Lockheed CEO Hewson: F-35 Performance Will Drive Profits
The price of the F-35 joint strike fighter will come down considerably over the next several years, said Lockheed Martin President and CEO Marillyn A. Hewson. But making the aircraft more affordable for the United States and foreign buyers, she noted, should not come at the expense of company profits.
Lockheed Martin is cutting costs company-wide and introducing new manufacturing techniques to help bring down the F-35 price tag of about $95 million per airframe to about $80 million. But Hewson rejected the notion that the company should sacrifice profits as long as the program is performing as promised.
“The goal is to reduce the cost of an F-35A fifth generation fighter to the equivalent of today’s fourth generation fighter. And we’re confident we’ll get there by the end of the decade,” Hewson said Feb. 18 at a news conference in Arlington, Va.
“By no means are we making exorbitant profits,” she said. “We are focused on performance. We’re going to stay focused on performance and, as we perform, we expect to get a return for that performance.”
Contractor profits have been a contentious issue since Program Executive Officer Lt. Gen. Christopher Bogdan took charge of the F-35 in 2012 and called on aircraft manufacturer Lockheed and engine provider Pratt & Whitney to put “more skin in the game.”
Hewson said Lockheed officials have had extensive discussions with the F-35 program office about cost-reduction measures, including stepped up pressure on all subcontractors to eliminate costs.
There is “ongoing dialogue with our customer,” she said. “We have had a good exchange of information on what it costs to produce the aircraft and what we’re doing to continue to drive down the cost as part of a development program,” Hewson said.
Lockheed and two of its major subcontractors Northrop Grumman and BAE Systems are spending $170 million over the next two years on manufacturing technologies that are intended to make the aircraft less expensive to produce. These initiatives, though, only will account for 20 percent of the overall cost reduction. The rest will come simply from higher production rates, which allows for greater efficiency, Hewson said.
The $80 million cost target is for the conventional version known as F-35A to be purchased by the U.S. Air Force and several foreign countries. The other two versions — the F-35B vertical takeoff aircraft for the Marine Corps and the U.K. Royal Navy, and the F-35C for the U.S. Navy — are more expensive because they have unique design features and will be built in smaller numbers.
Industry analysts said Lockheed is navigating through treacherous waters as it tries to bring costs down and make profits for its investors. Wall Street views the F-35 as Lockheed Martin’s “growth-engine,” noted industry consultant James McAleese, of McAleese & Associates. Even if the Defense Department’s budget is cut across the board under sequestration in 2016, many investors are bullish on Lockheed both because the company continues to pay substantial dividends to shareholders and also because of an anticipated F-35 production ramp-up, McAleese wrote in an advisory to clients.
There are growing concerns, though, that F-35 profits are not moving in the right direction. Lockheed Martin is “struggling with F-35 production operating margin,” said McAleese. F-35 production sales grew by more than $800 million in 2014, but operating profit was flat compared with 2013. Lockheed Martin is “under tremendous pressure to drive to double-digit F-35 production operating margin by 2017,” McAleese added. He predicts the company will resist any additional large-dollar affordability investments in F-35 “unless there is clear profit upside … and matching DoD funds.”
Investors are hopeful that Congress will approve the administration’s budget proposal for 2016 that funds 57 F-35s, he added. Lockheed Martin is “hungry for the expected jump to 57 F-35 aircraft.”
In 2014, the company produced 36 aircraft – an all-time high for a single year.
Industry analyst Byron Callan, of Capital Alpha Partners, has questioned Lockheed’s dramatic cost-reduction projections. “A key issue for the F-35 program is the ability of Lockheed Martin and its partners to reduce both unit and sustainment costs. Unit price reductions are projected, but 80 percent of these savings simply come from volume increases and learning curve, so this is something of a chicken and egg problem,” he wrote last fall in a note to investors. “The trick is to get buys in 2015-2018 so out-year prices can be realized.”
