, I'll say, has slight growth over 2017. Again, these are all relative to sort of the restated 2017 numbers under the new revenue recognition, but you should think of that as sort of low-single-digit growth
And I think where that may be a little surprising is given all the discussion we've had about the potential THAAD awards, especially with the Kingdom of Saudi Arabia and others, really that work is not planned in our outlook to start until the middle of next year
And that's a pretty slow build-up of costs relative to our supply chain on the THAAD program
So even though the numbers are very, very large, they really don't amount to just a huge amount of sales growth in 2018 versus 2017. RMS next year is about comparable probably as our current outlook for 2017 where we have LCS volume, including, by the way, the LCS ships for the Kingdom of Saudi Arabia, which is the only program of the ones that were announced where we've actually received some funding and we're starting to do some design work and so forth on the LCS variants for use in that ship by the KSA
And that's helping to offset really lower Black Hawk aircraft deliveries and volume therefore for next year as we talked about in our prepared remarks
And, lastly, Space Systems is probably down mid-single-digits
You should think of that as sort of the continuing trend of lower government satellite volume both for SBIRS and Advanced EHF
And, again, this is sort of the good news/bad news story where we have the same quantity of satellites that we're producing, because we're now in the fifth and six variants – or fifth and six quant number of SBIRS and Advanced EHF, we're making each one of them for less than the previous satellite
So, while the quantities stay the same, the pricing is coming down, and that's a good thing for us, by the way
And then that's – so that's a big piece of it
The other piece of it is literally there's very, very little commercial satellite volume or much, much lower commercial satellite volume in 2018 compared to 2017 as we wrap up two satellites that we'll deliver out in the early stages of 2018. So that's kind of the around-the-horn pieces, <UNK>, of what's driving the sales volume that I talked about in total at the corporation level
Hey, <UNK>
<UNK>, look, I think your math is actually pretty close to what I'm looking at
I think the one piece you didn't mention in all of that, and I don't know what you have in your model and I don't know what the other folks have in their models, but I'd be surprised if you have a FAS/CAS outlook of $860 million for next year
That's actually a little bit lower than this year
We incorporated the 25 basis point reduction that we saw through the end of the first three quarters in the numbers
I'm personally hopeful that we have an uptick in interest rates between now and the end of the year and maybe that goes away
But as we sit here right now, that's down considerably from at least what we were expecting the FAS/CAS to look like in 2018 compared to the $860 million
So that's a pretty good chunk I think of the difference from sort of the EPS numbers you were mentioning there
I think the absolute segment profit and the operating profit numbers you were talking about are probably pretty close to what we're expecting to see
Hi, Rob
<UNK> - Credit Suisse Securities (USA) LLC So <UNK>, for you, going back to the 2%, and I suppose this addresses some of what's already been discussed, but you've got this book-to-bill of 1.2. At some point there's a nice sales inflection up, so I'd like to talk about when that's coming; what your timeframe is for that? And then in the backlog, is that $104 billion a gross number or a net number? Is there any dead backlog in there that is pressuring sales that needs to come out?
If I understand the last part of your question, the answer is no
I mean, the $104 billion is backlog just like any other backlog number we would have presented to you at any point in time, Rob, so no to that question
Your book-to-bill question, the 1.2 and the $104 billion, the record number we had in the third quarter, and I think your question in a nutshell is so why doesn't that translate into higher growth in 2018 than just the 2% we're talking about? <UNK> M
<UNK> - Credit Suisse Securities (USA) LLC Yes
So I think, Rob, we do typically sort of three-ish year plans
And if you take a look here, which you can't, but if you look beyond 2018 into 2019 and 2020, we're probably in the 4.5%, 5% CAGR level for each of those two years over the 2018 numbers
So I think that's where, you know, some of that at least growth occurs
But some of the opportunities within the $104 billion and some of the opportunities that aren't in the $104 billion, such as the $15 billion of KSA – I'm sorry, Kingdom of Saudi Arabia order for the THAAD program, for instance, that <UNK> referenced in her remarks, even when that gets in backlog, that's a long cycle program, so it will take a while
Even though we're recording that on a cost-to-cost basis, it's still a long duration, long cycle program
So that was the point we were trying to make the comments about
This does really, really well position us for future growth for a long, sustained period of time
It just doesn't happen overnight, and especially if you will allow me to call 2018 overnight
And the other prospect that we've got long-term sustained growth for is the 53K, and it's got one of the slowest starts on a program that large that I have ever seen
I mean, we're literally talking two aircraft in the LRIP 1 contract
I think it grows to four in the next one
I mean, it's a very, very, very slow growth rate
So that's one we'd love to get some higher growth coming out of there
But that's the reason why I think, Rob, it looks a little like maybe compared to what you were expecting in 2018. I think it starts to pick up probably to where your expectations are much more in 2019 and 2020.
