Lockheed Martin Corporation (LMT) Earnings Call Transcript & Summary

Okay. Great. Good morning. I'm Doug Harned, Bernstein's Aerospace and Defense analyst. I am really thrilled to have with us again, Lockheed Martin. We've got with us today Frank St. John, the Chief Operating Officer of Lockheed Martin and Jay Malave, Chief Financial Officer.

Yes. So I'm going to start off with your favorite comments. Statements made today that are not historical facts are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities law. Actual results may differ materially from those projected in the forward-looking statements. Please see Lockheed Martin's SEC filings, including our 2023 Form 10-K for a description of some of the factors that may cause actual results to differ materially from those in the forward-looking statements. I'll kick it over to Frank for a couple of comments.

All right. Well, good morning, everyone. It's good to be here with you today [Audio Gap] 40th Bernstein conference. You're telling me there's like 1,700 folks here. This is my first and so I can honestly say this is the best one I've ever been to.

Great. I'm glad you didn't say it was the worst one.

So let me begin with just a brief introduction. Lockheed Martin is off to a really good start this year. We had some good momentum in the first quarter and that is carrying into the second quarter as well and given us pretty high confidence about our fiscal year outlook and also increasing our confidence about accelerating growth in 2025. On the F-35 program, the flight testing of the TR-3 software is progressing and we are getting good results out of that flight testing that are confirming and giving us confidence that we'll start delivering aircraft in the third quarter of this year. We're also building our backlog and that is on the backs of a lot of programs of record but also we've had some new wins that are really encouraging. Most recently, we had the early down select on the next-generation interceptor program. And that's notable, not just because of the new technology and the customer capability but also that was a first mover program in our digital transformation efforts as a corporation. And so it validates what we've been saying about the affordability and agility that's going to come when we develop things in a model-based enterprise with a digital thread. The last thing I'd say is, we're continuing to focus on and make progress on our 21st Century Security strategy. A recent example of that was a demonstration we just did where we defeated an advanced cruise missile threat using a PAC-3 interceptor, launched out of a MK-70 vertical launch system under the control of Aegis Combat System. This connects some capability across our corporation. It gives our customers something that's going to close one of their gaps. And it's just a demonstration of what we've been saying that if you digitally integrate capabilities you have, you're going to be able to rapidly deliver capability. So with that as an opening, Doug, I'll turn it back to you and we'll get into the questions.

Great. Thanks, Frank. As you said, this is your first time here. As COO, I mean, perhaps you could tell us little bit about how you work with Jim, what the COO role is all about and what you focus on?

All right. Well, the COO role is a lot about doing whatever Jim asks me to do. But mostly, that means focusing on and partnering with him on delivering strategies and plans to make 21st Century Security a reality. In the near term, that means focusing on delivering the programs that we have. F-35 is a great example, making sure that we have the subject matter experts there, making sure that we're working with supply chain to work our way through TR-3 and any production issues that come up. It also means working to make sure we have the people, the capital, the facilities in place to support the production ramps that we have ahead of us. And then also in the near term, it's making sure we have strategies in place that support the growth and capturing the new business ahead of us. In the longer term, what we focus on is 21st century security, really bringing commercial technology and the billions of dollars that have been invested in things like edge computing, networking, artificial intelligence and applying that to military problems for our customers as well as building out our supply chain, working on supply chain resiliency to include international partners. We're also working on bringing the corporation together as 1 Lockheed Martin, and that means not only offering things to our customers that are the best of what we have across the corporation but also driving the culture of finding best practices and spreading those around. And then lastly, it's about that digital transformation. It's a significant investment. It's going to go over the next 5 or 6 years and we're kind of flowing that through every program, every line of business and making sure that, that digital tool and process capability transforms who we are going forward.

Now to start out here, I'd like to get your thoughts on -- we've seen the President's budget for 2025. It's been constrained by congressional caps. I think for the most part, it's somewhat disappointing that we're kind of at this level where we actually budget -- we have negative budget growth in real terms right now. What -- when you look at that budget, how does it look for Lockheed Martin?

Well, I'll make an introductory comment and then I'll turn it over to Jay for some of the specifics. I think you're right in that it's a bit ironic that we're in a situation where we've got threats increasing at a rate that we haven't seen in decades. We've got technology increasing at a furious pace and yet in terms of real dollars, there's less resource. That puts the emphasis on us as prime contractors to the U.S. government to be more agile and more efficient and be able to deliver them capability within the resource constraints. But if you look at the specifics of the budget, '24 and '25, there are some good things for Lockheed Martin in there and I'll let Jay talk a little bit about that.

