Lockheed Martin Corporation (LMT) Earnings Call Transcript & Summary

Okay. Good morning, everybody. It's Noah Poponak here from Goldman Sachs' Aerospace and Defense Equity Research. Good morning. Thanks for being with us. Very happy to have with us our next presentation from Lockheed Martin. And joining us from the company is the Chief Financial Officer, Jay Malave. Jay, thanks so much for being with us today. We appreciate it.

Thank you, Noah. It's exciting to be here. I'm excited to have a good conversation and dialogue with you today. Just a quick comment here before we get in. Just as a reminder, today's discussion is likely to include some forward-looking statements that are subject to risks and uncertainties that could cause our actual results to differ from those that are forecasted. We have more descriptive and comprehensive and complete description of our risk factors in our 10-Qs and 10-Ks. And so with that, I'm ready to get into a discussion with you, Noah.

Excellent. Thank you. So clearly, it's a dynamic environment in your markets, given the geopolitical events that have transpired. I wanted to get your perspective on what this means for the multiyear, medium- to long-term growth rate in your end market? And we talked -- we were in your office in March, and we sort of talked about this, but maybe it's evolved even since then. So sort of curious what were you thinking the 3- to 5-year DoD authorization CAGR was before Russia, Ukraine? And what do you think it is now?

Right. Good question. So when you go back, say, 12 months and when we were developing our 3-year -- 3- to 5-year planning, we were assuming in the range of about a 2% budget -- defense budget growth over that period of time. And that was the basis of the revenue forecast that we had laid out last year in the third quarter call in October. You fast forward now to where we are and the world is in a much different place, as you know, Noah, and we've spoken about a lot, but not on the call -- not only on the call, but in other forums. And so you look at the President's latest estimates, their '23 budget and then the 5-year outlook that we put out there, next year is about 4% growth, and then it tapers down. If you put that CAGR that they provide, it's around 2%. My personal belief there is it's probably going to be upward bias to that moving forward beyond 2023. And even in 2023, there's likely to be some plus-ups. We obviously have to go through the process and let the authorizers as well as the appropriators do their thing and get it back to the President for a final budget to sign. But all the indicators are -- would suggest that we're probably seeing upside from where we are here. So what does that mean to Lockheed Martin? As we said on the call, we do believe that our baseline expectations, we said about 2% growth in '23 and then accelerating from there in '23 and '24 and beyond. There's probably similar type of a trend, which would be upside. The question for us is, really, to what extent? And we're still working through that. We really won't have a better view of that until probably sometime in the summer. We're going through our strategic planning process as we speak. We're trying to get a feel for at least some of the detail that we've been able to decipher and figure out what that means, and we're still going through it, and at the same time, be able to follow Congress as it put its marks as well. So there's -- we're really in the early innings of this outlook. It is a positive indicator for us, but it's still really a TBD. And that's kind of where we are. I know that's somewhat of an [ unsighted flying ] answer because everyone wants to know. We'll translate that into exact growth rates for '23 and beyond. But it's a little early for that. And I need to remind the audience that probably where we'll see that most is really in our backlog. Because we are a long-cycle business, the ability to convert that upside into revenue, it's going to take a number of years. And so we can talk about that more, but that's how we view it. But kind of big picture, really favorable trends.

Okay. Is there already specific discussion in your neck of the woods or on the Hill of plusing up this '23 request? I mean is that sounding quite likely? Or is it more sort of just a higher-level feeling just based on what's happening geopolitically?

Yes. I think it's a little bit more of the latter, Noah, just what's happening, what we saw in 2022. What we just saw with the supplemental for the Ukraine, that got plused up from $33 billion to $40 billion. And so just a general trend there that it just seems like that is where things are headed. As you know, Noah, we'll talk probably a little bit later about the F-35, but that's another indicator to us is that, even though the '23 budget -- it would had a fewer units aircraft in the proposal in the presidential budget, we've seen from the services that in their unfunded priorities list, that they want to see more aircraft. And that, to us, is an indicator that there's probably to be a -- I'd say, a warmer reception from Congress than you would have seen in the past.