I can give a shot at that, <UNK>
Again, this is all a little bit maybe taken on faith, since this is new revenue recognition when year heads and all of their modeling is based on the old revenue recognitions
But this will be how we come out with numbers in January of next year
So, maybe just starting with the same order as I did I think earlier going around the horn
I think for Aeronautics, you should expect our ROS probably in the upper 10% range, probably pretty comparable to this year
I'm very happy to say that the F-35 program we're expecting to be greater than 10% our overall program margin in 2018. And that's helping to offset really lower C-5 and primarily F-16 earnings, which led to margin growth due to higher risk retirements in 2017. But upper 10s is probably a good spot, frankly, for Aeronautics
And about what we've been saying for a number of years is that when we saw the F-35 program start to get to double-digit, we'd start to see Aeronautics get back to closer to where it was margin wise a few years ago
So we're sort of right at that cusp here
For Missiles and Fire Control, probably about – you should think of about a mid-teens sort of ROS, maybe slightly below the 2017 level
And I think that's an interesting one, because I don't think it's easily understood just how many new wins we have, in fact, won out of our Missile and Fire Control business
I mean, if I just go around the horn, <UNK> mentioned the Long Range Stand Off, sort of, the next-generation nuclear cruise missile
We also won the F-15 IRST
We won a large classified contract
We won the SOF GLSS we talked about
We won the ARTS – I believe it's ARTS 2D (sic) [ARTS-V2], which is sort of a radar threat emitter contract
I mean, these are all substantive starts, new starts for us
I mean, just to give you some idea there
We're in the process of hiring 1,000 engineers for these new programs that we won in 2017. So that's great from a long-term prospect for us, but it sort of hurts the margin in the near-term
And that's what keeps us sort of at the level that I just talked about
RMS, if you look at the EBIT or the ROS for next year, probably slightly higher than 2017. I'd say maybe in the mid-7%, maybe a little higher than that range in 2018. And then for Space Systems, I think, it's slightly higher than 2017. And that's primarily because we have less commercial satellite volume in 2018 than we did in 2017. And that's essentially at a zero margin business
So, as I said earlier, we've got two satellites that should deliver in the early to mid-part of 2018, so there's just simply less cost volume at that lower margin rate in 2018 than 2017, which helps the 2018 margin
And, importantly, I think, just to mention ULA, the equity earnings are pretty comparable between 2017 and 2018. I know I just gave you a lot, <UNK>
Hopefully that answers your question and makes sense to you
Hi, Doug
Actually, <UNK>, I think you pretty much nailed it
I think you've got the right numbers in your head and that's sort of the way I think about it as well
I don't think I've got a whole lot to add other than what you said
And, honestly, we weren't trying to indicate that
I think if you look at the chart in the web charts that we provided it said greater than $16.2 billion
And we tried to indicate that included $6.2 billion in 2017 and at least $5 billion each in 2018 and 2019. So we weren't trying to guide to a lower than $5 billion number in 2019.
<UNK>, first off, welcome to the call
Nice to have you on board
Look, we've looked at pension a lot of ways
I mean, we're already funded in advance of what the requirements of our pension plan to the tune of about $7 billion, almost $8 billion or so
We are well ahead of the game in terms of pension funding
I mean, we look at that constantly
And I'll tell you I know I've said this when I've talked to investors in various conferences and so forth
If in fact tax reform is initiated, we will clearly look at potentially accelerating our pension contributions, even if it requires taking out some debt to do so, simply because at the numbers we're talking about, let's just for argument's sake say it is actually a 20% statutory corporate tax rate versus 35%
That equates to real money when you get the benefit of the 35% deduction on your pension contributions versus a 20%
So we would clearly want to accelerate some in that regard if, in fact, tax reform happens
Short of that, I mean, unless there's maybe some – we have a couple of fairly significant collections associated with some international contracts right on the cusp of this year, 2017, that could slip into 2018. Depending on the timing of when those things happen, whether it's late December or slips into next year, if all of them happen and we get hit on the head with horseshoes in 2017, we might actually make a – try to get a dent in our pension contributions this year, which, of course, would lower our pension contributions next year sort of dollar for dollar
But that's sort of the only thing we're thinking about as we sit here today
But in any event, still, I would expect to achieve the $6.2 billion of cash from operations this year
If anything, on top of that, we might actually look at that as an opportunity to bring down or draw down the pension contribution, that $1.6 billion in 2018.
So we talked about, Sam, the pension contributions
We've teed up $1.6 million this year
We've said it's $3.3 billion over 2018 and 2019, which would imply a $1.7 billion required contribution in 2019. So that is increasing a little bit there
I'll tell you I don't like as a daily course to provide three-year guidance on much of anything
So we want to make sure when we talk those numbers, those are something that we can actually achieve
So I hope there's opportunity to do better than that
If you looked at the last three-year goal we did better than what we came out with in the early, what was it, 2014 timeframe
We've just got to make that happen
And we'll see what's going on in that regard for the next couple of years
We do have a little bit of higher capital expenditures over the next couple of years, which – I don't know if that's something you'd be considering, but probably $100 million to $150 million, maybe $200 million at its peak higher than this year
And you should think of a lot of that as some of the new business wins we've just had at Missiles and Fire Control that I'd talked about requires some capital improvements and some additional facilities and equipment there
And you may have seen that we're also building a fairly large facility out of our Space Systems company in Denver to accommodate greater capacity and greater sized satellites going forward, because we think that's where the market is headed
So sort of those higher pension a little bit, more than in 2018, and maybe a little bit of CapEx is some of the headwind that we're seeing
But other than that, I think it should sort of follow suit, as you said