Yes, maybe I'll start with just 2024 because we had plus -- some substantial plus-ups, F-35s were increased, combat rescue helicopter was increased, C-130 aircraft were increased. And so we benefited from that. Even when you talk about in the context of a 3% budget increase in 2024, our backlog increased by 2x of that growth rate. So we grew from 150 to 160 in our backlog by the end of 2023. You go here into 2024 for the 2025 budget and you look at around the portfolio and the programs, it's again, the support is still there. Whether it's Sikorsky CH-53K, we were just awarded, which we're honored to be on the program for next-generation interceptor, important program for us. Things like hypersonics in our space segment with combat or Conventional Prompt Strike long-range hypersonic weapon and a number of other programs. And so in 2024, even with the 2025 top line pressure, we have a line of sight to growing the backlog yet again. And if you look at our sales guide this year, the midpoint is about 2.5%, where the high end of our guide is closer to 3.5% to 4%. And so we potentially can get up to the higher end of our guide and still see our backlog grow. And so it just goes to the strength of -- and the breadth of our portfolio. And what we've been doing really not only the last 2 years but frankly, over the last 10 years positioning the company to be on these key programs. And so you've always got to keep an eye on when you're looking at 1% growth. But based on what we see today, we're trending towards higher growth than we originally anticipated for the year and still having our backlog grow. And I think that is a testament to the portfolio we have.

And the other thing we're seeing in the '24 and '25 budget is a recognition of customers on the value of multiyear procurements. So in the case of munitions, we're seeing multiyear procurements being authorized. In the case of CH-53K, there's an authorization for a multiyear there. So that creates opportunity for us from a business point of view, even in the budget environment.

When you think about it and I won't necessarily call them megatrends but macro trends, you're still dealing with some of these conflicts and the replenishments associated with those conflicts. We see that growth, particularly in our Missiles and Fire Control portfolio and that's going to be our highest growth over the next 3 or 5 years. And then you've got the whole nuclear threat, the China threat and so that's just modernization of new technologies there to keep pace. And so we're participating on both sides of those macro trends.

Yes, there's a lot in what you just said. And I want to get into a few different aspects of it, including the really good backlog growth that you've had. But first, going back to the budget, in your discussions on the Hill, I mean are you seeing any evidence that we could see, I'm going to try and say it nicely, so a less dysfunctional Congress than we have seen when it comes to defense budgeting. I mean we're -- it feels like, as you say, we've got these escalating threats there should be, if you look at history, that should lead to higher budgets. But we're not seeing it. What's the dynamic that you all see in your conversations in Congress?

Well, I would offer just a couple of thoughts. One is the compromise that we saw working through the supplementals over the last couple of months was somewhat encouraging that maybe there's a recognition that some things are more important than political positioning. And so that was a positive trend. We've also seen some public dialogue recently from some legislators about needing to change that cap because of the situation that we're in, in the world. And so there's some discussion about...

[indiscernible]

Yes. Yes, absolutely. Conversations about $50 billion, $55 billion needed for defense. Counterbalancing that, though, we're, I'd say we're maybe cautiously optimistic. But counterbalancing that is, we are going through an election year and things that are challenging, get more challenging in that environment. And so I guess I'd say that's the kind of a summary of where we're at. A few bright spots, but challenges ahead.

It should be and maybe there'll be kind of some recognition of that to -- maybe we'll see some -- we're not necessarily planning though for higher than what's kind of been laid out from a fighter perspective, let's say. And so one of the things that we're just -- there's going to be, I think, some program, whether you call them truncations, whatever the case may be, retirements to fund some of these new capabilities. So the customer within an $800 billion budget does have some wherewithal to make some of those tough choices. So we're expecting that, that's probably going to occur where you may see some retirements and you've seen it like A-10 aircraft and things like that. And so if there's adds that would be really kind of upside to the way we're planning.

Now, when you -- as you said, I mean, you've had some really nice backlog growth. If you look over the last few years, your revenue has been pretty flat. And are we seeing a turning point here where you could get up to kind of a mid-single-digit growth rate over the next 5 years segment? How do you think about it when you look at this wave you're getting in backlog?

