Lockheed Martin (LMT) Q2 2017 Earnings Call

Bruce Tanner – CFO

Positive book bill for international orders. 

“we still think we’ve got a chance to end the year potentially at around $100 billion of backlog if some of these, especially the Kingdom of Saudi Arabia orders come in this year, as opposed to next year. But even without that, 95 to 100 is probably what we’re expecting…So a positive book to bill. “

Upcoming changes in the revenue recognition principle may not have a signficant impact 

“we’re kind of I’ll say running rev-rec in addition to the normal methodology for the first quarter and second quarter….But so far everything is indicating that you would think we should see a whole lot of difference. And part of the reason for that is a lot of the units of delivery are what we call POT, Passage on Title transfer where we essentially record sales upon delivery…We don’t see a large drop off or a large increase or decrease in our POT deliveries there. most importantly on our rev-rec, F-35 is not – does not change one bit and that’s obviously the biggest driver of Aeronautics and for that matter, sales for the corporation.”

Lockheed Martin 4Q16 Earnings Call Notes

Marillyn Hewson

Current status of DOD budget

“I’d like to turn now to the status of DOD budget. Currently, the DOD is operating under a continuing resolution through April 28th for fiscal year 2017 with funding constrained to prior FY16 levels. While this will cause funds to be limited for certain DOD programs and likely delay expansion in others, we do not believe our 2017 sales, earnings or cash flows will be affected by this delay in receiving the full appropriations bill”

Recognition from both parties that global security threats are not decreasing

“Separately, the 2017 National Defense Authorization Act was signed into law last month and reflected bipartisan agreement that defense budgets should not return to amounts defined by the Budget Control Act or sequestration levels. I am personally encouraged by that fact, but there is recognition from both parties that global security threats are not decreasing and that in fact we do need to continue to put resources toward our national security and our interoperability with our allies around the world.”

Not seeing any change in international customers due to new admin

“In terms of other international customers and any reaction to the change administration. I frankly haven’t had any dialogue back from that as well. We — as we bring in — as we have an orderly transition of power in the United States of America, we have new leaders in the administration, they each — they have different policies they might put forward, but it hasn’t impacted our demand for our international products, a lot of our growth on international — in the international marketplaces in the F-35, it’s in missile defense, it’s an opportunity for F-16 and C-130J, opportunities for C4ISR, Space awareness, things of that nature and that continue — there continues to be a demand for those.”

Met with Trump about F-35, welcome the opportunity to speak

“Basically President Trump recognizes that the F-35 is a very large program, its largest program in the Department of Defense. He wants to make sure that that the American taxpayer is getting the lowest possible costs on the program and we share, we understand his concerns about affordability, we certainly share that. The meetings that we’ve had have been very productive, with very good dialogue. He asked excellent questions and he is really focused on making sure that that the cost comes down on the program and it is not about slashing our profit, it’s not about our margins when we have those discussions about how we get the cost of the aircraft down today and in the future. So I have welcome the opportunity to talk to him, because it gives me an opportunity to share with him what we have been doing in terms of bringing the cost down as you saw on the chart that we put in our deck today that we have been driving the cost down on the program that we have invested as ourselves and our industry partners in what’s called blueprint for affordability and we’re moving forward on sustainment cost reduction initiatives”

There appears to be bipartisan support for eliminating sequestration

“My opinion is though that there’s appears to be bipartisan support for eliminating sequestration. As I’ve said in the past, we have a lot of independent dialogues with various members of Congress, every one I’ve ever spoken to [Technical Difficulty] they don’t think it’s good policy and they want to get rid of it. So I think now with the current Congress and the new administration that it probably opens up the opportunity for really getting that done and I’m very encouraged that the dialogue has been around eliminating the defense sequester, just removing it altogether and there’s also a strong discussion around increasing defense spending, because we have for the last few years allowed our — with that budget caps et cetera, we have not been investing like we need to in recapitalization and then and readiness and a lot of things that you hit directly from our customers, our services telling Congress and telling the new administration that they need.”

Lockheed Martin (LMT) Q2 2016 Results Conference Call

Marillyn A. Hewson – Chairman, President & CEO

Increased full-year guidance

“Turning to the summary financials, our team continue to deliver broad-based results across the corporation, the second quarter numbers exceeding all of our internal plans. This strong year-to-date performance enabled us to increase full-year 2016 guidance for sales, segment operating profit, earnings per share, and cash from operations.”

There´s some progress on divesting IS&GS. Expect updated outlook if completed soon.

“Significant progress towards transaction closure continues to be achieved. We commenced our exchange offer on Monday of last week. Also last week, the Competition and Markets Authority in the United Kingdom concluded its review, satisfying another condition to closing…the offer provides Lockheed Martin stockholders the opportunity to exchange their shares of Lockheed Martin for shares of stock in a Lockheed Martin subsidiary, which then become shares of Leidos common stock upon completion of the transaction.”

