Lockheed Martin (LMT) Q4 2023 Earnings Call Transcript

Lockheed Martin (LMT -4.16%)
Q4 2023 Earnings Call
Jan 23, 2024, 11:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good day and welcome, everyone, to the Lockheed Martin fourth quarter and year-end 2023 earnings results conference call. Today’s call is being recorded. [Operator instructions] At this time, for opening remarks and introductions, I would like to turn the call over to Maria Ricciardone Lee, vice president, treasurer, and investor relations. Please go ahead.

Maria Lee — Vice President, Investor Relations

Thank you, Lois, and good morning. I’d like to welcome everyone to our fourth quarter and full year 2023 earnings conference call. Joining me today on the call are Jim Taiclet, our chairman, president, and chief executive officer; and Jay Malave, our chief financial officer. Statements made in today’s call that are not historical facts are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities law.

Actual results may differ materially from those projected in the forward-looking statements. Please see today’s press release and our SEC filings for a description of some of the factors that may cause actual results to differ materially from those in the forward-looking statements. We posted the charts on our website today that we plan to address during the call to supplement our comments. These charts also include information regarding non-GAAP measures that may be used in today’s call.

Please access our website at www.lockheedmartin.com and click on the investor relations link to view and follow the charts. With that, I’d like to turn the call over to Jim.

Jim Taiclet — Chairman, President, and Chief Executive Officer

Thanks, Maria. Good morning, everyone, and thank you for joining us on our fourth quarter and full year 2023 earnings call. In 2023, the 122,000 men and women of Lockheed Martin, working closely with our customers, made excellent progress advancing our 21st Century Security strategy and delivered strong financial results for our shareholders. Turning to Chart 3.

Robust demand for our broad portfolio of aircraft, helicopters, satellites, radar systems, and other products, services, and advanced digital technologies boosted backlog to a record $161 billion. Full year sales of $67.6 billion increased 2% year over year and came in stronger than anticipated, as did earnings per share of $27.55. To position the company to take full advantage of these future growth opportunities, we invested more than $3 billion across research and development and capital in 2023. We generated $6.2 billion of free cash flow, as expected, which resulted in year-over-year free cash flow per share percentage growth in the mid-single digits.

We returned approximately 145% of free cash flow to shareholders, over $9 billion through dividends and share repurchases combined. Our expectation for Lockheed Martin’s 2024 financial outlook include low single-digit growth in sales off of the higher 2023 base and a range of $6 billion to $6.3 billion of free cash flow. Our ongoing dividends and expectation for $4 billion of share repurchases will sustain our focus on returns to shareholders in 2024. We also plan to further advance our vision for 21st Century Security in the year as we believe that it is our responsibility at Lockheed Martin to bring the best of U.S.

and allied technology and industrial capability to help maintain an effective deterrent to armed conflict and to provide our armed forces with the capabilities to win should we need to. First, we work closely with our supply chain to apply anti-fragility measures and increase resilience through teaming arrangements to expand sources of supply and by making strategic investments in start-ups with cutting-edge technologies. For example, we are collaborating with a supplier in which we have a minority investment to accelerate our additive manufacturing progress, reducing material and process dependencies in complex thermal management applications such as heat exchangers. We also stood up a wholly owned subsidiary called ForwardEdge ASIC to work with major semiconductor fabs to design and manufacture the cutting-edge microprocessors that we need.

Second, we led the industry to broaden and strengthen the defense industrial base by making significant progress with our commercial technology collaborators to bring their innovations into the service and national defense. For example, in the fourth quarter, Lockheed Martin worked together with a team including Intel, Verizon, Microsoft, Juniper Networks, Keysight, and Radisys to successfully demonstrate a secure, resilient, hybrid 5G and military data link network in a live field demonstration in Colorado. Our 5G.MIL Unified Network Solutions performed as a tactical and commercial multi-node hybrid network for integrating land, air, and space operations. Together, we demonstrated absolutely cutting-edge system capabilities, performance, and operation for customers in a field setting by combining the best of our technology with those of our commercial teammates.

Third, we deepened relationships internationally with partners and allies to ensure that the U.S. can drive maximum interoperability in both industry and in military operations. We are making progress toward a mission-centric approach that uses the latest digital technologies to network aircraft, satellites, command centers, and other key elements together to vastly improve their effectiveness and deterrent value across our U.S. and allied customers.

One example from 2023 is the work with Australia to develop phase 1 of AIR6500 that’s a joint battle management system and the first of its kind in terms of situational awareness and interoperability. This increases collaboration with trusted allies and partners can also help reduce the fragility and increase the capacity of the defense production system. Last week, Lockheed Martin was awarded the Guided Weapons Production Capability Risk Reduction Activity contract, which will provide a mechanism for swift knowledge and technology transfer and serve as a pathfinder to manufacturing our suite of guided munitions in Australia with their workforce and with contributions from their society and their economy. Turning briefly now to the status of the U.S.

defense budget. The current proposed agreement being discussed with the administration and Congress would support an $886 billion top-line budget, 3% higher than 2023. We will continue to monitor the status of the U.S. budget process and strongly believe that Lockheed Martin programs will continue to be well-supported as the process unfolds.

I’ll now review a few notable highlights from our operations, starting with aeronautics and the F-35. We delivered 18 F-35 aircraft in the Technology Refresh 2, or TR2, configuration in the fourth quarter, bringing the 2023 total to 98 jets. We are making continued progress toward delivering the first TR3-configured aircraft. Today, over 90% of the TR3 functionality is currently in flight test, and we are further advancing the software integration to include additional aircraft and mission subsystems.

While this system maturation process continues to advance, it is taking somewhat more time than we originally anticipated. The second quarter customer acceptance of delivery software remains our target. However, we now believe that a third quarter may be more likely scenario for a TR3 software acceptance. We are taking the time and attention to get this technology insertion right the first time because it will be absolutely worth it.

