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Lockheed Martin (NYSE:LMT)

Sanford C. Bernstein Thirtieth Annual Strategic Decisions Conference Call

May 29, 2014, 10:00 AM ET

Executives

Marillyn Hewson - Chairman, President and Chief Executive Officer

Analysts

Doug Harned - Bernstein

Doug Harned - Bernstein

Good morning. I am Doug Harned, Bernstein's aerospace and defense analyst. And I am very happy again to have with us Lockheed Martin. And this year, I'm very excited to have with us Marillyn Hewson, who has been Lockheed Martin's Chairman and CEO for the last almost year-and-a-half. We're going to do a fireside chat format. So if you have questions please pass the cards to the middle. And with that, we'll get started.

And it's been almost a year-and-a-half now since she has been CEO. And I think it would be great to start just by understanding over that year-and-a-half, how have you seen the company, where do you think the opportunities are and what are some of the changes that perhaps you have made or are interested in making?

Marillyn Hewson

Doug, thank you. Thank you for inviting me today. It's really a great opportunity to have a chance to talk about Lockheed Martin. I appreciate your interest. I would like to first start there, if I could go to the first chart just to remind everyone that some of the statements I'll be we making maybe forward-looking statements. This is our Safe Harbor statement. And I would point you to our SEC filings, so that you can look at any risk that might be out there that where our actual result might not exactly lineup with some of the statements that I'll make today.

So with that, Doug, let me answer your question. As Doug said, I have been in the role about a year-and-a-half, and as I came in I didn't come in as a newbie, so to speak, in the company. I've been just -- I am in my 31 year with Lockheed Martin. So I've been a part of developing the strategy for the company for a number of years. And we are on that strategy, the strategies delivering results. We are very happy with how our company is performing. Our markets are changing, however, as you know.

We have been on a trajectory for the last about 12, now 13 years of two wars that have brought growth in the defense side of our business as well as in some of civil agencies that we support and that has now with the budget pressures in the U.S. and with us coming off of those wars, we're seeing a slight decline in those markets and the domestic market.

And so what we've been focused on as a leadership team is to continue to grow our international business. It's always been an element of our strategy, but in this environment we've stepped up our focused on that from a leadership standpoint and resources, because there is a strong demand for our products and capabilities internationally and because it is an area of growth for us.

Through that process then we do see many opportunities for the F-35, for tactical aircraft such as the F-35 and the F-16, for air mobility, such as the C-130J, for our missile defense compatibilities for THAAD, PAC-3, Aegis systems, Aegis Ashore, our Medium Extended Air Defense Systems, MEADS, and so there is a strong demand for that in the marketplace, continued demand in command and control systems, and intelligence, surveillance and radar systems. We have demand for situational awareness for the satellite, our cyber security, so a lot of opportunities internationally, Doug, as we're looking forward.

We are also continuing to look at opportunities in new adjacencies to the work that we're doing. In that cyber security is a good example. Littoral Combat Ship was a very good example of that, with the Littoral Combat Ship moving into that market, now we're seeing opportunities internationally where a lot of international Navy's are looking at the Littoral Combat Ship, bearing it as an opportunity for them.

We also are growing in other areas where we're looking at M&A acquisitions, small acquisitions, but I guess if I look back over the last year-and-a-half, the thing that really stands out to me is that focus by our leadership team on performing on the business that we have. The execution, I mean that's what drives the profitability of the business, that's what drives the continued new business, because our customers are satisfied with our performance.

They know we're continuing to invest in our portfolio. And so they come back to us for additional things. We are a technology leader in this business. And so we're going to continue to invest in our portfolio. We call it innovation with purpose, because we know clearly what business we're in and we're investing in those opportunities for innovation along that line.

Doug Harned - Bernstein

And you mentioned international, but when you look at that the U.S. business, obviously there have been some really challenges in the budget and in the budget process. Can you comment right now on what you're seeing in your interactions with Congress, with DOD? We've just gotten through the markups in the House Armed Services Committee, the Senate Armed Services Committee and it seems that there is an effort to add a lot of new things, but not necessarily make money available to fund them. Can you give us a sense of what you see going on in Congress today?

Marillyn Hewson

Sure, I'd be happy to. If you look at the bipartisan budget deal that got done at the end of last year, I think for our customer with the Department of Defense and the civil agencies as well as for our business and our industry gave us some near-term stability, some budget planning that we can do, because we're looking at that not being at the sequestration levels that were proposed having that leveling off and then understand. Certainly it had some cuts, but it gives us at least some certainty around that.

