洛克希德·馬丁 (LMT) 2002 Q3 法說會逐字稿

Good day, everyone.

Welcome to the Lockheed Martin third quarter 2002 earnings results conference call.

Today's call is being recorded.

With us today is Christopher Kubasik, Senior Vice President and Chief Financial Officer, and Mr. Jim Ryan, Vice President of Investor Relations.

At this time, I'd like to turn the call over to Mr. Jim Ryan.

Go ahead, sir.

Thank you, Andy.

Good morning and welcome to Lockheed Martin's third quarter 2002 conference call.

If you have not received the new's release, it is available on our web page.

I need to remind you that statements which are not historical facts are forward-looking statements.

Such forward-looking statements are made pursuant to the Safe Harbor provisions of the private securities litigation reform act of 1995.

See today's press release, as well as our 2001 Form 10K and our 2002 Form 10Qs for a description of the factors that may cause actual results to vary materially from anticipated results.

Now I would like to turn it over to our Senior Vice President and Chief Financial Officer, Chris Kubasik.

Thanks, Jim and good morning, everyone.

During this call, I will provide a brief update on each business area and discuss our financial outlook.

Jim will discuss our results and provide detailed projections for the rest of this year and next year.

I'll begin by telling you we're pleased with our third quarter results.

We grew sales, earnings, and cash, consistent with our previous projections.

Our 5% increase in year-over-year quarterly sales was driven by growth across all of our business areas, especially aeronautics .

It provided the greatest amount of growth, both in terms of dollars and percentage.

Now I will focus on each business area, starting with systems integration, our consistent growth contributor.

Following competitive demonstrations, the U.S.

Postal Service selected Lockheed Martin to provide and integrate up to 124 automated package processing systems across the country.

The contract is valued at up to $550 million.

We're proud to continue to support the U.S.

Postal Service as it moves forward in enhancing both safety and productivity.

We were down selected and received a $75 million U.S.

Army contract for its war fighter information network or Win-T program.

We're now working to develop and test the system architecture and technology that will be core to the service's multi-billion dollar program.

The army is expected to award a production contract in 2005.

The U.S.

Missile Defense Agency awarded a $90 million funding increment for our continued leadership of the Missile Defense National Team's Battle Management, Command Control and Communications program.

We successfully completed the Air Force qualification requirements for all laser-guided bombs.

We are now qualified to produce all variants of the laser-guided bomb kits and our entry into this growing market has generated over $100 million of backlog so far, as well as significant savings to our Air Force and Navy customers.

Overall, systems integration sales have grown organically for seven consecutive years and we expect solid growth to continue in 2003.

Turning to space systems, we were extremely pleased with the successful launch of our first Atlas V vehicle in August, as it placed a (indiscernible) satellite into its desired orbit.

As discussed before, we developed the Atlas V in cooperation with the U.S.

Air Force as part of the EELV program and it will serve both the government and commercial markets.

It is a significant accomplishment that our team, including our subcontractors, suppliers and the Air Force successfully launched the Atlas V within three months of the original schedule for this multi-year project.

An Atlas IIAS launch vehicle successfully boosted a Hispasat satellite into orbit in September, the 62nd consecutive Atlas success.

And a Proton vehicle launched an Echostar satellite into orbit during August.

A Lockheed Martin-led team was one of two contractors awarded $40 million by the U.S.

Navy to begin the advanced development phase of the next generation narrow band tactical satellite communications system known as MELOS.

The long-term potential for the winning team is in the billions of dollars.

On a less positive note, we were disappointed with the losses on NPOS, the environmental satellite system, and the next generation space telescope.

But our government space business continues to lead significant strategic programs, including the advanced DHF, Sivers, GPS-2-R and various classified programs.

As we've discussed previously, commercial space remains a challenging market given its conditions.

We have no commercial satellite awards this year and there have only been a couple of awards worldwide.

Year to date, we've booked three commercial launch vehicles.

In the aeronautics business area, we are making sustained progress on the F/A-22.

As you recall, the U.S.

Air Force redesignated the aircraft, the F/A-22, to reflect its multi-role capabilities.

The airplane completed its 1,000th test sorte milestone and now has over 2400 test hours.

The F/A-22 also achieved its first supersonic separation of an ANRAM missile and its first supersonic launch of an AIM 9 missile at Mach 1.1.

The airplane continues to be strongly supported by the U.S.

Air Force, and the new 2003 appropriations bill matched President Bush's request for funding.

Turning to the F-35 Joint Strike Fighter, this cost plus development program continues to accomplish major milestones, while ramping up to meet significant staffing resource requirements.

To date, the program has successfully completed the integrated baseline review and has finalized external design.

The next major technical milestone is the preliminary design review scheduled for March of 2003.

Turkey became the seventh international partner to official join the systems, development, and demonstration phase, and Australia is expected to formally join next week.

Regarding the F-16 Block 60 program, a major subcontractor recently announced a loss on its portion of the program.

This action had no impact to Lockheed Martin, as the subcontract is firm-fixed price.

The Block 60 program is on schedule.

The team successfully completed the comprehensive design review with the customer last March, and we also initiated first component assembly in June.

First production delivery to the customer is on schedule for mid-2004.

Now turning to technology services, our joint venture team was awarded the management contract for quadulant test range in the South Pacific.

The 15-year contract is valued at $2.7 billion.

As a 49% partner in this venture, we will not book the order as backlog and will not record sales.

However, we will record our share of the equity earnings.

We won the defense logistics agency supply chain's management contract, potentially worth $600 million over the next 10 years, and our key SA contract to train security personnel at more than 400 U.S. airports is going well, with over 39,000 screeners trained to date.

Turning to our financial outlook, for the full year, we are now projecting sales of about $26 billion, representing approximately 8% growth compared to last year.

For 2003, we continue to project top-line growth with sales estimates of 27 to 28 billion, consistent with our earlier estimates.

