Lockheed Martin Corporation

Ladies and gentlemen, thank you for standing by, and welcome to the Lockheed Martin fourth quarter and full year 2019 earnings results conference call. At this point, all the participant lines are in a listen-only mode. There will be an opportunity for your questions. Instructions will be given at that time. If you should require any assistance during the call, please press star zero, and Operator will assist you offline. As a reminder, today's call is being recorded. I'll turn the conference now over to Mr. Greg Gardner, Vice President of Investor Relations. Please go ahead, sir.

Thank you, John, and good morning. I'd like to welcome everyone to our fourth quarter 2019 earnings conference call. Joining me today on the call are Marilyn Hewson, our Chairman, President, and Chief Executive Officer, and Ken Posner-Reed, our Executive Vice President and Chief Financial Officer. Statements made in today's call that are not historical fact 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 today's press release and our SEC filings for a description of some of the factors that may cause actual results to differ materially from those in the forward-looking statements. We have posted charts on our website today that we plan to address during the call to supplement our comments. These charts also include information regarding non-GAAP measures that may be used in today's call. Please access our website at www.lockeedmartin.com and click on the Investor Relations link to view and follow the charts. With that, I'd like to turn the call over to Marilyn.

Thanks, Greg. Good morning, everyone. I hope you had a good start to the new year. Welcome to our fourth quarter 2019 earnings call as we review our results, strategic new business activities, key accomplishments, and our outlook for 2020. I will begin by expressing my gratitude to our entire Lockheed Martin team for a remarkable 2019. Over the course of the year, the corporation achieved extraordinary sales growth, earnings performance, strong cash generation, and record backlog. And it was through their dedication and commitment that we were able to deliver these results. Kim will discuss our financials in more detail and provide our outlook for 2020 But I'd like to begin by discussing a few of the highlights from 2019 that drove our strong performance. Notably, for the second year in a row, all four of our business areas grew sales, earnings, and backlog, with each contributing to our record cash from operations. Sales in the fourth quarter exceeded last year's fourth quarter by 10% and pushed 2019 growth to 11% over our 2018 results. Missiles and fire control had the highest overall growth in 2019, exceeding the prior year by 20%. Deliveries of tactical and strike weapons, development work on new hypersonic and classified programs, and PAC-3 missile production were the strongest contributors to the increase. Aeronautics also saw strong sales growth in the quarter and year, with 2019 annual sales finishing 12% above 2018, led by our F-35 program, which grew 14% in 2019. In space, the Next Generation Overhead Persistent Infrared, or NextGen OPIR contract, the GPS-3 satellite production program, and recent hypersonic winds continue to provide increased sales volume, as the business area exceeded their 2018 top line by 11%. And rotary emission systems finished the year 6% over 2018, driven by increases in shipbuilding, radar, and logistics programs. Our segment profit grew nearly $700 million year over year, resulting in a segment profit margin of 11% and earnings per share of $21.95. which was another high-water mark for the corporation. This quarter, our backlog increased $6.6 billion and is now approximately $144 billion, reaching a record level for the fifth consecutive year. And we had a strong quarter of cash flows, allowing us to use $1 billion to pre-fund our required 2020 pension contribution and a portion of our 2021 payments. and still generate over $7.3 billion of cash from operations for the entire year. Had we not made this discretionary payment to our pension trust, we would have delivered over $8.3 billion in operating cash, well in excess of our greater than $7.6 billion objective. 2019 was an extraordinary year across the corporation, with our team achieving record results in sales, earnings, EPS, cash from operations, and backlog. The strength of our portfolio has us well positioned to continue delivering mission success for our customers and outstanding value to our stockholders. Before reviewing significant accomplishments from each business area, I will start with an update on the F-35 program, which had an especially successful quarter and year. During the fourth quarter, our F-35 team delivered 51 fighter jets, bringing the total deliveries in 2019 to 134 aircraft, exceeding our joint government and industry target of 131 aircraft, a nearly 50% improvement from last year and a 200% increase from 2016. Since the program's inception, we have delivered 491 production aircraft with 347 jets being provided to U.S. forces and the balance of 144 planes being delivered to our partner nations and international foreign military sales customers. Keeping with the F-35, we are pleased that we finalized our agreement for Lots 12 and 13 this quarter. recognizing orders of approximately $5 billion and adding 112 aircraft to our backlog, bringing our backlog to 374 planes. We anticipate finalizing lot 14 in early 2020. Our joint industry and government team had established a longstanding objective of offering the F-35A model at a flyaway cost of $80 million in lot 14, and we were able to improve on that target one year ahead of schedule. The lot 14 unit price is now below $78 million, which allows us to offer this remarkable fifth-generation fighter at a price equal to or lower than legacy fourth-generation aircraft. Internationally, we were very excited to see Norway declare initial operational capabilities with its fleet of F-35 conventional takeoff and landing aircraft. Since the first F-35 model arrived at Erland Main Air Station in 2017, the Norwegian Air Force has conducted a rigorous operational testing program in unique winter and northern environmental conditions and has deemed it ready for combat. Norway is the third European country

and the fifth international customer to declare... Ladies and gentlemen, we apologize for the inconvenience. We will be restarting the call in just a moment. Thanks, John. And you're reconnected.