The step-function technological advances of TR3 will provide our customers with the onboard digital infrastructure of data storage, data processing, and pilot user interface to provide unmatched capabilities for many years to come. These include increased types of capability for air-to-air and air-to-ground munitions; advanced sensing, jamming, and cybersecurity capabilities; and more accurate target recognition. To achieve this level of reliable capability for the long run, the resulting aircraft delivery range for 2024 is between 75 and 110 and requires the TR3 hardware suppliers to keep pace with production demands both this year and in the future. Given the increasing operational capability and digital connectivity of the aircraft as a cornerstone of all-domain operations, international demand for the F-35 remains very strong.

In December, the Republic of Korea made the decision to procure 20 additional F-35 aircraft. Also in December, we presented the first F-35A to the Belgian government, which will be one of more than 600 F-35s that will be stationed in Europe across NATO member bases by the 2030. Aero also continued to advance the F-16 as the first European F-16 training center in Romania was inaugurated in November in a partnership with Romania and the Netherlands. This center will provide world-class training to enhance mission readiness and ensure safety of flying and operating F-16 fighter jets.

In addition, we delivered the first two Slovakian F-16 Block 70 jets in the fourth quarter. Deliveries for Slovakia totaling 14 aircraft will continue through 2025. Aero’s Skunk Works continues to pioneer groundbreaking innovation as well. And for a change, I can actually tell you about one.

The X-59 experimental supersonic aircraft built by Skunk Works and NASA Aeronautics was selected as one of Time magazine’s best inventions of 2023. The X-59 is expected to transform the future of commercial supersonic flight over land by quieting the sonic boom, one of aviation’s most persistent challenges. The X-59 was unveiled at a rollout ceremony earlier this month and is expected to take first flight later this year. Our MFC business continued to push technological advancements forward as well through modernization of air and missile defense and precision strike capabilities.

In the fourth quarter, we delivered the first Precision Strike Missile, or PrSM, to the U.S. Army and conducted system qualification test for an extended range Guided Multiple Launch Rocket System, or GMLRS, which will extend the range of the HIMARS system that many of you are familiar with. MFC also delivered the 800th THAAD, that’s a Terminal High Altitude Area Defense interceptor to the U.S. government in October.

And also, we successfully integrated the PAC-3 Patriot missile with the U.S. Army’s new air and missile defense radar system to defend against cruise missiles, tactical ballistic missiles, as well as hypersonic. International demand for the PAC-3 remains strong, too. This year, Switzerland and Romania each signed Letters of Offer and Acceptance for PAC-3 MFCs, marking 15 partner nations for this program.

RMS also saw strong international interest in the fourth quarter. The U.S. Navy awarded Lockheed Martin contracts to produce eight MH-60R Seahawk helicopters for the Spanish Navy and six of them for the Norwegian government as well. Today, Sikorsky has delivered 330 MH-60R aircraft to five countries, including the United States, 67 more are on order or in production for India, Greece, South Korea, Australia, and now, Spain and Norway.

Also in the quarter, Sikorsky installed the U.S. Army’s improved turbine engine on our RAIDER X, designed for the Army’s Future Attack Reconnaissance Aircraft or FARA program. This final phase of the RAIDER X build brings us one step closer to completing the system that will support the Army’s high-tech future missions requirements, and we anticipate the first flight of RAIDER X in late 2024. Finally, turning to space.

United Launch Alliance successfully launched the Vulcan Centaur rocket earlier in January. This launch was the first of two flights required to complete national security space certification, and the second planned mission can happen as soon as April. The U.S. Air Force awarded space a nearly $1 billion contract to develop a new reentry vehicle for the Sentinel intercontinental ballistic missile.

The reentry vehicle or Mk21A will be mounted atop the Sentinel. The award follows a technology maturation and risk reduction contract, and the ICBM recapitalization contributes to modernizing strategic deterrence and reinforcing Lockheed Martin’s critical technological contributions to the nuclear triad. And last week, the Space Development Agency announced Lockheed Martin was awarded an almost $900 million contract for Tranche 2 Tracking Layer to provide 18 small sats. Sixteen of those space vehicles are for missile warning and tracking and two space vehicles are for missile defense infrared sensors to be on board.

The first group of nine satellites is expected to launch in April of 2027. A lot going on at Lockheed Martin and all of our operations. And with that, I’ll turn the call over to Jay and join you later for questions.

Jay Malave — Chief Financial Officer

Thanks, Jim, and good morning, everyone. Today, I will recap our fourth quarter and full year 2023 financial results and provide our initial guidance for 2024. As I describe our results, please follow along with the web charts we have posted with our earnings release today. On Chart 4, we’ll start with the fourth quarter results for consolidated sales and segment operating profit.

We had a better-than-expected close to the year, nearly matching last year’s record fourth quarter. Sales exceeded internal expectations by close to $1 billion, with the improvement largely due to material throughput, leading to a less than 1% year-over-year decline in the quarter and a sign of improving synchronization between Lockheed Martin’s demand signals and supply chain fulfillment. The strong finish led to about 2.5% sales growth for the year, which was about $2 billion stronger on an absolute basis than originally expected last January. Overall, segment operating profit in the quarter was also better than expected on the higher sales volume and was down 1% year over year due to lower net profit adjustments and lower equity earnings.

Book to bill was 1.15 for the year, with strength across all four segments. Moving to earnings per share on Chart 5. GAAP EPS grew 2% year over year, with lower segment profit and higher interest expense more than offset by benefits from the lower share count and fewer mark-to-market losses. Excluding mark-to-market activity and other nonrecurring charges, adjusted EPS was up $0.11 year over year or 1%.

For the year, adjusted EPS was $27.82, up 2% year over year and consistent with the sales growth. The steady improvement this year resulted in higher adjusted EPS by about $1 per share from our original expectations last January. Moving to cash flow on Chart 6. We generated $1.7 billion of free cash flow in the quarter and $6.2 billion for the full year, helped by approximately $625 million in working capital reductions in the fourth quarter from strong and timely conversion of operational milestone achievement to billings and collections.