Note: IS&GS (Information Systems & Global Solutions) is one of five business units in LMT. The transaction alluded to here is the separation of IS&GS business from LMT and the merger of IS&GS with Leidos Holdings, Inc. which is expected to close in the third quarter of 2016.

The F-35 has significantly improved capabilities.

“Overall the [F-35 Joint Strike Fighter] program program continued to achieve good progress across the multiple fronts of winding down development activities, ramping up production rate and sustainment activities and securing customer support and demand….The tremendous technological leap in capabilities that the F-35 provides are being demonstrated on a daily basis to a growing number of domestic and international customers as the aircraft is fielded at additional sites.”

There´s been notable demand from customers n the US and internationally…

“Turning to customer support and demand for the F-35, key milestones this past quarter on the domestic side include revalidation to Congress by the Department of Defense of the critical and unchanged procurement requirement to replace legacy aircraft with 2,443 JSF fighters for the U.S. Air Force, Navy and Marines. Internationally, support remains strong and growing…I was able to see firsthand the growing international interest and support of the F-35 earlier this month, when I had the opportunity to attend both the Royal International Air Tattoo and Farnborough air shows in the United Kingdom.”

…as customers get exposed to its capabilities. 

“Customers and attendees were able to see up close the revolutionary capabilities of both CTOL and STOVL F-35 aircraft at the air shows as they performed their aerial maneuvers. This marked the debut of the F-35 at major international air shows, demonstrating the increasing maturity and progress on the program.”

They’re on track on production and cost reduction strategy.

“On production, we are on track to increase our deliveries to 53 aircraft this year and have delivered approximately 180 aircraft since program inception. In the area of cost reductions, we continue to make significant progress on our previously announced blueprint for affordability, shared commitment between the government and industry.”

Bruce L. Tanner – CFO & Executive Vice President

Improved top line and bottom line growth.

“Sales were higher by $1.3 billion or 11% this year than last year, driven by the inclusion of Sikorsky in the results of MST for about $1.2 billion and nearly $250 million in growth at Aeronautics driven by $400 million higher F-35 volume which more than offset two fewer C-5 deliveries in the quarter compared to last year…Our EPS in the quarter was $3.32, which represents about a 13% increase over the EPS in the second quarter of last year. “

Significant capital return via dividends and share buybacks.

“We generated $1.5 billion in cash from operations and returned $1 billion of cash to our stockholders in the quarter…With just over $1 billion returned to stockholders evenly split between dividends and share repurchases, we returned over 80% of free cash flow in the quarter.”

NB: In Q2 2016, LMT repurchased 2.1 million shares for $501 million (4.9 million shares for $937 million in Q2 2015) paying cash dividends of $501 million ($467 million in Q2 2015)

They might do some more share repurchases coming up.

“30%, 35% of our investor base is sort of income base. So, that’s a pretty significant element of our ownership that is driven, in fact, by the dividend yield. So, that’s an important aspect of capital allocation going forward…there’s still a backlog of options out there that as those do get exercised, we will clearly do share repurchases to offset that dilution. We will do share repurchases to offset dilution from the equity compensation as well.”

F-35 production step ups not expected in the H2 2016.

“We don’t currently have plans for F-35 production step-ups for the rest – or for the second half of the year, and so that’s one of the things that will cause the second half of the year to look a little wider probably than the first half of the year.”

Andrew Sohn: LMT, YHOO, SFS, UA

Andrew Sohn, a junior at Columbia University, has started to contribute to Avondale’s company notes database. Below are quotes from some of the calls that Andrew has read this week.



Lockheed Martin (LMT)


Acquiring Sikorsky Aircraft


The first strategic action we announced is our signing of a definitive agreement to purchase Sikorsky Aircraft.


Potential spinoffs or sales in the near future


The second major action is the commencement of a strategic review of our government IT infrastructure services work at Information Systems & Global Solutions and of our technical services work at Missiles and Fire Control. The strategic review will address the changing market dynamics affecting these businesses and will help us determine how to best position them for future growth and is expected to result in a spinoff or sale of the businesses.


Sikorsky catered to similar customer base, possible synergies


Some of the important strategic benefits of this acquisition are that Sikorsky has familiar customers. This familiarity will assist the integration process through utilization of similar knowledge and interaction with common customers.


Macroeconomic factors also helped acquisition of Sikorsky


Their strong aftermarket business is also expected to provide a long-term source of earnings to the Corporation and another lever of value creation. The opportunity to access capital in today’s historically low interest rate environment is another significant contributor to the rationale and value creation of the acquisition…Sikorsky footprint in the commercial aviation segment is well-established with the extensive activities supporting the oil and gas industry. While this segment has been under recent pressure due to low oil prices, it is expected to recover in the future and add value to the Corporation. We believe these current pressures enable us to make this acquisition at a low point in the economic cycle.