Please continue.

Hello, this is Greg Gardner. Apologies for the technical difficulties. Thank you for your patience. We're going to commence again with a call, pick it up with Marilyn, talk about the F-35. Thank you. Marilyn?

Thanks, Greg. So I'll just pick up again. Some of this I'll just repeat. It's very short. But I just want to cover all of F-35 update before I move into the other operational highlights. So I'll start with an update on the F-35, which had an especially successful quarter and year. During the fourth quarter, our F-35 team delivered 51 fighter jets, bringing the total deliveries in 2019 to 134 aircraft, exceeding our joint government and industry target of 131 aircraft, a nearly 50% improvement from last year and a 200% increase from 2016. Since the program's inception, we have delivered 491 production aircraft, with 347 jets being provided to U.S. forces and the balance of 144 planes being delivered to our partner nations and international foreign military sales customers. Keeping with the F-35, we were pleased that we finalized our agreement for Lots 12 and 13 this quarter, recognizing orders of approximately $5 billion and adding 112 aircraft to our backlog, bringing our backlog to 374 planes. We anticipate finalizing Lot 14 in early 2020. Our joint industry and government team have established a long-standing objective of offering the F-35A model at a flyaway cost of $80 million in Lot 14, and we were able to improve on that target one year ahead of schedule. The Lot 14 unit price is now below $78 million, which allows us to offer this remarkable fifth-generation fighter at a price equal to or lower than legacy fourth-generation aircraft. Internationally, we were very excited to see Norway declare initial operational capability with its fleet of F-35 conventional takeoff and landing aircraft. Since the first F-35A model arrived in Erland Main Air Station in 2017, the Norwegian Air Force has conducted a rigorous operational testing program in unique water and northern environmental conditions and has deemed it ready for combat. Norway is the third European country and the fifth international customer to declare IOC, a critical milestone for Norway and the entire F-35 team. Also this quarter, the Dutch Armed Forces welcomed the arrival of their first F-35 to sovereign soil. in a celebration attended by more than 4,000 people at Leeuwarden Air Base. Leeuwarden Air Base. The Netherlands has been a key partner in the F-35 program, and including the eight aircraft still stationed in the U.S. for training and testing purposes, has now taken delivery of nine CTAL jets in total. The Netherlands program of record is currently to procure 37 F-35s, with the opportunity for an increased order, as last October the Dutch government announced plans to purchase nine additional jets, bringing the total to potentially 46 aircraft. Turning back to our business areas, I'd like to highlight a few of the notable new business wins and follow-on awards that have helped position us for long-term growth. Rotary Emission Systems received an award of nearly $2 billion, for the detailed design and construction of four multi-mission surface combatant ships for the Kingdom of Saudi Arabia. This ship is a version of the Freedom variant, which were a combat ship we have been delivering to the U.S. Navy, and will provide the Kingdom with the capabilities needed for both shallow water and open ocean naval operations. We are honored to support the Kingdom in their Saudi Vision 2030 objectives. In Missiles and Fire Control, the U.S. Air Force announced the finalization of the $1 billion contract for the air-launched rapid response weapon effort we were previously awarded. Our hypersonic portfolio experienced tremendous growth during 2019, with the total potential value the corporation has received now exceeding $4 billion. Missiles and Fire Control also booked a $770 million order for PAC-3 missiles to provide additional interceptors and ground support equipment to the U.S. Army and the United Arab Emirates, continuing the growth in our air and missile defense line of business. Moving on to aeronautics, our air mobility team was awarded their third multi-year contract for the C-130J transport aircraft, approving the delivery of 50 new planes over the next few years. The finalization of this contract added an incremental 35 aircraft and over $2 billion to our backlog in the fourth quarter, with the overall value for all 50 planes expected to exceed $3.4 billion. This award comes as the aero team celebrated the delivery of the 2,600th C-130 airlifter since the program began over 60 years ago, with over 450 planes being the current J model. We are proud to be able to continue producing this venerable aircraft for our warfighters and those of the 70 nations currently operating it around the world. And in space, we were awarded a $3.3 billion 10-year IDIQ contract for the Combined Orbital Operations Logistics and Resiliency, or COOLER program, to provide support services on several military communications satellite constellations, including our advanced extremely high-frequency spacecraft. These satellites provide nuclear-hardened, anti-jam global communications to the White House, the State Department, and military users supporting the nation's nuclear command and control system. And we are proud to be able to support the ongoing mission of this critical element of our national security. These announcements reflect the strength of our legacy programs, both domestically and internationally, as well as the impact of our continued investments in forward-looking technologies to drive long-term growth. Turning briefly to budgets, the fiscal year 2020 Department of Defense Appropriations Act was signed into law last month and finalized defense spending for the current fiscal year. Total defense budgets have been approved for approximately $738 billion, consistent with the levels passed earlier in the Bipartisan Budget Act of 2019, and over $20 billion above FY 2019 enacted amounts. Our programs garnered strong support across all business areas, with the legislation including nearly $3.5 billion of increased funding beyond the presidential budget requests. including $2 billion for 20 additional F-35 fighter jets for a total of 98 aircraft, over $800 million for nine additional C-130J transport aircraft for a total of 20 planes, and increased funding for our long-range hypersonic weapon, Orion, and OPIR contracts, as well as increases for several rotary aircraft programs and other initiatives across the corporation. We believe our portfolio is well positioned to address important security needs for our nation with the increasing defense budget and these additional appropriations actions supporting continued growth opportunities into the future. Moving on, I would like to highlight several key accomplishments from across the corporation that demonstrate our commitment to developing new technologies as well as expanding the reach of our heritage solutions. I will start with Missiles and Fire Control, who passed an important milestone on a prospective new business opportunity. Our tactical missiles team successfully tested its next generation long-range precision missile for the U.S. Army's Precision Strike Missile, or PRISM, competition. The Missiles and Fire Control team launched PRISM from the Lockheed Martin High Mobility Artillery Rocket, or HIMARS system, successfully demonstrating accuracy, and range of flight, validating HIMARS interfaces, and testing system software performance. We are excited by the prospects of this enhanced surface-to-surface system and look forward to building on our long-running Army tactical missile system legacy as we progress through the upcoming procurement decision. Moving to RMS, our integrated warfare systems and sensors line of business was selected by the Japanese Ministry of Defense to produce two solid-state radar antenna sets for their Aegis Ashore system. Our SPY-7 radar offers enhanced detection range and sensitivity from previous legacy radar systems and will provide continuous protection of Japan from ballistic missile threats. Our RMS team has continued to invest in new technologies while leveraging current solutions And this new radar is a direct derivative of our long-range discrimination radar solution, a Missile Defense Agency program of record. Variants of the SPY-7 radar will also be incorporated into other U.S. and international solutions. And to date, this technology has been selected for 24 systems, ushering in the next generation of maritime and ground-based advanced radar technology. Moving to AERO, This past November marked the official start of F-16 production at our Greenville, South Carolina location. Fabrication activities began for components of this interfuselage, one of the first steps in building new F-16 aircraft for the growing demand from new international customers. The first delivery for our Bahraini customer will roll off this line in late 2021. And we look forward to increasing production as new orders are added to the backlog. I will close with our space business area, which delivered the Mars 2020 rover AeroShell to Kennedy Space Center in December. The AeroShell will encapsulate the Mars 2020 rover during its deep space mission to Mars and protect it from the intense heat as the entry system descends through the Martian atmosphere. This AeroShell marks the latest heat sheet ever used and will protect the vehicle from temperatures up to 3,800 degrees Fahrenheit. Lockheed Martin has built every aeroshell entry system for all of NASA's 40 years of Mars' exploration, and we are proud to continue this legacy as we work towards a July 2020 launch. Before I turn the call over to Ken, I'd like to reiterate my appreciation to the entire Lockheed Martin team for their contributions to an outstanding year and for helping to build a differentiating portfolio. Ken?