We maintained our commitment to shareholders by returning $3.8 billion through dividends and share repurchases this quarter and over $9 billion for the year or 145% of our free cash flow. Before getting into the segments, let me pause here to put the numbers in perspective. The key takeaway is that industry growth is crystallizing based on three converging demand cycles: first, to meet support requirements of the near- and mid-term security environment; second, to strengthen the effectiveness of existing security platforms and systems with improved sensing, connectivity, interoperability, and embedded intelligence; and lastly, to recapitalize platforms and systems that maintain technological superiority and deterrence over a longer time frame. We expect these demand trends to endure and drive requirements that closely match with Lockheed Martin’s advanced technology and systems integration capabilities.

The long cycle nature of Lockheed Martin’s systems has, in part, led to slower growth, but the 2023 results show that it is materializing, as evidenced by our 7% increase in ending backlog to a record $161 billion, as well as our return to top-line growth a year earlier than originally expected. And we demonstrated our confidence in the company’s positioning among these demand cycles and multiyear outlook by again delivering strong shareholder returns. Over the past two years, we have repurchased about 12% of the current market capitalization. OK, back to the segment details and starting with aeronautics on Chart 7.

Fourth quarter sales at aero were comparable year over year, with higher volume at Skunk Works and the F-16 production ramp, offset by lower volume on F-35, primarily production cost timing. As expected, operating profit decreased 7% from the prior year due to lower net profit adjustments. For the year, sales were up 2% as growth in Skunk Works and F-16 more than offset a low single-digit decline on F-35. Profit declined by 1%, primarily due to lower profit adjustments.

Book to bill for the year was 1.14, leading to 6% growth in the backlog to $60 billion, with nearly 600 aircraft across all production platforms in the backlog. Shifting to missiles and fire control on Page 8. Sales in the quarter decreased 4% year over year, driven by lower volume on PAC-3, due to supplier cost timing, partially offset by production ramps on JASSM and LRASM. Segment operating profit decreased 12% year over year, as expected, due to the lower volume and loss recognition related to a classified program.

For the year, sales decreased 1% year over year as growth in tactical and strike missiles were offset by program transitions at sensors and global sustainment and integrated air and missile defense supplier cost timing. Operating profit was down 6%, due to lower profit adjustments and the classified program loss. Book to bill for the year was 1.3, leading to 12% growth in backlog to $32 billion, driven by strong demand for tactical and strike missiles. Turning to rotary and mission systems on Page 9.

Sales declined 2% in the quarter, driven by lower volume across a handful of programs within our integrated warfare systems and sensors and training and logistics systems lines of business, partially offset by higher sales at Sikorsky from deliveries of international Black Hawks. Operating profit increased 2%, mainly due to favorable contract mix within our IWSS portfolio. For the year, sales were up 1% as growth in IWSS from radar and battle management system ramps more than offset declines in the other lines of business. Operating profit declined 2%, primarily due to lower profit adjustments.

Book to bill for the year was 1.14, with backlog growing 8% to $38 billion based on strong order intake on Sikorsky platforms, as well as radar and battle management systems. On Chart 10, as expected, space growth moderated in the quarter, with sales increasing 3% year over year, driven by higher volume in strategic and missile defense, primarily from next-gen interceptor as that program advances from its successful completion of Preliminary Design Review toward the Critical Design Review milestone. Operating profit increased 31% compared to 2022, driven by higher net profit adjustments across the portfolio. For the year, sales increased 9%, with growth across all lines of businesses, and profit grew by 10% as benefits from higher profit adjustments and volume more than offset lower ULA equity income.

Space backlog grew again in the fourth quarter and remains at a solid $30 billion or almost 2.5 times sales. Now, shifting to the outlook for 2024 on Page 11. Before discussing our expectations, I’d like to highlight a few key assumptions embedded within our guidance for the year. First, based on recent progress made in budget negotiations, we assume the U.S.

government passes appropriations bills by March, consistent with the funding levels within the president’s FY ’24 budget request, equating to approximately 3% top-line growth for the DOD. On F-35, as Jim stated, we’re targeting between 75 to 110 deliveries commencing in the third quarter. In addition, we anticipate sufficient progress being made on the MFC classified program to result in the recognition of losses from two production lots, amounting to approximately 50 basis points of margin headwind against our consolidated results. With that framework in mind, we anticipate sales between $68.5 billion and $70 billion, with a midpoint that represents approximately 2.5% growth.

At the midpoint, we expect growth in three of the four segments, with MFC leading the way at 7% growth from its strong munitions backlog. At the high end, all four segments would grow. Segment operating profit is expected to be between $7.175 billion and $7.375 billion, down at the midpoint as lower expected profit adjustments and the MFC classified losses more than offset volume benefits. Excluding the MFC classified program 50-basis-points impact, underlying margins in the balance of the portfolio are expected to be approximately 11%.

Our net FAS/CAS pension adjustment declines around $400 million from last year to a little less than $1.7 billion for 2024, due primarily to lower FAS pension income. The pension headwind, along with lower segment profit and higher interest expense, lead to lower expected EPS year over year to be between $25.65 and $26.35. For purposes of clarity, on Page 12, we’ve included an EPS walk at the midpoint of the range. Benefits from volume mix provide about $0.55, with the impact of the MFC classified program losses netting down segment operating profit to a $0.35 decline.

Total FAS/CAS pension is about a $1.40 headwind, with higher taxes and interest more than offset by the lower share count. A free cash flow estimate for 2024 has ranged between $6 billion and $6.3 billion. So, bringing it all together, we expect continued sales growth in 2024 off the higher 2023 base, some profit and EPS pressure based on loss recognition timing, but with continued solid cash generation, and capping it off with another year of capital deployment. So, in summary on Page 13, we closed out 2023 with record backlog and positive momentum that will carry us into 2024, with a line of sight to sustain out-year growth in sales, profit, and free cash flow.