On the earnings front, we continue to project earnings per share in the range of $2.50 to $2.55 per share for this year, along with our stronger sales growth outlook.

We are now more confident about achieving the higher end of the range.

For 2003, our operating plan outlook supports our currently-stated EPS guidance of $2.75 to $2.85 a share.

However, there are likely changes to pension plan assumptions, which, when combined with actual returns on planned assets, could have significant changes to GAAP noncash pension expense, and as a result, impact our GAAP EPS projections.

I'd like to make a few comments on pension accounting.

In previous disclosures, we have said that earnings related to employee benefit plans, being FAS 87 and FAS 106 combined will decline substantially 2002 and result in an expense in 2003.

These disclosures were driven by the prolonged weakness in equity markets.

The trend toward increased expense, as a result of market forces, is most evident in the area of pensions, where FAS 87 calculations are highly sensitive to changes in key economic assumptions.

There are three key factors driving the FAS 87 calculation.

First, is the actual 2002 return on plan assets, which we will know at the end of the year.

Second, the assumed long-term rate of return on plan asset.

And third, the assumption for the discount rate.

The measurement of our pension plan occurs on a calendar year basis.

We will complete our assessment by the end of the fourth quarter and we will discuss the results with you during our conference call in January.

Clearly, the preliminary analysis indicates a downward bias for all three of these key factors.

In the meantime, our earnings release has provided sensitivity analysis for changes in these assumptions and the resulting impacts on EBIT.

There is a much smaller impact on cash flow and Jim will provide a more detailed explanation in a moment.

Let me also mention that FAS 87 could necessitate a balance sheet adjustment.

Any adjustment doesn't impact the income statement but does reduces booked shareholders' equity.

With our strong balance sheet and the lack of impact on our cash flow, we anticipate that such an adjustment should not have any detrimental impact on our credit standing.

And I should remind you that any adjustment is subject to reversal in future years should interest rates increase or planned returns improve.

Turning to cash flow, we generated about $1.1 billion in the third quarter, bringing our year to date total to $2.4 billion.

Third quarter cash was positively affected by favorable working capital performance across all business areas and the collection of a significant milestone payment on an international F-16 program.

Looking to the full year, we are raising our 2002 free cash flow outlook to at least $1.5 billion and we are increasing our two-year cash flow outlook to at least $2.2 billion.

Jim will provide more details on free cash flow.

We are pleased with the significant progress on the divestitures of the telecommunications businesses.

In the third quarter we reached an agreement to sell Lockheed Martin Inner Sputnik (phonetic), and in October, we closed the sale of COMSAT International.

As a result, all four of the discontinued operations are either closed or under contract, and the transaction amounts and terms are consistent with our earlier expectations.

Recently, we announced a new share repurchase authority and rescinded an existing one.

We simply wanted to refresh our repurchase capability and at the same time improve its flexibility.

The new authority represents about 5% of the outstanding shares.

We're pleased with our results through the third quarter and our ability to increase our outlook for sales and cash flow.

Our businesses are strong, with solid top line growth and improving operational margins.

The Defense Appropriations Bill recently passed by Congress and signed by the President strongly supports our programs across the board as we continue to carry out these critical national security missions.

To close, the women and men of Lockheed Martin continue their focus and dedication in supporting our forces around the world, our law enforcement officials here at home, and all those who are working to provide homeland security.

We know the value of each taxpayer's dollar and the responsibility of providing the best systems and products.

Jim, I will now turn it over to you.

Thank you, Chris.

To allow as much time as possible for Q&A, I will not focus my remarks on the quarter's results, which are explained in detail in the news release.

Rather, I will update our sales and margin guidance by segment for 2003 and 2003, and I should remind you that these projections are before any possible impact to pension expenses next year.

Then I will talk about FAS 87 pension accounting versus pension funding, which are two separate calculations.

And I will close with some details on cash flow.

Beginning with systems integration, sales in 2002 are projected to be between 9.3 and 9.6 billion.

In 2003, systems integration sales are expected to increase to a range of 9.7 to 10.1 billion.

Systems integration's margin is expected to be 10.5 to 11.0% in 2002.

In 2003, the margin is expected to be 10.0 to 11.0%.

This represents no change to prior guidance for systems integration.

Turning to space systems, we expect 2002 sales to range between 7.0 to 7.3 billion and between 7.1 to 7.5 billion in 2003.

The guidance in both years was previously 6.8 to 7.2 billion.

The sales increases are primarily due to additional volume in military space programs.

For both 2002, and 2003, space systems margins are expected to be in the range of 6.5 to 7.0%, unchanged from prior guidance.

Now let's talk about aeronautics.

We expect aeronautics sales in 2002 of between 6.4 to 6.7 billion, an increase from our previous guidance of 6.0 to 6.4 billion.

For the year 2003, we expect sales in aeronautics to be 7.5 to 8.0 billion, an increase from the prior guidance of 7.1 to 7.5 billion.

The increase in both years reflects continued volume ramp up on the F-35 Joint Strike Fighter contract and other development activities.

In 2002, we expect approximately 20 F-16 deliveries.

In 2003, we estimate F-16 deliveries to ramp up to around 60.

Regarding the C-130J we project 10-12 deliveries for both 2002 and 2003.

Aeronautics margin in 2002 is estimated to be approximately 8.0%, down slightly from the prior guidance of 8.0 to 8.5%.

In 2003, the margin is projected to be 8.0 to 8.5%, as compared to the previous guidance of 8.0 to 9.0%.

The revised 2002 and 2003 margin ranges reflect volume ramp up of lower margin development activities, mainly the F-35 Joint Strike Fighter.

Now on to technology services. 2002 sales are projected to be around 3.0 billion, with 2003 sales projected in the 3.0 to 3.4 billion range.