Thank you, Marilyn, and good morning, everyone. As I highlight our key financial accomplishments, please follow along with the web charts that we included with our earnings release today. So let's begin with chart three and an overview of our results for the year. Sales, segment operating profit, Cash from operations and earnings per share closed ahead of our expectations with record highs. We generated $7.3 billion of cash from operations after a $1 billion discretionary contribution to our pension trust this quarter. And we continued our cash deployment actions, returning $3.8 billion of cash to our shareholders through a combination of dividends and share repurposes. We again grew our backlog to $144 billion, a new record high watermark. In summary, it was an outstanding year for the business. Turning to chart four, we compare our sales and segment operating profit this year with last year's results. Sales grew 11%, or $6 billion, compared with last year to $59.8 billion, continuing the strong performance over the first three quarters, while segment operating profit increased 12%, or $700 million, over last year to nearly $6.6 billion. On chart five, we compare sales by business area with last year's results. And as Marilyn mentioned, all four of our business areas experienced strong sales growth in 2019, led by missiles and fire control at 20%, which was driven by production volume in tactical and strike missiles and air and missile defense. And for the first time, all four business areas delivered sales above $10 billion. On chart six, we'll discuss our segment operating profit by business area. Following sales, all four of our business areas also increased profit in 2019, and the corporation ended the year with total segment operating profit 12% above 2018 levels. Chart seven shows our earnings per share for 2019. Our EPS of $21.95 was up $4.36, or 25% higher than our results last year, driven primarily by operational performance. Moving on to chart eight, and as previously noted by Maryland, backlog has increased again to a record high for the fifth consecutive year. All four business areas increased backlog in 2019, with the largest increases coming from space, driven by strategic missiles, and at missiles and fire control, driven by air and missile defense. We had a strong book-to-bill ratio of 1.4 for the quarter and 1.2 for the year. On chart nine, we will discuss the cash return to our shareholders in 2019. Subtracting our capital expenditures from approximately $7.3 billion of cash from operations, our free cash flow was greater than $5.8 billion. We increased our dividend by 9% and exceeded our share repurchase objective by $200 million in the fourth quarter. This brought our total cash return to shareholders to $3.8 billion for the year, or 64% of free cash flow, providing strong returns consistent with our historical cash deployment actions. Moving on to chart 10, we provide an update to our 2020 trending data with our revised outlook for the year ahead. Our outlook for sales ranges from $62.75 billion to $64.25 billion, which is an increase from the $62 billion we first indicated last quarter. The midpoint of this range represents a 6% increase over 2019 results. The range of segment operating profit is estimated to be between $6.8 billion and $6.95 billion. Our estimated FASCAS pension adjustment is just above $2 billion. Our estimated range for 2020 earnings per share grows to between $23.65 to $23.95 per share. The midpoint of this range represents a 7.7% increase over 2019 results. Cash from operations is now projected to meet or exceed $7.6 billion, and I'll discuss this in greater detail on the following chart. On chart 11, we will walk through our future cash expectations, folding in the $1 billion discretionary pension payment we made last quarter. Strong operational cash performance and a continued focus on working capital management allowed us to increase our cash outlook for 2020 to greater than or equal to $7.6 billion. a $100 million increase to the combined 2019 and 2020 outlooks we provided in October. And we now see approximately $7.7 billion of cash flow from operations in 2021, a $700 million increase, bringing our three-year expectation to $800 million greater than our prior assessment. On chart 12, we break down our sales and segment operating profit outlook by business area. All four business areas are positioned for continued sales growth in 2020, led by missiles and fire control at 10%. Segment operating profit growth is projected to grow at approximately 5% in the aggregate, with our largest growth in aeronautics at 8%. And finally, on chart 13, we have our summary. We believe 2019 was an exceptional year for Lockheed Martin. Our key results exceeded previous highs and have positioned us well for continued growth and value creation in 2020. And as we discussed earlier, our focus on innovation and investment has resulted in strategic new business opportunities and a robust legacy of programs. And with that, we're ready for your questions. John?

