Lockheed Martin Corporation (LMT) Earnings Call Transcript & Summary

Good morning, everyone, and thank you for joining us today. My name is Peter Arment. I'm the senior aerospace and defense analyst here at Baird, and we are very pleased to have with us the management of Lockheed Martin Corporation. This is a fireside chat, so we encourage anyone to ask questions through the web porthole, and as time permits Mitch, we'll certainly try to address those. From the company, we have John Mollard, who's the acting Chief Financial Officer. And before we get into the fireside chat, I'm going to pass it over to John to take a couple of opening comments and then we'll get into do it. So John, welcome. Thank you.

Thanks, Peter. And I'm going to open by saying that I'm going to be making some forward-looking statements in today's remarks and those forward-looking statements are being made subject to the provision of the safe harbor provisions within the federal security laws. And I'd encourage you to refer to our SEC filings for a full description of the risks that may cause the forward-looking statements I'll be making today to differ from the actual results. So with that out of the way, I'll turn it back over to you, Peter.

Terrific. I really appreciate that. I'm sure we made the lawyers all very happy. That's great. So thank you again for joining us, John. Really, it's great to see you.

So obviously, the growth environment is the big topic, right? Growth has been a big topic in the airspace and defense world the last few weeks, and Lockheed Martin has also talked about that in the last earnings call. So if you could just bring us up to date your thinking both over just the near term, I guess, the short run and then how you're thinking about how this all kind of plays together when we think about it longer term.

Yes. Sure, Peter. Great question. You probably saw in our October release, we're guiding to a top line revenue number of about $67 billion for this year, which represents just about a 2% growth rate over our 2020 actual results. And then looking ahead, we guided to a slight decline in revenue to about $66 billion for 2022. And then what we talked about, and we'll talk about it in some more depth later, we're projecting an increase -- a slight increase in sales moving from 2022 to 2023 and then continuing to grow beyond '23 into '24, '25 and '26 at increasing levels of growth through that period of time. I'll say in the near term, and I don't think this was unique to our situation, we've got some supply chain headwinds that arose for us pretty much for the first time during the third quarter, kind of specifically in the month of August, where we were seeing actual results in early September that were below our planned levels. That level of supply chain activity running below plan continued in September. We fell behind plan coming out of the third quarter. And as a result, we took down our full year guidance for 2021, down to the $67 billion, 2% growth rate. But looking ahead to '22, so you've got supply chain issues kind of underpinning some of this, we're highly confident that these supply chain issues will get resolved incrementally over the next 3 months, 6 months, 9 months, 12 months. We're actively working with our supply chain. That said, heading into '22, we've got, like I mentioned, about $1 billion decline in total top line revenue. The #1 primary driver of that decline is the U.K. United Kingdom, in the middle of this year in 2021, renationalized activity we were doing in support of their atomic weapons establishment. That gave us a $900 million year-over-year headwind moving from 2021 into 2022. But once we get beyond '22, we expect to see a pretty decent set of growth prospects in front of us. Now we're going to need to perform to our contractual requirements. We're going to need to prevail in some competitions. But there's 4 major areas that we see underpinning our growth prospects. The first is in the area of hypersonics; second is in our classified activities; the third, which is the easiest to kind of talk about, is growth and programs of record; and then the fourth are some significant competitive new business awards that will be decided over the next few years. And if you combine those 4 buckets of growth with the $135 billion we had in backlog as of the end of the third quarter, I feel very confident in our ability to achieve the sales projections that longer are -- that we just talked through.

That's a great overview. Let's just maybe just revisit the supply chain items just -- and how that's had an impact on your kind of -- on your growth. So what is actually maybe the specific impact? And you mentioned you first started to note it in August. So maybe you could describe that a little bit and how you see that abating, if that's such a word, in '22.