Okay. Yes, we'll get more into that. Just first, on the sort of higher level question. So what we've discussed so far is sort of a U.S.-centered view. Remind us how much, at this point, of Lockheed revenue is international? How much of it is Europe? And what kind of increases do you think we could see in the budgets you sell to there? I mean, we saw the announcement from Germany. But Germany was a little bit of an outlier in terms of its size compared to its -- where it was relative to that 2% of GDP NATO commitment. So yes, just kind of level set us on those exposures for you. And how much budget change you think we could see in these other regions?

Sure. So total international sales for Lockheed Martin, about 28% of our overall revenue exposures is international. Of that, about 1/3 is Europe, specifically. So total revenue is about 10% exposure to Europe. If you go back over the last, say, 5 to 7 years or so, there's been a fair amount, about almost 3/4 of the countries have been spending below their 2% target in defense of GDP. And so Germany was certainly a strong signal that, that app needs to be ramped up. And the other indicator I would use is, again, and I don't want to spend too much time talking about the F-35, it's just the demand that we've seen in the F-35 and the awards that we're seeing there. And so we expect it to continue to grow as other countries aspiring to reach this 2% target. How that translates into a specific growth rate for us is really, again, hard to tell, just even on a macro level and what it means to Lockheed Martin, specifically. But as I mentioned, with the U.S. -- same thing with the U.S. on the international side, we expect that to be upside pressure as well. And so more to come, obviously. And we're, again, it's the same thing, we're in the early innings. But again, it's really trending positively there.

Okay. You've mentioned F-35, and we'll get more into the program specifics there. But just where else are you seeing the immediate kind of incremental demand on the back of what's occurred, whether it's in the direct Ukraine need or whether it's part of the new budget processes that are shifting things around?

Sure. I mean the first thing that comes to mind is tactical missiles as were -- as well as air and missile defense. And we've heard a lot about Javelin Missiles. President Biden was in our facility last week. And so -- and Jim Taiclet talked about that over the weekend in Face the Nation as far as trying to ramp up our capacity, doubling it from 2,000 to 4,000 units. And that's likely to take a couple of years for us to get there. And so we're seeing, just beyond that, really, precision weapons is an area of -- has become, obviously, of increased interest for us. Turning that into proposals and turning that into contracts, it just takes some time. But that's certainly an area where we're seeing a lot of incoming, both domestically as well as internationally, interest and inquiries is our ability to really ramp up in those particular areas. Beyond that, helicopters continues to be a source of international inquiry and interest. Same thing with fighter aircraft, both F-16 and F-35 are also areas. And just, again, going back to F-35, whether it was Finland with 64 aircraft, Germany with 35 aircraft, and we saw a big announcement from Canada. There's just a lot of demand there as well, and really, on the back of just outstanding aircraft performance. And we hear a lot about that from our international customers. And so we've got a wide-ranging portfolio and products and the interest is wide-ranging as well.

Okay. Okay. Great. Yes, that's helpful. All right. So let's get into the business segments and some specific products and program lines. So let's round out that F-35 discussion. I mean, you touched on it, but what should we make of this '23 request? Is there an incremental effort to reset the multiyear delivery number even a little bit lower? Or is it just that there's an ongoing negotiation? Or is it timing related to the TR-3s? Or is it weaving in international? There are a lot of crosscurrents there, what should we make of that '23 request?

Right. Well, I think, first thing is there's really no interruption in the long-term program demand. We've talked about over 3,000 aircraft, 3,300 and over 2,400 or so in the U.S. DoD requirements, with the majority of that being in the Air Force. We don't really see that being interrupted in any way. We're talking about -- the force is right now talking about timing. What they talked about the '23 with the presidential budget was really making sure that they can get themselves set in their nuclear modernization efforts. And that's something that obviously is important. But at the same time, if you listen to some of their quotes, they've also talked about, look, if I have additional monies, I absolutely want to put those back into the F-35. And we saw that in the unfunded priorities list, where they wanted to add back 19 aircraft between the 3 forces. And so generally speaking, when you go back to the underlying demand, we believe it's still there. we still believe in the 1-56 type of -- production type of requirement from a demand perspective. And we'll work through it here. I think that if there's going to be plus ups, the F-35 will be a certain area where they will be. And we think that it will migrate back to this original type of 85 aircraft type of requirement for '23. But obviously, it's got to play its way -- itself out. And it's got to go through the congressional committees, both on the authorizers as well as the appropriators and then come back to the President. But we think that -- yes, again, we're just trying to manage timing. And I think we'll get through that, though, and it will kind of probably get itself back to where it was before, when it's all said and done.

