Lockheed Martin Corporation (LMT) Earnings Call Transcript & Summary

Okay. There we go. All right. Good morning, everybody. It's Noah Poponak from Goldman A&D here. Thanks for being with us on day 3 of our conference. I'm going to keep it moving along out of my sector coverage with our next presentation from Lockheed Martin. Very happy to have with us from the company, the CFO, Ken Possenriede. Ken, good morning. Thanks so much for being with us. We appreciate it.

Hey, good morning. Good to see you, Noah. Good to see you, everybody.

Awesome. And Ken, I think you're going to start with the opening slide here, and then I'll drive.

You bet. Yes. So if we can click the next slide. So yes, forward-looking statements. So just a housekeeping matter. So let me just read this. So 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. And actual results may differ materially from those projected in the forward-looking statements. Please refer to 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. So thank you, Noah. Ready for you.

Awesome. Okay. I thought I would start this morning, Ken, on cash flow and then go into the businesses. Just given cash flow is a big focus for the business right now, you're in the process of deploying some capital. So I'd love to get the latest on that. So you have 3 years of targets. If I look at the historical sequencing of your outlooks, it goes up multiple times every year. And so I wonder, as we stand now, is there still upside? And where would it come from in your multiyear cash flow targets? And then you have this R&D tax treatment item. Maybe just give us the latest on how you're feeling there. And then you're in the process of deploying towards AJRD. Maybe just level set everybody on the status of that transaction.

You bet. Yes, that's a mouthful, Noah. So yes, let's start with cash. I would say this about our culture. We have spent a large amount of time in the last couple of years of ensuring that the entire corporation, so not just the financial community but the entire corporation, understands the implications of delivering products on time or not on time, what the consequences are to our working capital. And I'd say we have done a really good job. We call it, frankly, a culture of cash. And we have the entire corporation committed to driving cash flow throughout the corporation. So I feel really good about that. And with that, we've worked really hard reducing our working capital, specifically our contract assets. And then on the liability side, where appropriate, working with our international customers trying to get customer advances or contract liabilities as they're stated on the balance sheet. And so with that, we were able to see strong growth on cash flow, not just this year but the next couple of years. And as you stated, we give guidance for this year, but we also give, I'll call it, pretty definitive trend data for the next couple of years, and that's exactly what we did. The other piece that you had going on this year is the pension relief act, which was really twofold. One, and mainly for cash flow, from an ERISA standpoint, it allowed us to not make required pension contributions through 2025, which for us was $1 billion holiday, I'll call it, this year and $750 million next year and the year after. And after tax and after the implications of the second piece, which was the CAS recoveries, basically, the government allowed us to smooth out interest rates, which will reduce our CAS recoveries, which is a little bit of bad news in the short term, but I'll expand on that in a second, allowed us to take our cash flow numbers for '21 through '23 up $1 billion. So we're now guiding $8.9 billion this year. We see a path to $9.1 billion next year and $9.2 billion in 2023. And we do think there are some opportunities there, and one of them is what I talked about earlier. And if you look at our working capital, we think there's some opportunities to take down our contract assets, which basically means deliver on time or accelerate our deliveries, work on milestone payments with our customers to reduce that number and grow cash. And we feel pretty comfortable