Lockheed Martin Corporation (LMT) Earnings Call Transcript & Summary

Good morning, everyone. I'm Kristine Liwag, Morgan Stanley's Head of Aerospace and Defense Equity Research. I'm very excited to host our next panel with Lockheed Martin. Before we get started, I'll have to read this. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley representative. So for our next panel, definitely very excited to welcome Jim Taiclet, CEO of Lockheed Martin; and Evan Scott, CFO. So welcome, Jim and Scott -- Jim and Evan.

Good morning.

Great. So maybe just to kick off, Jim, this has been a question from a lot of investors, which is about the technology insertion in the battlefield, right? We've seen sovereign customers needing more equipment sooner. We've seen the proliferation of low-cost autonomous systems being pretty effective in the battlefield. And then at the same time, you also see -- and maybe this is the part where investors don't see as much, there's also more need for high-end types of solutions. So can you talk about where Lockheed's role is in this environment? How do you counter some of these lower-cost autonomous systems, and how do we keep prepared? And what is the environment for these high-end threat environment, too? And where does your company fit?

Sure. Well, I'm glad you started it off, Kristine, this morning with technology. And good morning to all of you here. Thanks for coming today. And I'm, first of all, going to be, as the next Air Force pilot, very proud to say that U.S. government and us speaking of technology just announced this morning the long-term multiyear agreement for the Joint Advanced Tactical Missile, which is an air-to-air missile that's more advanced next generation, if you will, will change the deterrent posture that we can provide. And the JATM, as it's called, [ AIM-260 ], is going to be produced, but it's not even in full-rate production yet. And the U.S. government has already agreed with us to a long-term multiyear contract to deliver it. That's how good this technology is. Our role in this entire changing ecosystem, I believe, is to take the Lockheed Martin systems integration heritage. We make the most advanced systems like the JATM I just described, F-35, Trident missile, Patriot PAC-3, MSE. These are highly complex, very high-capability devices and products and platforms. We've gotten a history of almost 100 years of being able to do that. We have the DNA. We have the muscle. And with the way that warfare is evolving, we're taking that muscle, we've been working on this for about 3 or 4 years, and going from the systems integration lead to the mission integration lead. And what's the mission? Well, let's talk about products first, and then we can evolve to the mission. The product is air-to-air combat, air superiority. That's 1 of the 12 missions that we designed to. And with JATM, for example, what we've done is we've integrated the most advanced next-generation air-to-air missile with the most advanced fighter aircraft, F-35 and F-22. We did that mission integration because now, our app, if you will, or the Air Force's app or the Marines and Navy, their app is not like Google Maps to just have navigation to show you where to go next and how to turn your car. Their apps are shooting down other airplanes and protecting yourself. So we can do the systems integration, JATM, into F-35, for example, seamlessly, that's in our muscle memory. But what we can do is a mission systems integrator is match those two complex systems together and then match them with digital technologies that allow the mission, through a mission technology road map, to keep advancing capability. If there's a new missile, that's great, it's a step function up. If there's a new airplane, it's great, it's a step function up. But every 3 to 6 months, we're also using digital technologies to create more capability. And the real centerpiece for Lockheed Martin is to be able to do systems integration into a mission integration package with new technologies. And new entrant products and those from Northrop Grumman or Boeing Defense, that's our sweet spot is full mission integration, and we've been practicing that for, call it, 4 years with these mission technology road maps. Our goal is to work with our customers, the users, to create decisive military advantage at a theater level scale. That is really the core mission of Lockheed Martin. And so that's what we do. The key thing on the high-end platforms and systems and the low-cost counter-UAS systems, for example, is that you've got to have, for certain mission subsets, the high-end system. So just to talk about in missile defense for a moment, the PAC-3 MSE and the [ pad ], expensive high-end, super capable missiles, they can hit long-range ballistic missiles, they can also target hypersonic missiles and everything below that. The trade-off of using a PAC-3 missile for a Shahed drone is not a good one economically. And so we know that there's other ways we should be able to deal with drones. And so the drone solutions we've come up with, the newer technologies using some start-ups as suppliers actually, some of our venture investments with suppliers or solutions to the mission road map, we've come up with 2 or 3 systems now that we can integrate into that air defense missile defense. And that will create deterrence, which is really what our product is. Our product is deterrence. It's not a PAC-3 missile. It's not simply an F-35. It's creating deterrents against great power conflict, which is a very valuable service. So that's our role is to be the mission integrator using our systems integration capabilities and the high-end products that we actually do make.