Yes. Thanks. Yes. So we saw a supply chain shortfall in August for the first time. I mean we've globally been dealing with the pandemic for 18 months. And we've got a fairly expensive supply chain, roughly -- at least 60% of our cost of goods sold is coming through the supply chain. That supply chain has been mitigating COVID-related impacts for 18 months. They've drawn down safety stock. People have been working overtime to fill in for people that are out as a result of personal situations. You can work overtime for some level of time. You can draw down safety stocks. But increasingly, over time, you're going to start seeing a fragility in the supply chain. And where that has showed up is a difficulty in the supply chain to respond to changes, relatively routine changes and requirements. I mean they're doing their best to keep up with the regular operational tempo. And then if you have slight course corrections and requirements, it's really putting a strain on the system. Our supply chain leadership team saw that, like I said, call it, a $400 million shortfall to plan in August and then another $300 million in September. So cumulatively, we fell behind plan by about $700 million during the third quarter. And to put that in context, our supply chain run rate is about $700 million a week. So you think about it year-to-date, we fell about a week behind, which isn't the end of the world, but when you're running at a $700 million weekly rate, it becomes a pretty big number pretty quickly. Our projections for the fourth quarter, and I'll give our supply chain leadership team a lot of credit, they've got in there with the supply chain. We've done a lot of analysis that it's -- there's no sort of smoking gun. It's across all names in our supply chain. There's names you would readily recognize. There's names I don't even recognize that are having impacts. We're continuing to accelerate payments through our supply chain to try to help those that are struggling with financial situations, and a lot of those suppliers are dual use. They're supplying to commercial aerospace. They've got fixed costs. Their revenue from the commercial side has been reduced. That's put a pressure on their cash flows. We're looking to mitigate their stress financially. We're looking to mitigate their stress operationally by, in some cases, embedding some of our people in with the suppliers to help them recover 2 program plans. Looking ahead to the fourth quarter, we expect to recover from the run rate we saw in the third quarter, but we don't anticipate being able to get back to our original plans. During the fourth quarter, we expect we'll fall another $300 million behind, which represents another day or 2. So kind of in broad strokes, we lost about 1.5 weeks -- or we're projecting to lose about 1.5 weeks of supply chain activity in closing that this year. But we're -- yes.

Yes. That's an excellent rundown because I think it's a great way to tie it because it certainly seemed like it was -- while it is a big deal, when you break it down to kind of a 1 week or 1.5 weeks, that's encouraging that, that's going to continue to decline going forward. Let's move forward on the DoD budget, kind of your implications -- your view on the growth over the next few years. It certainly seems like the process is certainly better than what I thought with the change of administration, change of Congress and how the budget might shake out. So maybe you could talk a little bit about how you guys are seeing it now.

Yes. Great question. So I'm sure most of your audience is aware that the President's budget for government fiscal year 2022 is about -- for DoD is about $715 billion coming off a prior year of $704 billion. So you call it nominal level of growth. You've got various committees within Congress doing markups to that $715 billion President's budget baseline. There's sort of a range of markups depending on what committee you're talking about, but they're in the $20 billion to $25 billion incremental adds to that $715 billion baseline. We're encouraged about the trajectory and the direction of those increases. We're also encouraged because a number of our programs are well supported in some of those markups. The open question in our mind, and I'm sure in a lot of the audience's mind is how much, if any, of that incremental appropriated -- if those appropriations come through, how much could translate to revenue in 2022 or 2023. And the answer to that is going to be a function of a few things. And first of all, I should have prefaced this by saying we're currently operating under a continuing resolution, which is not atypical for this process. We are very familiar with dealing with the impacts caused by a continuing resolution backdrop. So it's not causing us any great level of angst at this point. There comes a time though where if you're continuing to operate under continuing resolution, you see cracks starting to appear. But let's fast-forward and assume we get a regular budget established. If we can get these markups in place and appropriated, the question for how much translates the revenue is, a, how much? Is it $25 billion? Is it $20 billion? Is it $30 billion? When does it get appropriated? How long does it take the services to get us under contract? How long does it take us to get our supply chain under contract? My -- the [ bold ] case or the upside case is some of the threat environment that we're seeing, I don't think it's any surprise, anybody that covers aerospace and defense would have seen the recent slew of articles in and around the Chinese hypersonic weapon test that I think it would be fair to characterize that event is catching a large portion of our national security apparatus somewhat flat-footed, which may translate to increased urgency in and around our ability to develop counterthreat strike capabilities or straight defensive capabilities. So from a national security environment, my reading of the tea leaves is there will be strong support for, plus us, to the President's budget. I should mention that our projections are all based on that President's budget baseline.