This decline from our previous guidance of 3.2 to 3.6 billion for 2003 is primarily due to lower NASA volume.

Our government IT business continues to grow at double digit rates organically.

Margins in technology services are projected to be 6.0 to 6.5% in 2002, and 6.5 to 7.0% in 2003.

This represents no change to the previous margin guidance.

The final segment is corporate and other.

Sales in this segment are minimal.

Our projections for corporate and other EBIT remains unchanged.

We estimate a range of 10 to 50 million for this year and 50 to 100 million in 2003.

The projected sales outlook for the Corporation is now about 26 billion for 2002, the top of our previous guidance range.

As Chris said, this represents an 8% growth rate compared to 2001 and in 2003, we continue to estimate sales ranging from 27.0 to 28.0 billion.

Backlog at the end of 2002 is expected to be about $70 billion.

I would now like to supplement Chris's comments on the potential impact of Lockheed Martin caused by employee benefit plans.

Regarding income statement impacts, we've historically combined FAS 87 and 106 for discussion.

Going forward, we will focus on FAS 87.

FAS 106 is much smaller than the pension fund and funding is less mature.

As a result, expense is fairly stable from year to year and cash recoverability is about equal to expense.

As you know, FAS 87 determines pension income or expense for GAAP financial reporting purposes, not for the funding requirements of pension plans, which are driven by IRS rules and other factors.

A major factor in determining the pension funding requirements for our business is the CAS rules, or, cost accounting standards, that calculate the allowable funding requirements each year. 100% of annual funded pension costs, as determined under the CAS calculations, are allowable and are allocated to our government contracts.

Under cost plus contracts, we recover increased funding requirements immediately.

Under fixed price contracts, we recover incremental costs to the extent that they have been priced into the contracts.

Based on our current business and contract mix, we fully expect a majority of future incremental pension funding costs will be recovered through pricing or billings.

For 2003, we project funding of 150 to 200 million, which is consistent with what our outlook as has been throughout all of this year.

And it has been factored into our precash forecast, which was increased as announced in today's release.

From an earnings standpoint, FAS 87 pension income, which is set at about $150 million for 2002, is expected to be an expense in 2003 of between 50 to $100 million.

This projection is based on the current 9.5% long-term actuarial rate of return assumption, the current 7.25% discount rate, and an assumed actual rate of return on plan assets for the year 2002 of approximately 5%.

As Chris mentioned, these key factors will be finalized by the end of the year, when we complete our annual evaluation process and will be provided to you when we release fourth quarter results in January.

In summary, GAAP earnings are impacted by the calculations under FAS 87 for pension funds, and our non-cash income or expense.

Funding requirements are determined by multiple factors, including cost accounting standards and IRS rules.

The calculations are independent from one another and the change from year-to-year can vary considerably.

A key discriminator between government contractors and other companies and other industries, is the fact that pension costs are allowable costs under government contracts.

Over 90% of Lockheed Martin's sales are to government customers.

To the extent that both FAS expense and CAS funding increase in any particular year, CAS recoveries will partially offset the income statement impact of the increase to FAS expense.

Now turning to cash flow.

For the third quarter of 2002, we generated approximately 1.1 billion of free cash.

In 2001, we generated almost $900 million in the third quarter.

The cash flow for the current quarter, and the year-ago quarter, included a milestone payment related to an international F-16 program, net of payments to subcontractors and suppliers of approximately $450 million.

Year to date 2002, we have generated $2.4 billion in free cash.

As we have previously mentioned, we expect a use of cash in the fourth quarter.

We expect the bulk of the year's tax payments to be made in the quarter and we will also make interest expense payments of more than $250 million.

Previously received advances will decline in the fourth quarter as work progresses on these contracts and no new significant advances are expected.

Based on year to date performance, we've increased our free cash flow guidance to at least $1.5 billion in 2002 versus our previous guidance of at least $1.3 billion.

For the two years, 2002 and 2003 combined, we now expect to generate at least $2.2 billion of free cash flow, an increase from our prior guidance of at least $2.0 billion.

I would like to reiterate that our definition of free cash flow excludes any proceeds from, or income taxes paid on, divestitures.

Also, it subtracts all capital expenditures made by the Corporation, but offsets those expenditures with proceeds from fixed asset disposals.

In 2002, proceeds from fixed asset disposals have been minimal.

See the earnings release for a reconciliation between the GAAP statement of cash flows and free cash flow.

Capital expenditures for the quarter were 135 million and are expected to be around $700 million in 2002. 2003 capital expenditures are also estimated to be around $700 million.

This is a slight decline from previous 2002 guidance and an increase from prior 2003 guidance.

The 2003 increase is primarily due to capital requirements to support our growth, particularly in both aeronautics and technology services.

Depreciation for the quarter was approximately $100 million.

Depreciation is expected to be under $450 million in 2002 and around $475 million in 2003.

The previous guidance was $450 million for both years.

Regarding our outlook for interest expense, the projection is about $580 million in 2002 and about $550 million in 2003, unchanged from prior guidance.

The projection for average shares remains at over $450 million in 2002 and more than $460 million in 2003.

The tax rate is unchanged from the prior projection of approximately 31% in 2002 and approximately 32% in 2003.

In 2002, the tax rate is prior to the recognition of the one-time R&D tax credit settlement.

In both years, the tax rate assumes a continuation of the current income tax benefits allowed for qualified international sales.

And now, Andy, we are ready to take questions.

Thank you.

If you you'd like to ask a question, press the star key followed by the digit 1 on your touch-tone phone.

In the interest of time, we are asking you limit yourself to one question and a follow-up.

Once again, that is star 1 to ask a question.

We take your first question from Heidi Wood with Morgan Stanley.

Good morning, nice quarter, guys.

Chris, can you tell us, what accounted for the sharp drop in inventory this quarter?

Could you repeat the question, you cut out, Heidi?