So FY '14 appropriations and all of that is underway and our programs are well supported in that budget. In FY '15, as you said, we're in the mark. We're in the congressional deliberations. And my dialogues in that environment, my take, is that our customer and our nation from a national security standpoint needs more than what that budget supports and that was the message that came through in the President's budget, when they outlined the opportunity growth and security initiatives. If they had additional money, these are all the things we'd like to spend them on.

And so I think our law makers are looking at that to say, where can we fund these things that are important to the Department of Defense, in case of the health mark. I mean they actually are projecting what's going to be in the overseas contingency operation as a way to fund some of those additional things.

So in the dialogue I have it's clear that it's a challenge. Clearly, we got a budget pressures and we have to continue to figure out how best to address that. From Lockheed Martin standpoint, I would tell you that having the F-35 well supported in both the House and Senate and by our customer I think is very important. It's 16% of our sales. It's an opportunity for growth for us.

In the long-term, it will continue to be a large area for us. And it's a capability that's very much needed in the U.S. and in our international partners. And then if you look at the rest of the programs that are there, I think it speaks to the fact that we have a strong portfolio that winds up well with that defense budget.

What will happen beyond FY '14 and '15 once we get through this budget cycle on '15 and to '16 is we have an uncertain situation, Doug, because that is when sequestration would come back into place unless Congress does something about that. Everyone I speak to says they want to do something about that. So my optimism says, hopefully they'll get together and they will do something about that. We may still see some cuts in FY '16 and beyond, but not at the sequestration level.

Doug Harned - Bernstein

Have you seen any change in the attitude in Congress since we've had the issues with Russia and Ukraine, some of the issues in the South China Sea? Has this changed the dialogue at all?

Marillyn Hewson

It has. It absolutely has. And it has around the world. I mean I have traveled literally around the world in last several months and I am leaving on another trip here just shortly. And I spend a lot of time in Europe as well as in the Middle East and I'm heading to Asia-Pacific.

I mean these are areas of the world where it is absolutely, front and center with our international customers as well as with our domestic customers and with our Congress. So the tensions in Ukraine and the aggressiveness with Russia there, as you mentioned the South China Sea and the tensions over there, the North Korean's and their unstable behavior, just different reach and it continues in the Middle East to be a dangerous neighborhood and a lot of tensions that arrived there.

All of those things say to us as a nation and to our allies around the world that while we have budget pressures that a number one thing that any nation has to do is to be focused on their national security. And so as you deal with budget pressures, each one of these nations I speak to say, but we still have to address the national security strategy that we have to protect our citizens and to provide them with the essential services that they need. And we've got to figure out how to manage that budget.

I think that was the spirit behind the President's budget that was proposed for FY '15 with this added element via ways that if they have the additional spending this is where they would spend it, because they are absolutely very much pressured in this environment and then the projection out forward, if they don't address sequestration.

Doug Harned - Bernstein

You've been in the, I would say, enviable position of Q4. You hit a record backlog, which not that many companies in this industry can claim. And as you look forward now, I know expectations are that revenues, it will be down a little bit this year. IS and GS perhaps a little weaker, but as you look forward beyond this year given that record backlog, should we expect a growth trajectory coming out of 2014?

Marillyn Hewson

I would say, first of all, what you should look at on that backlog is that that gives us a lot of resiliency in a time when our primary customer is at sort of at the flat or slightly declining level, which as you acknowledged, I mean we are going to see our sales piece slightly decline this year year-over-year. And actually last year, it was the first time we've seen a decline in our overall sales for many, many years.

So that backlog is if you look at our business, the predominance of our business are long-cycle businesses. We build aircraft, satellites, things that from the time we get the order, the contracts sign to the time that we actually deliver is three years, some times three years plus. So the things that are in that backlog have already been funded, have already been in prior year's appropriations and will not be impacted by sequestration. So that should give you that sense.

In terms of growth, we are focused on continuing to grow. We're just not going to grow with the same trajectory just because of the markets we operate in, but this focus on the international marketplace as well as the ramp up in the F-35 is what's going to allow us to start seeing some growth I think as we move forward.

The F-35, itself, if you look at that over the next five years, close to half the orders are going to be in the international marketplace and even in the program of record that doesn't include South Korea, that has formally announced their intent to buy the F-35. It doesn't include additional tranches of F-35 with some of our other security cooperation partners are contemplating such as the Israel and others. So I think that we'll see continued growth in that large element. And then as I mentioned missile defense and the other, strong demand for our products around the world.