Okay. Yes, I mean, is there an element of -- some things are left out of the request, knowing they'll be plused up and that's part of the expected plus-up process? Or is that not really a factor?

Well, I mean, it could be a bit -- for me to confirm it, I would be speculating. I really -- I think that how they go about strategically, their budgeting and their requests, I can't speak to specifically. While I can sit there and tell you is that their support for the program has been strong. They say if I have the money, when I absolutely take additional aircraft, the answer is yes. And I accept what they say at face value.

Okay. Maybe give us a status update on your latest lot negotiation. What's still being negotiated and debated? And then give us an update on where the sustainment and logistics process stands?

Sure. The negotiation continues to make progress. We've made progress since our first quarter call, and that was a few weeks ago. And we continue to close the gap. I think both parties have a sense of urgency to get this closed and get it behind us. But there is still a gap, and it is closing. And Jim talked about on the call, there were things like just the lower volumes relative to lot 12 through 14. We've had the impacts of COVID, increased costs from COVID. And we've had supply chain escalation and inflation that's been a part of the mix as well. And so part of it has been data collection, being able to present that to the customer. But we're getting closer to the later innings of this negotiation. We're really excited to be able to get it -- to bring it to a close. And again, there's still some open items. But I would tell you that gap is closed in just a few weeks. So I think we're making excellent progress with our customer, and we're hopeful that we'll be able to get this done before the end of the quarter. As I mentioned on the call, to the extent that we're unable to do that, we are likely to see some revenue impacts here in the quarter, it would be timing. And it could be in the range of $500 million or so. But I'm optimistic that we'll be able to get there and that we won't see an impact. As far as sustainment, we're excited about being able to offer a performance-based logistics program. We see that probably putting a proposal together and submitting it to the customer probably in the first quarter of next year, in that ballpark, sometime early next year. And when you think about that, it's something that, in my prior life, in working in the commercial industry, it's just -- it's a great solution for the customer. Because it gives a customer cost certainty, while, at the same time, focuses -- the supplier focus is on really driving cost out and driving better performance of the aircraft and of maintenance of cycles. And so it puts the incentives really in the same -- puts the customer and the supplier incentives in the same place. And so that's something that we're excited about, really trying to provide that level of service to our customer. As we've talked about in the past, we've been able to reduce our flight per hour. Our cost per hour or 45% over the past odd number of years. We expect through 2025, we'll be able to reduce that another 40%, and that's what we're clearly focused on. And that's the basis of what performance-based logistics will be an enabler of us being able to do that for our customer. So I think that's what to expect probably sometime early next year and then go through probably negotiating, getting contract later in the year next year.

Okay. Can you earn the same margins under that model as you have in the past under prior sustainment models?

I think you can because you're really focused on continuous improvement, on really ensuring that you have the best data that you can provide to yourself and to the customer to really drive down the cost of maintenance visits and using all the learnings that you have and just driving it -- continue to drive it down. And as -- when you have a fixed price arrangement like that, you're incentivized to really try to drive down that cost over that period of time. So I think that, again, I said our incentives are aligned as far as giving certainty to the customer and trying to drive down just better performance and a better cost posture on the program.

Okay. Excellent. Let's shift to MFC. That segment had a very robust growth rate multiple years in a row. Looking back, slowed down a little bit last year. You've got -- you have it down this year in the guidance. A lot of that is just tough compare. But maybe just walk us through what the transition is there. And then inventories were depleted, then they were refilled. It sounds like now they're being depleted again. And so -- but then you do still have a higher base than you had 5, 7 years ago. So in the context of the total Lockheed growth rate transition over the next few years, what does MFC look like in that?

