Lockheed Martin Corporation (LMT) Earnings Call Transcript & Summary

Good morning, everybody, in the room and on the webcast. I'm very happy to be opening our UBS Global Industrials and Transportation Conference here in beautiful West Palm Beach. My name is Amit Mehrotra. I'm the electrical equipment and multi-industry analyst here at UBS. I'm joined on stage by Steve Fisher, Gavin Parsons and, obviously, our introductory keynote, Lockheed Martin. As Steve will kind of note momentarily, we are really proud of the size and scale of the conference, which is really made possible by our valued clients and as well as corporates. We sincerely hope you make this kind of a staple in your post-Thanksgiving, early December, I think next year, December 1 through 4, right here at the same location. So please save the date. We'll be kicking off the conference today with Lockheed Martin, led by Gavin Parsons. One programming note before I hand it over to Steve. We will be having our second keynote today at 4:15 p.m. right here, and that will be the Director of MIT's Artificial Intelligence Lab, which will be followed by a reception on the lawn. So that will be obviously interesting in terms of AI's impact to industrial trends and energy infrastructure demand. So I'm going to hand it over to Steve to give you some quick stats on the scale and breadth of this conference, and then we'll hand it over to Gavin to lead our first keynote with Lockheed Martin. Thanks again for coming.

Good morning. Thanks, Amit. Appreciate that. So I'm Steve Fisher, UBS machinery, engineering construction and building materials analyst. So just for some historical context, I've been part of this UBS Industrial Research team for over 20 years, and I've never been more excited about a lot of things, as I am today. Certainly, excited for this conference. I think it's one of the biggest and best and most robust that we've ever had, certainly the only one that we've had golf at, and even a Lawrence Taylor sighting for those that were there yesterday. But other things that I'm really excited about is basically the team that we have here now. We have the long-running talent that we've had in the group for a long time, including Tom Wadewitz, Josh Spector, Damian Karas, and Allyson Gordon, both on the trading and now sector sales side. And I'm really excited about the new team members we have with Amit, with Gavin Parsons, John Lovallo, Josh Chan and Joe Spak. This is a lot of talent and really excited for that. Also I want to point out, really excited about the Evidence Lab offerings that we have, giving you great proprietary data analytics. And then more recently, the UBS-ARC, which is our network of privately held companies, providing unique insights run by Daron Pope. So we really are appreciative of having everybody here, excited to work with you all. And with that, I'm going to turn it over to Gavin Parsons.

Thanks, Steve. All right. Are we on for the webcast? Thank you. Jay, thanks so much for joining us.

Well, Gavin, thank you for having Lockheed Martin here. Happy to be here.

Perfect. Do you have any prepared remarks, or...

I do. I've got our safe harbor statement, so give me a second to make it. 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. Okay. With that out of the way, all yours.

Awesome. Well, I think maybe I'll start with a high-level question since we're the keynote here. In terms of national security just becoming much more relevant for all industries, I guess, can you tell a little bit about how you're seeing the battlefield evolve both internationally and within the U.S.?

Yes. I mean, over the past few years, there's certainly been a number of learnings. And I'll start maybe with small, cheap, autonomous -- maybe not autonomous, but vehicles. And when battle space allows for it, those have an appeal because of the disruptive effects that they can deliver. So it's difficult to defend against a lot of things, think of drone swarms and the like. As the battle space becomes more contested and more difficult, you need to augment that capability with more sophisticated effects and/or capabilities. So for example, things like, when you're dealing in the battle space, where you've got significant electronic warfare, cyber, in addition to other kinetic effects that become more sophisticated, you need other defensive measures and other offensive measures. So things like electronic countermeasures, things like other autonomous types of vehicles, more secure communications and networking that allow for greater bandwidth as well as lower latency, things like stealth. And so there's a number of things that have to be brought to the table fairly quickly. And when you look at the DoD's priorities over the last few years anyway, you see really an investment in both areas, the small, lower cost vehicles, things like the replicator initiative, which provide numbers. And then you see other things like CCA, collaborative combat aircraft, which are intended to pair with demand platforms to provide a multiplier effect. And so those are capabilities and investments that the customer is making. Of course, there are things like additional stealth capabilities, additional like sensor capabilities such as converged sensors, RF converged sensors, where you can do multiple mission capabilities with one aperture as an example. And so those are all areas that the customer is investing in. And so it's not only small and lower cost, but it's also higher-end exquisite type of capability that can be brought together and paired together ultimately over a contested environment. And so that's what we see. And our investments, internal investments are really geared towards that exact capability. While we may not be a low-cost provider, say, on small unmanned vehicles, we can provide command and control type of capability to those types of vehicles. By the same token, as you know, we also have the stealth capability. We can do converged sensors. Jim talked about, in the third quarter call, our ability to introduce AI capabilities into real space. And so again, Lockheed Martin, you think about what we are, we are an exquisite systems integrator, which enables us to really work in every domain, whether it's land, air, sea space, cyber. We're able to provide those capabilities and integrate different systems and capabilities to our customers.