Yes. And so that's very true, Doug. If maybe go back a little bit, when you think about 2023, we came into the year thinking that we would be flat. And we did grow. And so we were able to -- when you think about Lockheed Martin, it's more of a long-cycle business. But we were able to convert some of that backlog in 2023 and drive a growth rate -- returned to growth faster than we had originally anticipated. You go into 2024 and that growth rate is accelerating. And then you go into 2025, we expect it to continue at least at what we see this year and be higher potentially. Can it be 5% in a particular year? Yes, it definitely can be 5% based on the backlog. Frankly, this year want it to be 5% with the backlog but there are some kind of either capacity constraints. We're still kind of working through in certain programs, just supply chain performance and things like that. And so the demand that we have, the backlog that we have would support a 5% growth rate. Right now, we've got that moderated over the next 5 years. We could see 4% to 5% in any given year depending on how kind of the underlying operational cadence can catch up. And so I know we'll probably talk about ramps maybe later on in the discussion. But we're pretty focused. Right now, we're performing for the most part on the ramps that we had expected. There are a few programs that are a little bit slower than we had anticipated. And so we're just being, I think, generally conservative. But going back to your question, can we see a 5% growth rate? Yes, we can.

Well, then an important part of this, I would expect is, is going to be international. We've seen significantly more demand in Europe. But I would say on the other side of this, a while back, we went through a huge amount of demand in the Middle East, which may not be as aggressive now. When you look around the world and look at your international demand, sort of Europe, Middle East, Asia, how do you see it? Where are you benefiting and what's the net impact?

So I'll -- Jay, if you don't mind, I'll just start off with that. And so starting with Europe. Obviously, there's a significant ramp-up in the budgets, reflecting the decades of undercapitalization in defense capability. And especially in Eastern Europe and the Nordics and the Baltics and anybody that is within 1,000 kilometers of Russia has now got an urgent demand for capability. And you add to that, this deterrence demand -- but you add to that also the aging Russian equipment that many of these countries had in their defense inventory. So things like helicopters, fixed-wing aircraft, artillery systems. All of that is aging out. It needs to be recapitalized and they're also not likely to go to Russia to get that capability. And so that's creating demand for artillery systems like HIMARS, fixed wing aircraft F-16, Black Hawk helicopters. All of that is European focused. Obviously, in the Middle East late last year and in January, they are keenly focused on Iran as a bad actor and we've seen this over the last couple of months. And so things like integrated air and missile defense, integrated command and control, refresh and upgrade of some of their fleets of transport aircraft and fixed wing aircraft are all very much front and center and those are good opportunities for us as well. And then I just got back from a couple of weeks in Asia talking to the Koreans and the Japanese who are really in a bad neighborhood. North Korea is shooting missiles over Japan kind of on a monthly basis. Japan has still got contested territory with Russia in the north and they watch them very carefully. And then China views Korea and Japan as kind of an impediment to what they want to do in the region. And so all of those things together are creating increased budgets in those countries, increased desire for integrated air defense, long-range strike, advanced platform capability, C2, all of that is things that is at the heart of our portfolio. And so that's a good base for us to take off from.

When you roll all that up, where do you see international going as a percent of Lockheed Martin?

Today, we're around, I think it's 27%. If you look at from where we are today, we'd expect that our growth rate internationally to be -- you're talking mid- to high single digit over the next 5 years, which then implies the U.S. DoD would be a little bit lower [indiscernible] growth rate consistent with what we're seeing in the top line fighter. But that's -- it's going to outpace U.S. growth. And it's pretty much, again, not fully in the backlog but a fair amount of this business is already in the backlog. And going back to -- particularly a country like Australia, which -- they're buying C-130s, they're buying Black Hawks, they're buying F-35s. We're successful with them on satellite programs, military communication satellite programs and AIR6500, which is a joint all-domain command and control system. So you have just these buildouts that are happening and modernization happening internationally and we're participating very much -- Australia is just a great country for us. But as Frank mentioned, Japan, Europe, we're seeing very similar types of -- the demand environment there.

What's interesting to me about what you're saying is that this seems to have changed a little bit because we always would talk about PAC-3s and THAAD but the range of programs that you're able to -- systems and -- you're able to export now seems to be expanding. Is that fair?

Yes. I would say so. You think about -- it's not only kind of getting the licenses -- export licenses but it's also our capability that we're able to really bring it to relevancy internationally as well. How many satellite -- international satellite programs that we had in the past, not all that many. And in Australia, we have the GPS and now the satellite communication. So it's just -- it's an expansion of our portfolio capability beyond, as you mentioned, kind of missile defense type programs, F-35 has always been an international program. F-16 is another one that our backlog over 120 to 130 aircraft is all international, on the F-16. And C-130 backlog has got a fair amount of international as well. So it's pretty broad-based. And you're now -- the Black Hawk, I mean they're just around the portfolio. International radar, ground-based radars, were successful with Norway 1 year ago, with our modernized TPY-4 platform. And so we just continue to see and offer these systems to international customers.

And the more we deliver for these international customers, the more we're able to build relationships in those countries and then that feeds demand for other capability.