Of course, we will continue to invest in 1LMX as part of our strategy to ensure our people, processes, and systems remain the most advanced in the industry. And we remain committed to disciplined and dynamic capital returns to shareholders. With that, Lois, let’s open up the call for Q&A.

Questions & Answers:

Operator

Thank you. [Operator instructions] And our first question is from Myles Walton from Wolfe Research. Please go ahead.

Myles Walton — Wolfe Research — Analyst

Thanks. Good morning. I was hoping to lead off with aero and the F-35 in particular. In the margins, number one, that you’re looking for in ’24 are down about 40 basis points.

Is that primarily on lower incentives as a result of the delays in delivery? And then more broadly, for the supply chain on the F-35, given the absence of deliveries, can you continue to simply build inventory or is there a point at which you’d actually have to slow down the supply chain? Thanks.

Jay Malave — Chief Financial Officer

OK. Thanks, Myles. On the margins for F-35, what we’re seeing in 2024 are lower favorable profit adjustments. And so, it’s really twofold.

One of it is the F-35 where as we make progress on the TR3 program, as well as getting ourselves into production, it’s difficult to take risk and rely on risk retirements as we’re still facing this program and the progress we’re making there. And so, we assumed that the profit adjustments slow down in 2024 in the F-35 program. There’s also some headwinds on C-130 program where we’re seeing the effects of inflation and also some disruption related to supply chains and pressures that we’ve had there. And so, when you look at that decline year over year, you’re talking about 30 basis points that’s, say, half and half between C-130 and F-35.

On the production cadence for F-35, you know, yes, we feel pretty confident in where we are through the third quarter. And to the extent that there were any delays beyond that, we would have to revisit our production cadence at that point in time. But right now, all signs are pointing to our production and delivery restart here in the third quarter.

Myles Walton — Wolfe Research — Analyst

OK. Thank you.

Operator

Thank you. And the next question is from the line of Scott Deuschle from Deutsche Bank. Please go ahead.

Scott Deuschle — Deutsche Bank — Analyst

Hey, good morning.

Jay Malave — Chief Financial Officer

Good morning.

Scott Deuschle — Deutsche Bank — Analyst

Jay, I hate to ask on 2025, but at the high level, is the 10.5% total company margin guide for ’24, is that the right jumping-off point for thinking about ’25 or is it the, you know, 11% underlying margin or is it the 10.8% margin you did in ’23, just in terms of identifying jumping-off point for thinking about ’25? Thank you.

Jay Malave — Chief Financial Officer

Yeah. I think you do have to start at the 10.5 to jump off. And, you know, we do have a line of sight and a path to get overall back to 11%, including the absorption of these losses on the MFC classified program. But it’s going to be a gradual march back up.

And so, I wouldn’t expect that to snap back in 2025. I would expect there to be, you know, in the range of, say, 10 basis points to 20 basis points of improvement starting in ’25, and that to continue to grow at that rate until we get back up to 11.

Operator

Thank you. And your next question is from Gavin Parsons from UBS Equity Research. Please go ahead.

Gavin Parsons — UBS — Analyst

Hey. Good morning.

Jay Malave — Chief Financial Officer

Good morning.

Gavin Parsons — UBS — Analyst

Jay, what does the pension contributions schedule look like beyond 2024 and do you have any opportunity to pull that forward or use the balance sheet to offset that?

Jay Malave — Chief Financial Officer

Yeah. Good question. That’s something that we’ve contemplated. Just where we are from a baseline perspective, zero contributions required in 2024.

2025, we’re looking at in the range of about $1 billion of required contributions there. And so, you know, we’re always looking at whether or not there’s an opportunity to pull forward. As you mentioned, the utilization of our strong balance sheet to potentially do that. We haven’t made any firm decisions on that, but that’s definitely an opportunity that’s under consideration for us.

Gavin Parsons — UBS — Analyst

Thanks.

Jay Malave — Chief Financial Officer

Yup.

Operator

Thank you. And our next question is from the line of Pete Skibitski from Alembic Global. Please go ahead.

Pete Skibitski — Alembic Global — Analyst

Hey. Good morning, guys.

Jay Malave — Chief Financial Officer

Good morning.

Pete Skibitski — Alembic Global — Analyst

Jim or Jay, can you give us a sense for how much the ’24 guide is impacted by what looks like a, you know, on the order of a six-month delay here to the government’s budget and, you know, still a little bit of a lack of clarity on the supplementals?

Jay Malave — Chief Financial Officer

Yeah. For the most part, Pete, it’s not really impacted significantly. You know, in our case, we’re able to build up inventories, and then as we get the funding, we’re able to take that to sales. And so, for the most part, we’ve kept all of our processes intact.

That becomes more difficult if the process extends beyond March. And that’s why I was very clear in my comments that we’re dependent on this happening that the budget getting clarity and finalization in March because going beyond that makes it very — just makes it difficult for things to get on contract, and you run out of runway in the year to convert those into sales.

Pete Skibitski — Alembic Global — Analyst

OK. Appreciate it. And then anything on big awards you’re expecting in ’24 and maybe the timing of NGAD?

Jay Malave — Chief Financial Officer

Well, just some key things that we’re talking about from sales perspective, you know, Lot 18 and 19 is a big one for the F-35 program. We also have some long-lead F-35 awards that we would be expecting as well. We’ve got things — there are some classified contracts across the portfolio. I can’t really get into any beyond that.

But you’re talking multibillions of dollars there that we have in our order plan for this year. There are things like PAC-3 orders, which is multiple billions of dollars there for FY ’24 requirements. And also, I would say hypersonics at space, particularly on CPS, is another one that can approach $2 billion. So, there’s a number there.

You know, as those get kicked off in the year, we’ll certainly report on those and keep you apprised on the progress.

Pete Skibitski — Alembic Global — Analyst

Thank you.

