Lockheed Martin Corporation (LMT) Earnings Call Transcript & Summary

Good afternoon, everyone, and welcome back to the Barclays Industrial Select Conference. I'm David Strauss, aerospace and defense analyst here at Barclays. And we're pleased to have Lockheed Martin as our next presenting company. And we have Ken Possenriede from Lockheed, the CFO; and Greg Gardner from Investor Relations. Just in terms of housekeeping items, again, on your screen on the side, you should see audience response questions. We appreciate if you took the time to respond to those. And we're going to share the details of those when we conclude the conference later today. So with that, I'm going to turn it over to Ken for a second, and then we'll get started with the Q&A session. Ken, thanks for coming, and go ahead.

Hey. Thank you, David, and good to be here. So yes, I have a housekeeping matter as well. So it's our forward-looking statement that you can refer to in our filings. So statements that I'll be making today in today's conference that are not historical fact, they're going to be considered forward-looking statements and are made pursuant to the safe harbor provisions of the federal securities law. And actual results may differ materially from those projected in the forward-looking statements. And as I stated, please see our SEC filings for a description of some of those factors that may cause actual results to differ materially from those in the forward-looking statements. So thank you, David. Over to you.

All right. That's great to have that out of the way. So let's start at a high level, Ken. I want to touch on a little bit your guidance for this year and then think a little bit further out. So with the potential for growth to slow, that's a big topic. I'm sure you've heard about it already in meetings. You, along with others, seem to be pointing to this idea that you can outgrow whatever the budget does do. Just talk about that and the potential for that in the context of your domestic portfolio as well as the international side.

Sure. Happy to. And like I said, great to be here. Wish we were in Miami, though. Maybe next year, David.

Or years from now.

So at this stage, as you said, we do see budgets are flattening, but I'm going to state it's still a solid number. When you look at the threats, we believe we see the landscapes as still requiring significant investment in defense and security. These concepts in the national security and defense strategies, they continue to apply, and we think Lockheed Martin is very well positioned to address those issues. And for us, it starts with our backlog. And you've heard me say this in the January call, it's at over $147 billion, which was a year-end record. In fact, how we're seeing our bookings this year playing out, we'll have record backlog to end the year as well. Still, really historically strong number. And if I went back and I looked at 2017, the end of 2017, our backlog ending 2020 was 40% higher than what it was back then. So we have seen strong growth specifically to burn that out for the future. So even if the budgets look to flatten, we have -- we've seen strong support for our portfolio on the Hill. And specifically, the FY '21 DoD appropriations that was just signed last month, in there, there was 17 F-35s added, 9 C-130Js. There were some additional CH-53Ks and Black Hawk helicopters added. And there's a strong interest in an eighth THAAD battery. So we see strong congressional support for our portfolio. And just to remind folks, on the last call, we guided to sales growth of about 4% in margins at the midpoint of 11% and cash from ops, and this is after we're going to do another billion-dollar pension contribution in 2021. We're going to have cash from operations after that of $8.3 billion. And this comes after 1 more victory lap for 2020. Year-over-year, we grew sales at 9%. And with our cost takeout initiatives, we were able to grow earnings at 9% as well in 2020. And all this, I'd say, reflects some very strong performance even in an environment of slower-growing budgets. And just for completeness, you asked about international. So just some comments on that. You've probably seen in our 10-K that we filed last month, international sales were about 25% of our portfolio. And historically, we've had sales in the roughly 27% to 29% range internationally. So this was a little lower than that. But looking out at our long-range plan for orders this year and following years, we're projecting a percentage a little above that range. And that's primarily due to aero. So think F-16, C-130 and F-35. But I'd be remiss if I also didn't talk about integrated air missile defense, PAC-3 and THAAD. We're seeing strong demand there. And then we have some international opportunities for our heavy-lift helicopter, the CH-53K. So we should still see some strong international sales continuing. So I'd say considering all these elements, we believe the building blocks are there for some solid continued growth for us.

So if I look back at the last time we went through a budget downturn, you had the F-35 really starting to take hold and grow. And you actually did outperform from a top line perspective. But more importantly, you did a great job in terms productivity, margin improvement, and you kind of led the way in terms of capital deployment and really focusing on the dividend. So how do you kind of view that opportunity this time as we come into, at least probably, a slowing budget environment? So in other words, how do you see opportunity from a productivity, cost-saving, margin opportunity? And then from a capital deployment standpoint, obviously, your dividend in absolute dollars is much, much higher today. So fair amount of pieces to that question, but why don't you go ahead?