Thank you. Ladies and gentlemen, if you wish to ask a question, please press 1 then 0 on your telephone keypad. You may withdraw your question at any time by repeating the 1-0 command. If you are using a speakerphone, please pick up the handset before pressing the numbers. Once again, if you have a question, you may press 1, then 0 at this time. One moment, please, for our first question. And we'll go to Rob Stallard with the Vertical Research. Please go ahead.

Thanks so much. Good morning.

Good morning. Good morning, Rob.

Quick question for Marilyn on the F-35. You mentioned in the release that your guidance had a bit of a caveat regarding Turkey. I was wondering if you could give us an update on the progress in allocating those Turkish delivery slots and also realigning the supply chain.

Sure. Thanks for the question, Rob. I would just say, you know, we've been working with the U.S. government for several months on addressing how we're going to manage the eight aircraft that we're that have been delivered for Turkey, as well as looking at alternate suppliers for the Turkish suppliers. And so in terms of the upcoming lots, we have a lot of demand for the aircraft, as you are well aware, and we've had the congressional ads that will offset those needs from the Turkish aircraft deliveries. We've got it well solutioned. Anything you want to add to that, Ken?

Just, you know, Rob, just from the revenue side, Maryland's got it right. So the United States government, for the ones we've delivered in such a day, which would be the lot 10, lot 11 aircraft, they're earmarked for the United States government. In lot 12 through 14, the block buy, each of those lots, eight aircraft were earmarked for Turkey for a total of 24. The congressional ads, for the most part, will take care of that. So we're in good shape with the block buy. We'll now work lot 15. We just got the RFP from the US government. So I think from a revenue standpoint, we're in great shape. You have other customers that are coming into Japan, as you recall, want to order an additional 105. We have Belgium. We're in a competition for Finland. Switzerland and Canada. We feel good about those, especially as Marilyn mentioned, the $80 million aircraft. We got there a year ahead of time. And you probably saw in the press the polls want to buy 32 aircraft. So I think from a revenue side, it's well in hand. From a supply standpoint, almost all supply out of Turkey will be removed by March of 2020. There will be a handful of suppliers that will continue to work with fruit December 20th. And as I mentioned, we got the lot 15 RP, so we'll sort all that out post-2020 as we go on. But I think we're in a much better spot now than we were with the turkey situation.