So we have a new administration. It sounds like those are pretty clear national security priorities, but the budget is not infinite. So what are your thoughts on kind of the spending priorities, both programmatically, but also for the overall defense budget level?

Yes. It's a little hard to say really at the moment. We're expecting -- right now, we're working under, for '25, a continuing resolution, as you know, Gavin, through, I think, it's December 20. That we expect that to get extended, but a final budget probably not to be concluded until probably sometime in the first quarter. We expect, as a result, that the '26 budget, at least the presidential request will come out probably short time thereafter, which could be the second quarter. So we're going to be living, I think, under a little bit of an area of uncertainty related to budgets. We know kind of what's funded under continuing resolution. We have to operate under that. But I would expect over time that there will be different priorities in this administration. It typically happens. New administrations will prioritize things that maybe the prior one didn't. I think the good thing about Lockheed Martin is that we're accustomed to that. We know how to operate in that environment and how to adjust quickly. So as I mentioned, there are a lot of key capabilities. I would expect some of these capabilities to continue. But again, it's really got to be -- we really have to see what their projections will be and what they're requesting.

Your view on the fiscal '26 budget request when I think the Fiscal Responsibility Act is no longer in place?

Yes. I mean I think that that's something that they may or may not decide they want to comply with. We'll see. I mean that's -- deterrence is certainly a key capability that the administration, every administration, wants to maintain, obviously. Where you could see, and you see these things with government efficiency, where you could see elements of addition by subtraction. So ultimately, you could see a higher budget request than what we've seen from the prior administration, but it could be as a result of some things either being curtailed or canceled and other things being prioritized. So there's really, I think, a level that we just -- until we get that visibility, it's really hard to speculate on what we'll see. But as I mentioned, again, we operate in pretty much every domain, and we're ready for changes. We're accustomed to seeing these changes and we adjust quickly.

Maybe pivoting to the F-35. The press has reported you have a handshake deal on Lots 18 and 19.

Yes.

What can we expect for timing of an award? Could you receive that this year? And I believe you already have a placeholder in your guide for some financial impact of the timing. And if you could refresh us on that?

Yes, sure. So yes, we have a handshake. That handshake has to though put itself into memorialized fashion. So it's unlikely between now and the end of the year that we'll have a definitized contract. What is more likely is that we will be operating under what is referred to as an undefinitized contract action. But that will enable the funding to be applied to the program and enable for us to operate and incur cost and record revenue under that contract. And that would be then fully definitized at a later date. There's still -- we still don't have that undefinitized contract action finalized yet. And so we're still working with our customer to do that. And the impacts will remain the same. If we're unable to do that by the end of the year, you're looking at a couple of billion dollars of revenue associated profit and $1 billion plus of cash flow. But again, as we said in the third quarter call, it's timing. We're doing everything that we can with our customer to get this undefinitized contract action completed here in the year. But it's possible where -- even in the case where we do get it, the undefinitized contract action, that will enable us to record revenue and profit for the cost that we've incurred to date. It's possible it may become so late in the year that our billing won't convert to cash until January. So there's still some things that we need to work through. I think we're on a very good path. I think having the handshake is a very positive sign. And we're getting close. We're getting close. I'm bullish that we'll get there by the end of the year. And if we don't, it's really a timing impact.