Yes. So yes, we're -- we have embarked on a cost competitiveness initiative for the last couple of years. Actually, it started under our former CEO, Marillyn Hewson, and Jim's picked it up. We actually had a dedicated executive, still do. And again, not to be redundant, but it does start with the backlog. And if you think about 60% of our backlog as fixed price, when we take costs out of our portfolio or for the future avoid costs from occurring, in the short term, that is going to go to our bottom line. And long term, it's going to make us more competitive. And we're still very focused on that, David. And I think there's lessons learned to come out of this whole COVID experience. If you look at our population, we have about 114,000 employees. And right now, we have about 55,000 of them, including me, working from home. And in fact, if you just look at my organization, we have closed the quarter and closed the year from an accounting standpoint remotely virtually. So a lot of those individuals do not have to come back to work in the office full time. And in fact, some of them may only come in the office periodically. So we're being very thoughtful about our square footage. We've got about 70 million square feet that we either own, lease or are government-owned and contractor-operated. And we're being very thoughtful about looking at our footprint and trying to take out, I'm going to say, millions of square feet going forward just because we're going to have folks that just aren't in the office, and we're going to go to a hoteling concept. And the other thing we're also really looking hard at is travel. And does it make sense going forward for us to travel as much as we did pre-COVID? We've proven we can operate very effectively and spending a fraction of those costs on travel during this COVID. So we challenge ourselves to reduce our travel post-COVID to just not go to pre-COVID levels. So a lot going on there, and I know we're excited to see where this goes. Just regarding capital deployment and financial strategy, we still haven't finalized our financing strategy, and that's specific to Aerojet Rocketdyne. But big picture, we're a $100 billion market cap company, and the cash that's needed for a transaction the size of Aerojet Rocketdyne is around $4.5 billion. We have the cash on the balance sheet to go do other things that I'll talk to in a second. We have a strong history, David, of providing a strong dividend, and that is still at the top of our list. The Board approved an increase in September of over 8%, and that was the 19th consecutive year that we've increased our quarterly dividend. I'd also say part of our long-term strategy, we're going to keep investing in organic capital expenditures to build out our capacity to deliver on our core products, to build out our facilities that -- and we're going to need to deliver on those products in the future. So for example, we're making investments in Palmdale, California, and Marietta, Georgia, right now so that we can drive some of our leading-edge technology into production and really help our customers scale to that. And alongside those CapEx investments, we're also going to continue to invest in R&D that's important to us to sustain our technological leadership. And again, both in traditional or defense-centric areas, such as hypersonics and also more commercial areas, such as networking. So I'd say those first 3 are: it's dividend, it's CapEx and R&D. And we've also taken a lot of actions over the past couple of years to strengthen our balance sheet, and that gives us a tremendous optionality in a variety of areas. And overall, our capital position remains very strong. You know this. We have very minimal debt. We continue to reduce our pension volatility with the buy-in and buy-out initiatives that we've embarked on in the past. And we've been generating solid cash flows. And a result of that, we've got top ratings from our creditors. And I'll add that we've guided to at least $1 billion of repurchases again this year, and we have about $3 billion in repurchase authority from the Board. So just step back, last year, we were very sensitive to increasing our buybacks during the pandemic with everything going on regarding the CARES Act and progress payment benefits. I think that was appropriate. This year, though, we'll work through the priorities that Jim Taiclet, our CEO, has laid out. We'll see where it plays out. We're -- right now, we're opportunistically buying back stock. I'm still going to guide to the $1 billion, but we'll see where that goes. And absent any investment opportunities that drive growth, we'll look at other options like buybacks. And we've said it before, if we don't see -- we don't see a benefit in growing our cash on our balance sheet.

Great. So wanted to talk about the Aerojet. So Aerojet was doing -- or is currently doing about $2 billion in revenue, $300 million EBITDA. You obviously have this fee-on-fee issue. If we were to think about what -- before we start talking synergy, revenue and cost synergies, what does that look like as part of Lockheed given this fee-on-fee issue?

Yes. So I'd say, first, this is a long-term strategic opportunity for us. We've -- with Aerojet being a leading propulsion provider, we think having them as part of the company will help strengthen our tactical missile and air defense lines of business. We also believe we will find engineering benefits by bringing these propulsion systems more closely integrated into the overall contract and the overall design of our missile and rocket products. And frankly, this should help be a value to customers from an efficiency perspective, tighter engineering integration and better production planning. And we believe there are a lot of operational benefits to bringing together the propulsion system with the rest of our integrated product.

