Despite a decline in sales, Lockheed Martin [LMT] on Tuesday posted stronger than expected first quarter earnings due to a swing to pension income and higher operating profits at most of its business segments.

The higher operating profits combined with an ongoing share repurchase program led the company to raise its earnings guidance for the year.

The F-35 Joint Strike Fighter. Photo by Lockheed Martin.
Lockheed Martin expects significant order growth for its F-35 Joint Strike Fighter in FY ’14 and FY ’15. Photo: Lockheed Martin.

Net income climbed 23 percent to $933 million, $2.87 earnings per share (EPS), from $761 million ($2.33 EPS) a year ago, soaring above consensus estimates of $2.54 EPS. A year ago pension expenses detracted from profits but this quarter the company enjoyed pension income. The company’s profits were hindered by the fact that the federal research and development tax credit has lapsed, a benefit that added $46 million (14 cents EPS) to earnings a year ago.

Segment operating margin rose 130 basis points to 13.4 percent on higher overall segment profits. Bruce Tanner, Lockheed Martin’s chief financial officer, said the 13-plus percent operating margins are unlikely to be sustainable, particularly as the company expects increasing volume from the F-35 strike fighter program, which will carry lower margins.

Lockheed Martin said its Aeronautics, Missiles and Fire Control, Mission Systems and Training, and Space Systems all boasted higher profits, driven by risk retirements on the C-130 aircraft, the Hellfire missile, radar surveillance, combat systems,  and the Advance Extremely High Frequency satellite programs. The company also attributed the higher operating profits to the lack of a charge in the first quarter versus a $30 million reserve a year ago, a boost from the Common Broadband Advanced Sonar System, and higher volume on F-35 production contracts.

Sales in the quarter slipped 4 percent to $10.7 billion from $11.1 billion a year ago. Only the Aeronautics segment boosted sales, with the gains coming from F-35 production, increased deliveries of C-5 airlifters, and higher sustainment activity and more deliveries of F-16 fighters.

Marillyn Hewson, Lockheed Martin’s chairman, president and CEO, said the company’s programs are well supported in the Obama administration’s FY ’15 defense budget request. She also said there is continued strong international interest in the company’s air and missile defense, air mobility, tactical aircraft and cyber security offerings, which helped drive higher international sales in the quarter.

Despite a planned near-term reduction by the Defense Department in F-35 orders between FY ’16 and FY ’19, Hewson said that the order profile is still strong, with 20-plus percent growth in FY ’14 and another 30-plus percent in FY ’15.

“These increases in projected annual aircraft order quantities are indicative of increasing aircraft maturity and growing customer demand” for the aircraft, Hewson said, adding that international support for the program is also expanding and will help soften the blow from lower domestic defense spending. She highlighted South Korea’s recent decision to acquire F-35s as evidence of growing international support.

Free cash flow in the quarter was $2 billion and the company returned 78 percent of it to shareholders, with more than $1.1 billion going to share repurchase and $444 million to dividend payments. Backlog at the end of March stood at $79.6 billion, down from $82.6 billion since the end of December.

For 2014, Lockheed Martin is expecting its segment operating profits to range between $5.3 billion and $5.4 billion, up from the forecast in January of between $5.2 billion and $5.3 billion. Per share earnings are now expected to be between $10.50 and $10.80 versus prior guidance of between $10.25 and $10.55, with the gain driven by the higher than expected operating profits and a lower share count.