Doug Harned - Bernstein

And I want to get back to the F-35 a little bit, but just on that we did see in the President's budget taking down the carrier version, that that ramp has been slowed. So there has been a little bit of reduction in quantities there. I know you have the international side as well. When you look at the outlook for the F-35 now, is there any change that you're seeing first in volumes on this ramp? And if you can give us a sense what that ramp looks like now? And then second, when you think about margins, if you're at a slightly lower volume, does that impact your ability to get margin on that program?

Marillyn Hewson

Well, first off on where the program is. We're in the low-rate initial-production, LRIP, right now, as well as finishing up the development program and that development program is going to continue on out until l late '18 or early '19 before we wrap it up.

So we're in the flight test program, which is going extremely well. We're wrapping up getting the software. It's in flight test for the initial operating capabilities in Marine Corps that happens next year. We'll wrap up that flight test this year on that software. The software for the Air Force, which goes to IOC in 2018 is going well, I mean 2016 and then 2018 for the navy.

So all of those, that software is moving through technical issues that come along in a test program. We've already had great trials on the arresting hook. We're going to see trials on that in October. We have helmet where we've made the selection on the helmet. We're through the critical design review on that helmet and moving through its process. It's going well.

So there is not any technical issues out there. We'll continue to flight test program. Other things may arrive, that's why you do a test program and then we'll address them as they come. So I would give you the sense that we're confident. The development program is moving through with pace as we would expect.

The ramp up of production is also going well. We've brought the cost down from LRIP 1 to LRIP 7 by about 55%. We're continuing as we ramp our production to bring that cost down. The ramp up in production right now was relatively flat. Last year we delivered 35, this year we're going to deliver 35 or 36, somewhere in the same range. And then we will start to see a ramp on production for the F-35.

If you look at, for example Lot 8, which we're in the negotiation process on right now, well it has 43 aircraft in that lot there for the U.S. There is also additional aircraft for the international. So the ramp will continue. We'll probably see on out by the time we get to full rate production up in over 100 aircraft that are in that as we move forward.

What's important about that ramp up in production is that's what continues to drive the cost down. When you're on a learning curve, the volume, I think everybody knows the volume will help drive unit cost down, but for us it's 80% of that cost, and then the other 20% we're working on a lot of cost reduction initiatives to continue to drive the cost down.

Our customer has highlighted what that cost of the aircraft will be by the time we get to full rate production. And it will be comparable to a fourth generation aircraft cost for that aircraft and bring tremendously unique capabilities that our customers in the U.S. as well as international customers are looking forward too.

Doug Harned - Bernstein

But can you give us a sense on how you see the margin trajectory going here for the airplane, when you see this getting out to the kind of numbers that you typically see on a mature?

Marillyn Hewson

Sure. Today the margins for the F-35 are lower because it's a development program. So it's a normal cycle that you go through on a development program. When we're in the system design and development phase, the SDD phase, that has lower margin and then as you go through the LRIP, you graduate up as you get more stability, retire risk, you're able to achieve higher margins.

The way I see it is that it's going to be a damper on our overall margins in Lockheed Martin for a few years as we get through that process offset by our growth on international, that will help us in the overall margins at the top level of the company. But on the F-35, itself, what we envision is that it's going to go the way of other tactical aircraft programs, such as the F-16. Today the program of record is around 3,000 aircraft. The F-16 we've sold 4,600. We're still selling more. And we see that through that process, we're going to continue to increase our margins, then we'll be in line with that, and sell much more internationally.

Doug Harned - Bernstein

And so when you look at Aeronautics overall and you look at margins going forward, do you see -- I mean, obviously the F-35 can have a larger contribution as we go on. Do you see being able to hold those margins, at least the current levels?

Marillyn Hewson

I think for F-35, right now it will continue, I mean for Aeronautics, because F-35 is growing as much as it is. It represents about half of that business area of sales. And that's going to continue to grow. So that because it's a lower margin than the rest of the business area that's going to have a damper on margins, but that will be for some period of time. So maybe it's going to be around 10.5%, and then overtime as the F-35 matures and you get higher margins, it will bring that up.

Doug Harned - Bernstein

And I want to talk a little bit more about margins, because I know in your past roles, say electronic systems, you've had a very strong focus on cost. And this is something, I think you and your peers are all focusing on given the challenging budget environment we've seen. Can you give us a sense now if some of the initiatives or progress you've made on cost and how you see that going forward?