Got it. No. That's very helpful. And I think -- I don't think a lot of us would have thought 12 months ago post the election that we would have had potential stability in the -- from the DoD spending. So that's favorable. And obviously, it's favorable for -- given your portfolio. Maybe we could just -- so that's very helpful on the top line. Maybe you can talk a little bit about how that -- your strategy is on capital allocation as we think about that. I think all the investor base certainly always looks at Lockheed Martin as someone who has been very active in terms of capital deployment. And so maybe just give us some updates there.

Yes. Another really good question. I'll start out by saying it's a lot easier to do -- affect those capital allocation if you're generating a lot of cash flow and I'm pleased with the guide we've given for a 3-year cash from operations generation perspective of generating in excess of $25 billion of operating cash flow. And we've got a great balance sheet, we're a single A. As those of you know from a ratings perspective, that strong balance sheet and the cash -- strong cash generation give us a lot of strategic optionality. And one of the concepts I think Jim did a nice job of articulating in the October call is our process is dynamic yet disciplined capital allocation, where sort of our guiding star is what opportunities do we see having the highest probability of leading to a sustainable growth in free cash flow. And we have internal metrics of not just free cash flow, but from a shareholder perspective, what's your free cash flow per share. And as we go around the horn, the highest probability that we see of generating sustainable free cash flow comes from reinvesting in our business. And we're going to reinvest in our business to the maximum level that our business can efficiently absorb. And you can even put so much into R&D and you can put so much in the capital expenditures and get good value and returns in that -- in those investments, but you're going to reach a point of diminishing returns. At some point, you're now just spending resources inefficiently. When we think about the amount of organic opportunity that we see to do reinvestment in our business, when we look ahead, we're projecting that in '22, for example, we're going to spend about $2 billion in capital expenditures and about $1.5 billion in independent research and development. And if you combine those 2 internal investment mechanisms and you get $3.5 billion, which, in total, represents about $0.5 billion increase to the levels of spending we're doing in 2021. A lot of those investments are going into broadening our already highly capable platforms, making those platforms more interoperable across the DoD's network and infrastructure. There's a concept the technologists call network effects where systems are talking to systems and capabilities are getting delivered at speed, much higher than humans are able to do sitting around the table and processing. So we're going to put a lot of our effort into expanding our capabilities and coming up with new capabilities. We're also reinvesting in the business in sort of an unglamorous area, but in -- some would call this table stakes. We need to continue driving, I'll call it, model-based engineering or a model-based enterprise approach across the corporation. We've opened several digital factories of the future. It's just common sense that you can much more effectively design a new gear if you're not having to build 15 prototypes in an actual cyclical form, right? If you can do that with engineering tools, and I'm not an engineer but I remember being a financial analyst when Lotus 1-2-3 became available. And just the ability to do in an electronic spreadsheet I didn't have to add was transformational. And...

I miss Lotus, too, John. I miss Lotus, too.

Yes, yes, yes. You're young enough, you probably started on Excel, right?

No. I was a Lotus guy. But anyway, go ahead. Finish then.