What accounted for the sharp drop in inventories this quarter?

Okay, well, first of all, thanks for your comment about the quarter.

Inventory came down, I think it was close to $850 million.

A variety of that comes from advances that are non-refundable, that are offset against that account.

Progress payments also offset that, and we continued to deplete the inventory as a result of launching launch vehicles and satellites.

Gotcha.

And with respect to this change in guidance on aeronautical, can you walk us through why that's changed from the prior guidance you'd given us in the second quarter?

At that time you also knew you'd have a ramp-up in Joint Strike Fighter.

And also touch on the $15 million charge you took on the aircraft modification.

Was that a one-time thing?

Is that aircraft mod work appreciably behind you now?

Let me give you detail on aeronautics by our line of business and what our outlook is.

For F-16, for this year, we're looking at about 1.9 billion to 2 billion of sales and see that number growing to 2.5 to $2.7 billion.

F-22 is consistently in the 1.5 to $1.66 billion range for this year with a little bit of maybe upside in '03.

And Joint Strike Fighter is 900 million to a billion, growing to 1.7 to 1.9 range.

And C-130 is pretty constant, about a billion dollars a year as we continue to forecast 10-12 deliveries this year and next year.

So, it is the continuation of the Joint Strike Fighter ramp up, the ability to have our subcontractors come on board and to hire the appropriate resources and that really is the driver on the sales growth in the aero.

Obviously, JSF, as we've talked about before, being a cost plus development program, tends to have a little lower return at this point in the development cycle and that's what's driving down slightly the margin outlook.

Relative to the aircraft modification, it is our expectation that that is a one-time charge.

I will mention that that is clearly included in, both our definition of continuing recurring earnings, and our GAAP results.

We have not tried to call that out as an unusual or non-recurring item.

It is mainly behind us, we have a family of classified and unclassified programs that require modification and there were some performance issues that we believe we've addressed, And this is a couple hundred million dollar program and given the charge, we wanted to call it out and let you know about it.

Gotcha.

Thanks very much.

Thank you, Heidi.

We will go next to Steve Binder with Bear Stearns.

Yes, just a follow-up on that question, Chris.

With respect to aeronautically, you bumped your revenue estimates by $400 million.

But as far as the JSF program, it looks like from prior guidance in the second quarter your bumped it about $100 million by itself.

What else was bumped for the projection for '03 in sales?

Let me ask Jim to kind of go into maybe a little more detail than I did on lines of business to get that outlook for you.

Okay.

Steve, if you have another question, why don't we look up that answer for you.

Ask your second question.

Sure.

Chris, maybe you to handle this, or Jim, either one.

On the funding issue, you talked about '03 not changing at all, but when you look at it in the '04 time frame, I imagine it will be a bump, probably affected by '04 performance, but is there a pretty big step-up in '04 in funding?

Because, you know, Raytheon talked yesterday that their funding in '04 will be up $300 million.

Let me try to answer that.

As you know, Steve, we generally try not to give out, you know, our '04 guidance in piece meal parts until January, but I understand the desire for a little more insight on the issue.

Just to set where we are, we're talking about CAS, the cost accounting standards, funding amount.

If we go back to '01, that was essentially flat. 2002, the year we're in right now, we're projecting just under $100 million.

For 2003, we're looking at about 150 to $200 million.

And you're absolutely right on '04, the performance for the remainder of '02 and '03 is going to be critical to that, but we would -- if we had to pick a number at this time, say maybe an additional or incremental $100 million on top of that -- on top of that number.

So, I guess that would get you to 250 to 300.

But I want to emphasize, and you understand the variability at this point in an estimate like that.

Okay.

And I guess while I was waiting, maybe just one other thing, with respect to commercial space, you touched on no orders on the satellite side, you know, it looks, like I'm guessing, one order on the launch vehicle side.

You, when you look at your manifest out in '03, you've kind of given out guidance for Proton Atlas launches, but, is there still open slots there that you need to sell to, kind of, keep to that guidance?

And, you know, with respect to commercial satellites, you know, is there further, you know, what's your plans there at this point, you know, with respect to downsizing?

Ultimately what do you plan to do there since volume is, obviously, going to fall even further now?

Okay.

Let me start with the commercial satellite manufacturing question.

And just to go back and make sure everybody's on the same page, commercial satellite manufacturing does account for approximately 2% of our sales.

At the beginning of the year, we had nine commercial satellites in backlog and we had three deliveries this year and no new orders.

In fact, to the best of our knowledge, there has only been one order placed worldwide that's in our addressable market.

The management team, led by Al Smith in Space, has done an outstanding job streamlining the operations, reducing both the infrastructure and the head count.

The operation is now at the break-even point, even with the reduced through put.

We've talked in the past about the need for some sort of industry rationalization and we're evaluating all of our alternatives at this time.

We've set a goal of resolving this matter by the end of the year and plan to meet that commitment.

So, consistent with our policy, Steve, we're not going to comment on specific strategic matters, or potential acquisitions or divestitures.

But clearly, this is a focus area and we're looking for the best solution for our shareholders.

Relative to launch vehicles, just to reconfirm for 2002 and 2003, we're looking at 7 to 10 Proton and Atlas launches on a combined basis.

We don't see any reason at this time to change our guidance and I think, at most, we might have one to two that are in negotiations that we'll fill and allow to us meet that commitment.

So, no change on the guidance for launches.

Okay, thanks a lot.

Let me ask Jim to give you a little more of the detail on your aeronautics question.

Steve, the increase is Joint Strike Fighter, F-22, and volume on some other aeronautics programs, none of the larger programs.

I guess, the reason I ask is because you brought margins down to the low end of the 8-9, 8.5, right?

And you brought them down and, you know, that the F-22 margin rate is not terribly dissimilar than the average right nor for the segment.

I understand JSF is below.