we'll be able to do that. You talked about the status on the R&D tax. So for everybody's benefit, part of the 2017 tax law that went into effect not just reduced corporate taxes from 35% down to 21% but then stayed at 5 years out, which would be in 2022, corporations -- publicly held corporations are no longer allowed to expense R&D expenses. It's required to amortize those over 5 years. And the way it's written, basically, it's not just our independent research and development. It would be contracts that are of a developmental nature, which would then be a sizable impact to us starting in '22. It's $2.1 billion in '22. It is $1.6 billion roughly in '23, and then it will continue to drop down over that 5-year period. We've been talking to key constituents in the government and AIA to make sure they understand what the implications are. Why is that important? It's important for a variety of reasons. One is we're very focused on internal investments. This ultimately could impede the amount of internal investments we can make. And since I'm talking to shareholders, it could ultimately impact the cash deployment to our shareholders via dividends and buybacks. So that's important. The other piece that's lingering out there now that everybody is certainly aware of is the Biden administration is talking about increasing corporate taxes from the statutory 21% up to anywhere from 25% to 28%, and you need to factor all these things. Another provision is FDII, which is the foreign-derived imputed income, benefit that we get basically building product in the United States and then exporting into FMS and DCS customers. They're talking about eliminating that. So I think there's going to have -- my perspective is there's going to have to be a lot of conversation with all these factors in there because, if all of that got enacted, it would basically, my view, stifle any investments or it would be difficult for us to make investments internally or externally, which brings me to, I think, your last point, which is the status of Aerojet Rocketdyne. We're now going through the second request of questions and inquiries from the FTC. We expected this. This is normal. We're going through that right now. And from a time line standpoint, we believe we'll get through that, and we're hopeful that it'll be satisfactory to them. Feedback from the customer set, hopefully, will be positive. We think it makes sense for this acquisition to occur, and I'll get to that in a second. And we believe we could see this thing close by the end of the year. And as you stated, Noah, we have a lot of cash on hand. We have -- we're underleveraged, if you will, from a debt standpoint. And we're going through that right now, what makes sense in this low interest rate environment, how much cash should we take off the balance sheet and how much should we go into the debt market, and factor that all in with the investments we're trying to make internally, whether it's CapEx, independent research and development, other investments or the cash deployment that we're very focused on, whether it's share buybacks or dividends. But back -- just back to Aerojet Rocketdyne, when we were doing due diligence with them, it was clear to us that they would be a better supplier, not just to Lockheed Martin but to industry, call it, a merchant supplier with Lockheed Martin being the owner. We saw a lot of synergies there from a cost standpoint that we will take out cost, which will make them more competitive. Them being part of us, we believe, we can make significantly more robust investments to enhance their products for our portfolio and for our merchants -- and as merchant suppliers to industry and to our ultimate customer. And it also made sense looking at combining our engineering organization with their manufacturing or production operations organization. We saw that would allow for a more seamless transition. That would allow us to reduce cycle time, build better product and at a lower cost for our customers. So we see a lot of compelling reasons why it makes sense for this transaction to occur. I know that was a mouthful. Hopefully, that scratched the edge, Noah.