So Jim, maybe taking a step back, I think right now in the U.S., we have the lowest number of veterans in the population. So could we just -- can you just provide a little bit more color regarding what people see in the media? For example, you look at Ukraine, it's effectively drone and trench warfare, which I think was not what people thought what warfare in 2026 looks like. But also what you just mentioned right now, you talked about decisive capabilities in the theater level. I mean, that's very different from a drone/trench warfare. Can you just expand on the difference a little bit? Because I do think that on the high-end capability of Lockheed, maybe investors are underappreciating what that means to be relevant in a great power type event.

I think the starting place for the Ukraine stalemate essentially, trench warfare is that neither side has been able to create air superiority in a level that we just described. If either side, Russia or Ukraine had complete command of the air, this drone/trench warfare may not have developed. It wouldn't have had time to develop, and we would be in a different situation. But you do have to have both. You have to have the high-end control of the air. And also, you have to be able to counter these new autonomous relatively low-cost attack weapons is what they are. That may not necessarily be what we will emphasize. What we will emphasize is the much more complex mission of counter UAS. Almost anyone can build with Chinese parts generally, and that's how the Russians and the Ukrainians are doing it. With Chinese parts, you can build a drone that can drop a hangar and [ agent ] a trench. Almost anyone could do that in their garage. But when it comes to seeking out that drone, identifying it and destroying it en masse, hundreds or thousands, that is a much tougher mission set. So again, the offensive drone warfare is an easier technical problem, frankly, than counter-UAS. And so what we've been doing, building this muscle of mission technology road map, assessing evolving kind of threats or new weapons that are put into play like in Ukraine and actually also in Iran now. We're able to quickly motivate our engineers to design to the mission, not designed to an RFP only. So that's where the 2 systems -- the counter UAS systems that we're scaling now came from. They came not from a lengthy RFP from the U.S. government, they came from us with our experts, many of them ex military and ex intelligence community veterans coming in, building those technology road maps and saying, we have to be able to do this. And there's no RFP from the government. They haven't really thought through the technical solutions yet, or maybe they're going in a different direction. What we do with our mission technology road map, say what do we have right now, like on the shelf and deployed, by the way? Because if it's deployed, it can be used quickly. So some of the things that we have on the shelf or actually the Army does [ hellfire ] missiles. We built tens of thousands of those a year. There are more tens of thousands of those in the stockpiles across all our allies in the United States. And so we kind of unleashed our engineers with these mission technology road maps. These are day job, which is respond to RFPs, then design to those. But a lot of their time now is built on figuring out what the next thing is going to be, maybe even before the U.S. government puts a request for information out about it, and offer them solutions. That's the new Lockheed Martin. We're not just waiting for RFPs. We are, but that's not all we do. Right? Now we're looking at our own mission technology road maps and saying, what's the next thing is going to be needed? And how can we scale it to a theater level? When I say theater, I don't mean like a movie theater, I'm talking about the Pacific Ocean, okay?

Big theater.