Yes. I was going say so we're transforming the internal business through reinvestment, but we're also constantly evaluating our portfolio and we're looking at what our customers' mission set and requirements are. And we're tough critics on ourselves. If we see gaps in our capabilities that we think would make sense for us to bring in-house, we're going to look at it. We've got a Lockheed Martin venture fund that's investing in early-stage technology companies. We'll do joint ventures, we'll do teaming agreements. We'll go to outright acquisitions like the Aerojet Rocketdyne transaction. We're anticipating closing in the first quarter of '22. So delivering capabilities to our customer, we're going to reinvest in the business. We're also going to do -- look at continuing to bring in new capabilities inorganically through any form or fashion. That said, we're still -- given the amount of free cash flow we're generating, we're still going to have excess cash balances. And when we look at where our stock is trading today, if you look at our free cash flow and you do any kind of cash yield metrics, which I'm a big fan of the discounted cash flow sort of analysis, but I see no reason why our stock is trading where it is compared to our intrinsic value. And we're going to put our money where our mouth is. We've articulated our plan to buy up to $6 billion worth of our stock back, which is a meaningful percentage of our market cap today over the next 12 to 18 months as long as our stock's face's undervalued. And finally, to wrap up this monologue. Our yield -- our dividend yield is very attractive to a large set of our owners. Our largest class of active investors is in the yield category. And our track record of growing a dividend is very attractive to a...

I know. I mean Lockheed historically has been cash is king and Lockheed has always generated a lot of cash. When you updated you for your guide, that was obvious. Maybe quickly because we only have a few minutes left, your thoughts on the F-35 replan, its impact on your kind of cash flow either positively or negatively. And then maybe just weave in there how O&M and sustainment kind of can impact that.

Yes. Sure. Great. Hopefully, those of you that haven't downloaded our webcast from October, there's -- if you haven't -- and you're interested in the F-35 forward view, we put in a chart because there's been some opacity around what the longer-term track of F-35 revenue looks like in the 3 categories that Peter mentioned, production is the largest element. We'll do about $13 billion this year. But over the course over the next several years, that number will be in and around $12.5 billion, it will be roughly flat. Then we've got development activity, which historically has run about $2 billion. We had some performance issues related to a capability called TR3, which is a technology refresh in the cockpit. We're working our way through that with our partners to get that capability delivered and fielded into -- begin to be inserted into aircraft being delivered out in with Lot 15. So that revenue will be sort of a slow growth, about $2 billion a year in annual upgrades to this already highly capable platform. And then the growth in the F-35 that we're projecting is in and around sustainment where, today, we're doing, I'll call it, $3.7 billion. And if you look out in time, by the time we're at 2026, we'll be over $5 billion. It's like a 6% compound annual growth rate. We are taking a lot of cost out of the program. If you look at the number of fielded aircraft at the end of 2020, we had about 111 aircraft out there. If you fast-forward out to 2026, we're going to have over 1,500 aircraft. The compound annual growth rate in fielded aircraft is like 16%. And the growth rate in flight hours is even higher than that 16%. So again, to put the 6% growth of sustainment in context, think about a 6% growth in cost on a base that's growing in excess of 16%.

I think that it's a massive program and obviously continues to be one that's going to be generating a lot of cash for you. And I know you're putting that cash together in strategic acquisition as well. We only have about a minute or so left. Maybe you could just give us your latest on the Aerojet Rocketdyne acquisition and confidence around expected to close in the first quarter of '22.

Yes, sure. We -- in our AJRD of both certified completion, the FTC has a process called -- they'll have a request for information. And in this case, they had a second request for information. We've complied with those requests. And with that second request, we certified compliance with that request. We're continuing to engage with the FTC, where there's ongoing conversations between all parties involved. We think this is a terrific transaction for the U.S. government, for the taxpayer. We think we are an absolute the best owner for AJRD with our know-how and what they do, our access to capital for innovation and growth. The kind of products we're building, I think, will benefit from the tighter integration of their activity into ours. Absolutely committed to remaining -- to have an AJRD be a preeminent merchant supplier across industry. It's in our best interest for them to be a terrific supplier to allow us to participate in programs we don't participate in today. So we think it's a win for our customers, win for the taxpayer, win for the supply chain and a win for Lockheed Martin. We're expecting closure in the first quarter of '22.

Terrific. Well, we're out of time. But John, I want to appreciate -- thank you very much for joining us. Thank you, Lockheed Martin, for participating in the topic and hopeful we have to do this live and in person next year. So thanks again, John. I appreciate it.

Thank you, Peter.

Have a good day. Thank you.

You, too.