Yes, that's great. That gets it all of it, and I appreciate all that detail. So let's circle back and go segment by segment here. So looking at Aeronautics and starting on the F-35 program, given its significance, maybe just update us, level set us on what you expect for unit growth versus aftermarket growth here. When do we see the next lot orders? And was anything surprising related to that program and the budget?

Got you. Yes. So F-35, as you mentioned, is a key part of Lockheed Martin's portfolio. In the first quarter, I believe it was roughly 27% of our sales. It is a big piece of Aeronautics, which happens to be the largest business area in the corporation. And there's 3 pieces. And it probably makes sense for me to talk about the 3 pieces. There's development, production and sustainment. Once STD ended, I have to be honest, I thought you would start seeing a significant drop in development spend. And along came a demand by our customer set in a good way for enhanced capability on the product. And we're now seeing multi-billion dollar development demands for what we call follow-on modernization. But I would call it an enhanced technical insertion because, on production, the customer, from a capability standpoint, end users love what this aircraft is capable of doing. So we'll continue to do modernization for the near future. In fact, TR3 and Block 4, we're going to cut that over on to Lot 15, which then brings me to production, which is the biggest piece of F-35. Last year, as you recall, we had a plan to deliver about 137 aircraft. Along came COVID, we, industry, working with our customer, I would say we're -- did some incredible work to ensure that our employees and those that were on our sites were safe. We went to an alternate work schedule. We worked with the customer to get progress payments from 80% to 90%. We flowed all that money down to our supply base, and we continue doing that today for our distressed supplier and our small business suppliers to keep them vibrant, and we were able to deliver 120 aircraft. That was our guide in April, and that's what we delivered in 2020. Due to COVID, we came out with the range this year, 133 aircraft to 139 aircraft. I'm hopeful we'll be on the higher end of that. But for now, that's where we're guiding, and that was due to COVID as well. Plan on record right now is 169 aircraft. And then after that, you would see a growth, to some extent, up into the 170s. Strong demand from the Air Force. We're still seeing that. We're still seeing they have a keen interest in 1,763 airplanes across the U.S. and partner country demand and also our FMS countries' demand and also new FMS countries. So we see a strong demand there. The only thing I would say is we're now in conversation with the customer set, looking at does it make sense for us to do some kind of smoothing. Nowhere near ready for prime time yet but doesn't make sense to go from the 133 to 139 this year, up to the 169 or would there be some interim step to smooth that out. And then we'll ultimately get to a -- I'm not going to call it a peak, Noah. It's a plateau because you're going to see at that plateau level us being there for quite some time based on the demand we see. So that then takes us to the aftermarket or sustainment. This year, we're talking about low -- I'm sorry, high single-digit growth. We anticipate seeing that for the next couple of years. And if you just looked at where we are from an O&S standpoint, we're standing up. We're still standing up bases. We have stood up roughly a little less than 50% of the bases. So we'll continue doing that. We'll double the size of the fleet in the next couple of years. So there'll be a keen interest to continue sparing and repairing those aircraft and then back to development. When we cut over some of that modernization that I described, they're going to want to retrofit some of the existing aircraft in the fleet. So we'll see some growth there as well. So no question, production is going to be the largest piece of F-35 going forward. It's not going to be the fastest-growing piece. That is going to be sustainment. And as I mentioned, development is a nice surprise that there is still demand for us to continue adding capability on to the aircraft.

What would be the basis or the reasoning for smoothing the -- where you are now on units to that plateau?

If it were to be done, it would be done to make sure when we're cutting over that technology, we're doing it at the appropriate time in the appropriate lot with appropriate aircraft.

So it's related to the technology upgrades.

It's related to the technology upgrades.

There's been some suppliers in the industry that have talked about some delays and challenges with that. What's your take on what's going on there?

Yes. So you're specifically talking about TR3, which is Tech Refresh 3. And specifically, it was the integrated core processor. In fact, if the folks on the call read our 10-Q, you would have seen that we suspended profit on that. So we, industry, worked with the customer. This is a cost-plus contract. We agreed to do this work at no profit. So we actually did what's called the de-book on the profit that we had booked already. We feel, working with our industry partner, we have the technological issues behind us. So now it's just getting through the work to be able to cut this over on Lot 15. So I think we're out of the woods from a technological issue standpoint. It's now getting that technology through the development cycle, so we could cut it over on to Lot 15.

Okay. Got it. F-16 has had new lives in the order book. How are you thinking about how you want to handle the production rate from here on that program?

Yes. F-16 is a great story. So if you go back a couple of years, we built our last F-16 in Fort Worth, and you literally had the F-35 program, because of its demand for real estate, basically pushed F-16 out of the building. So when we delivered our last Iraqi aircraft, we really didn't have any customers in the order book, and I give the team a lot of credit. We upgraded the aircraft. So it's now enhanced capabilities with the Block 70. And lo and behold, we worked and shaped with our customer in Bahrain and then came Slovakia and then came 3 other customers. And we now have 128 aircraft in backlog, which is a great achievement, moved the production line to Greenville where we're now building out aircraft, and we'll deliver the first 8 F-16s next year in 2022. You'll then see us start to get to a cadence of 1 a month. And then by the middle of the decade, we'll be 3-plus a month. And you'll then hopefully start seeing additional orders. We're looking to shape F-16 interest with other countries across the globe, and we feel really good about that. And I'd be remiss if I didn't talk about the modernization of aircraft that are already existing in the fleet. We see strong demand there as well. So yes, F-16 is alive and well. It's a nice story, and it's one of our fastest-growing pieces of Aeronautics.