Okay. And yes, any sense of how we should be thinking about this fee-on-fee issue and what it does to the financials for Aerojet as part of Lockheed?

Yes. Really, what you -- what we got to talk about is we think, on the whole, we're going to make Aerojet Rocketdyne a better merchant supplier. I know you want to talk about fee-on-fee, but there are other customers out there also. So I think all customers, including Lockheed Martin, are going to see a lower cost from this transaction. And also, they're going to see a better -- frankly, a better quality of product. They're going to see enhanced capabilities and increased innovation. And we're hopeful to turn some of our hypersonic development work into production contracts down the road. And we see Aerojet Rocketdyne as playing a key role in making these weapons more effective. And ultimately, downstream, we're hoping to see some revenue synergies here as well. To answer your question, for cost synergies, as we see it today, notionally, we've estimated about $100 million of annual gross pretax cost synergies in the first couple of years. And then it's ultimately going to ramp to about $150 million. And think of these items as coming from advanced manufacturing initiatives, supply chain management, I would say administrative costs you normally see in an operating -- a public company and back off the savings that we're not going to need. We also look to gain synergies in more operational areas that may or may not result in cost savings. We'll see. And think of those as in the area of IRAD, CapEx and some program performance areas where we have greater commonality. But the punchline is, we see these cost takeout initiatives that we're focused on as -- and increased efficiencies as more pro-competitive and not anticompetitive. And one other point I'd make is, we can invest more in Aerojet Rocketdyne capabilities than if they were a stand-alone company. And I'd also say, Aerojet Rocketdyne would be -- is going to be a more reliable supplier as part of Lockheed Martin than it would be as an independent supplier. And I -- the other point I'd make, David, is -- I'd stress is we have every intention of continuing to be a merchant supplier across our industry. And we're going to continue to play fair, and we're going to be a very effective supplier for all of our defense primes. And as a merchant supplier under Lockheed Martin's ownership, the business plan -- our business plan, frankly, is to offer it to all customers, and that was part of our valuation. So we think, with the revenue synergies and the cost synergies I just described, this is a very compelling story for Lockheed Martin and for the other primes and the ultimate customer, the United States government and our partner nations.

Wanted to touch on cash and the outlook there. So you've done a great job of continuing to grow operating cash flow despite increasing headwind on pension. Working capital, it looks like it's been a bit of a headwind. Going forward, how do we think about working capital? We obviously don't know all the moving pieces within your operating cash flow forecast. But it would seem like maybe you're counting on or you think you're going to some -- to a certain extent, unlock some of this working capital that you've built up over the last couple of years.

Yes. You got it. And you're right. We did outlook strong cash flow this year. And I tried to give the Street a glimpse into '22 and '23 because we do think we have line of sight there. And we expect at least $8.3 billion in 2021, as I mentioned earlier. I guided $8.7 billion in 2022, and that's after a $700 million pension contribution. And then approximately, I think we're going to hit $9 billion in 2023, and that's again, after about an $800 million pension contribution. And if you go back to the October time period, this is about a $900 million improvement over those 3 years from our last outlook. So we worked very hard on this. And that's -- I'd say that this kind of cash generation is really a reflection on the outstanding operational performance we're seeing across all 4 of our business areas. We put an emphasis across the company to run more efficiently and minimize working capital, and we think it's showing, David. And as CFO, I could say this just isn't my organization, the financial organization doing this. It's frankly broad-based, and it's been embraced across the corporation. We're working hard to get our cost -- our product set out of the factories and into the customers' hands, speeding up production cycles the best we can and getting payments in faster. And we're always looking to get advanced payments when we sell direct to our international customers. So we're attacking working capital from many angles. And not to complicate this, as I said, I gave you the pension number. So I probably can move on from that. And just on the pension side, we're still looking at that. But from a cash standpoint, for '21 cost accounting standards, we're seeing about $2.1 billion. And going forward, it's probably a little bit higher than that, rough numbers by about $100 million, and then we'll start seeing a tailwind there. And just as a reminder, which is a good news story, we've got about over $8 billion of pension prefunding credits to recover through those CAS, billings and collections, and that's part of that CAS dynamic that I just mentioned.

The R&D capitalization issue doesn't make a lot of sense to me that CRAD potentially gets captured in this. But are you seeing any traction on that on the Hill? I mean obviously, we have an administration change, but any traction to maybe just at least eliminate the CRAD portion? And I mean does this kind of drag out to the last minute as we get kind of close to the end of the calendar year?