Is there any single long pole in the tent to getting that done in the negotiations?

No. Now it's in the detail of the Ts and Cs, even an undefinitized contract actually doesn't have every single term fully defined, but there's still, outside of price and general terms, things that need to be finalized. And so the teams are working through that. They have their -- the Joint Program Office has to go through the review process. They have to get approvals, as do we internally. And sometimes those could be delayed, even though there's a meeting of the minds in terms of the general critical terms.

I think I also saw you've got Lot 20 long-lead funding. How much visibility or how many years of kind of locked-in pricing and terms do 18 and 19 and then 20 give you?

Well, the long lead for 20, again, is exactly that. When you think about the cycle time to deliver an aircraft, you're looking at 2.5 to 3 years. And so what this does, just keeps the program moving along. We won't deliver those aircraft until sometime, I believe, in 2027, and so 2028. And so this just helps us order the material, bring it in. The profitability of that is really a TBD, because we haven't really got into firm negotiations on Lot 20 with the customer. That will go through its own separate process. And so you have some initial funding here to keep the program on track. We will -- once we conclude 18 and 19, then we'll start, at a later time, to negotiate Lot 20. And even though it could be 1 lot, it could be multiple lots, we'll see -- that's a dialogue we'll have with the customer. And so there's more to come on that one. Lot 18 and 19 is the one that we'll have pretty definitized pricing here, and that should be hopefully done here this month.

That includes an inflation catch-up?

Yes. I mean there's certainly going to be aspects of incremental costs related to inflation. What I would say about our managing of this program in collaboration and partnership with the Joint Program Office is that, by and large, we've been able to keep the cost increases on that program lower than the rate of inflation. So I think that we've done what we could. We're driving productivity to the extent that we can. We're working with our suppliers to keep a lid on cost. So I think that's the way to look at how we're managing that program. Yes, it's going to be higher cost for 2 reasons. One is because of inflationary effects, also because of the technology, new modernization that's going to be inserted comes with a higher cost as well. But even so, we're doing a good job of managing the cost increases, as I mentioned, lower than the rate of inflation.

And international demand there is still pretty strong. I think I just saw Romania. What other countries are in the pipeline? And is there upward pressure on the production rate at some point?

Yes. Well, first of all, we're proud of Romania being the 20th international customer to the program. We're very excited to welcome them to the family. There continues to be significant international demand. I would say Europe and the Middle East are 2 areas where we see it. As you know, we have to collaborate with the U.S. government. Certain countries can take the aircraft, certain countries cannot. But the demand cycle is pretty strong for it. Besides the fact that it's the most advanced fifth-generation platform, it's also interoperable. So it allows our countries to work together and work with the U.S. when you have a common platform and operating system. As far as the production rate, we're pretty, I think, locked in 156 per year in terms of the build rate as well as the delivery rate is what we're trying to get to. And I don't see that changing anytime soon. The investment necessary across the entire value chain is pretty substantial to take it up, even into, say, the 160 to 170, it's a pretty big number. And so we had a handshake a few years ago with our Joint Program Office partners on 156 being the number, and I believe that, that will be the number for the foreseeable future.

What's the latest on the PBL or services contract potential?

Yes. On the PBL, so this is just for those that don't know, it's a performance-based logistics program for the F-35 program, sustainment of the aircraft. The customer had decided that they were going to take a pause on that type of program. And so the manner of contracting and transacting with our U.S. customer right now and over the next few years is likely to be more transactional. And so it will be similar to what we've had before, where we work together to try to drive down the operating cost of the aircraft, and we transaction -- basically, the way they'll purchase the parts and repairs will be on a transactional basis. And we're okay with that because we've done that before.

You guys have given some great detail on production rates in MFC. But I wanted to ask higher level, we're obviously spending a lot of munitions. We need to restockpile, probably reconsidering where stockpiles or levels need to be. How do we think about what that balance is when we do restock?