Adjusting operating profit and EPS guidance


On Chart 20 we provide our updated outlook for the year. We are leaving both orders and sales unchanged at this time… We are increasing our segment operating profit by $75 million due to our strong performance through the first half of the year and as a result of our increasing profit, we are also increasing our earnings-per-share guidance by $0.15 to a new outlook of between $11 and $11.30 per share.




Industry has more competition, and customers looking more at prices


As you know, there is a lot more competitors that have come into the marketplace and our customers’ priorities are changing and what they’re looking at more – they’re much more price-sensitive and so the elements of our business predominantly will be in the work that we’re doing for civil agencies, IT infrastructure type services.



Sikorsky offers more leverage through cross-selling


I think in particular the international sales market is an interesting one for us where we – through the combination of our portfolios coming in having a discussion about the security needs of our international customers whether it’s F-35 Littoral Combat Ships, now Sikorsky helicopters is a much much more powerful discussion than what I believe the current parent could have in terms of bundling products and services together to go into the international marketplace.



Yahoo (YHOO)


Tailwinds last Q3, not so much this time


You may recall, in Q3 of last year, we had a number of beneficial factors that led to a very good quarter. These included the World Cup, new patent license royalties, and some accelerated fees around the Alibaba IPO. As a result, we expect to see some pressure in terms of year-over-year trends in Q3. We expect to be able to continue to show strong top line revenue growth in terms of GAAP, but our revenue ex-TAC and adjusted EBITDA will likely be under pressure year-over-year.


Focusing on expanding market share


We’re also making important investments for the long term. We are investing heavily to grow market share through both traffic acquisition and marketing. Two examples are our recently announced partnerships with Mozilla and Oracle, both are large search deals that we believe will enhance and stabilize our market share. But they obviously run at a lower margin than our organic traffic.



Mobile search is important


Mobile search is key to Yahoo!’s future. Search is half of our business. Users are more and more transitioning from desktop search to mobile search and we think it is fertile ground for innovation.



Premuim ads, native pricing, and video pricing drove revenue growth


So across more premium ads being sold, native pricing improving, and the enhancement of video pricing being added to the mix, that’s really what drove a lot of that 10%.



New NFL deal offers new opportunity


On the NFL, one, we’re so excited that they chose us. It’s such a new area for them. It’s a great area for us. The fandom of the NFL is just immense, and so we’ve been working very closely with them to understand how the experience should be presented, how we should make it available to our different users, where on our site we should make it available.



Smart and Final (SFS)



10% unit growth is the goal


In the Smart & Final banner, our goal is 10% unit growth each year. That equates to 20 new stores in 2015 and at the end of the second quarter, we’re right on that pace.



Extra! In favor of Legacy


We also plan to continue our steady pace of Legacy Smart & Final banner store to Extra! store conversions and opportunistic relocations. With more than 50% of the Smart & Final banner stores now in the Extra! format, the fraction of legacy stores will continue to drop each quarter.



Deflationary pressures larger than expected


Generally speaking, deflationary pressures were higher than expected in the second quarter, but it’s important to note that we’re seeing across the board deflation in every category. In fact, in the Smart & Final banner, we tracked 27 sub categories of sales and in the second quarter, we believe that only four of the 27 categories were deflationary, but three of these are key volume categories for us; Cheese, dairy and produce and deflation in the quarter had an overall negative impact on sales growth.


Expanding into delivery models


One other element in introducing Smart & Final to potential new customers is our test of delivery formats. We’ve pilots in limited geographic areas in both San Francisco and Los Angeles markets. With Google Express for same day and next day delivery and more recently with Instacart, an on-demand delivery model, while our experience is limited, we’re encouraged by the potential of both delivery models to better meet the needs of our customers as well as the potential to attract new customers both households and businesses.

Under Armour (UA)


Making strong moves into NBA market


To help drive this initiative we’ve recently brought on Terdema Ussery who for the past 18 years has served as President of the NBA’s Dallas Mavericks and has prior industry experience in athletic footwear and apparel. We can speak to this in more depth at our Investor Day meeting at September but we want to be clear today about our intent. This category focus will provide the structure to help us sell more shirts and shoes. This structure has proven successful for us in Golf with the combination of great product; a great asset and a great team helped us double revenues in the past two years.



Using Connected Fitness platform to expand customer base


We can do so because of the strength of our Connected Fitness platform, but we continue to add more than 100,000 unique registered users of a platform every single day. We remained in the early stages of incumbent potential of what the world’s largest digital health and fitness community with now over 140 million athletes can do to help us build consumer engagement and drive healthier lifestyles…Ultimately the more people exercise the more athletic footwear and apparel they will buy. Again we will provide deeper detail on our Connected Fitness opportunities in September at our Investor Day but we’re extremely pleased with the growth of our community and the type of insight we can bring to our consumers lives.