I wondered why, you know, is it really just mix?

You know, you took that cost adjustment in the quarter, I wonder is there any other issues that might be affecting the margins in '03 beyond just mix?

Steven, we will look up some of the other volume activities, but I think some of them are associated with some development items, not on large programs that could impact the margin, but we will get the detail later on.

Okay.

Thanks a lot.

Next we go to George Shapiro with Salomon Smith Barney.

Yes, good morning.

In the space area, it looked like there's another $25 million charge you effectively took for the launch vehicle business.

At this point, Chris, given that the margins this year have all been including these charges, and the margin guidance for next year isn't changed from this year, are you assuming that those charges continue through next year or what effectively is keeping the margin down from what would be a much higher number if you took these charges out?

Okay.

Thanks, George.

Our guidance for both '02 and '03, we've talked about really two major lines of business.

The government line of business and the commercial line.

Government continues to be high single digits and the commercial business as we've talked about in the past, continues to be at a loss, and our projections are trying to be realistic relative to the current market performance.

We record all of the losses as we're aware of them.

Some of these are, in fact, event-driven, tied by the actual signing of a contract or an order, and we have three launch vehicle orders to date.

The loss that you see here was a result of a contract being agreed to below our cost basis.

And we think our outlook in projections are appropriate given these market conditions.

Chris, I mean, if you took these losses out, you'd run a margin north of -- I mean this quarter was 8.2.

The second quarter was 8.8.

You're running a lot higher.

So, you're implying that these kind of charges are going to continue, I guess through next year?

Or is there something else that's involved?

No, I think your summary is appropriate, George.

Okay.

And then expendable launch vehicle investment, was it higher this quarter than last year's quarter?

And how about relative to the second quarter?

Okay.

Third quarter was basically flat relative to the second quarter of '02 and then relative to third quarter '01it was a little less.

So, no -- no change, big picture as we've talked about before, 2001 and 2002 are the peak years for the start-up on EELV.

That number does come down in 2003, and by 2004 and beyond, it is effectively immaterial or diminuous.

And Chris, the fact that it comes down next year, all the more reason to -- to think that maybe the margin next year ought to be somewhat higher, but I guess we will see as we go.

No doubt.

We will monitor that.

I think the -- the unknown here is the commercial space market.

And clearly, we've talked in the past about the Titan IV launch vehicle program, a very mature program that was a significant contributor to our sales and earnings, continues to decline as planned and -- and that's also driving some of that year-to-year comparison, George.

Okay.

And then in the corporate and other, can you go through a little bit more detail than what was in the release because, you know, it was a bigger number than what we've been?

I know some of the issues, but is interest income in there, as well, I mean the cash balances were up a lot, even though, probably, the rates were down a lot.

Sure, let me -- let me first focus on the quarter.

Third quarter of 2002 compared to the third quarter of 2001.

EBIT, of course, we're talking about the $28 million versus the $9 million.

Right.

Three major components I'd like to focus on.

Interest income was down slightly.

Probably more as a result of the rates than the balance itself.

We also have in there our stock-based compensation that we've talked about.

There was an increase on that relative to the third quarter of '01.

As a result of the change in our stock price during that -- that 90-day period.

And then, joint ventures and total, we had some losses in 2001 from equity accounting related to entity that's we've talked about previously, like an Americom, Aces, Astro Link, those types of entities.

On the nine months, 2002 compared to 2001, the same major categories.

We have an overall decrease, two main drivers there, interest income is down, substantially.

And again, stock-based compensation for 2002 is about double what it was in '01, and then we have the offset going the other way on the same ventures, as I mentioned, where we were recording the equity losses in '01 are now behind us.

Does that help, George?

Yes, that's good.

Thanks.

Thank you.

We will go next to Kai Von Rumur with SG Cowen.

Yes, a follow-up on George's line of questioning, EELV, can you give us any guidance in terms of, you know, the level of expenses?

I assume they're going to be fairly flat this year and kind of the pattern within the year, was this the highwater mark in terms of when those expenses were going to peak?

Yeah, Kai, on EELV, we've talked all year that the second and third quarters would be the peak on the start-up and that looks like that is playing out as we had projected.

And then in 2003, of course, we expect that number to decline, you know, in that 50% range.

For competitive reasons, as we've talked about in the past, we have not actually given those numbers, but we would say that they are -- they are negative and they are significant.

You've seen and read about the investments that we're all making in the launch vehicles and maybe at some point down the road we will give you the numbers after the fact.

But that's no change from what we've been saying all year.

If that's the fact, to follow-up on what George is saying, you have these expenses this year, the EELV is down.

If I do the math and take out the expenses and there are no expenses next year, what you're really saying is, the margin before all of this will be down 200 basis points, even though the mix is shifting toward military space, which is more profitable, like this doesn't seem to add up.

Okay.

Let me try to give you even a little more detail.

First of all, I would not remove all of the start-up for '03 as we've talked about.

That would be maybe half of what it had been in '02 and '01.

That's what I'm assuming.

Okay, I'm sorry, I thought you said you had taken it out.

But let's take half of it out.

We've talked about Titan IV having high margins.

For quite some time and that program coming up on its completion.

We've talked about military space as being the high single digit margins, but I will remind you that we have two rather substantial development programs in there, Sivers and advanced THF.

And given the early stages of those development programs, they're in the lower to mid single digits and will probably evolve over time.

They are cost-plus, as we've talked about, the returns on those types of programs tend to be less than fixed price.

External tank volume and through-put on NASA is, in fact, down a little bit, and as we've talked about before, we're trying to have a realistic outlook on the commercial space markets, both from the satellites and the launch vehicles.

When you look at all of those and rack them up, it keeps us in the guidance that we've talked about. 6.5 to 7% for both 2002 and 2003.

Okay.

Great.