Europe. Yes. That's right. The Middle East. So how do you scale something that is -- if it's a really cool science project and you can't scale it and you can't teach in 15 minutes, a high school graduate Marine to use it, it's interesting, but it's not effective. What we're doing is effective at that level. And so what did we take? We took the Hellfire missile, which is a helicopter-carried missile that goes from air to ground. It was designed to hit tanks and things in the Cold War. And our people use digital technology, new software, a new integration package into an existing launcher architecture and an existing missile. And we changed it from an air-to-ground missile off the helicopter to a ground to air missile to hit these drones. And we've been testing that out at Yuma and other places with the military, and it works. Of course, it works because the pieces already exist, we just repurposed them. And so a mission technology road map says, I got Hellfires, I've got a launch architecture. It's already deployed with the U.S. Army and many others. How can I repurpose this for this new threat that came out? And that's an example of it. And I'll give you the other example because it's actually more esoteric. The [ Grizzly ], which is this ground to air missile technology that we developed, has to be tied into a command and control system, which is, again, another strong point of Lockheed Martin. So the command and control system has to identify the many -- it can be hundreds of drones, as I said. It has to make sure that they're enemy, it has to make sure that they're nefarious. And then it has to do what's called target weapons matching. I got 100 weapons, I got 200 targets. What are the best combinations to eliminate that large threat? And that system has to then queue a weapon. Now these things are not toys. They are explosive devices with rocket motors in them to go ahead and will be launched, track and hit a couple of hundred drones. And so that, again, is a differentiable technology capability that we have and others have in our space, if you will. Yes, I'm sure. Boeing Defense has a similar version. We know Northrop does and others. But we have a pretty advanced one ourselves. And we tied that Hellfire missile and a new mission into that command and control system that we evolved for counter UAS. And then we added another device, which our guys -- our folks invented, which, at our request, like, okay, how do we -- we've got a missile solution. We need a directed energy solution to match with that, to accomplish the mission and take it another step forward. And so our engineering team developed our own UAS, which is probably about as big as a large dining room table, weighs a few hundred pounds, and it's got the 4 rotors. It takes off vertically. And on top of this is LiDAR, radar, infrared, a bunch of sensors and a box. And that box is a high-power microwave that this device will tie to the same [ Sanctum ] command and control system. I've got 200 targets, 100 are going to get hit by the Hellfire missiles I have at my disposal. There's still another 100. That Sanctum system will parse out which of those targets goes to the kinetic solution, which is the missile, and which goes to the electromagnetic solution, which is microwave. And it will then assign this drone to go to those other additional threats, fly beside them, make sure with all the sensors that identifies it as an enemy drone, zap it with the high-power microwave. That zap fries the electronics inside the drone. The drone just fails. It can do that 50 times on 1 battery charge, and that goes back for a battery charge. So if you have 10 of these and you have 20 [ Grizzly ] launchers, you can deal with 200 drones coming at you, much more effectively than anybody can today. Now you've also got the solutions of F-16 firing area air missiles, other solutions. And the layered defense that we are creating with our mission technology road map will be, I think, will be the force protection solution for the U.S. government for bases, for THAAD missile batteries and things like that. But 1 little product or 1 little piece of this from a startup can't do this alone. Someone's got to mission integrate it. And this example that I just gave you of Sanctum uses a radar not made by the great Lockheed Martin that does [ Aegis ] and all the tippy radars. It was from a start-up we invested in called [ Fortum ]. We use [ Fortum ] radars because they are very transportable, light and resilient. And so you can get a couple of pickup trucks, put a [ Fortum ] radar on it, put a Grizzly in the back of the other truck. And you can go out and protect forward operating base, a stadium, something like that. And that's the way we're thinking now as a company. I mean, it literally took 3 or 4 years to drive the [ Z axes ] to big old Lockheed Martin and the 4 business areas. But that's how we think now, that's how we operate. That's how we plan. And that's how we allocate our R&D. And you might have noticed, our R&D budget has gone up significantly and as our CapEx budget because we are now investing our cash flow -- part of our cash flows into all these opportunities that no 1 is thinking like this. I'd like to think we are. So that's how all this technology does come together. And the real match is, again, as an ex-Air Force pilot, I know that you need the big platforms for 3 things: range, payload and survivability. So that's the F-35. That's the F-47 coming down from Boeing. That's the F-16, the F-15. You've got to have those big platforms because they have the range to get to the target. Now we're talking high end again. Range to get to the target, the payload, like the [ B2 ] could carry a 2,000-pound weapon, put it down an air shaft and blow up a nuclear facility in Iran. It took us 32 hours to get there and back for the airplane. That's the kind of platform you need to do the high-end missions, but if it should be heavily complemented with networking with lower-cost systems and with new entrant systems that not necessarily coming from the big prime contractors. And so our goal is to welcome the venture firms. And we have our own venture fund actually to help them. We welcome in new entrants like [ Fortum ]. And then the other example I'd give you because changing this company to be more of a commercial technology company at least think that way, is another alliance we have with a company called [ Saildrone ]. [ Saildrone's ], again, start up, but it's been around a few years. They can actually build autonomous shifts that, guess what, they're really interesting because they work. But what they need is they need payload. They need something to put on the ship to make a theater level effect or deterrent against our conflict. What are those things? They are weapons. And so we teamed up with [ Saildrone ], their autonomous ocean vehicle, 1 they have, 1 they're developing. And on the first one, I guess that we're going to put the Grizzly system. So we're going to put the Grizzly system and the Sanctum command and control arrangement on these autonomy ships that we don't make and that General Dynamics doesn't make. Or [ BAE ]. This is a company that came out of literally nowhere that we can now use to improve the deterrent posture in the Pacific Ocean or elsewhere. And they could have done it on their own. We didn't have a ready-now product. So we married up with them, and we are deploying and testing the Grizzlies now with them. And then we're going to put something called a Mark 70 launcher, which can take much bigger missiles and put it on a [ Saildrone ] ship. And that's what we have. That's how we have to act now. And that's why Lockheed Martin, I think will differentiate itself over some period of time. And these long-term agreements that we're putting in place, starting with munitions, including the one I just described this morning, and could go to any other system that we make where the government agrees there's long-term demand. So we want to change the whole industry, which will allow for more creativity, more advanced development by us and hopefully by everybody in our sector and also, over time, expanded margins. Because these framework agreements are designed to allow industry, if it gets successfully get the cost down, to have expanded margins. The system we live in today, for the most part, the annual budgeting and recontracting system -- something when I came from commercial telecom back to this arena, I was reminded that if we take cost out of a program next year, our revenue and margins are going to go down. So why would you invest $10 million in a new robotic system to make your Patriot missile cheaper if you're just going to have to renegotiate your revenue margin down? With the framework agreements, that doesn't happen. And what we agreed to do, by the way, with them is if we get above a certain margin expansion, which we all -- we keep all of it, then we're going to do some -- there's a profit-sharing algorithm or formula that some of it will get back to the government and reinvested in the program. So this is much more of a commercial technology approach, flywheel, if you will, to actually make our industry better and stronger and higher margin, which allows us to invest more and the government to invest more. And we'll have a more effective national defense with that. And I think this country will demonstrate -- this country and this company will demonstrate that is a better way to run the national defense enterprise and the relationship between industry and government. And guess what it will do, it will open the doors for a lot of other companies to come in, whether they're start-ups or new entrants or high-tech companies, we have partnerships with Verizon for 5G, which we're developing a really cool project, which I don't talk about now, but it's really cool with them and their 5G network. We have alignment with NVIDIA since I think 2017 on AI. Same with IBM, we're doing quantum, we just opened another out lab together in Switzerland to work on quantum. So we're working with all kinds of companies across many industries now. We want to bring that big tent to our national defense. We have a more effective national defense and we can have higher margins. So that's what this really is all about.