Marillyn Hewson

Sure, I'd be happy to. I think in our business we have seasoned leaders that understand you got to keep your business base on line with the markets that you're in. And so we started looking at what was happening in our markets with the flatter declining some numbers of years ago. If you go back to 2008 or so we were about -- 2009, we had 146,000 employees, today we're 113,000 employees.

So unfortunately, we have had to take some reductions in our workforce. We've had to get out of over capacity and shutdown some facilities. We're focused on our overhead cost. We're looking at our capital expenditures. But at the same time, we're continuing to invest in the business, to invest for growth, and last year our IRAD was up 13%, close to $700 million. So it's a balance of like any business would do how you evolve to the markets that you're operating in.

Our actions on the front-end I think have helped us to keep our rates down, to keep us to be -- to meet the affordability initiatives that our customers need in this time with budget pressures, and allowed us to continue to perform and it has helped our performance in the business. I think the biggest thing that's helped our performance in the business, however, is the performance on our programs.

Our teams are performing well on our programs. And when you don't have losses and de-books and things of that nature, when you're performing on your programs, that's going to hold your margins up. And as those programs mature and those margins increase and you're able to take to retire the risk on those programs and take those margins back, that's some of the upside that that you've seen in our business.

We typically run somewhere between the low-11% to the high-11% margins overall for Lockheed Martin. They're probably going to stay in that realm. It's a mixture of programs. We're growing the internationally, yet we have the bit of a damper from the growth of the F-35. A lot of puts and takes in the business, but that's what we would envision going forward.

We're going to continue focusing on cost. It is something we do every day in our business and productivity improvement, what happens externally may drive some different things that we have to do on our programs. But we have leaders in our company. My leadership team, there is nobody on my leadership team that doesn't have at least 25 years with Lockheed Martin under the belt, several of them are over 30 years, like myself.

We know how to deal with up cycles and down cycles in our business and how to get our cost structure and our business aligned with the business space that we have. But at the same time, what we're doing with the near-term challenges that happened in our business, we're positioning this company for the future.

So we are investing in things that we know will be opportunistic for us, things that are important to our core business to make sure that we are evolving our product lines. That we're prepared for the new product lines, like long-range strike or opportunities in cyber security, a whole range of things along that line and then at the same time performing on the programs that we have.

Doug Harned - Bernstein

If we go to international, again for a little bit, can you talk a little bit about where you see this going? And right now, I think you're about 17%?

Marillyn Hewson

Correct.

Doug Harned - Bernstein

And if you look over the next couple of years, you've talked about getting to a 20% type of the level, but I'm interested that right now F-35 doesn't play much role in that international number, because you're very early days. But set F-35 aside, where do you see international going in the next couple of years?

Marillyn Hewson

Well, you're absolutely right that F-35 is an element of that. And we've said we'll get to at least 20%. I think we'll go higher than 20% of our sales that will be international. But just some of the things I talked about earlier, missile defense. There is a strong demand for missile defense around the world. And when you look at our portfolio of missile defense capabilities, I think we're very well-positioned to continue to grow that element.

So today, we have a contract for this THAAD, the Terminal High Altitude Area Defense system, that system are contract something like $3.9 billion with the U.A.E. and the U.S. combined together. That system is in demand in the Middle East by other countries that would like to buy that system. PAC-3, we have sold around the world. There continues to be a strong demand in the Middle East and other parts of the world for the PAC-3 missile. We think those two are going to be a big growth opportunity for us internationally.

We do the Aegis system for Ballistic Missile Defense on not only U.S. ships, but for other ships. Even with the LCS variant that we want to sell around the world. There is an interest in Aegis like missile defense system that could be put on those ships going forward. We have Aegis Ashore, where we're standing up land-based Aegis systems in Romania and Poland. We think there will be other opportunities for that. So missile defense is a big area.

F-16, the venerable F-16 is still selling around the world. We have backlog to 2017 and we expect to continue to sell it beyond that. We have customers interested beyond that the ones that are on contract to continue to grow the F-16. So on an airlift side, the C-130J, U.S. government is looking at a multi-year buy the C-130J, but in addition to that there are international customers in the Middle East and Israel and other parts of the world that continue to buy the J. And so that piece of our business.