If I just ask one last quick one, the -- you know, if I add up the upper lower end of your range, the upper end gets to $29.1 billion, if we do the bottoms up, and the lower end is 23 -- 27.4.

You know, that's -- that's a little different than what you said of the 27 to 28.

What's the disparity?

Well, there's -- there's no disparity here.

We give the ranges on a business area by business area, of course there is variability and likelihood of occurance within each business area.

And then, we try to tighten up the range on the total consolidated basis.

I think if you look at the practice we've had for the last several years, you will find that the sum of the parts is always provided a wider range and we didn't think it was appropriate to give a sales range of 23 to 29.

We've tried to weight all of these items in there, whether it is the variability and timing of the launches, which are booked upon the launch, aircraft deliveries.

Of course, you know, on F-16 and C-130, we record those revenues upon delivery and then we have the ramp up on significant programs like JSF and UAE.

That's where we are at this point.

As we get closer to those periods, you know, we try to tighten up the range and give you more detail.

That's what's behind that one.

Terrific.

Thank you.

Thank you.

We will go next to Byron Callen with Merrill Lynch.

Yes, good morning, gentlemen.

Nice quarter.

Chris, first, your request and two quick questions.

The request, could you consider breaking out the FAS 87 expense on a go-forward basis?

Maybe showing a separate line item the way Northrop has and the way, I think, Raytheon will?

Okay.

Okay.

And secondly, as far as the questions are concerned.

First, you mentioned preliminary design review on F-35 was in March.

Is that a pull forward?

I thought was that was going to happen mid-summer.

Well -- okay, well first of all, Byron, thanks, to answer your question on the FAS 87, clearly there's been a lot more focus on -- on this topic, understandably and we're going to work over the next -- over the next couple of months to come out with a format and a way to best communicate this to all interested parties.

So they can really understand and see the improvements we're having within the Corporation and in operational on a (indiscernible) level.

So, we'll look at what others are doing and are open to input and feedback, but it is clearly our intent to be as transparent as possible and give you the data you need.

We will do that.

And the preliminary design review for JSF has consistently been in that March/April timeframe and we're feeling pretty confident that March of '03 is when we will have that completed.

So, no change at all.

Okay.

Good.

And second, just a little nit, shares outstanding, does that include the share buyback you recently announced?

Or is that excluding that recent development?

Yeah, as I mentioned, the share buyback is really just to give us a position and the tools necessary for one of several options with our excess cash.

Clearly, we have not had any buybacks and it is really to provide us the flexibility, if we choose to go that route.

We currently don't have any plans to do so.

We have not bought any back and so that would assume business as usual and we will look at that relative to all the other different options for uses of our cash.

Okay.

If that helps.

Thanks a lot.

Thank you, Byron.

We will go now to Sam Pearlstein with Wachovia Securities.

Good morning.

You mentioned that for FAS 87 income, I guess, or expense next year, you're assuming -- the 5% return this year.

Can you talk about year to date or through September, where were the actual returns for the plans?

Sure, Sam.

We're, through September, right around negative 10%.

Okay.

And then in terms of the advances, you had originally talked about a 300 to $400 million use of cash for advances this year and about a billion dollars next year and, I guess through nine months we've certainly seen that as a source of cash on the cash flow statement.

I wonder, should that be as slightly negative this year?

Sam, we're actually projecting close to about $4.7 billion as our ending customer advance balance on our balance sheet.

So, we're looking at a 4 to 500 million burn-off here in the fourth quarter.

Given the success that -- that we've had on the Block 60 program, the cash payments probably come in a little sooner than we might have forecasted or led you to believe.

Clearly, they were both expected this year, we had planned one maybe in the October timeframe, but given the good performance of that actually arrived here in the third quarter.

So, we ended right around $5.1 billion in advances and we would expect that to be in the 4.7 range by the time we close out the year.

That will be the usage, relative to '03 -- we're still seeing the approximately $1 billion burn on those advances.

Okay.

Can I just add one follow-up?

Are there any orders that you have received that you didn't actually, you know, get into a firm contract to actually book yet?

I'm thinking the Korean Aegis that was announced; there anything else that's significant that we wouldn't see yet in the backlog?

Yes, we have a couple of programs.

Why don't I have Jim give you a little detail on those.

You're onto a good point, Sam.

You will read and hear a lot about the awards and then the actual contractual signings, sometimes it does take an additional couple months or quarter.

Jim, you want to give Sam some detail?

Sam, coming up in the next 12 to 18 months or so, I mean, and some of these will be in the near term.

For example, the F-16 with Chalet (phonetic) has been mentioned in the price press.

It's moving along, but obviously not under order yet.

The F-16 for Oman.

The C-130 J multi-year, which is in the budget.

We're not sure if it's going to be one large order or spread out over multiple years, but there are no orders on the multi-year yet and our focus, the F/A-22.

The F/A-22, which is in the budget, that, of course, is not signed up and put under order yet.

Those are some of the obvious ones that -- you know, you've heard a lot about in the press but are not in backlog yet.

Okay.

Thank you.

Before the next question, I wanted to answer an earlier question on the aeronautics increase in sales for 2003, versus our prior guidance.

It's really broken up into four areas.

Joint Strike Fighter, about $100 million.

F-22, a little more than $100 million.

Aeronautics R&D, is about $100 million.

And F-16 also about $100 million.

So, when you add the four together it is approximately $400 million.

Next we go to Chris McCray with Deutsche Bank.

Thank you.

Can you give us a sense on the technology services area.?

With, you know, 180 millionish and upside from the Kwajalein contract and yet a slight downgrade of sales guidance, kind of what the delta is coming from there?

Sure, Chris.

First I will talk about the Kwajalein award.

That is a joint venture, an entry that was actually awarded that, Kwajalein Services Inc.

Lockheed Martin owns 49% of that joint venture.

We will only be recording the equity earnings from that.