Excellent. If I move over to MFC, MFC has had, I think, 4 years of double-digit organic revenue growth. The midpoint of the guidance this year gets you to 5. So when we think about beyond this year, do we stay closer to the 5? Or do we go back to something closer to the double digit? Because you had, at one point, talked about this being the fastest-growing segment for a period of time. And you mentioned that having to put in capital has been a constraint, that there's been a bottleneck. So does that reaccelerate beyond this year?

Right. So yes, a lot going on in Missiles and Fire Control. So if you look at our strike weapons like Hellfire, it wasn't that long ago we were building 6,000, 7,000 aircraft -- I'm sorry, missiles, excuse me. And if you look at -- look back to the capacity that you talked about, the capital spend, we have built out where we're now going to deliver about 11,000 Hellfires a year. We see that as probably the max capacity. The good news is it's not going to diminish. We see about 11,000 a year. Same thing with GMLRS. We're basically at capacity now. I'd say if you go to the air missile defense segment, the biggest growth area there for us is PAC-3. We're going to deliver roughly 350 PAC-3s this year. We're still building out capacity. We're going to get to 500 in the next couple of years. Right now, that's capacity. There is demand higher than that for the 500 that we see working with our customers. The question is do we continue building out capacity beyond the 500? Can we hold that 500 and try to become more efficient to build more missiles than the 500 with the real estate we have? And then I'd say the last piece we have was the classified program that we won that is now in development, going very well. Customers pleased with our performance, which will then -- basically then transition into production in the middle of this decade, and you'll see continued growth there. The last piece, I'd be remiss if I didn't talk about, hypersonics for Missiles and Fire Control. And the biggest program that they have is the Air-Launched Rapid Response Weapon or ARRW. We have gone -- basically gone through the development portion of the ARRW program, and we're actually going to get our first production lot this year. So that seems to be progressing as well. But I'd say if you take all that in terms of what is basically going to be at steady state and where we see growth, I could see us being in the mid-single digits for quite some time. No, I'm not sure we're going to get back up to the high double digits based on what we see. Now obviously, there could be threats and other global issues out there that may change that dynamic. But right now, I would say we're probably safe to say mid-single digits is probably where we're going to be.

Okay. It suggests something changed or slowed relative to when the expectation was for that to be the fastest-growing segment, although, I mean, depending on exactly how you define -- exactly where the other segments land. But did something change?

Well, I think the only thing that changed is we're now starting to get at capacity on some of the products we talked about. And then the question will be is that steady state increase or decrease? We don't -- we certainly don't see it decrease in [ pick ] Hellfires. But right now, based on what we're seeing and what's in the inventory out there, we see it staying at a steady state. So basically, strike weapon's pretty much at steady state, might be some opportunities with that, but fastest-growing piece will be PAC-3, PrSM and then hypersonics and the classified piece. So I think when you balance all that out, that's why right now, we're forecasting mid-single digit sounds about right.

Okay. Since you mentioned hypersonics and that splits time with the Space segment, and then the Space segment maybe is part of the challenge in entering the fastest-growth segment answer -- because there's been a lot of new wins there and the growth rate has been pretty healthy. So maybe just level set us on hypersonics. I mean what have you won? Or what surprised you positively versus negatively? And if you could fold that into just the broader discussion of growth ahead in the Space segment.