Cyber security. There is growth in cyber security. It's a largest threat for many countries right now, it's the cyber threat and they need help. And we have the capabilities to help them. So they are asking for our help around the world in that arena. Our communications and control are in our ISR. So all of those, mission systems and things that we know how to do is what I am hearing from our customers around the world that they need help on. So I expect that, as I said, we'll grow to 20% and beyond and it isn't just F-35, it is certainly in that whole range of our portfolio.

Doug Harned - Bernstein

And I'm interested in missile defense, in particular. I mean it's something that, if you look at it, do you see this as a sort of a wedge that continues to grow, international missile defense, because in one sense you can do a project and you could finish it up and then start the next one. It's anonymously all additive, because of the timing of these. So if we will -- can you give us a sense if we were to look out from today to say five years from now, how large is international in this missile defense for Lockheed Martin? What do you expect out of that business?

Marillyn Hewson

When I mentioned missile defense, I mean I forgot to bring up what I think is a real growth opportunity for us as well as the Medium Extended Air Defense System, we call it MEADS or MEADS, depending on how you like to pronounce it.

But this is a consortium that where the U.S., Germany and Poland approved funds to develop this system. And now the Germans and Italians are looking at that as they're making their decision on that. And I think it will come through as their defense system for their country. That's about a $3.2 billion opportunity.

And then Poland has a $5 billion opportunity, the Polish Shield they call it, but this is the Shield of Poland opportunity for their missile defense system and we are in the down select on that opportunity. And I think that is a $5 billion budget item for them in Poland. So that's a big growth opportunity for us.

So as I look at that in the portfolio, if you consider F-35, the next two big elements as we look at our portfolio would be THAAD and PAC-3. And then MEADS, just come through another parts of the element. Those are also in our top-70% of our business. So if you look at that growth opportunity, it's F-35, F-16, C-130, THAAD, PAC-3 and that kind of encompass a very large element of our growth opportunities.

Doug Harned - Bernstein

Is it impossible to size THAAD, sort of a dollar size of what that international missile defense is?

Marillyn Hewson

Today, well, on international missile defense piece, I really don't have a number right up the top of my head. I will say, if we're today about $8 billion in international sales, and we're going to grow to 20% of our portfolio, that gives you the topline. And then at the top of my head I don't have a number.

Doug Harned - Bernstein

And MEADS, I mean that's had a rough time in the U.S. budget, but are you more optimistic now then say a year ago on what the potential is for that in Europe?

Marillyn Hewson

Well, I absolutely am, because it's the most modern, most capable system. I mean that's what they need. They don't need an older system. They need a new system, one that has 360-degree capability, one that is mobile. In that European environment, they need a system that can meet their missile defense needs. It's lower cost to operate. So overall, if you're going to buy a new system, you want to buy the newest system that's got all the capabilities. And I think that's what MEADS brings to them.

We are, as you said, it's an opportunity for us, even in the U.S. The U.S. has invested a lot of money in the MEADS and we have the PAC-3 MSE on that system that the U.S. is looking at how they will harvest the technology from that. So we expect actually, as they look at upgrading their Patriot systems and opportunity even in the U.S. on element of MEADS. But the surveillance radar that comes with that system on MEADS is one that I think brings tremendous capability. And it will give -- you could even think of it is potentially being a NATO system, it's already NATO-operable.

So it's able to be -- and if you've got the Pols and the Germans and the Italians, and particularly other Baltic countries that need this kind of capability, it could be in a position where it's got this interoperability with NATO to be the NATO system. It's what my vision would be for our customers there.

Doug Harned - Bernstein

And when you look at space, and look long-term, I mean space has been fairly flat for you to say. And if you look longer-term, the Air Force has some real challenges. They are funding the tanker. They are funding F-35. They are funding long-range strike. That forms the big reds in the air force budget.

And right now we've got a set of constellations that you're involved in space, AEHF, SBIRS, GPS III. If you go out longer-term, where does space go? I know there is another part that's hard talk about here, but I am trying to picture, can space revenue stay flat? Are we going to see that have to give some to pay bills for the other part of the Air Force needs?

Marillyn Hewson

As I look at the needs of our nation on the capabilities of those space systems, I mean you mentioned several of them that gives secure communication for our war fighter and for our Department of Defense, gives us the missile warning and detection, that gives us the situational awareness on the battlefield, I mean, GPS, that all of this rely on, for our own capabilities, but certainly from a defense standpoint and it's the upgrades to that with it's capabilities that we'll bring that are stronger capabilities and with more anti-tamper and things to that nature.