So, that is why you do not see the backlog for the sales in the outward, you know, in the growth projections.

We did, obviously, lower the sales guidance for '02 and '03, probably look at, you know, three main drivers within technology services.

We talk about our government IT business, our information technology business.

That is performing very well and continues to grow at the double digit range.

But that is being offset by reduced work in NASA, specifically the CSOC (phonetic) contract, you probably read was being recompeted in '03.

There is other NASA work that we perform where there's been some reduced funding, whether it is the Johnson Space Center, as an example.

Department of Energy work has a little bit of a revenue with it and that's trailing off and even our aircraft modifications is basically flat.

Jim, did you have more on that?

Yes, I just wanted to add that we downsized the commercial IT business a little bit more and actually, have eliminated all losses in that line of business for 2002.

So, all those items, Chris, are driving the sales numbers we talked about.

Yeah, thanks, sometimes I need to hear things twice, I guess.

I apologize.

That's all right.

On the space side, following up George's comment, I'm am trying to get a better sense of how the pricing adjustments work.

Does it really reflect, in your view, sequential quarter-over-quarter degradation of pricing, or are there other mechanisms whereby maybe you adjust contracts retroactively or evaluate those periodically for contracts that were booked years ago and that's why it happens?

A little help there?

Sure, Chris, that's an excellent question.

And the answer is actually both of those items are contributing to these market reserves.

Let me take the second one first.

We do have a firm contracts in -- in backlog.

Just to give you an idea right now.

We probably have 28 launch vehicles in -- in backlog when you look at all the Atlas and Protons.

And those are firm price and we have our best estimate of cost.

What we've talked about a couple of times over the last few years, as the market demand decreases, we've cut our production rate and that tends to drive the fixed cost being allocated to a smaller base, so, we would make adjustments to our backlog for those programs or vehicles that are already at break even, not from the price side, but from the increased costs being absorbed or or allocated to those.

On new business, clearly event-driven and we look at each contract has negotiated, and on occasion, there is more cost than the contract value and we will recognize that upon the (indiscernible).

Does that help?

Yes, thank you very much.

We will go next to Joseph Campbell with Lehman Brothers.

Hi, good morning and congratulations on yet another clean quarter and I guess everybody else is showing how hard it is to do this.

I have a couple of questions about items we've talked about.

First, Chris or Jim, on this pension stuff, and I wondered if you could just help us with thinking about the way we should think about these FAS changes and the CAS disclosures that you've given us, not so much as to tightening up the specifics of your guidance, but how to think of them.

I guess it seems to me that in trying to understand the head wind from these changes, that it seems we should be thinking about the differences between CAS and FAS, rather than making some independent adjustment or subtraction, strictly based on FAS 87, since you're reimbursed for the CAS announcement.

Maybe just a tutorial about how these things work together and how we should think about the numbers or use the numbers correctly that you've given us.

Right.

Well, Joe, first of all, thanks.

And relative to pensions and the pension stuff as you call it, we really look at three pieces, the earnings per share impact, the cash impact, and the balance sheet impact.

And then we try to address each of those in the press release.

Let me first hit on EPS.

I think you're absolutely right to look at the difference between the CAS, the cost accounting standards, which tends to also be identical to cash, and the FAS 87.

And that difference, obviously being the non-cash amount, would really be what drives any earnings per share delta.

And as I mentioned earlier, once we finalize our analysis, we will look at that in January and try to lay it out in a way where it will be clear and concise as to what the impact is and how it impacts our '03 and '04 guidance.

Relative to cash, again, I think that was a good summary that it's generally reimburseable, allocable, and, as we've said, we actually increased our cash guidance for this year and '03, and that does assume, and have factored into it, these new funding requirements.

But, again, a majority of that, as you well know, is recovered within the relatively short period of time.

And then the balance sheet piece is the non-cash, non-P&L hit as required by FAS 87 under the minimum liability calculations.

So, Jim, you want to add a little bit to that?

Joe, I would add that the FAS calculation is based on a valuation process that every company goes through, and looking at the rate of return assumption and discount rate and, of course the actual 2002, in this case, will be whatever it is for each of the companies.

The CAS calculation is not as -- it doesn't change as quickly.

The CAS assumptions ar based on usually an independent actuarial.

They tend to be much more long-term looking and they don't change as quickly.

The CAS and FAS don't move lock step.

It is true in 2003 and 2004 that CAS will go up, but, you know, based on the sensitivities, the FAS could go up much more.

If that makes sense to you.

Yes.

One other thing, just I noted in looking at one of the other large companies, they had a FAS disclosure last year that was on the order of a billion dollars, but then they went on to say, but, well, only a bunch of it, you know, 3/4 of it went into the P&L because the rest of it was still in inventory because it hadn't, you know, hadn't shipped the particularly product against which the -- which gets the, you know, the FAS numbers were allocated, so there was yet another wrinkle between EPS being just CAS versus FAS.

But the extent to which it had actually found its way to EPS versus still sitting in inventory, would seem to suggest there was a, you know, sort of yet another complicating factor in how to think about -- how to interpret the, sort of, footnote amounts and the ones you give us.

Right, Joe, I think if you take it down to that level, theoretically, it is probably right.

However, we don't see that kind of difference being that material.

Probably 70 to 80%, you know, of our revenue, is recognized on a percent complete basis.

It is really the launch vehicles and the aircraft that we record upon delivery.

And really two combinations, as long as that percent stays the same and on a year-to-year basis we don't see huge swings within the inventory and receivable accounts, I think you will always have the right 12 months delta.

As it ramps up, I agree, there could be a slight difference.

That's part of our focus, how much detail and specificity do you really need or want?

Otherwise we will be -- and that's our goal and we will have that -- we will have something proposed to you in January that I think will accommodate everybody's --

And just another -- back to Heidi's question about the -- as you said about $850 million of reduced inventories, I guess it wasn't quite clear to me what was going on here.