Yes. MFC is a -- should be a bright spot for us when you think going forward. When you look at just the '23, the presidential budget, and you look at some of the line items there, you see both tactical missiles and missile defense growing high single digit, just in the '23 budget. Now for us, that takes a number of years for that to convert to revenue. But at least it's the start of a nice backlog growth and really reinvigorating the growth outlook for that business. I'd say that the MFC also is participating in hypersonics, and so they have some pretty good program exposure there, where we also would expect to grow. When we talked about our growth pillars, our 4 growth pillars, hypersonics was an element of that. And it wasn't just MFC, it was our Space business, as well as our Aero -- our Aeronautics business all participating in hypersonics. But we're going to grow that collection of programs from $1.5 billion to $3 billion over that period of time, over 5 years, and MFC is going to be a big participant in that. The other element, I would say, a growth for MFC is in classified programs. And they have some really strong program exposure there in classified, which should also be a source of growth over a number of years. I think I'm going to not really throw out any type of specific growth rates there. I'm going to wait until we do that in our typical third quarter call when we lay out our 3-year outlook. What I can tell you there is that there should be a decent grower for us going forward because of their exposure to these pillars of growth that we have.

When you report the third quarter in October, you will roll forward a 3-year outlook and be sort of providing some kind of segment growth, total growth, cash flow forecasts with that report?

Yes, we'll do the consolidated 3-year look, and we'll give you the growth rates there, consolidated cash flow and things like that. And I would expect to give some segment or business area color as to the drivers of our growth expectations. So yes.

Okay. Yes, I just asked. I mean there's specific guidance this year and then it's sort of a directional comment for next year and then a directionally faster comment for the year after.

Right.

It sounds like you're planning to get a little bit more specific than that.

I think that, again, it will be similar to what we laid at out our 3-year revenue outlook there. We laid out a 3-year cash flow outlook there. But given the environment, whatever is going to help our analyst community model as well as our buy-side investors make better decisions, we'll play out the information that's going to be necessary to make the proper decisions.

Okay. Excellent. If we move to RMS, you have the -- that's down in the guidance this year as well. You have the Black Hawk transition. Maybe just remind us how impactful the Black Hawk transition is? How long does it last? Does that go into next year as well? And then what are the other main drivers of a reacceleration at RMS?

Yes. So certainly, the Black Hawk will taper down. It will continue to taper down beyond next year as well. Now what we have is a CH-53K, which will more than offset that, which will drive some solid growth there. But we're not just a, call it, CH-53K and Black Hawk player. The key program and campaign for us is going to be future vertical lift of the FLRAA program, and we're expecting a decision in the second half of this year. You may have seen yesterday, there's some commentary that, that decision has probably slipped about September time frame for an award there and a decision. And so that's something that we're going to be tracking very closely. But RMS is more than just Sikorsky. There's some international radar programs that we are excited about, and we think that, that could be a source of growth for us as well in the future. And I would say that beyond probably the next few years, there's some international joint all-domain operations-type platforms that -- we're leveraging our ESS platform to go and help win. And so you'll hear us talk a lot about our technology development on joint all-domain operations, and RMS is going to be a big player in that. And we're seeing some -- so I call it pathfinder tech programs that are -- internationally, that will enable us to really form a program of -- a basis program that will help us utilize that in the United States as well. And so we're excited about RMS beyond just Sikorsky.

Okay. FLRAA, you're now hearing September?

Yes. So there was some commentary that came out yesterday that we were thinking that it would be early in the third quarter. It looks like it's, right now, later in the third quarter from a decision standpoint.

If you had to hit 2 or 3 bullet points on Sikorsky versus Bell in the FLRAA competition, what would those be?

I'd say the first one would be footprint. The aircraft will be able to land in a wider area or more confined areas. And so its ability and applicability to the mission set that the Black Hawk task today provides an advantage. The other one will be maneuverability. It's -- we talk about time of the -- to complete in a tighter mission. And we may not be the fastest platform point-to-point, but I want to make clear that our speed does meet the requirement of the RFP, and our proposal certainly has that. And when you look at speed of the entire mission, because of our maneuverability, we believe that has an advantage over the competing aircraft. And we did the 700-mile mission here from West Palm Beach to Nashville to show the maturity and the capability of our aircraft. So we believe we have been able to demonstrate to our customer that we have a mature offering as well. So I'd say those 3 factors is maturity of our technology, the maneuverability of the technology, and its ability to really work in more confined spaces sets it apart from the competing offering.

