Higher operating profits combined with lower taxes and pension expenses lifted Lockheed Martin [LMT] to a strong third quarter and the company once again increased its outlook for earnings this year.

The defense contractor on Tuesday posted a 53 percent boost in net income to nearly $1.5 billion, $5.14 earnings per share (EPS), from $963 million ($3.32 EPS) a year ago, smashing consensus estimates by 87 cents per share. Sales increased 16 percent to $14.3 billion from $12.3 billion.

Lockheed Martin's F-35 Lightning II at the 2018 Paris Air Show. Photo: Lockheed Martin
Lockheed Martin’s F-35 Lightning II at the 2018 Paris Air Show. Photo: Lockheed Martin

All four of the company’s operating segments contributed to the top and bottom line gains with the F-35 fighter program contributing handsomely as sales on the company’s marquis program were up $655 million. Higher volume and sustainment work on the F-35 coupled with higher margin production contracts, improved performance on sustainment work, higher risk retirements and new development all aided the profit line. Lockheed Martin delivered 20 F-35s in the quarter versus 15 a year ago.

There is still some room for margin expansion on the F-35 program but the cost curve will be leveling out and profit growth on the fighter will come from the continued ramp up in production, Bruce Tanner, Lockheed Martin’s chief financial officer, said on the company’s analyst call.

In addition to the F-35, Lockheed Martin touted a number of other programs that bolstered its overall results: classified programs at the Skunk Works advanced development including the tactical and strike missiles, the LANTIRN and SNIPER targeting pods, radar surveillance systems, the Multi-Mission Surface Combatant (MMSC) for Saudi Arabia, multiple C6ISR programs, the CH-53K helicopter program, Space Based Infrared System satellite and government satellite services. Each of the operating segments posted double-digit percentage sales and earnings increases.

Cuts to federal corporate taxes that went into effect at the start of the year continue to provide benefits this year and were a key contributor to Lockheed Martin’s higher earnings, with the overall rate for the quarter 6.5 percent versus 25.8 percent a year ago. Lower pension expenses also helped the bottom line.

Segment operating margin was 11.1 percent in the quarter versus 10.4 percent a year ago while the company’s overall margin improved 10 basis points to 13.7 percent.

For all of 2018, Lockheed Martin now expects earnings to be about $17.50 EPS, up from prior guidance of between $16.75 and $17.05 a share on higher projections in segment operating profit and to a lesser degree lower taxes. Operating margin is expected to be 10.9 percent and sales are forecast to be around $53 billion versus the prior outlook of between $51.6 billion and $53.1 billion.

Cash from operations this year is expected to be at least $3.4 billion, $100 million above the previous forecast.

Lockheed Martin tallied more than $18 billion in orders during the quarter, sending backlog to a record $109 billion. By the end of 2018, the backlog is expected to exceed $120 billion, driven by a pending block buy contract worth around $13.5 billion for 219 aircraft covering low-rate initial production lots 12 through 14 for the Air Force, Navy, Marine Corps and international customers, Tanner said on the company’s analyst call.

Despite the strong order flow in the quarter, Marillyn Hewson, Lockheed Martin’s chairman, president and CEO, said the company was “disappointed” in losing out to Boeing [BA] on three major opportunities, the Navy’s MQ-25 unmanned aerial tanker, and the Air Force’s T-X advanced pilot trainer and UH-1N helicopter replacement programs. However, she said the company bid the lowest possible prices it could and if it had matched Boeing’s offers and won the contracts it would have incurred losses greater than $5 billion over all the programs.

Hewson said that “affordability is an important element” for the customer base and that the company assumes that when proposals meet a customer’s technical requirements, price becomes the determining factor.

Tanner warned against drawing “a long conclusion from three awards,” saying the determination to go with price means the “best capabilities” are not going to the warfighters in these cases. He added that lowest price technically acceptable isn’t a “universal” experience with regard to other major program decisions this year and that Lockheed Martin did win awards where “we weren’t the highest price.”

Lockheed Martin also provided guidance for jrpreliminary trends for 2019, with sales expected to be up between five and six percent and segment operating margin between 10.5 and 10.8 percent. Cash from operations is expected to be at least $7 billion. F-35 production is pegged to grow from 91 aircraft in 2019 to 130 next year, and new development work on the program is also expanding, Tanner said.

The primary reason for the expected dip in margin next year is a forecast for lower equity earnings from the United Launch Alliance (ULA) joint venture with Boeing due to few launches and a change in launch vehicle mix away from the Delta IV, which he said is the most profitable rocket in ULA’s suite, Tanner said. He also said that new starts for both classified and unclassified programs are also putting pressure on future margins.

Hewson and Tanner downplayed the impact to weapons sales to Saudi Arabia stemming from the potential impact of any sanctions due to the current cloud hanging over U.S. and Saudi relations over the killing of Saudi dissident and journalist Jamal Khashoggi by an alleged Saudi hit squad in Turkey. Hewson said the only significant order so far from a number of potential multi-billion deals touted by U.S. President Trump more than a year ago is for the MMSC.

Tanner said sales to Saudi Arabia next year are expected under $500 million and less than $900 million in 2020. He said the largest order that is pending with Saudi Arabia is for the THAAD anti-ballistic missile system but that even if the order goes through, associated sales and profits will be deferred until an improved radar system is ready to make the overall system capable, noting that the initial operating capability isn’t planned until around 2023.