So those systems you just described, I think form the basis of very important situational awareness for our nation as well as secured communications and deeper communications. And our space customers and the Department of Defense are going to continue to need those. So they have a plan of additional satellites they will buy over periods of time on each one of those and we expect to continue to participate in that.

Doug Harned - Bernstein

IS and GS, I mean you and many of your peers have all seen some challenges in this market, both on the demand side, but I'd also say on the contracting side with the use of, in some areas, the lowest price technically acceptable, procurement process or award process, how do you view that business today in terms of both what the revenue outlook is? And then second the ability to bring margins up there?

Marillyn Hewson

Well, first off from the revenue outlook, we will be down again this year in revenue. It's the nature where that piece of our business is and the budget constrains that our customers on civil agencies have. But your description of the market and what's happening on pricing and things like that, I mean our focus is on value creation.

So where we want to participate in that market is where we bring value. We don't want to be in a competition to the bottom on price or anything like that. That's not the kind of work that we think we bring value to our customers on. So we're mission focused. We're focused on providing the capabilities out of our IS and GS business, that are higher-value add to our customers. So we're not looking at going after that low-end stuff. So that should in one sense help us to hold up our margins where they are.

Today, we are right around 9% margins in IS and GS. We have been for the last 12 or 13 quarters. We foresee that to move forward because of the way that we're shaping the business, even as we see some decline in the sales. At some point, we expect those sales return because there is a continued need for the kind of things that we're doing. It's just I think we are in that phase in this market as are our colleagues in the industry that we have to move through.

Doug Harned - Bernstein

A couple of questions here, which get to some new capabilities, and one of them you already mentioned, and it's in that area of cyber. Can you give us a sense of how large cyber is today for Lockheed Martin? And what you see that growth path going forward looking like?

Marillyn Hewson

So I think if you define cyber security in the broad sense, it's very large, and I wouldn't be able to put in exact number on it. But if you look at all those systems that we have and that we protect and you look at that we produce and protect, it has an element of making sure that they are protected from adversaries, that numbers in just the platforms and systems that we produce, so within the centralized portion of that we have within our IS and GS business.

And in that business, we are growing at about right now it's around $1 billion worth of sales in that business. We are even moving into supporting commercial customers there, because a lot of large companies, whether they are utilities or they are banks, in the financial side or in other critical infrastructure, they need help in protecting their systems, just like we've been able to protect our systems.

We are constantly post as the largest defense contractor by advanced persistent threat, that once get into our networks, then we come up with a very intelligence-driven capability over the years. We develop long before the terminology cyber security was coning, because we have been protecting our networks and we've been protecting some of our government customers' network over the years.

So that capability to be able to monitor detect and to work any advanced persistent threat, we know how to do. We have the system. We continue to invest in our capability in that arena and that's what we're taking to the marketplace. Some of the areas, that are important, not only in the financial and the commercial side, but on the international side, there is an interest in our capabilities.

So we have stood up centers in Australia and in Canada, even in the U.K., where we are doing work for customers, where we have interest in the Middle East around cyber security, in the Asia-Pacific. These are areas of the world where there is going to be a continued demand. We expect to grow our cyber security business.

Doug Harned - Bernstein

And you mentioned commercial, because that is a very competitive arena and you're also going up against companies that understand commercial systems quite well. What are the challenges you see in going into that market? I mean typically defense companies can work well in federal systems, but it gets harder as you move away from that.

Marillyn Hewson

Well, Doug, you're right to say there are differences. And we never go into a new market unless we know what we're doing. We know the product line. We know exactly what we are offering. If we have to go to market differently, we hire talent to support that. We do the right things, so that we go to market appropriately.

The products and capabilities that we take to that market, the core competence that we have for that is known, it's a same thing that we do on the government side, that we would take commercially. And then we make sure that we have the talent there, on the actual marketing element of it, to make sure that we do it appropriately. And frankly, we are seeing that business grow and we are excited about it.

Doug Harned - Bernstein

Another growth area that I've got a question on here is on unmanned. And I know there's a lot of work that you have been doing in unmanned, so I don't think, you can probably talk about even, but can you give us a sense for what your strategy is on unmanned? What some of the platforms areas are that you're interested in pursuing?