That's very helpful, Jim. That's a very comprehensive view. And I think that's an underappreciated view of your role because sometimes if the investors think, "Oh, you're just old Lockheed," and it seems like there's a lot of invigoration happening with the company.

I'll give you 1 other little story about this is how we're different. So we -- I said, took the straight jackets off our engineers for some of their time and energy. And [ Evan ] and I and Frank St. John, the COO, we go to factories kind of almost every week, I think 1 of us are there, so -- or all of us are there. We do our executive team meetings at factories every month. So when I go to 1 of the plants, there's a lot of them, but I go, well, show us something we haven't seen before that's not in the LRP or a long-range plan or not on contract yet. What are you guys working on here. And so we went to Orlando, Florida, we have a missile fire control plant there. And very proud looking, most of the young people were at the end. And this was the -- show me something we don't know about yet. And that's where we first saw -- this was about 9 months ago, 6 months ago. Saw Grizzly, it was there with the missiles in it. And we saw the Sanctum, mean looking kind of microwave killing machine. And I just looked at both of them. I go, these tested positively in the field with the customer, and they said, yes to both. These things actually work. And I said, build 1,000 of each of them right now, and we'll figure out how to either sell to the U.S. government or somebody else or lease them out. This is the right technology solution. This is scaleable, and we're going to have a couple of hundred of these Grizzlies ready to deploy by the end of the year. That's not the old Lockheed Martin all think.