In inflation-adjusted dollars, the F-35 still costs much more than the F-16, Callan said. Hewson’s assertion that the company will deliver F-35s below $80 million per aircraft is optimistic, he added.
“We have been a bit skeptical of that claim.”
Fiscal year 2019 will be a pivotal one for the program as it is scheduled to begin full-rate production of 175 airplanes.
Hewson said her $46 billion company has implemented austerity measures across all corporate operations that will benefit the F-35 as well as other programs. It has squeezed $1.17 billion in savings from its subcontractors. Since 2008, it has slashed its corporate footprint by 7.5 million square feet.
For F-35 specifically, Lockheed Martin last year unveiled a “blueprint for affordability” that included $170 million in corporate investments in manufacturing technologies. Hewson said she is unfazed by the drumbeat of negative news that often surrounds the F-35. Watchdog agencies and the Pentagon’s weapon testers have regularly published reports that highlight technical and financial challenges in the program. “What we’re seeing is nothing new on those reports,” Hewson said. She sees no “show stoppers” ahead. “This is a complex development program.”
The next hurdle for Lockheed is to negotiate new low-rate production contracts with the Defense Department. Last year it signed “low rate initial production” contract lot eight. LRIP nine and 10 proposals were delivered to the Pentagon in January and negotiations will continue in the coming months, said Lorraine Martin, executive vice president of Lockheed Martin and general manager of the F-35 program.
The last LRIP should be lot 11 in 2017. The promised lower prices by 2019 are pegged to full-rate production of 175 aircraft that year. Martin said the per-aircraft price has plummeted by 57 percent between LRIP one and eight. The unit price under LRIP eight was about $115 million for the airframe and engine.
By LRIP 10, about half of the orders will be for the F-35’s foreign buyers, which currently include nine countries. “The build rate is extremely important” to meet cost goals, Martin told reporters.
The manufacturing efficiencies proposed in the blueprint for affordability are just coming to fruition and it still remains to be seen if the savings materialize. If they work, the Defense Department has committed to invest an additional $300 million over three years, Martin said. Without this additional funding, the $80 million per-airplane cost goal might not be achieved. Under Lockheed’s projections, the manufacturing efficiencies will reduce unit cost by $10 million by 2019
Among the initiatives is a new technique for applying coatings for the inlet bump that saves $6,000 per airplane; an automated canopy production technology that saves $3,500 per aircraft, a composite molding technique for wing tip trailing edges that reduces labor and saves $10,000 per aircraft; a new way to buy aluminum forgings in smaller pieces which cuts waste and saves $65,000 per aircraft; use of cryogenic cooling made of compressed liquid nitrogen to replace standard oil-based coolants, saving $4,000 per aircraft; and a new laser surface preparation that saves $12,000 per airplane.
“These improvements have to be tested,” said Martin. “They have to earn their way into the airplane.”
Lockheed officials, meanwhile, are gearing up for some significant events coming up for the F-35 in 2015. Notably, a major international pilot training school is being set up at Luke Air Force Base, in Arizona. In a few years, said Martin, “It will be the largest F-35 base in the world, with 144 aircraft.”
Italy’s and Norway’s first F-35s are scheduled to roll out in 2015, and the Marine Corps has set a July deadline to declare the F-35B “operational.” The Air Force will be next in 2016. The Navy will be taking the F-35C out to sea off the East Coast this year aboard the USS Eisenhower for flight tests. It does not plan to declare the airplane operational until 2019.
The F-35 was supposed to have made its international air show debut last year at England’s Farnborough Air Show, but the F-35 was grounded following an engine fire. Hewson said she expects Lockheed Martin to participate in this year's Paris Air Show but did not disclose specific plans for the F-35. “We will be there as we are at many air shows. We will continue to have a presence at Paris.” According to a Lockheed source, the company does not want the F-35’s first international air show to be in a country that is not buying the F-35, so it will probably wait to make another try at Farnborough in 2016.