Operator

Thank you. The next question is from the line of Jason Gursky from Citi Research. Please go ahead.

Jason Gursky — Citi — Analyst

Hey. Jay, just a quick clarification and one for Jim, and sorry if I missed this. But the deliveries that you’re expecting for the F-35 this year with the acceptance on T3 happening potentially in the third quarter, can you discuss a little bit about the cadence throughout the year? Do you expect to deliver some F-35s through — throughout the year and maybe, you know, the older version of it in the first half of the year? Just trying to get a sense of whether you’re truly doing 75 to 100 aircraft in the second half of the year and what does that tell us about, you know, the potential for deliveries in 2025. Can you get to 200 in that year as a bit of a catch-up? And then, Jim, for you, just overall expectations on, you know, bookings, book to bill for this next year based on the pipeline that you’re seeing, and maybe just kind of update us on your current thoughts on the competitive environment and, you know, fixed price versus cost plus and how you — how the industry and you all specifically are kind of reacting to the contracting environment and what’s being asked of you and whether you’re toggling back more toward less risky programs? Thanks.

Jay Malave — Chief Financial Officer

So, let me get into the deliveries, Jason. You know, we do have a handful of deliveries we expect in the first half. But for the most part, you’re talking, you know, 90% of the anticipated deliveries actually will happen in the back half of the year. And so, I think that’s just the way to think about it, just a handful, really, in the first half.

You know, maybe I’ll kind of give a little bit of color and then hand it over to Jim on — for the year, we still expect there to be strong demand and we have a pretty solid line of sight to a book to bill that would be above 1 yet again in 2024. And so, you know, obviously, these things have to materialize, the budget has to be approved, and all these things have to happen, but the line of sight is there for continued growth in orders, as well as in our backlog. A couple of things, too, and just on the question about cost plus. The interesting thing is that part of the margin pressure that we saw in 2023 was due to mix.

Our percent of sales of cost-type contracts went from 38% in 2022 to 41% in 2023. That in itself caused some margin pressure, about 20 basis points, relative to what we were anticipating in the year. And so, we’re actually seeing an uptick in cost plus contracts, which we think kind of bodes well in terms of risk tolerance in the way some of these stronger technological types of programs will be contracted for. And so, I think that is a — generally speaking, a favorable trend.

Well, the other thing that we’re — you know, just to talk about what we’re thinking about contractually, and Jim has really led the way here, is that we just are employing a lot more pricing discipline than we have more recently, and we’re looking at things and ensuring that there’s just more analytical support for the way we approach pricing, that we capture any types of technological advantages that we may have. Also that as we make an assessment of risk, A, the contracting vehicle is appropriate to that risk, but then our pricing accounts for that risk as well. And so, that’s the way we’ve been approaching things for, really, this year going into 2024. And I’ll hand it over to Jim.

Jim Taiclet — Chairman, President, and Chief Executive Officer

Yeah. Sure, Jay. So, look, there’s a near-term and a long-term approach that we’re taking to government contracting with industry. And the near-term piece of it is a lot of what Jay just described, really matching the pricing and the risk profile within our company, I’ll say.

Now, I don’t know what other companies are doing or how they’re making their decisions. But, you know, we’ve recognized and I’ve said to our senior customer base, you know, that look, we’re in a monopsony environment here, meaning there’s a single buyer, you know, for the most part for almost everything that we make or Boeing Defense makes or General Dynamics makes. And, you know, to, I guess, the government’s credit in one — in a way, they’ve been taking advantage of that monopsony power, if you will, over the industry. And what’s happened as a result of that over the last number of years or even decades is you have lots of programs which are over-cost, cost overruns, right, whether fixed price or cost plus, and you have schedule delays because what that monopsony environment can do is give so much power to the buyer that some of the competitors feel that they’re must-win programs for them that they will take, you know, tremendous risk on costs and pricing and tremendous cost on the ability to technically deliver these capabilities.

So, when you multiply those two risks together, you get a lot of cost overruns, a lot of schedule delays, programs, you know, reviewed by Congress, etc. So, I’ve been advocating in the near term and certainly implementing with our company, we don’t have any must-win programs with Lockheed Martin anymore. If we have a good business opportunity with a balanced price-risk profile, we will bid. If not, we will not bid.

If we hit our limit parameters, we won’t go beyond those. A competitor may win, so be it. And so, that’s our near-term approach to this. The longer-term approach is in addition to delivering products that we and our cohorts in the traditional defense industry do so well, we need to start migrating toward delivering capabilities, right? So, capability would include either products that are already fielded and/or new products, but especially digital technologies, which is why we are collaborating so — with so much effort with commercial tech companies large and small because we can value price capabilities, right? If we sell products, and that’s all we do as an industry, we are kind of locked into the FAR, the Federal Acquisition Regulation, as it is written today, which means even at fixed price contract, you’ve got to provide all your cost information, right, and you have to do it often every year, even with a multiyear fixed price.

And there can be adjustments. So, we want to move, you know, as briskly as we can as an industry with our commercial partners to their kind of pricing, which is value-based subscription. That’s going to take time. It’s going to take changes in government.

It’s going to probably take literally acts of Congress to do it. But that will be the thing that will make our industry healthier on one hand, the traditional defense and aerospace industry, but it’ll also invite in the commercial tech companies who are basically, if you look at the broad scope, investing 10x what we are in R&D. And we want to bring a lot of that 10x R&D and all that talent over into the Defense Department as part of their supply chain, but it’s really tough under the FAR for those companies to put time and attention and effort into DOD. So, that’s the long-term — a long-term solution, but the near-term solution will also continue.

Operator

Thank you. Your next question is from Doug Harned from Bernstein. Please go ahead.

Doug Harned — AllianceBernstein — Analyst

Good morning. Thank you.

Jay Malave — Chief Financial Officer

Good morning.