Well, it's hard to say. A lot of the information in terms of stockpiles are all classified information. But what I could say, based on our discussions, based on the contracts that we have, MFC alone has a $40 billion backlog. And it's my belief that the demand cycle for MFC will stay pretty strong through the rest of the decade because of the replenishment in addition to increasing stockpiles, not just in the U.S., but internationally as well, whether you're talking things like GMLRS, HIMARS, PAC-3, all those systems, Javelin, all of those systems, we see a pretty enduring demand through the rest of the decade there. And so we've had a lot of dialogue with international countries, not just selling them equipment and systems, but also developing co-production capabilities. So countries like Poland, Australia, Germany are areas and countries where we're developing relationships, where we will co-produce and increase our capacity at the same time in those areas. And so we've talked about MFC being a high single-digit grower for Lockheed Martin. We've got a pretty good runway there, pretty good visibility there. And even if you see conflicts come to an end, which, quite frankly, we would like to see them come to an end, we still see that demand cycle being pretty strong.

So if I come to that low to mid-single-digit growth framework, you've talked about supply chain being one of the determining factors of whether you can get to mid-single digit or not. How derisked is that within the low single-digit band?

Yes. When you think about low single digit, maybe I'll be a bit more specific there. You're talking in the range of like 3%. It's not really going from 1%, 1.5% to 5%. It's really going 3%, 3% to 4%, 3% to 5% type of thing. And if you look at where we are, and I don't want to just sit there and say it's all supply chain, because there have been areas just in our own facilities and operations that have been challenged as well. So I refer to it as the entire value chain, supply chain as well as Lockheed Martin's internal operations. I think what we've seen over the past year is pretty solid stability. And we know that the amount of supply chain issues, I'll start with supply chain, and even I'll call it, really our internal operations as well, the issues have narrowed. And so we know exactly where they are. Unfortunately, they've been stubborn, because they've been the same for the last 3 to 4 years, but at least they have narrowed. And really, the question is not being able to keep up with the current volume requirements, it's really stepping it up at a 5% compounded rate is really the question. And so we were comfortable with a low single-digit rate around this 3%. And to the extent that we can continue to have a synchronized operation, both internally and with our value chain and with our supply chain, then we can see it go up. And I've been a little bit more conservative on that because it's a pretty big step-up given what we've seen over the last 3 to 4 years. What I would say, though, is if you look at 2024 as a good example, we came into the year thinking that our sales growth would be around 2.5%. We updated that in midyear to 5% once we got the visibility that the whole value chain could produce at a higher level. And so I think that's the way we'll approach it going into the year a little bit more conservative. As events occur and as time passes, if we see the whole value chain being able to maintain a higher level of throughput, then we'll increase our expectations accordingly. So it's really more of a wait and see and it's a little bit more of a show-me story. But the opportunity set is certainly there. I mean, given our backlog, again, at the end of the third quarter, a record backlog, and that wasn't even recording the backlog associated with the Lot 18, 19 negotiation. When you think about that, that's another, say, $10 billion or so that would be added to our backlog. And so the visibility is solid. The visibility is there. And we're just trying to make sure the entire value chain can keep up with that demand.

So it sounds like low single digit, pretty high confidence. The supply chain is not going backwards. It's just how much growth can it support?

Right. Exactly right. Yes.

Any quantification you can put around supply chain improvement, any metrics that can help us track that?

Well, what I would say is that we have seen performance improve generally to a level that before COVID hit. You're talking 2018, 2019 time frame. And when I refer to that, it's really on-time delivery type of metrics have generally recovered to those levels. And now we're stepping up with higher volumes, and they've kept pace with that. Now what I would say is those on-time delivery rates weren't fantastic to begin with. There's a lot of opportunity there. But at least we're back to that same level of performance now. Now it's a question of working with all of our partners on how we improve those rates from here. And the most important things are on-time delivery and quality. So they could be at a 95% rate in on-time delivery, but if the quality is poor, it disrupts our production flow. And so you have to get those things together, and that's what we're working with on. And as I mentioned, the issues are a little bit more narrow. So we've got our resources working, whether it's internally or with our suppliers, to really beat those down.