Brand imaging is about consistency and long-term commitment


And so brands are built on consistency, consistency is built in trust and trust is built in drops and is lost in buckets. And so what you see is we had a great big pouring I think of credibility in the sport of basketball and which Steph brings us on a day to day basis but that’s going to require a lot more investment and it’s going to require a long-term commitment. And so we want to let everybody know particularly our consumer but frankly our competition as well that we are moving in the basketball we’ve been working on this for it’s not an overnight success we’re working on this for years if not decade and we’re incredibly proud of where we’ve gotten to but we’re really just getting started.



Don’t want to expand through fanbases


So we’re now looking at, a) our profitability and it’s been one asset at the time and it’s been things from joining the EPL football with people in places like Tottenham Hotspur and then finding ways to make investments the recent announcement we had with Sao Paulo Football Club down in Brazil it’s not an immediate return for us. I’ve always said I don’t really see us as a licensed jersey manufacturer I don’t like that idea of growing sport by simply selling fan gear, we want to be on the authentic athlete we want to be on the pitch on the court on the field. But there is ways for us to get in and so finding the resource that we can spin off to make an investment in the market is very new for us like Brazil, its’ a big deal. And so we’re — I think we’re very patiently doing that around the globe where we’re finding assets that make sense and especially we can reinforce at markets that we can create an ROI that’s sooner than later.


Lockheed Martin at Sanford Bernstein Conference

A digest of some of the top insights that I’ve gathered from this week’s earnings calls.  Full notes can be found here.

Focusing on international with US slow

“what we’ve been focused on as a leadership team is to continue to grow our international business. It’s always been an element of our strategy, but in this environment we’ve stepped up our focused on that from a leadership standpoint and resources, because there is a strong demand for our products and capabilities internationally and because it is an area of growth for us.”

f-35 is 16% of sales

” From Lockheed Martin standpoint, I would tell you that having the F-35 well supported in both the House and Senate and by our customer I think is very important. It’s 16% of our sales. ”

Something needs to be done about sequestration again in 2015 2016

“What will happen beyond FY ’14 and ’15 once we get through this budget cycle on ’15 and to ’16 is we have an uncertain situation, Doug, because that is when sequestration would come back into place unless Congress does something about that. Everyone I speak to says they want to do something about that. So my optimism says, hopefully they’ll get together and they will do something about that. We may still see some cuts in FY ’16 and beyond, but not at the sequestration level.”

International tensions get international governments attention on defense

“the tensions in Ukraine and the aggressiveness with Russia there, as you mentioned the South China Sea and the tensions over there, the North Korean’s and their unstable behavior, just different reach and it continues in the Middle East to be a dangerous neighborhood and a lot of tensions that arrived there.

All of those things say to us as a nation and to our allies around the world that while we have budget pressures that a number one thing that any nation has to do is to be focused on their national security. And so as you deal with budget pressures, each one of these nations I speak to say, but we still have to address the national security strategy that we have to protect our citizens and to provide them with the essential services that they need. And we’ve got to figure out how to manage that budget.”

Long cycle between contract and delivery

“So that backlog is if you look at our business, the predominance of our business are long-cycle businesses. We build aircraft, satellites, things that from the time we get the order, the contracts sign to the time that we actually deliver is three years, some times three years plus.”

Have sold 4600 F-16s

“But on the F-35, itself, what we envision is that it’s going to go the way of other tactical aircraft programs, such as the F-16. Today the program of record is around 3,000 aircraft. The F-16 we’ve sold 4,600. We’re still selling more.”

International focused on missile defense, f-16 and cyber security

“There is a strong demand for missile defense around the world.”

“the venerable F-16 is still selling around the world. We have backlog to 2017 and we expect to continue to sell it beyond that.”

“There is growth in cyber security. It’s a largest threat for many countries right now, it’s the cyber threat and they need help. And we have the capabilities to help them.”

Going rate for missile defense system is $3-$5 B

“And then Poland has a $5 billion opportunity, the Polish Shield they call it, but this is the Shield of Poland opportunity for their missile defense system and we are in the down select on that opportunity. ”

Cyber security at $1B right now, expanding commercially too

“And in that business, we are growing at about right now it’s around $1 billion worth of sales in that business. We are even moving into supporting commercial customers there, because a lot of large companies, whether they are utilities or they are banks, in the financial side or in other critical infrastructure, they need help in protecting their systems, just like we’ve been able to protect our systems.”

Commercial is not necessarily the same market as government

“you’re right to say there are differences. And we never go into a new market unless we know what we’re doing. We know the product line. We know exactly what we are offering. If we have to go to market differently, we hire talent to support that. We do the right things, so that we go to market appropriately.”