Sure. Yes. So if you just think hypersonics, this corporation a couple of years ago, I would say, got it right. Everyone knows we have 4 business areas. They actually had an integrated team that was cross-business areas solve the hypersonics problem with the customer. We invested almost $200 million to get to where we are today. And it was really 3 business areas, and I'm talking about strike weapons now, and I'll get to the defensive or counter in a second. But on strike weapons, it's really Aeronautics, Missiles and Fire Control and Space. And this year, we're going to do roughly $1.5 billion in sales on hypersonics. And I talked about Aero, and Space has the CPS, or the conventional prompt strike, weapon. And if you look at that program, Noah, it's about 2/3 of -- Space is about 2/3 of our hypersonics sales this year. And then the other is Aeronautics, which is Tactical Boost Glide and a couple of other programs. But all complementary, all 3 of these business areas working together. I'd say no surprises, no regrets. We think we're on a path -- on a strong trajectory to be -- make our customers successful and us to continue to grow in hypersonics. And I'll give you one example that you had, HCSW, which is the Hypersonic Conventional Strike Weapon, that got terminated. And I have mentioned it in the past that this customer -- these customers are ultimately going to test these products out and ultimately knock down, and that's exactly what happened. It was no fault of ours. We were performing, and basically, the customer came in and said, "We're going to terminate this program." And they actually took the money from HCSW and moved it into other programs, and we were the benefit of that. We're starting to see an interest in demand on the defensive side of hypersonics. So you will probably see in the not-too-distant future us talk about responding to requests for proposals on defensive aspects of hypersonics. And that market is going to start to grow and increase as well. You wanted to talk about Space? Yes, Space this year, if you take away the termination of the Atomic Weapons Establishment program that we're going to wind down by the middle of this year, this is the U.K. program where they want to renationalize it and take it over, and again, no performance issues with us. But if it wasn't for that wind-down of that program, Space would be growing roughly 7% this year, and that's driven by hypersonics. That's driven by OPIR. It's driven by classified. We've had a lot of nice classified wins in the past, and it's also driven by GPS and Orion. These are long gestation programs, if you will, long life-cycle programs that are going to continue going into the future.

Okay. Excellent. With hypersonics, one way I was thinking of asking this is it's sort of like you described as the customer has a number of irons in the fire and seeing this kind of figuring out exactly what they want to do and working through development programs to do that. How many individual hypersonic programs are currently contributing to Lockheed Martin revenue? And how many could that be at a plateau in the future when this is all more mature?

Yes. That's tough to answer, but we're roughly -- we're performing on roughly 7 programs today. And as I mentioned, they are all strike weapon programs. But I would say the lion's share of the sales that we're generating this year are a handful of programs. There's 3 of them. I'd be speculating, Noah, on how many programs are there because it's just influx. And that goes back -- you got to look at what is the administration's priorities. And based on one of their key priorities is there is an acknowledgment of a Chinese-Russian threat, and there is an acknowledgment of their hypersonic capabilities that, from a strike and a counter strike standpoint, we see there will be a demand out there for continued enhancement of those technologies, and you will continue to see programs that will grow from that. So it's probably difficult to answer. But we do see -- we do believe there's going to be growth in strike weapons and counter strike weapons from a hypersonic standpoint.

Okay. Got it. Let's round out the segments with RMS and maybe start there by just giving us your latest thoughts on timing and likelihood of success with the Future Vertical Lift programs.

You bet. Yes. So out at Sikorsky, we're really pleased with the progress Sikorsky has been making, double-digit profits now, been a long time coming. But we're really pleased with where they're going, and we're pursuing 2 Future Vertical Lift programs, one being FARA, one being FLRAA. Today, the medium-lift helicopter procurement is actually in front of the lighter version of the helicopter. So FLRAA is in front. We've been down-selected with the other competitor. We're now testing our aircraft, the Defiant, with our partner, Boeing. Feel really good about where that program is, where we are with that program. You will see a down-select in not-too-distant future. The plan of record is basically late next year, middle of next year. Program of record plus where we see international customers, that market could be $80 billion. And right behind it is FARA. And FARA, the plan is to get that out in roughly -- down-select in 2024. And just back on FLRAA, one thing I should say is we believe we're going to get an RFP very soon. So this program appears to be on schedule. And I'll get back to FARA now. The FARA market size is roughly $15 billion, $20 billion, $25 billion. We feel good about that. You'll see those programs go into production late in this decade to complement what we have in production today, the Black Hawk, the search and rescue helicopter, presidential helicopter. So we're feeling good about where Sikorsky is.