Doug Harned — AllianceBernstein — Analyst

As you look at Tech Refresh 3, this delay, and then going longer as you really want to build out the full kind of Block 4 capabilities, which continue to seem to expand, you know, first, as Tech Refresh 3 takes longer and then as you look toward the kind of multiyear trajectory on Block 4 implementation, how do you see delays here affecting your production rate knowing that you’ve been trying to produce sort of at the full 156-type rate, but, you know, can that continue as you look at these challenges, if they get more difficult?

Jim Taiclet — Chairman, President, and Chief Executive Officer

You know, look — Doug, it’s Jim. I think we can continue at this rate. You know, demand from the U.S. services and our international customers, you know, air forces, navies, etc.

around the world is they need the aircraft, right? They’ve got to recapitalize the planes that they’re still flying that I was trying to get when I went to pilot training in 1983, right? So, this is essential that this production line keep up. It’s the — basically, it’s the recapitalization of the allied fighter aircraft force is the F-35. And so, I think the key to that is full transparency and, you know, realizing the reality of the situation. When you’re trying to drive this much technology into an air vehicle, you’ve got to be honest about the schedule.

What can industry do, what can the test and evaluation community handle in the various militaries to accept that technology, and what’s the supply chain capacity? And we’re being, you know, brutally honest with the — our services and our joint program officers to what we think industry can do with us and our airplane. And industry is who makes the radar. Industry is who makes the EOPs, the electrical optical system. The industry is who makes the electronic warfare suite.

It’s not us. So, we have to be brutally honest as an industry and with our suppliers’ inputs to that with the government and say what is feasible to keep the production rate up. I think that’s starting to get traction. I hope it gets more traction because we cannot afford to be over-optimistic in the ability to deliver these technologies as rapidly as one might like.

There are real technical and physical challenges to doing this. And our commitment to the government, need of the service chiefs and our allies is I will tell you honestly what we think industry can do with the jet. And if you want to push it beyond that, I’ll tell you what the risks are and what the cost might be to do it. But let’s agree on a feasible executable plan for exactly, Doug, what you talked about.

Operator

Thank you. Your next question is from Sheila Kahyaoglu from Jefferies. Please go ahead.

Sheila Kahyaoglu — Jefferies — Analyst

Good morning, guys. Jim, I don’t want to talk about what happened in 1983, but in terms of the puts and takes for MFC, if you could just talk about the 7% top-line growth you guys have, what are the biggest program drivers there between missile defense and tactical and defend the margins you’ve already, you know, highlighted, the 50 bips from the classified programs. Are there any offsets? And I really appreciate your commentary about the government and how you plan to sell to them. So, I was just thinking where do you think that’ll manifest itself in its portfolio — in your portfolio the fastest? Is that MFC? And specifically, can you give any specifics?

Jay Malave — Chief Financial Officer

Yeah. Sure. I’ll start with the growth drivers. And, you know, for MFC, they’re what you would expect, tactical and strike missiles.

So, the guided weapons, the HIMARS, JASSM, LRASM. All those will continue toward their march toward these ramps for — by 2025 and, in certain cases, 2026 and 2027. So, that is the largest driver of the growth. And that’s followed by integrated air and missile defense really on the back of PAC-3.

So, we’ll start seeing a more significant spike in PAC-3 activity and deliveries over the next few years here as we get to 550 by 2025 and then ultimately 650 by 2027. So, those are the two — really the two businesses — the lines of business within MFC that are going to be driving it, which is really should be no surprise.

Jim Taiclet — Chairman, President, and Chief Executive Officer

And when it gets to — you know, moving toward a value pricing model, Sheila, the first place that’s already starting to happen is in command and control, command situational awareness, information advantages our customers would call it. So, those are largely digital services, right? You know, you’ve got, you know, sensors on satellites, aircraft, ships, radars out, you know, scanning the sky, infrared sensors in space, you know, looking for plumes of heat when a missile is launched, things like that. That’s data, right? So, how do we gather all the data from our sensors, whatever domain they happen to be, in land, air, space, etc.? How do we make intelligent data fusion and then present commanders and decision-makers with options using AI and other digital services? So, yeah, this will be probably the first place where we can value price because my goal is to bring in commercial technology to do that digital data fusion evaluation, AI application, etc. As I said a minute ago, commercial industry is investing, you know, 10x what our aerospace and defense industry could invest in these areas, and we need to take advantage of that.

The only way they’re going to participate in a material fashion in that industry is value pricing. They’re not going to provide cost information. It’s just not how their industry works. You know, they’re not delivering an airplane that you can add up all the costs that it took to make that airplane and give it to the government so they can give you the margin on top.

So, these command and control systems. And they’re real programs, by the way. Defense of Guam is a program like this. AIR6500 is one that I mentioned.

And also, something called Joint Fires Network, which will be deployed in the INDOPACOM command of the U.S. So, this is where I think it will start. And then as we look at mission road maps that we’ve established and drawn out inside of Lockheed Martin and we’re now sharing and have been sharing with the U.S. services and DOD, we’re looking for capability gaps where digital technology can really make a difference, right? So, I’ll give you one really quick one.

So, if we could get a direct feed from, you know, an orbiting satellite scanning a wide swath of the Pacific to find ships and actually directly provide that data link and that information to aircraft flying in the area, then those aircraft can vector toward those targets and turn on their radars and get a much more precise location and maybe even a tracking solution to sink the ship, if that’s what’s needed. And so, that’s a mission gap, a capability gap that we would have in an anti-ship mission. And so, you know, how do we value price that because that’s basically a data management exercise, which requires what we call 5G.MIL? It requires an artificial intelligence solution within it, and it requires, you know, the management of that data at various classifications, which is something, you know, not many companies can do, besides those in our industry. So, we can value price something like that.

And I think it’d be a capability gap that would be interesting to the Department of Defense and they might accept value pricing. But, you know, not to take too much time on this topic, but one of the things that we’re really advocating for at Lockheed Martin, and we’ve got some friends of the court that are trying to work with us on this, is how do we set up an adjacent acquisition process in the Department of Defense to its traditional acquisition process, designed and reconstituted and originated to purchase digital services versus platforms and products, which is what the traditional acquisition system is built to do. That is a heavy lift. It is very complicated.