In terms of the biggest growth drivers, you mentioned MFC being one, but what are some of the other big contributors, whether it be CH-53K, hypersonics?

Sure. As I mentioned, MFC, we kind of -- you look at over the next few years here, you're looking at high single digits. Probably the next highest grower would be RMS, which is, say, 3% to 4% over the next few years. And again, if you look at -- you break them down and they're $17 billion, $18 billion segment. Sikorsky is about $6 billion of that. Over the next couple of years, Sikorsky is actually going to -- is projected to grow pretty nicely. CH-53 is certainly going to drive growth over the next 2 years, but CH-53K is going to drive growth over the next 5 years. This year, we're going to deliver about 4 aircraft. We're expecting that to double next year and continue to double until we get to between 20 to 24 aircraft a year of full rate production. So we still have got a continued ramp there. Over the next year or so, we've got volume growth on the Black Hawk Multi-Year X contract. We've also got growth on the MH-60 Romeo model there over the next 2 years. Those, after the next 2 years, will come back down a little bit. So over a 5-year period, Sikorsky will grow kind of really low single digit, thinking maybe 1%, 2%. And again, that's going to be on the back of CH-53K. But what you have in RMS, which I don't think is fully appreciated, they have other lines of businesses in there besides just Sikorsky. They've got what we refer to as integrated warfare sensors and systems business. Think about Aegis systems, think about radar systems, both naval and ground-based radar systems. They've gone through a pretty significant upgrade and modernization of their radar systems, and we are seeing recapitalization cycles related to radars. As I mentioned Aegis, continuously updating that system for the Navy. And then we've got our other business, which is the C6ISR business, which is where we have our JADC2, our joint all-domain command and control type of systems there. We've got a contract with the Australian government referred to as AIR6500, which will provide really this whole command and control, situational awareness system for the entire country. We have a similar contract for Defense of Guam. So again, as I talked about before in your first question, the connected space, the ability to communicate and having assets, systems and platforms to be able to connect more easily, exchange information, stronger data links is exactly what these systems provide. And so we're in the front and center on that. And that will drive growth for RMS as well. That's why I feel confident a little bit more than 3% to 4% besides Sikorsky. Over the longer term, Sikorsky is starting to come back down a little bit. When you look at the rest of the portfolio, Aeronautics. Aeronautics, even though the F-35 production has kind of flattened out, we still expect there to be strong growth on the sustainment side. And as we mentioned, whether it's a performance-based logistics program or transactional, the demand is going to be there because there's more aircraft in service. As they age, they'll have to go get sustainment work. But in addition, the aircraft is going through a modernization cycle at the same time. So equipment has to be replaced. And so we feel pretty comfortable. Back in 2021, we talked about F-35 sustainment growing at a 6% clip on a 5-year CAGR. It's going to be at least that. I would say, 6% to high single-digit growth on that over the next 3 to 5 years. So that will be a growth driver for Aeronautics. F-16 over the next few years will also grow as we continue to increase our rates there. We're going from 2 a month to 4 a month by 2026. We'll get to 3 a month next year as we deliver out on that backlog. So those will be 2 areas of source of growth. C-130, generally pretty much flattish. And we'll see what happens in our ADP Skunk Works business, what happens. There's a lot of classified activity that happens there. You can't really speak much about it, but we're projecting some growth there as well. So when you put it all together for Aeronautics, you're talking low single-digit growth there, because the F-35 production is so large. And then lastly, space. Space, the areas that are going to drive growth in space will be their strategic and missile defense area. So think things like next-generation interceptor, think about their hypersonics programs, long-range hypersonic weapon, their conventional prompt strike weapon. And the fleet ballistic missile is going to be going through a life extension, too, so a modernization of that for the Navy. And so that will be the growth driver -- that line of business will be the growth driver for space. The traditional space business, while we're seeing growth in the small satellite constellations, things like SDA transport layer, tracking layer, those types of programs and contracts, some of the exquisite programs, because of where they are in the life cycle, OPIR, Next Gen Geo as an example, will come down. So as these exquisite systems come down, you've got these newer small sats going up, but they kind of cancel each other out. So in the end, space all in would probably be a low single-digit grower over the next 3 to 5 years. So all in, that kind of forms the basis of -- we talked about low single-digit starting point for 2025, but it's kind of the same formula going forward over a 3-year basis.