That's great. Thank you very much.

And ladies and gentlemen, just a quick reminder, if you do have a question, please press 1-0 at this time. And one moment for our next question. And we will move to Miles Walton with UBS. Please go ahead.

Thanks, and good morning. Can you lay out the three-year cashout with the update with the $800 million of incremental? I'm just curious. Give us the backbone on the net pension recovery in there and how much things I imagine contributions came down, but it also looks like your CAS recovery came down. So just trying to piece out about $800 million, how much is from your operations. Thanks.

Do that. Do that, Myles. So yeah, I think we should start with how we ended the year with cash that got us to making the voluntary pension contribution. We ended, you guys recall, we ended the third quarter up in working capital by $1.2 billion. Fourth quarter from third quarter, we actually reduced our working capital by $500 million. So for the year, we were just south of growing our working capital by $700 million. So with that strong cash generation in the fourth quarter, we thought it was prudent to make the pension contribution of $1 billion. And so if you go forward and look at 2020 and beyond, Miles, and also recall our Lockheed Martin Investment Company, our returns were superior to what we assumed back in October, or frankly what we assumed in the beginning of the year. They ended the year at 20% returns on their assets. So with all that, our CAAS contributions came down in 2020. to just south of $2 billion. We're not required to make a pension contribution this year. So going forward, our CAS recoveries look like they'll be about $2 billion in 2021. Our pension contribution, recall the last time we spoke regarding 2021, we thought our pension contribution would be $2 billion. By making the billion-dollar pension contribution, not only eliminated the 2020 pension contribution, it reduced the $2 billion pension contribution by half a billion dollars, but also because of the great returns we made in last year, it looks like our pension contribution now in 2021 as we see it is below a billion dollars. It's just going out to 2022 and then I'll stop. looks like our CABS recoveries will be roughly $2.2 billion, and that $2 billion pension contribution in 2022 that we discussed in October looks like it's about $1.7 billion, $1.75 billion. So a lot of it is improvement, volume improvement, margin improvement throughout the business, but some of it also is due to the returns we made on our pension in the past.

Our next question is from Rob Spengard with Credit Suisse. Please go ahead.

Hi. Good morning. Good morning. Marilyn, Ken, you both went through a lot of detail on the international successes on aircraft and chip platforms. And, Marilyn, you sort of previewed the question I wanted to ask when you talked about Japanese Aegis. But I wanted to talk about your recent modernization wins at DoD. They're sizable. You've had things like hypersonics and AIM-260 and MFC. Sentinel Radar at RMS, and I wanted to see how these might translate to even greater longer-term market share internationally, or are they too strategic to export?

Well, that's a great question, Rob. I mean, we always, you know, working with the U.S. government, as we look at these systems, we're always looking at what systems could potentially be provided to our allies to increase their defense capability and capacity. you know, without hitting each one of these specifically that you outline. I mean, just I think the Aegis system is a good example when you look at some of our increases in things like PAC-3 and THAAD and now with the radar capabilities. I mentioned the opportunities that we have on, you know, long-range discriminating radar. It's all in our planning that when we work with the U.S. government that we make sure that we have an opportunity to consider not only the needs of the U.S. government, but on many of these systems, what they could provide to the international community. And as you can see with our very robust backlog of $144 billion, it gives us an opportunity to not only perform on that work that we have, but to continue to invest in new technologies and new capabilities. And that's what we've been doing for a number of years. We have highlighted areas in the radar arena in hypersonics and directed energy and a whole range of systems and capabilities that we recognize we've got to constantly provide our customers with the advantages that they need over our adversaries. And so we're always looking well ahead of now to invest in it. And we think that with that, it is with an eye toward being able to support our international customers as well.

Next question is from Ron Epstein with Bank of America, Merrill Lynch. Please go ahead.

Yeah, good morning. Good morning. I was wondering if we could just walk through a little bit when we think about the F-35 program as we go into 2020 and maybe even beyond, how you think about the mix between OE and sustainment? I mean, there's been a lot of, I guess, press about the sustainment going from something like the total flight hour cost at 35K per hour going down to 25K per hour. I mean, how does that impact the program, and how should we think about, as we model F-35 in the 2020 and beyond, the mix between OE and sustainment?