Marillyn Hewson

Sure. Unmanned capability and autonomy and all that, we do see as a growth area, an important area that our customers have told us. There is a requirement that they have. And we are in all domains. I mean we have underwater vehicles that are unmanned that we've invested in, some that have an opportunity even to go commercially. So that allow us for example to assess, to support companies that have oil and gas rigs and needs unmanned vehicles to assess, what kind of shape they're in after hurricane or just for normal maintenance.

We have land vehicles, so our Squad Mission Support System is an unmanned vehicle that has been taken into theatre, that can carry things for our troops into forward operating situations or that can be fare as to take injured soldiers back. So it's got a lot of capability from an autonomy standpoint. We see that as a growth area on the land side.

We have unmanned capabilities in aircraft. A full range of those from things such as the Desert Hawk, which is our handheld type of surveillance unmanned capability, to the K-MAX, which is our supply helicopter that's unmanned that's been used in theatre carrying something like 3 million plus pounds of cargo to forward operating basis, getting our men and women out of harms way, they're not driving over potential IEDs and things of that nature. So the Marine Corps, yet again extended that. They want to continue to deploy K-MAX and we think there is other opportunities for that.

We have Persistent Threat Detection Systems that are unmanned, the aerostats, the sensors that can see what's happening around the world. Then we purchased some companies in the unmanned arena. One of our products is Fury, which is an unmanned capability of a smaller type aircraft. We have Stalker, which is another smaller unmanned air vehicle. And then we're developing a lot of other areas.

We also have ground operations that we support in unmanned. It is a growth area for one that we're investing in. As you said, we'll continue to invest in it going forward, because we see that there is a real complementary way to go to a battle space with space with both unmanned and manned capability.

Doug Harned - Bernstein

Now, I want to kind of shift gears here and go to cash, and I mean helps in understanding how you're looking at cash deployment. Can you give us a sense of what you're looking at this year in terms of repurchases for example?

Marillyn Hewson

So first off on cash deployment. I mean cash generation is in the lifeblood of our company and it something that we work on every single day. So I think we have a strong track record for generating cash. We just increased our cash outlook for the year from cash from operations.

We're going to continue to have a focus on that. So it's a real attribute to the team that we're consistently focused on that. We also have made a commitment many years ago I think back as far as 2003, that we would churn at least 50% of our free cash flow to shareholders.

If we just look back at that track record, and since 2003, we churned 100%. $28 billion, we've returned to shareholders in the form of dividends and share repurchases. Our dividend record, I think is a track record that for the past 11 years. We have increased our dividend double-digit every year for the past 11 consecutive years. And we'll look to our board as to what they're going to do this year. They look at it on an annual basis. They make a decision, but because we do have strong cash that that is something I'm sure that they'll look at very seriously.

And then on the share repurchases. Our experience has been to been in a mode not to allow scope creep, in our share creep, in the number of our shares that are out there, because we give the stock options to our employees, and the executive comp as well as in other comp in our business, and they exercise those options and that could have some dilution.

And we want to make sure that we address that and that's kind of been our motto over the years to make sure we offset any options exercised. It's been for us, we cutoff stock options last year. So we're no longer giving stock options. So you won't see that kind of dilution of getting them out.

And our employees, because our stock price has been on a nice increase, have been selling and exercising their options. And when we've been able to buy them back in such a fashion that it's been really a very good position to be bringing them back at a very significant cash influx for us.

So this year, we said it's been objective of about $1 billion of buyback and share repurchases. And well we'll look at it as we move through getting these stock options out of the system, then it will open up an interesting opportunity for us as we look at dividends and share repurchases that how we return that to the shareholders and still meet our commitment of at least 50% of free cash flow.

Doug Harned - Bernstein

And that's why I was going is that there has been a fair amount of dilution. And so as you look forward over the next few years, should we expect share count reduction? I mean as you continue to follow this strategy and hopefully have less dilution. Is that the right way to think about it?

Marillyn Hewson

Yes. I think we are already on a path of having reduced our share count. And so we'll make the decisions on, given our business what makes sense to meet our commitment to return that cash. And if we don't have another use for that cash, it doesn't make sense to have it still on the balance sheet. That we'll look at how we go back, getting it returned to shareholders.

Doug Harned - Bernstein

And you all made a pretty important decision a little while back on a very significant increase in the dividend. And you took it over, that time it was 5% yield. I mean you have the sort of high class problem of share price going up so much, so that yield came down. But when you think of the mix of dividends versus repurchases and cash deployment. How do you think about that balance? What do you look at?