Yes. You have quite a lot going on there. You mentioned Sikorsky now at a double-digit margin. If I look at the RMS total segment margin, it's climbed its way back to 10 here. But if Sikorsky is now up 10, it would imply the other half of RMS is also around 10. And I would think that, that other half of RMS would have a higher margin, just being kind of more technology-rich or looking like some of your other segments. Is that Sikorsky double-digit before the amortization and that's bringing it back down? Or how do I spread that up?

The answer is yes. Yes. So Sikorsky is double digit prior to the purchase accounting amortization, which is a little north of $200 million. But just back on the rest of the portfolio, they are performing very well. So if you look at IWSS, which is Aegis, we just got another award from an international customer on Aegis. Our radar programs are performing very well. But remember, a lot of our radar programs are in their development stages now so they are going to be -- they're going to suppress margins. But Aegis is a strong double-digit margin program. You have training, which is growing. You have a mix of contract types there, and then our C6 portfolio that is cyber undersea there's a whole variety of things going on there. You have the blend of what's cost plus and fixed price there as well. But the rest of the portfolio, we believe, is performing very well.

Okay. And I guess, maybe trying to round out the margins at the company level. So RMS from -- and Sikorsky has programs that are moving from development to production, and the other half of RMS is [ I think ] moving from development to production. Eventually, that deal amortization rolls off. It would seem like that margin could move a decent higher. Now the Future Vertical Lift outcomes will impact that but not imminently. So is that correct? And then, I guess, maybe one way to ask you is just do any of the 4 segments have major margin change in the medium term? Or do they all look pretty similar 3, 4 years from now than they've -- compared to that?

Yes. So let's start with RMS since you started with RMS. So if you look at Sikorsky, $5-plus billion business, we see that continuing to grow. As I mentioned, and you just confirmed, you have search and rescue helicopter that's in production. You have, obviously, Black Hawk. We're delivering Lot 9 aircraft this year, in production, obviously. Lot 10, we're negotiating right now, should get to a handshake later this year and get -- keep that going. Presidential helicopter is now in production, continue to see that prosper. And you mentioned Future Vertical Lift. Assuming we're successful on both those programs, think about middle of this decade, later in this decade, still going to be in development, which is going to suppress margins. So it would not surprise me if you saw Sikorsky margins increase a little bit, but there is going to be a little bit of that overhang just because of the size of those Future Vertical Lift programs being in development. Going around the horn in Aeronautics, you have strong growth at the Skunk Works, which is at least initially in development either in FPI-type contracts or cost-plus-type contracts will be suppressed margins there. I think where F-35 is today, unless there is a dramatic change on how we contract for sustainment, as you know, we offered up the PBL, performance-based logistics, concept. So we're in the process of working that through. But I would say production margins will basically stay where they are. So I'd say F-16, you may see a little growth there just because of the growth in production. But I'd say overall, Aeronautics is going to be where it is today. And then Missiles and Fire Control, just based on the portfolio we went through and the growth of the development program, the classified development program, margins are going to be where they are today. And then Space, you'll have a large preponderance of cost-plus programs. And ULA, where we see it this year, that's our joint venture with Boeing, equity income that we get, likely is going to be in the future where it is today. I would see margins likely being where they are today. So I'd say macro for the corporation, we're going to be where we are today, maybe a modest improvement, but I'd say where we are today.

Okay. That makes sense. All right. We have gone just a minute or 2 over our allotted time here and managed to get through all the businesses and talk some cash flow. So we'll wrap it up there. Ken, I really appreciate you being with us today. This is great. Thank you so much, and everyone, have a great day.

Thank you, Noah. Everybody, be safe. Look forward to next year being in person.

Yes, me too.

Take care.

See you later.