Sure. Hey, Ron, it's Ken. I'll take that. So, yeah, in 2020, you know, if you look just macro at F-35, We actually see pretty strong growth year over year. Sales are going to be up about 8%. Think of that as the lion's share is still production. So production year over year will be about 8%. But we still see development work, even with SDG winding down, with follow-on modernization and other development activities. We'll see development this year grow from 19%, about 10%. From a sustainment standpoint, we're still on these annualized buys, and we're still standing up bases. And we've talked about the performance-based logistics proposal, that white paper that we put in. So we'll see high single-digit growth in sustainment. And if we continue on these annualized buys, it will still continue to grow. You'll see sustainment over time become the fastest piece of the F-35 program. It'll likely double in size from a sales perspective in the next five years. It potentially, you know, throughout the next decade could double or triple from where it is today. But I think the PBL... is an interesting concept. And we're starting to have that conversation with the customer. And it basically is to talk about what you just described. It's to accelerate to get the cost per flight hour of maintaining the aircraft down to what the customer would see as an affordable level, but also the availability of the aircraft to get that up to levels that are more like fourth generation aircraft. And the onus then would be on industry. The risk would be on industry. We would do the investing for our customer set. We would have the infrastructure in place. And assuming we performed, we would sign up to these service levels. We would expect a return that's more in line with that type of contract. We're hopeful we'll be able to get to the table with the customer in 2020 and shape this thing and hopefully be able to get a deal that's acceptable to both parties. But You're right. In the future, you'll see sustainment grow faster than the rest of F-35. At least in the short term, it will still be production until we get to capacity, which should be peak capacity, which should be 2023, 2024.

But I would add there's continued demand around the world. And as we continue to – we're now at a very affordable unit price on the aircraft. And And as long as we can offset the development costs that will come as we continue to upgrade the aircraft and then drive the sustainment costs down, I think we see an outlook of great opportunities for the aircraft around the world. That's right.

Ladies and gentlemen, another quick reminder, if you do have a question, please press 1-0. And next, we'll go to Noah Popanek with Goldman Sachs. Please go ahead.

Hello, everyone.

Hey, how are you doing, Noah?

Doing well. How are you, Ken?

Okay, thanks.

So I wanted to stay on the multi-year cash flow discussion. I could sort of see the investor question that was previously, does it grow in 2021 because of the contribution step up moving to 22 with the contribution step up now there year over year. So one, do you grow cash from ops year over year in 2022? And I think you have five-year internal planning. So Maybe you could speak to can you grow cash flow every year in the five-year period because that just remains a big investor question. And then having given the pension pieces, I wondered if you could also speak to capital because that came in a little light for the year. Yes. That would be very helpful. Thank you.

Thanks, Noah. You know, just a clarifying point, from a long-range plan standpoint, we do current year plus three years out, but I will give you a little – I'll try to give you a little color, 2023 and beyond, but I don't have an absolute number for you. So I think you wanted to start with 2022 since I gave you color up to 2021, and that's actually – a timely point right now, not just because of pension funding, CapEx, but just from a cash generation dynamics, including the pre-funding, looking at our growth, our focus on working capital. It basically would all point to cash from operations out in 2022, frankly, being north our 2021 number. We see a path to greater than and equal to 7-7. There is one issue that it's worth talking about now, and it's the remnant from the Tax Reform Act of 2017. The law has a provision that kicks in, and it kicks in in 2022, which requires research and development expenses to be capitalized rather than being expensed. Right now, though, the law, it's still a little bit vague what the exact definition of R&D is. And believe it or not, I've actually read the legislation myself, and I do see some vagueness in there. But in the interest of transparency, it's probably good we talk about that now. So if the IRS made the determination that the law applies to all R&D expenses, it probably would take our cash number down. So this would be things we're expensing now that we would have to amortize over five years. It would take our cash from ops in 2022 probably down to about $6.5 billion. But I'll say this. It doesn't seem logical to us that that was their intent. And if it was just a subset of the R&D, we still see a path to getting north of $7 billion. So we're still working through this. So, you know, just to summarize, north of, you know, north of 7-7, if it's the way things have been operating in the past, if this R&D tax bill kicks in, It will be, you know, probably in the mid-range of 6.5, and if it's a subset of that, we still see north of $7 billion. But operationally, we're still going to generate a lot of cash. We still have a focus on working capital. You know, you talked about CapEx. You're right, it was a little light this year. So we ended the year at roughly $1. Because of the things we've discussed in the past, the buildings that we're building in the business areas, we'd see CapEx in 2020 at about $1.7 billion. Next year, probably comparable, about $1.7 billion. And then what we know today, it would start tapering down. It'll be below $1.7. Last point you asked about was 23 and beyond. You know, just talking about Sikorsky, you'll start seeing a lot of those programs go into production. You'll start seeing F-35 will continue to reduce contract assets. So we see, you know, though I don't have an absolute number for you, we see strong cash flow generation out in that time period as well.

Our next question is from John Raviv with Citi. Please go ahead.