Great around the horn. In space, when do some of those exquisite programs fully lap and when do they roll off, so we can see that underlying growth?

Yes, there's still probably another 3, 4 years there. And it's not just kind of the exquisite space. You've got Orion is another one that will start to cycle down. While we're under contract for a number of capsules there, it will start to cycle down as well. So we've probably still got at least 5 years of a little bit of a tail down on those based on the life cycle of those programs.

And then on F-35 production flat. You talked about sustainment growth. Is modernization growing as well? Or is that steady?

Absolutely. No, no. F-35 will grow in modernization, and it will come through sustainment revenues is where we'll see it. So that's why I said that 6% is probably the floor. With the modernization, it will probably be high single digit.

Appreciate the clarification. So how do we translate that all back to margins, the 10 to 20 -- or I guess, 10 bps base case, 20 bps opportunity framework?

Right. Yes. So the 10 to 20 basis points of margin expansion, which is just baseline where we are today. This year, we're expecting about 10.5% margins. On a same basis, historically, we've been 11% plus in our margins. So there's certainly runway for us to claw back and get to what I would refer to as more of an 11% run rate starting in 2027. And we've talked about that being a steady increase of 10 to 20 basis points per year over that period of time. And for a number of factors. Number one, we should get a mix benefit just from MFC, as they're the highest grower in our business, they're the most profitable as well. So that we should get a mix benefit from MFC driving us over the next few years. We'll also should get a benefit from lower losses from the MFC classified program that we're delivering out now. And so that will give us a little bit of tailwind. And so if you kind of do this in the context of 2025, that's 20 basis points of benefit. The one thing that I mentioned on the third quarter earnings call is that we had just general, across the rest of the portfolio, our EAC adjustments or profit adjustments were at least at that point in time were projected to come down. And so that was a 10 basis points headwind. So it was kind of pointing towards 10% of expansion in 2025. We'll see. We're going through that now. It's not -- I think it's fairly typical where, earlier with lower visibility, we were little bit more conservative on the profit adjustments. And people have asked, well, shouldn't it just be a run rate of 20% of profit every year? We'd like that to be the case, certainly, but you can't really look at it that way. It's really program schedule specific. And it's really when you have scheduled a risk retirement to occur. So you may have a risk retirement, say, in 2024, but not another on a particular program or a contract. But that next risk retirement opportunity may not occur again until 2026. It just really depends on the schedule of that. And so that's what we need to go through the detail of understanding where our programs are, where we see the opportunities for risk retirements and other productivity gains that can deliver higher profit adjustments. To the extent that we can hold that flat, then your 20 basis points would drop through. The other thing I would say is that there is a little bit of variability as well. And you kind of maybe have to go back to 2024. As I kind of laid out kind of in the context of 2025, the 10, 10 and maybe minus 10. On the classified program at MFC, we're still evaluating that program. So it's still possible even here in the fourth quarter that we can take a forward loss on that particular program. And that would really change the whole profile -- our margin profile. If you think about that, if we recorded all the losses here in the fourth quarter, then the forward margins would automatically pop closer to -- say, closer to 11%. So we're still going through that analysis. We have to go through that every quarter. And we'll do that again this quarter. To the extent that we have a triggering event from an accounting perspective, we would record all the forward loss there. And the other program that we just keep an eye on is the classified program at Aeronautics. We've taken some charges this year, year-to-date on that program. And we're not out of the woods from a risk perspective, and that's something we just keep an eye on.

So the 10 to 20 basis points, not necessarily perfectly linear, but that's the average over time.