It’s what I kind of referenced earlier where you’re literally going to need an act of Congress to do this. But if we want a value price as an industry, bring in commercial partners at scale, I think the government needs to consider and actually go do this with us.

Jay Malave — Chief Financial Officer

Let me just circle back, Sheila, on the margins in your question. I’ll use MFC as an example in 2024. When you look at their headwind, their headwind is about 200 basis points of margin compression in the year 2024. The MFC classified program is actually accounted for 230.

And so, the rest of their business is actually expanding by 30 basis points. And so, they’re doing everything we would expect them to do in their core business. In general, across all of Lockheed Martin, the way we’re approaching these headwinds is really threefold. First, we’re just keeping a tight lid on overhead and indirect costs and streamlining that cost structure where the opportunities exist.

The second is we’re driving cost reduction in our direct cost base through supply chain optimization, factory productivity, and also 1LMX-driven efficiencies. And then lastly, we talked about a little bit earlier in the call is just making sure that we’re employing pricing discipline across our bidding proposals. And so, those three together will help us drive to a better result in the future and give us confidence that we’ll be able to expand margins, even with these headwinds.

Operator

Thank you. Your next question is from the line of Seth Seifman from J.P. Morgan. Please go ahead.

Seth Seifman — JPMorgan Chase and Company — Analyst

Hey. Thanks very much and good morning, everyone. Maybe one clarification and one question. Jay, on F-35, at the end of ’24, should we think about there being maybe 120 undelivered aircraft in inventory based on, you know, the production rate of, you know, 150-plus and the deliveries you’ve told us? That’s the clarification, and that inventory will have to be worked out over the subsequent year or two? And then as far as the question goes, I think you talked about 10 basis points to 20 basis points of segment margin expansion in ’25.

You know, if we thought about only one lot exercised on classified missile, that’s probably 25 basis points. The margin in aeronautics seems pretty depressed in ’24. So, you know, you’d think there may be some potential for expansion there. And you just talked about the efforts that you’re making across the company to support margins.

Are there other discrete headwinds that we’re not aware of that wouldn’t allow — you know, that would prevent more than that kind of 10 basis points to 20 basis points that you outlined?

Jay Malave — Chief Financial Officer

Yeah. Let me start with that question first, and I’ll come back to the F-35. Just on the 2025 margins going forward, yes, it would be essentially one lot versus two. However, you got to take into account the volumes that are in that lot versus the volumes that were in these first two lots.

And so, you really — if you think about it from a gross headwind, it doesn’t necessarily change all that much because you’re — there’s more in there. And so, that’s what’s keeping the pressure. You know, there’s not just an automatic lift because we’re going from two lots to one lot in a subsequent year. On the F-35, I mean, I think what you — the way you talk about it, Seth, is right.

Anywhere between 100 to 120 aircraft is — in terms of undelivered against the 156 type of expected delivery rate is the right way to think about it, yes.

Operator

Thank you. The next question is from the line of Ron Epstein from Bank of America. Please go ahead.

Ron Epstein — Bank of America Merrill Lynch — Analyst

[Audio gap] question —

Jay Malave — Chief Financial Officer

Hey, Ron.

Ron Epstein — Bank of America Merrill Lynch — Analyst

So, I’ll do the question first. What are you thinking about the opportunity for the Black Hawk going forward? Meaning, I don’t know, we’ve kind of heard there’s some challenges on future vertical lift. And what opportunities does that open to you for the Black Hawk?

Jim Taiclet — Chairman, President, and Chief Executive Officer

Ron, it’s Jim. Look, the Black Hawk — and, you know, I’ve gotten to fly it autonomously and by hand, actually. I think it has a lot of potential. There’s an interest in Congress for modernization of the Black Hawk.

There’s a huge fleet out there. And by adding some of these digital capabilities like autonomy and AI to the Black Hawk, which is a really reliable platform that’s offline, in units today in great numbers and across our allies, that’s a real, I think, value opportunity for the armies and rank corps and others that use the helicopter. So, I do think there’s a lot of upside there. I don’t want to comment on anybody else’s programs or how well or not they may be doing.

But this is a proven scaled vehicle which with digital technology upgrade and insertion can be very, very versatile. And that can be done much more rapidly than new production of new aircraft. So, I do think that there’s upside there. Now, the services and Congress have to agree to that and fund those modernizations and keep those units flying, and that’ll be up to them.

But we are trying to provide them every opportunity to make that decision by inserting digital and other technologies like autonomy that will really make the aircraft much more capable in doing missions like air evacuation, resupply of a hot landing zone, things like that, that when you put it into the entire equation of completing a mission, it will be a good value to consider it.

Operator

Thank you. And our next question is from the line of Kristine Liwag from Morgan Stanley. Please go ahead.

Kristine Liwag — Morgan Stanley — Analyst

Hey. Jay, Jim, I mean, there’s been discussion in the public markets about the depletion of U.S. missiles and munitions and a potential shortage. I mean, that said, from your commentary today, it sounds like supply chain issues continue to linger, weighing on the company’s ability to convert the demand into revenue.

So, can you talk more about the additional actions you’re taking to improve the supply chain’s ability to get products through the system and what metrics are you monitoring and how much upside could you see in 2024 if things improve?

Jim Taiclet — Chairman, President, and Chief Executive Officer

I’ll make a couple of comments and ask Jay to follow up. The steps that we’re taking to take the fragility out of the missile production system are varied. One of them is, and it’s very specific, we are endeavoring to stand up a third solid rocket motor supplier in the United States that can be additive to the industry supply chain we have today, which hasn’t been performing well, right? That’s one piece. More broadly, we’re using additive manufacturing and we’re bringing in more varied suppliers into the supply chain so that we can get the materials we need from a more diverse set of group of suppliers outside of solid rocket motors.