Hey, thanks, everyone. I won't ask you about 2025 and beyond, if that's of that for now. But in the context of all that cash coming in, what about cash going out? Leverage is noticeably low. You highlighted returning 54% of free cash from the shareholders. It's been higher in years past, but I know your stock's been lower in years past. So just how do you think about cash allocation going forward, given all these dynamics?

Sure. So let's start, John. Let's start with 2020. You know, for planning purposes, we're assuming share repos of about $1 billion. We're assuming we do increase the dividends. You know, for planning purposes, it would be $0.20 a quarter or $0.80, similar to what we – per share, what we did in 2019. So, you know, round numbers and, you know, A-plus percent increase in the dividends. We do have another tranche of debt that matures in 2020. It's $1.2 billion, I believe. It's the second tranche of Sikorsky. For planning purposes, we're assuming we let that mature and pay it back. Our treasury organization is constantly looking at whether it makes sense to refi or look at our entire debt on the balance sheet, whether a debt exchange makes sense. We'll go through that. through the year. We will be opportunistic, like we were in the fourth quarter of last year, where it makes sense from a share repo standpoint. In fact, we did our first accelerated share repurchase program. It went very well in the fourth quarter of last year. And as you recall, 2018, with our stock price down, nothing to do with our fundamentals, but with what was going on with the market, we were very opportunistic in terms of that. And so, you know, we'll see going forward where it makes sense to do that. You know, what we didn't talk about is inorganic growth. You know, Maryland has, we meet at least eight times a year with the senior leadership team to look at a pipeline in terms of things that make sense for us to invest in or, frankly, to invest in. And as you said, we do have the firepower. on our balance sheet to go do that. I'll remind you that we got a credit rating increase by all three agencies, so with debt being cheap, if there is something out there from an inorganic standpoint that fits within where we think we need to go with our portfolio, we would be inclined to do that.

But I would just remind you that we really are happy with our current portfolio. We don't really see any gaps right now, but we'll, as Ken said, constantly keep a screen on it as we always do.

Next, we'll go to George Shapiro with Shapiro Research. Please go ahead.

Yes, good morning. Good morning. Hi, George. A couple of questions. MFC and space backlog were up well north of 20%. Why isn't the growth rate greater in 2020? And then also, if you just go through the balance sheet a little bit, there was a big increase in inventories, maybe partly offset by contract assets. And likewise, accounts payable were way down, maybe offset a little bit from liabilities. Maybe just walk through what's actually going on in a balance sheet as well. Thanks.

You bet, George. Ken will handle that. So you asked about space and missiles and fire control, and you're right. So we overachieved the orders plan this year by north of $20 billion, and two of the big drivers were exactly that, space and missiles and fire control. But I think what you need to do is look at the detail of what some of those programs are. So at missiles and fire control, A big driver of what went into backlog would be THAAD, KSA, and PAC-3 Poland. And those will be multi-year programs going forward. So you will not see a burndown like some of the tactical strike weapons programs, integrated air and missile defense, backlog will take longer to convert to sales. Same with space. Space is a platform business. And you have, recall I talked about in the past, the multi-year, the three years of AWE we got. So we will not get an order this year on AWE. We also got some big orders on Orion and OPIR. which would take longer to convert to sales. Regarding the balance sheet, you're right, George, we did have some inventory growth in 2019. But, you know, the way we look at it, I kind of look at contract assets and inventory and, frankly, put them together. So we actually had contract assets decreased in 2019 by roughly $400 million. Inventory for the year roughly grew $600 million. So I would say from an asset standpoint, we had 11% sales growth. Think of that as roughly $6 billion of sales growth from 19 to 20. We grew contracted assets and inventory by only $200 million. Going forward, We do see contract assets increasing in 2021. We see working capital in 2020 growing by rough numbers. It'll be comparable, a little bit more than this year. But remind you, we're growing sales by roughly $3.5 billion. So that's in line with what we've had in the past. And then 2021, we see a marked improvement from a working capital standpoint. We will only grow working capital by, say, $200 million. This is our plan today, but, you know, we will continue to try to perform on that, and with our focus on working capital, one of the main places that we will work is in contract assets in 2020 and 2021.

Next, we'll go to you, Kai von Rummer, with Cowan & Company. Please go ahead.

Yes, thanks so much. Everybody has talked about cash flow. I'm more interested in kind of what you do with it because your net debt to cap is now 1.4. If you increase your dividend 10%, if you buy $1.5 billion in stock every year, you're basically going to burn through like $4 billion in debt. So where are we going here over the next couple of years? Do you want this net debt to cap ratio to go below one, or are you going to deploy the cash? And if so, what are your relative priorities? Thanks.