Well, Jim, I think that kind of dovetails into my next question. It seems like, look, the U.S. government, the Department of War wants speed, scale, agility, commercial terms on some of these technology. So for these examples that you've highlighted, it's really clear that you're moving in the same direction with them. So can you share with us how do you think about further alignment and where you are in your journey for Lockheed to be fully aligned to this type of new business model?

I'll let Evan speak to the financial outcomes that we were hoping and expecting to come from all this. But there's leadership now in the Pentagon at the very top even that has true commercial investing and operating experience. And that team, and we have complete alignment on how to change this relationship between government and industry. And you can go back to 2020 when I came off the Board at my colleague's invitation. I was on the Board of Directors and can come in to manage the amazing management team we have. In 2020, I did an interview with CSIS with Dr. [ Hamre ], and I talked about all of this stuff. And out in the world, Deputy Secretary [ Find Verghis ] was running his hedge fund, they have and haven't had had for years investments in defense space. Look, probably looking at the same issue the same way. And the fact that both of us now are somehow here allowed us to negotiate that first PAC-3 MSE multiyear agreement. That was his team in mind with us there for much of it, figuring out these -- they call them heads of agreement, it's basically a framework or a major term sheet on how to do commercial-type contracting between the U.S. government and the aerospace and defense industry. And so the leadership is there to seize the moment, so to speak. We've been practicing for this for 5 or 6 years from now, and we're really welcoming it. Now the prior administration did get some multiyear munitions contracts through with us, which was great. But with this kind of new breed coming into the Pentagon leadership, and the need, frankly, to really scale up given the situation in Europe and also now in the Middle East, the moment was right, the people were right and the energy was there to do it. And we do need Congress to come in for the full funding of the whole 7 years, if you will. But they've already been doing 2 or 3 years so far on some of the programs we have under these long-term agreements. I do think Congress will see the value of this and the protections that we put in for the government and the upside they put in for industry, and I think they will get there. The budget process is going on now. That isn't -- that is important as the theme. The theme is to have a more effective defense industry, if you will, and more effective national defense, using the old cost base yearly system for -- especially for programs that you know are going to go on for years is suboptimal, heavily suboptimal. And now I think that the universe of people that care about these issues are starting to say, okay, this is a better way to do this. And let's get on with it. And they are getting on with it. And again, we announced yet another of these agreements this morning on something that's not even public yet. It's been developed with us and the Air Force for years, but it's not even full rate production. So this is the -- I think this is the tide where it's going, and we're going to continue to lead it because we have very big programs with very long cycles. Long -- many multi-multiyear programs of record, whether it's F-35 or [ Trident ] missile or other things like that. We can make this industry government arrangement, much more efficient, much more effective, especially given the threat environment. And last thing I'll say because I'm a lapsed engineer too. So I'm not flying planes anymore. And I really was an engineer, but I have a degree, enough to get you in trouble. But this is a big engineering problem that the country has. They got escalating threat. We have an escalating threat. And you pick your spot, China, North Korea, around Russia, very dedicated to competing with us, I'll say. And then we have technology moving faster than it ever has in human history, both in physical and digital worlds. And then you got more or less a fixed resource defense budget, so to speak. I know there's -- is it $1.15 billion, is it $1.5 billion. It can't get infinite. It's not going to double or triple. So the threats trip -- doubling and tripling the speed of technology development is doubling or tripling. But the resource is the same. And the only way to close that engineering equation is to change the system that you operate under. And that's what we've been trying to do for the last 4 or 5 years.