Yes, I'm pretty comfortable with 10 to 20 per year. Again, people ask why isn't that 30 to 40. Maybe. It depends. I think for us to do -- we could snap back to 11% next year if we took the charge on [ 0600 ]. So there's still more to come on that, and we just need to complete our evaluation of these contracts.

And the trigger on front-loading that charge is based on the customer award profile or your accounting of the probability...

Yes, it's an analysis of probability. It's certainly a judgment call, but there's things like our conversations with the customer, their commitment to the program, any visibility we may have to funding, our performance under the program, are we tracking to performance requirements and schedule requirements and meeting all those milestones. So there's a number of things that go into the mix. We bring those all together and have to make a determination on whether or not there is a triggering event as a result.

Is the 10 to 20 basis points still the right framework even if you get that step function next year on MFC?

When you say the step function...

If you're able to frontload the charge?

Well, if we frontload -- yes, I think we could still do 10 to 20 basis points. So 10 basis points from the lower losses on that program would go away. So what we would still need is, right now, we've got the reduction in profit adjustments canceling out the mix benefit from MFC. But to the extent that we have clarity on at least a flat profit adjustment profile, then you could see margins on an apples-to-apples basis still step up. So say, for example, if you recorded all the losses this year and you say you adjusted those out. So you said my run rate margins this year, if I adjusted out the losses, the big losses from that program, it would be closer to like, say, 10.9% or so. Can I get to 11% next year? I think the answer to that is yes. Just to kind of keep it simple.

Makes sense. One thing in terms of the fixed price versus cost-plus discussion that's been ongoing for some time, which has, I guess, come to the fore again with the discussion of maybe government efficiency. Are there still contracts lapping that were fixed price that you've absorbed a lot of inflation impact over the last few years? You guys have spoken at length about not wanting to take on high-risk fixed price contracts. But just if you could kind of wrap that up into what the margin impact has been and how you're bidding those going forward?

Yes. The number of contracts remaining, I think that may expose us to risk related to inflation is fairly limited now. We've adjusted for those. What you may have seen is unlike maybe other companies where they were taking negative EAC adjustments. In our case, because of the way we were just conservative accounting, what it did is prevent us from taking actual positive adjustments. So we had to hold profit booking rates rather than stepping them up because of the impact of inflation. We still have some lingering impacts. There's still a couple of contracts sitting at Missiles and Fire Control. But if you look at their performance this year, they've more than offset that in their portfolio. They've done quite well. We've got some fixed price. The classified program at Aeronautics is a fixed price contract that, again, it's more of our ability to contain the risk versus necessarily inflation in terms of just learnings, technology learnings. We've got a couple of fixed price contracts sitting in Space, which are fairly large. But again, those are in classified areas, and we're performing quite well under those contracts. So I'd say the exposure is limited under fixed price contracting really to these 2 classified programs that we talk about often, the MFC classified program and the Aeronautics classified program.

Maybe coming to cash flow, and then I'll open it up if anybody has questions in the room. Translating all that down to the cash flow guide, a couple of moving pieces with the working cap and the timing of the F-35 payment. What are the kind of the bridge items from this year to next year, the kind of the major moving pieces?

Sure. When you look at, say, this year, and our guide was $6.2 billion is what we tightened it up to in the third quarter. And there's a couple of -- let me just talk about that, like what's in that. And so we had, related to our agreement on the F-35 to deliver aircraft, about $600 million of headwind related to that program, which will be -- it's timing, we'll get that cash back over the next few years. We offset that entirely by really some international advances, which enabled us to really continue to deliver the guidance that we had coming into the year. Into the year, our guidance was $6 billion to $6.3 billion, and now we're $6.2 billion. So we pretty much offset that headwind. As you go into next year, right now, we've got a required pension contribution of about $1 billion we've talked about. You do get a tailwind on F-35 of about $1 billion. It's a pretty big number given that we're delivering aircraft, we'll deliver more than the 156 rate next year in addition to achieving the milestones of the agreement that we had laid out. And so some of those withholds will start coming to us as well next year. That's partially offset by these advances that occurred in 2024 of $600 million. So net-net, the F-35, I'll call it, net impact there is about $400 million of a benefit. You've got $1 billion of a headwind related to pension. And that's what we've been working on in terms of trying to drive out through improved working capital. A day of working capital at Lockheed Martin is about $200 million. So you need a couple of days to really kind of work that out. It's possible, and that's what we continue to drive organically. As I mentioned before, to the extent that we're unable to get there all the way through working capital, there's other opportunities in use of the balance sheet to reduce that headwind. As I mentioned, the way to think about it as well is that when you make a pension contribution and a payment, that actually hits free cash flow. So reported free cash flow could come down. But when you augment it with other opportunity, potentially if we were to augment it with debt, then your capacity, your available cash to maintain deployment to investors remains the same. So we've talked about, in the past, dividend of around $3.1 billion and a placeholder of share repurchase around $3 billion. Our ability to [Audio Gap] with pension will enable that, will continue to enable that cash deployment program.