Marillyn Hewson

Well, what we really look at is what is our ability to recommend to the Board of Directors a dividend increase relative to our cash and what make sense for us in that sense. Our focus is on what are our uses of cash? What is our commitment to shareholders? And what would we then recommend in terms of that increase in the dividend.

Doug Harned - Bernstein

And then with respect to pension, how are you looking at pension contributions over the next few years as well?

Marillyn Hewson

Well, I mean in terms of meeting the ERISA's contributions, we have made -- we're in good stead in that sense. I mean we're well funded to meet the obligations that we have from funding our pension plans. And so we will monitor that going forward. But I mean that's really how we operate, if we look at how the returns are coming in our pension investments with the discount rate and we manage within that.

Doug Harned - Bernstein

So from ERISA standpoint, you're basically fine right now.

Marillyn Hewson

Yes. We are.

Doug Harned - Bernstein

On the other side of this as we go through cash harmonization, I mean you have talked about numbers sort of in the $8 billion to $9 billion range in terms of cash, we should expect coming in over, I would say, next five or six years. Is that a fair characterization?

Marillyn Hewson

I think that's fair, yes. I mean that's based on the fact that we have paid that into our pension plans. And just like a commercial company gets reimbursed for their pension, because they put on the price of their products, it's part of what the government contracting that is sitting out there, that we would expect to get paid back from the government, reimbursed from the government for our input into the pension plan. So you're right, it's at $9 billion right now. And we're looking at it coming in through cash harmonization over the next several years.

Doug Harned - Bernstein

Because going back to our cash deployment discussion, I mean this creates an interesting opportunity to deploy more cash and how do you think about the use of that cash when it comes in?

Marillyn Hewson

Well, I mean as we talked about, there is uses of returning into the shareholder in terms of dividends and share repurchase. I had mentioned that we're continuing to invest in the business. We will continue to look at potential acquisitions, small acquisitions that might help round out our capability or open access to new markets or look at what kind of capital expenditures.

We talk some earlier about reducing footprint. We're also increasing footprint in some parts of our business, where we need to spend some capital expenditures, where some of our product lines are growing, and we're expanding in those areas or where we're shutting down a facility and we have to standup a lab or enhance an area to take the work that we're moving in an existing facility. So we'll look at all of those uses of cash and do what any good business would do, deploy them appropriately.

Doug Harned - Bernstein

Well, as we wrap up here, I'd like to finish. If you can give us a sense, if you look at the next five years, what do you see are the two biggest opportunities and what are the two biggest challenges?

Marillyn Hewson

Well, absolutely, the biggest opportunity I see is the F-35. I mean that is our growth platform in terms of a one program. Today, it's 16% of our revenue. It's going to grow to 20%. It's a very important opportunity for us. It's stabilized production-wise, I mean in development program and through the production, so I think it's maturing. I mean, we're not done with development, but it's maturing. And there is a strong demand for it around the world. And there is no other capability. It's truly unique and one that countries need and our country's need. So that's a big growth.

And then the second piece I would say is international. We talked a lot about that today, Doug, but the international growth opportunity is demand for our products. The fact that we have this portfolio that I think is one that lines up internationally. I also think on the U.S. government side, we're going to see growth as we get through these budget pressures that we have in the near-term.

We've been positioning our company for that. We had for many years been shaping our portfolio. It is that core portfolio for the U.S. government. It's very strong and we expect that could be a demand going forward.

In terms of challenges, we'll have to watch and see what happens on sequestration. That will be a challenge for our customer, if sequestration cuts, stay in place after FY '16 and we want to be there to support them. We're willing to help them as they address affordability, as they address how they're going to spend that.

We do still think that they need the products and capabilities that we have and so we're going to be there to help shape and invest in them. So that we can make them more affordable, to make them wider, extend the range or whatever it is to help them deal with the challenges that they have.

And then one of the things that we always stay focused on in our business is continuing to develop our talent. People are the lifeblood of our company. They are the innovators. They are the ones that are doing the things that we need. So we'll continue as a leadership team investing in their development making sure that we can attract and retain the best folks as we move through and innovate for the future of this company and position ourselves for the future.

Doug Harned - Bernstein

Well great. With that I want to thank Marillyn for joining us. And we're going to wrap up here.

Marillyn Hewson

Thank you.

Doug Harned - Bernstein

Thank you.

Question-and-Answer Session

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Source: Lockheed Martin's (LMT) CEO Marillyn Hewson on Sanford C. Bernstein Thirtieth Annual Strategic Decisions Conference (Transcript)
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