Okay. Let's maybe round out the segments with Space. That's down in the guidance this year with program transitions. Just sort of maybe give us the lay of the land on that. And then similarly, what do you -- I know some of the hypersonics work flows through missile, some flows through space. What else are you excited about and drives a growth reacceleration in the Space business moving forward?

Well, sure. We did see -- we are seeing a little bit of transition in OPIR. Well, I would just say that OPIR did get some incremental funding in next year's presidential budget. And so I think that was a positive surprise for us. It's still a question whether it's just a timing or whether it's truly incremental funding over the life of the program, but that it was a positive, I think, for 2023. I'd say the other element of Space is just our classified activity. I talked about it on the call, the first quarter call, our award of a $4 billion-plus program. And it's a classified program, so we really can't obviously talk much about it. But there's a lot of activity happening in the classified area. And I've talked about this in the past, where you're seeing missions go from certain domains into space domain. So we're not only seeing a augmentation of exquisite satellites out in space today with responsive satellites, but we're also seeing mission sets -- capitalization of mission sets being added to the Space domain. And we're really, really in the thick of that. A lot of those are in classified arenas. And -- but we're excited that we'll be a player in that, and that will reaccelerate growth for us in the Space business area and segment going forward. I'd say the other thing here and we've talked a lot about it. It's not a huge driver of growth, but it's a key program, the SDA transport layer. We were awarded Tranche Zero. We were also awarded Tranche 1 to provide more prototype space vehicles. And that's just a key enabler of the joint all-domain operations, architecture, having that communication network and space. And again, Lockheed Martin is a key player in that, and we're excited to be on that program. And I'd say, the other element, which is not necessarily Space, but it's in the Space is -- again, I talked about before of it was they're a player in our hypersonics. So they have both the CPS and the long-range hypersonic weapon, which is essentially the same weapon for the Navy and for the Army. And so that will be a growth driver for them. And then we're a player on next-gen interceptor there. And we believe that we'll be successful and have the right offering there for the long-term program as well.

Okay. Which major programs or drivers of the expected multiyear top line organic revenue growth acceleration have we not touched on in going segment by segment?

No, you froze there a little bit, can you rephrase the question again?

Yes. We've talked through the business segments and through a number of programs. What if we -- what's an important driver in the multiyear top line acceleration that we haven't hit on that we should, if anything?

Yes. We've talked about -- a little bit, we talked about how hypersonics classified [Audio Gap] both. We're pretty excited about sustainment on the F-35, our programs there. And we expect the sustainment growth to be about 6% between now and 2026. And so [Audio Gap] our 4 pillars of growth, that's about 18 [Audio Gap] is the programs of record. And we're pretty locked in on that growth rate for that element of these 4 pillars. And so we're pretty excited about that. 2022, we've talked about that, [Audio Gap] but we're excited to come out on the other side of 2022 and really resume growth in '23 and beyond.

Okay. Excellent. The entire industry, including Lockheed Martin, has seen some short-term -- or, I guess, part of the question is, how short term or not supply chain, logistics, labor-related headwinds? Maybe give us an update on how that's going? And what solutions you're able to put forward? And how much visibility, if any, do you have into when you can have full resolution of these items?

Chain, it's still really no different. It is a day-to-day, week-to-week type of endeavor. We do [Audio Gap] supply chain to make sure that they can deliver to us. So keep in mind that our first tier supply chain is dependent on second, third, fourth tier. And from time to time, we are still seeing surprises that we have to go and figure out how to mitigate. And so we talked about in the first quarter call, I think our supply chain operations team did a great job of managing it. We're still seeing it. And the reality is that we're going to see a gradual improvement. And the question for, I think, the industry is getting back up to where they were delivering before from an on-time delivery perspective, but also their ability to catch up what they've been able to deliver. And that's really the question, Noah, is how quickly will they be able to recover some of the delays that they've had in the past [Audio Gap] is an ongoing thing. [Audio Gap] As far as recovery, I think there's a general belief that we'll just snap back in a particular quarter. You really have to think about this gradually over quarters and, frankly, potentially years. And I think that, as we talk about things in the current circumstances, [Audio Gap] you ramp up, we've talked about that taking probably multiple years of being able to ramp that up. And we're seeing that in just in our current demand. And so it's really going to be quarter-to-quarter. We just have to update you quarter-to-quarter where we are. But I think we have to expect really more of a gradual type of improvement over a longer period of time.