Will the inventories which are now running 2ish be back to the $3 billion level by the end of the year?

Is there something unique about the way UAE or somebody paid you that's causing this to seem depressed for a moment?

What's happening?

It seems unusual to have, I guess but if f you've done the work but haven't shipped a thing or recognized the revenue, suddenly if you get a big payment it just shows temporarily as reduced inventory because there is no place else to put it?

Right.

A couple of things, first of all, the inventory balance at the end of the year, we're projecting to grow, maybe closer to the, you know, 2.4 to 2.5 billion range, not nearly to the 3 billion range.

As we hit certain milestones, we do apply the advances and the progress payments to inventory.

If you look at our 10K and annual report, you will see progress payments and advances are both an offset to inventory, and a liability on the balance sheets, and we've traditionally talked about the liability on the balance sheet.

That's the --

Right, the $5 billion.

The $5 billion number.

So, you almost have to look at the two in combination, and I think it's best to say as these milestones are hit, and it is the timing and application of those advances to inventory versus keeping them in liability.

So was that, the progress, the asset line, the progress payment and pre-paid expenses isn't shown on the number, but I take it that that subtraction from gross inventory is an important part of what happened rather than the inventories themselves going down?

Yeah, I think that's fair and we will -- we'll, like I said, we will get back --

Yeah, we'll see it probably when we see the "Q".

Exactly.

Okay.

Terrific.

Thank you very much for the answers.

Thank you.

Andy, we have time for one more question.

We will take our final question today from Joe Nadell with JP Morgan.

Good afternoon.

I guess first, just to clarify, your pension guidance currently incorporates about 100 basis points of pressure from '02 to '03.

So,to the questions on the space margins earlier, is that -- is it fair to say that across-the-board you're facing that equally among the segments or is it distributed differently among the different segments?

Yeah, the pension expense noncash for the most part, FAS 87, is allocated to each of the segments.

I think we've generally said if you were to use revenues, head count, as a general benchmark, you will get pretty close as to how we allocate.

It is more complicated than that, but it is on the relative side of the entity to the total Corporation.

Our 2002 guidance, there will obviously be no change to the FAS 87 and 106 but specifically FAS 87 numbers as those were determined at the beginning of the year.

Our 2003 guidance, 275-285 a share, assumes the long-term rate of 9.5% and the discount rate of 7.25.

As we've talked about.

You know, we'll adjust those as appropriate as the end of the year.

Jim, do you have anything else that?

I wanted to add that, you know, the economic margins in our segments are better than they appear because of, as you mentioned, the increase or the -- the conversion of pension income into an expense already in our outlook between '02 and '03.

Yeah that, was the point was I trying to make.

I think to a couple of earlier points, it would be maybe helpful to split it out altogether as Northrop Grumman does, and that way we'd be able to see what economically is really happening year to year.

And on cash flow, Chris, are there potential pluses to your plan for the next five quarters?

Versus what you've laid out?

You've laid out a couple of reasons why you're going to have cash bleeding.

But are there any advances you're expecting potentially next year?

And as I second part of that, you're net debt is now down to just under $4 billion, you think that's going to up a little bit?

What are you going to do with the dividend, the share repurchase?

You must be thinking a lot about cash deployment these days.

Right, Joe.

Relative to the cash potential upside, clearly ongoing working capital improvements.

I think we've made a lot of progress over the last two and a half years with well over, you know, $4 billion of cash coming in.

We think there is still some continued opportunity there, especially as we improve our processes and go to our shared service concept.

There is always a possibility for direct international programs.

As you know, our international sales are, either foreign military sales, or direct, to the extent that some of these things ship from FMS to direct as we see them now.

That could bring in some additional cash.

We're always working hard in the tax arena.

Relative to deployment of cash, clearly Vance, Bob, myself and the whole management team does look at the possibilities that we have an ongoing process where we look at dividends, share repurchase, debt repurchase and selective acquisitions where they make good sense operationally, financially and strategically.

That's an ongoing process and we will give you more information as that rolls forward.

But right now, the focus is probably more on the debt reduction side with selective acquisitions, if we can find any that make sense.

Just to push you a little bit, on the debt side, are there any attractive, you know, is there an attractive situation in terms of buying back bonds like you've already done over the past 18, 24 months?

Or should -- are we getting to an inflection point here where it becomes a less attractive option?

I will just say, Joe, that's something that's just one of many uses that we look at all the time, and obviously, we can't have any type of disclosure to impact the market relative to any of our actions.

So, I would just conclude that we're aware of the different opportunities and we continually evaluate them.

We look for the best possible use of that cash to enhance our shareholder value.

Thank you.

Nice quarter.

Thank you.

Joe.

Andy, let me summarize that, and then we will wrap it up.

I think we've spent a lot of time talking about FAS 87 today.

Clearly, there's been a lot written on this topic and our press release contains significant details on that matter.

I think this needs to be viewed in context.

The operating performance is strong and should remain strong, and our operating performance assumptions, underlining our guidance, remain unchanged.

In fact, the pension expense changes driven by these market forces are likely to mask the improvement our operating performance.

We are going to work hard over the next few months to communicate that in the manner so that you and the investing public will understand that we continue to make significant strides in improving the operating performance of the Corporation.

I want to thank you for taking time to join us today.

The management team, led by Vance Coffman and Bob Stevens, continues to focus on driving shareholder value.

The programs and companies are experiencing strong operational performance and we're pleased to be able to increase our cash and sales outlook for the remainder of this year and maintain our strong operating earnings growth projection for 2003.

We look forward to talking to everybody in January.

We will report our actual 2002 results and provide guidance for 2003 and 2004.

Thank you very much.

This does conclude today's Lockheed Martin conference call.

We thank you for joining us today.

You may now disconnect.