One of the things that Frank mentioned is really going to customers as 1 company rather than offering them just a discrete program or system. And we've really, probably spent the last, I want to say, 3-plus years of really taking an integrated approach to our sales. And we've got Michael Williamson, who's our Chief Business Development for the corporation and was before me, as well as Frank and Jim, really have -- the company just changed and it's really making an effort to really provide integrated systems to the customer, not just 1 capability.

F-35. So that's close to 30% of revenues, clearly a critical program. You've gotten up to the 156/year rate but as you mentioned, the Tech Refresh 3 has been difficult. Can you walk us through where this all stands now? I mean I know -- it's been pushed out, Tech Refresh 3 is pushed out into next year. You've talked about having a sort of subset of those capabilities on earlier deliveries. Where is the program today?

So where we're at today is, from a hardware point of view, we are continuing to build aircraft at that 156 rate. Software capability, as I mentioned in my opening, we are in the process of flight testing, we're following a combat training software build. And that will allow aircraft to be delivered and go to operational units and begin the standup of bases and pilot training and everything that's required to lead into a combat capability that is going to be fully delivered in the first half of next year. So from a hardware point of view, things are good and flowing, from a software point of view, we're finalizing that flight test program and we're going to start delivering jets in the third quarter. I think it's important to remember, though, that TR-3 is the beginning of a development and modernization process of the F-35 that's going to go on for the next 8 or 10 years. And so it's really important that we get this processing and data infrastructure correct within the aircraft because it's the foundation for new mission capability that is going to extend into the 2040s and beyond.

Then how -- so the completion of Tech Refresh 3 has slipped multiple times. And it's central to Block 4 and how do we get comfortable that this is going to finally get on track and we're not going to see this continue to push out?

I guess I'd say the -- I guess I'd say right now, all I can tell you is that the flight testing is going well and that we're very confident that we're going to start delivering jets. And that with that TR-3 processing and software as a baseline, future integrations are just going to have a good foundation. We're also making investments in infrastructure. I think you've seen some language in -- congressional language about investing in infrastructure for test aircraft, for test labs and facilities so that we can pave the way for a smoother integration. I'd like to think we've learned our lessons on TR-3 and that we're going to see this -- just see this get better as time goes on.

So with this, I mean, you've continued to produce at 156 and you get paid for that, you get some money on delivery, right, in cash. But -- so that's all been fine. Is there any concern that -- and I'd say from 2 standpoints, if Block 4 Tech Refresh 3, if it continues to get delayed, so -- that you might have to pull that rate down. We're also -- we've seen in the budget, there's been a reduction in the '25 budget, which it looks like Congress could even take some more out. How does that play into your thinking on that 156 rate, given that there's a lot of international demand at the same time. Sorry, there's a lot in that question but...

Yes, I think it's still to be played out, Doug. I mean it's -- the range of outcomes, it's -- yes, it could dip for 1 year or 2 but it also could stay at 156. It becomes a question of where these volumes finally -- where do they land? And what flexibility would our customers have, with international customers to be able to move around delivery. So it's possible you can accelerate some deliveries, rebalance and really see maybe a slight change to the production rate. Depending on the timing of that, it's also possible that because we're already building aircraft that would be delivered in future years that our ability to make significant moves and accelerate different customer sets may have passed in certain cases. And so it's really -- it's a work in progress in terms of what it would do to the rate. But I think what we have to keep in mind is, even if we were to dip for 1 year or 2 years, the program of record, the customer has been committed to over the long term, this program, we're talking a lot of aircraft. And so I think we'll get through this. We will get ourselves on the right schedule for a Block 4 incorporation and make this aircraft even better than it is today as the industry-leading aircraft in the world. So -- yes, kind of it's a little painful for the short term. Here, it's putting some pressure on cash. It's putting some pressure on profitability as we watch our booking rate and all that type of stuff. But we're talking about getting through this over the next year or so and then getting ourselves back on track towards delivering to the full program of record. And so there's been no change there. And I think the long-term demand is going to continue to be the foundation of Lockheed Martin for many years to come.

And one other thing here. It's not -- I mean, directly, it's not your problem but there have been -- we've seen real delays in engine deliveries. That's obviously a separate contract. But is there any point where delays in engines impacts your work and production?

So where we're at today, we've got enough engines in inventory to stay ahead of the production build rate. And so we're not seeing that impact now. We're projecting that to be an impact in the near future. We do work that obviously very closely with the customer to make sure that, that doesn't become an issue. We do have other supplier challenges that are, I guess, I would say, pacing the rate. And so we're looking at the processors. We're looking at the other TR-3 hardware elements because those are -- those are new hardware configurations that have to ramp up and be at full production rate to support this year and years going forward. So we're keeping a close eye on that but the engines haven't been as big an issue.