How should we think about how that layers into the multiyear growth forecast? I mean, I guess, on the one hand, if it's impacting 2022, it resets the starting point and the denominator of the next year's growth rate and so on and so forth. So maybe it doesn't have an impact. But it does seem to be incrementally more of a headwind above and beyond when you first laid out that growth path.

It's not only do we have to understand just this incremental budget environment. How does that flow out from a contracting standpoint. Also have to take a look at our supply side and [Audio Gap] we're in the time frame that we had before, once we get under contract, is that's still the same case. That's something that we're going through now. It just adds complexity to the formula in terms of determining what that means to a revenue profile. What I will say is that probably the best way to look at it will be the backlog and how [Audio Gap].

Jay, are you there? Jay, can you hear me? I think there's a -- I think the Internet connection...

Yes. I can hear you now, Noah. I just got you.

Okay. Yes. Sorry, I think you got a little bit choppy there, but I heard most of that. Let's maybe round out on cash flow statement, how you're thinking about balance sheet, capital deployment. Maybe just walk us through the progression of what the drivers are outside of the business segments over the next few years because there's several of them. There's working capital movement, there's the pension inputs. What's the capital plan? And then also, if you could update us on this R&D tax treatment item. And yes, how that all rolls into your multiyear cash flow outlook?

Right. So yes, let me -- we had laid out cash flow around $6 billion a year over the next 3 years. And certainly, that's stepped down from what we did in 2021 of nearly $8 billion. The driver for us is CapEx. We're ramping up this year. We've talked about $1.9 billion and that stays level. And when you compare that to depreciation, our depreciation runs about $1.5 billion. So our biggest kind of use of cash is not really on the CapEx side. Tax is obviously a big driver as well this year. It's a $500 million-plus impact, assuming the R&D capitalization and that will twirl down a little bit in '23 and '24 would be a drag. Working capital is also a use of cash. It's anywhere between, say, $200 million to $500 million a year. And those are things that we'll do a deep dive on this year as we reset and relook at our 3-year outlook again, [Audio Gap] but that's certainly the level of investment that we need [Audio Gap] supply chain working capital. The natural inclination will be what can we do to drive down inventory in unbilled receivables. But we're really in an environment where we're trying to actually increase our inventory to make sure [Audio Gap] and we're asking our suppliers to do the same. And so we're not going to be penny wise and pound foolish, we're going to do the right thing operationally there. But just holding a baseline of the $6 billion, we'll update that and take a look at it. As far as the R&D capitalization, I was encouraged by some -- last week, over the past week, there's been a movement, nonmine dilution in the [Audio Gap] a full repeal [Audio Gap] really funding and subsidizing that. And so I'm hopeful that we've seen the bipartisan support, and this was at least a first move to try to get that into this legislation. It's somewhat promising [Audio Gap] at least through, I think, 2025 in that ballpark. With returns to where they are this year that [Audio Gap] from a deployment standpoint, what you've seen here in 2022 over 1% of our free cash flow in dividends and share repurchase. I would expect, over the next few years, to be more of the same, and if not, maybe a bias to the upside. But I'm reluctant to really kind of lay out exactly what that is, where we're going through. As we go through our organic outlook, we'll take a look at what our capital deployment outlook would be in conjunction together. And that's when I'll probably lay that out again in this October call for the third quarter call. It's positive. At a minimum, you should expect us to continue to deploy around as a baseline, 100% of our free cash flow, and we'll see if there's any upside from there.

Okay. Excellent. All right. We've made it to the end of our allotted time here. So I'm going to have to wrap up here. But Jay, thanks so much for being with us today. We really appreciate your time.