What are the considerations of using the balance sheet or other methods to fund pension, and whether or not you do a 1-year or a multiyear?

Yes. There's a number of things there. We can have a range of outcomes there. It could be we just do it year by year. It could be you do multiple years. The good thing about just looking at it maybe year-by-year is the fact that you continue to drive the internal operations to offset it organically. So by driving just more working capital improvements is really our goal rather than just kind of wiping out 3 years. So it's possible we may be looking at this on a year-to-year basis versus a multiyear. But the approach will be the same, whether it's individual year versus a multiyear takeout. And so again, I think when you look at our working capital performance, it's among the best in the industry, but it's not at a level that we've been able to achieve in the past. We've been better. And so the opportunity set is there. I've talked with the management team often that our goal is just to get back to where we were before. It's not like a goal that we've never achieved before. And to the extent that we're able to do that within the time period that we need to, we can make a lot of headway to mitigate these pension headwinds.

Great. Any questions in the room for Jay?

That clear? All right.

Well, maybe 1 or 2 final ones from me?

Sure.

While I have you. That working cap, how much of that is ex F-35?

Say that again?

The working cap capture opportunity. How much of that is...

A lot of it is in -- well, yes, a lot of the opportunity -- so all of the opportunity we're looking at is ex this F-35 kind of tailwind that we're going to see. But the F-35 program itself still has a lot of opportunity, both in production and sustainment. And so that's certainly an area of focus for us to drive out just more efficient productivity in the program and also better contracting there. And so that's certainly an area of focus for us. So we'll get a tailwind on F-35, not just because of the timing of our achievement of milestones and because we'll deliver a higher aircraft, but there's still certainly opportunity on that program. Same with the F-16. Sikorsky has opportunity as well. So if you think about it, the platform businesses is where a lot of our opportunity exists. If you look at our Missiles and Fire Control and our Space businesses, those 2 segments have very strong working capital performance. And so where do we focus on? Really the platform businesses at RMS as well as at Aeronautics.

And maybe last one. You guys are committed to buybacks. You've got a dividend. What about thoughts on M&A?

M&A, we're open-minded on M&A. We take a look at opportunities as they present themselves. There's been a pretty robust pipeline of review. Our threshold for M&A is fairly high. But we look at opportunities and we look at them from a strategic lens. You think about what we are, as I mentioned before, it's an exquisite systems integrator. In those areas, that makes us somewhat exposed, if you will, to a strong supply chain. There are areas where we may see strategic vulnerabilities where we think we need to thicken our capability, and we would go there. Or there may be areas where the performance of supply chain is not as strong as we would like it to be, and we said we want to take that in-house. So it varies. It's kind of looking at it vertically. I wouldn't expect us to go wide a far of any type of capability. We've got a core capability in our defense portfolio. We do a lot of different things within that portfolio. It's a matter of just making it stronger. So we're open-minded, and we kind of take it as it comes. And the threshold for returns has to be there. The cost synergies, the revenue synergies have to be there. The strategic fit has to be there, but we'll take them as it comes.

Makes sense. Perfect. I think we can leave it there. Thank you very much for the time.

Well, thank you very much, Gavin. Appreciate you having me here. Happy to be here.

Thanks, Jay.

All right.