So, Kai, as I mentioned earlier, I think, you know, our priority is, or from a plan standpoint, the debt on the balance sheet as it matures, our plan would be to pay it off. We will certainly look at whether it makes sense to refi in this low interest rate environment. We certainly will look at talking to the owners of our stock as we go around this year to talk to our shareholders what type of dividend increase is acceptable to them for them to continue to be interested in our stock. The last couple years, though we've planned for a billion dollars of share repos, we have overachieved. We've opportunistically in the last two years have bought back more stock than we planned. There is some likelihood we would do that as well and that, you know, we'll decide on that. We talked about, you know, in the past about our portfolio as Marilyn mentioned. We're very pleased with our portfolio, but if something out there makes sense for us to acquire, we have the firepower to do that. If you look at the composition of who owns our stock, it's almost 50% our yield investors, so we will certainly pay attention to our yield. Even with the high appreciation of our stock, we still have a very strong dividend yield relative to our share price. But I think the net is we're not going to let cash, you know, we've demonstrated this over the last couple years, we're not going to let cash sit on our balance sheet. We will use it.

And next question from Doug Harned with Bernstein. Please go ahead.

Thank you. Good morning. Good morning, Doug. I wanted to go back to the F-35 sustainment because I wanted to make sure I understood how the math works out here because if I think of, in a broad sense, and I'll put PBL aside for the moment, but if I think in a broad sense about sustainment activity being somewhat proportional to the fleet size, and if right now you're still building out depots, so there's, I would think, a surge in sustainment work at the current time for that, And then if you have to bring down dollars per flight hour over the next few years, how does this, how do you get to a doubling or tripling of sustainment revenues in the next five years? I'm just trying to figure out how this all flows.

Okay. So, uh, yeah, a lot going on. So, you know, just for completeness this year, we see sustainment growing. Not quite double digits, but close to double digits. So there are roughly 21 bases that are stood up. We still have quite a few to stand up. We have, you know, a large number of 491 aircraft out in the fleet through year end. We're going to deliver 140 aircraft this year. You know, rough numbers, 160 next year. 22, 165, and then we'll start getting up to the 170, 175, 180 aircraft delivered. We'll continue, as you said, drive down the price per flight hour from roughly $35,000 to $25,000. What I'd like to remind you, though, is half of that is the government cost. Half of that is our cost. But you will still continue to need sparing. Marilyn mentioned the modernization work that is continuing. You will start to see from a sales or revenue standpoint more modernization sales and sustainment once we have these depots up and sparing rather than the cost of standing up the depots. So going forward, you will see a sizable ramp in modernization costs where the customer working with us deems which aircraft it makes sense to modernize, and then to spare the fleet.

Next, we'll go to Seth Seifman with J.P. Morgan. Please go ahead.

Great. Thanks very much, and good morning. Can you mention the outperformance on the orders this year? I guess, first of all, where do you expect to – you know, exit the year in terms of backlog relative to last December 31? And then in missiles and fire control, you know, when do you anticipate that the margin rate there would stabilize and then, you know, maybe start to move in the other direction?

Gotcha. Okay. So we actually see what we know today. We see our backlog this year growing, you know, roughly $3 billion, $4 billion today. You know, if you think about our orders, orders this year will not, probably not be as strong as they were in 19, but you do have some notable orders this year. So, you know, this year, you know, we have three F-16 production orders in 2020, Bulgaria, Taiwan, and Morocco. We'll definitize F-35 Lot 14 this year. In the fourth quarter, we have F-35 Lot 15. There is a variety of hypersonics awards that will come out this year. We have the Indian Navy MH-60R that will occur, the Seahawk PBL. So our book to build the way we see it this year is a little bit over 1. You know, it's 1.06. So we will grow backlog this year to roughly 147, 148. Regarding missiles and fire control, we've talked about this in the past. You do have the development program, the classified development program that is kicking in. It'll continue to grow for the next couple years. We've talked about some of the risk retirements that we've had in the past. Some of those will not occur this year. But it's probably next year or the year after that we would see our margins start to stabilize on missiles of fire control. There will be other new prototype programs. So if you think about hypersonics, especially in missiles of fire control, it is strike hypersonics. We're investing in the counter hypersonics, but we really haven't seen any orders there yet. would not surprise us if we're put under contract this year and going forward for counter, and those will be dilutive to margins as well.

Hey, John, this is Greg. We're at the top of the hour, so I think I'll turn it back over to Marilyn for some final thoughts.

Thanks. Let me wrap it up and conclude the call today again by thanking our 110,000 Lockheed Martin employees for their remarkable efforts over the course of 2019. because it was a year that we delivered outstanding strategic operational and financial performance. Our corporation continues to excel in attributes we most value, and that's providing critical solutions to our customers and returning value to stockholders. So thank you again for joining us on the call today. We look forward to speaking with you at our next earnings call in April. John, that concludes our call today.

Thank you. And ladies and gentlemen, you may now disconnect at this time.