And also, we’re looking at international opportunities to build this equipment, including in Australia and in Poland, and U.K. and others that are kind of untapped for co-production or joint ventures with us to do these things. And Germany I should mention as well. So, these are some of the approaches we’re taking.

And it really comes down to these three areas which is how can we, on one hand, take basic steps in anti-fragility to more suppliers, more diversity on the supply chain. Different labor pools, better training, those kinds of things which are just basic. Secondly, how can we insert technology to make this a more reliable production system, which we just mentioned? And then thirdly is how do we get international countries and take advantage of their labor forces, their supply — sub-supply chains, etc. and get them into the production system? So, we look at this in all three areas of our core company strategy and apply it to missile production.

Jay, anything you want to add?

Jay Malave — Chief Financial Officer

Yeah. I’ll just say, you know, over the last year, Kristine, you know, we’ve deployed resources. So, we haven’t just sat back and waiting for improvement. Depending on the supplier, depending on the issues, we have deployed manufacturing engineering resources, we’ve deployed quality engineering resources and program management resources, as well as, in certain cases, we’ve actually deployed hourly workers to support suppliers in certain cases.

And so, we’ve taken a all-hands-on-deck approach where we’ve seen the issues become more significant, and we’ve done everything we can to support these suppliers and help them get through. I would expect that to continue where we see, you know, these bottlenecks. But as I mentioned earlier, we did see some general improvement. We are expecting that improvement to continue.

And, you know, in terms of potential upside, what I would point you to is that if we’re able to unlock and see a little bit better performance, then that would drive us to the high end of our sales profit and EPS range.

Operator

Thank you. Our next question is from Matt Akers from Wells Fargo. Please go ahead.

Matt Akers — Wells Fargo Securities — Analyst

Yeah. Hey. Good morning. Thanks, guys.

Could you tell us on F-16 real quick just the latest thoughts on the ramp rate here and also just margins on that program, how that compares to the segment now, and then sort of, you know, do they get better over time as you kind of come back down the learning curve?

Jay Malave — Chief Financial Officer

Yeah. So, we delivered five aircraft in 2023. We would expect that to triple, potentially quadruple here in 2024. And so, we’re — the ramp is in — certainly in full force.

We’ve got over 30 aircraft there in WHIP as we ended the year. And so, you know, that is — I think from a delivery standpoint, increasing the production cadence has all — is all trending well. From a profitability standpoint, you know, you may recall, we’ve had some pressure because it’s taken us longer to get to this point. And so, that puts some pressure on our initial contracts.

Here, as we fully deliver those out and deliver on the subsequent contracts, we will see profitability improve on the F-16 over the next few years.

Operator

Our next question is from the line of George Shapiro from Shapiro Research. Please go ahead.

George Shapiro — Shapiro Research — Analyst

Yes. Hello.

Jay Malave — Chief Financial Officer

Hi, George.

George Shapiro — Shapiro Research — Analyst

I was looking at a longer-term perspective here. If I look at the margins like from 10 years ago, you know, MFC made 18%, aeronautics made 11%, space made 13%. And so, we’re obviously down in all of those categories overall, maybe 200 basis points from 10 years ago. So, my question is, was this due to a lot of the fixed price development, more aggressive bidding, and now, you’re trying to change that so when we look toward 2025, we actually could see margins go up from where they’d be in 2024, or kind of are they just lower margins overall that we expect to see from what we used to see?

Jim Taiclet — Chairman, President, and Chief Executive Officer

George, hey, it’s Jim here. I think the story I told a little bit earlier today is what caused that. There’s margin compression in the whole industry here, you know, driven by the monopsony customer. So, you know, they got pretty good at figuring out how to use their position, you know, in the quarter analysis of how they should negotiate contracts.

And what I think you’re seeing is, you know, boards and management of companies in our traditional space, I’ll call it, are understanding this now. The management tends to not necessarily — senior management tends not to necessarily be historically wedded to this business model and looking at other ways to run these companies. And so, we are taking the shareholders’ interest into account and all the things we’ve talked about, which should help improve our margins, even though it may result in some, you know, difficult discussions with some of the customer base. We’re prepared to do that.

But I think over the last 10 years, as you said, there’s been a decline, and it needs to reverse to have a healthy industry.

Maria Lee — Vice President, Investor Relations

OK. Hey, Lois, I think we’re at the top of the hour, so I’m just going to turn it back over to Jim for some final thoughts.

Jim Taiclet — Chairman, President, and Chief Executive Officer

OK. Thanks, Maria. So, over the past 12 months, again, I mentioned the people of Lockheed Martin have worked relentlessly to advance this vision we have for 21st Century Security and transform our company internally, and they created, produced, and delivered cutting-edge capabilities that are focused on what the Defense Department says is its own strategy that they call integrated deterrence. And we’re trying to maintain our company values along the way, and that’s to do what’s right and respect others and perform with excellence.

And all this yields positive results for our employees that work here, our customers and our suppliers, and especially our shareholders. So, thanks again for joining us today, and we look forward to speaking with you on our next earnings call in April. Lois, that concludes the call. Thank you.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Maria Lee — Vice President, Investor Relations

Jim Taiclet — Chairman, President, and Chief Executive Officer

Jay Malave — Chief Financial Officer

Myles Walton — Wolfe Research — Analyst

Scott Deuschle — Deutsche Bank — Analyst

Gavin Parsons — UBS — Analyst

Pete Skibitski — Alembic Global — Analyst

Jason Gursky — Citi — Analyst

Doug Harned — AllianceBernstein — Analyst

Sheila Kahyaoglu — Jefferies — Analyst

Seth Seifman — JPMorgan Chase and Company — Analyst

Ron Epstein — Bank of America Merrill Lynch — Analyst

Kristine Liwag — Morgan Stanley — Analyst

Matt Akers — Wells Fargo Securities — Analyst

George Shapiro — Shapiro Research — Analyst

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