Lockheed Martin [LMT] yesterday posted strong first quarter earnings despite a slight dip in sales due to operational improvements and the company left its outlook for the year relatively intact but said the ongoing budget sequestration would pressure sales to the low end of its guidance range.

Net income climbed 14 percent to $761 million, $2.33 earnings per share (EPS), compared to $668 million ($2.03 EPS) a year ago, well above analysts’ estimates of $2.04 EPS. Segment operating margins were up 20 basis points to 12.1 percent, contributing to the rise in earnings. Income a year ago was also impacted by higher pension expenses while the first quarter of 2013 benefited from lower income tax expense due to the extension of the federal research and development tax credit through 2013.

Sales decreased 2 percent to $11.1 billion from $11.3 billion a year ago, and the company said the impact to business from sequestration has been limited so far but going forward it expects the across the board budget cuts to clip $825 million from sales in 2013. Despite the lower expected sales due to sequestration, Lockheed Martin maintained its revenue guidance for the year at between $44.5 billion and $46 billion with expectations now at the low end of the range.

The impact to programs from sequestration is basically evenly spread, Bruce Tanner, Lockheed Martin’s chief financial officer, said on yesterday’s earnings call. However, with the FY ’14 budget there “is no peanut butter cut,” he said, meaning that that reductions don’t have to be even across the board.

“That’s different than what we will see in fiscal year 13…and this is sort of the proof-of-the-pudding of whether or not your portfolio aligns to the government’s strategic interests or not in terms of the DoD’s priorities,” Tanner said. “We think ours does. We think [our portfolio] has more staying power in that environment than in a peanut butter environment.”

Lockheed Martin’s Aeronautics segment drove the sales decline in the quarter due to few deliveries of F-16, C-130J and C-5 aircraft as segment sales fell 14 percent to $3.2 billion. The decline at Aeronautics, which was less than forecast, was partially offset by a solid double-digit increase at Missiles and Fire Control, and to a lesser extent by gains at Space Systems and Information Systems & Global Solutions.

At the segment level, operating profit gains were driven by the Mission Systems and Training group due to risk retirement on the Medium Extended Air Defense System and the TPQ-53 radar system, more than offsetting a sharp decline at Missiles and Fire Control, and smaller decreases at Space Systems and Aeronautics.

To help mitigate the future impacts from sequestration, Lockheed Martin continues to focus on growing its international business, said Marillyn Hewson, the company’s president and CEO. Last year the company generated 17 percent of its business from international customers and the goal remains to derive at least 20 percent of sales from foreign customers in the next few years.

International growth drivers will be the F-35, F-16 and C-130J aircraft programs and missile defense programs such as the Aegis system and the THAAD anti-missile program, Hewson said.

Lockheed Martin continues to pursue technologies and projects in emerging markets such as alternative energy but Hewson said these will not move the needle on revenue in the near-term. She added that the company’s capital risks on these projects are minimal as the investments are not large.

While defense spending is contracting, Hewson said that the company’s government customers are not looking for industry consolidation among the major prime contractors. The customers feel the number of primes “is about right,” she said, adding that she expects consolidation at the second and third tiers and lower.  

Backlog at the end of the quarter declined to $77.9 billion from $83.3 billion at the end of 2012, while the book-to-bill ration was well under a one-to-one ratio with sales. Free cash flow in the quarter was about $2 billion and the company spent $461 million on share repurchases and $371 million on dividends, both more than a year ago.