洛克希德·馬丁 (LMT) 2005 Q2 法說會逐字稿

Good day, everyone and welcome to the Lockheed Martin second quarter 2005 earnings release conference call.

Today's conference is being recorded.

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

At this time I would like to turn the conference over to Mr. Jim Ryan.

Please go ahead, sir.

Thanks, Amber.

And welcome to the call.

We have posted charts on our web page which supplement our comments.

Also please refer to the Safe Harbor, which is included in our web charts.

Statements in today's call that are not historical facts are forward-looking statements and are made pursuant to the Safe Harbor provisions of federal securities law.

Actual results may differ.

See today's press release and our SEC filings, including our 2004 Form 10-K and 2005 Form 10-Q for description of some of the factors that may cause actual results to vary materially from anticipated results.

I will now turn the call over to Chris.

Thanks, Jim and welcome to our second quarter call.

Today I will focus my comments on three areas.

First -- our continued strong performance.

Second -- our ability to raise guidance.

And finally -- our approach to increased shareholder value.

We had another strong quarter at Lockheed Martin as all of our businesses had excellent performance both operationally and financially.

In fact, all five business areas increased their margins and EBIT not only for the second quarter, but for the six-month period.

We've issued a detailed press release and posted web charts and Jim and I will be prepared to answer any follow-up questions that you may have.

While we had a strong quarter, I think we need to step back and look at the big picture.

And what I see is a management team and a workforce committed to continuous improvement and focused on consistent and reliable performance.

In fact, for five and a half years, quarter after quarter we've met our financial plan.

And for ten consecutive quarters and 22 of the last 24 quarters we've been cash positive.

For 14 consecutive quarters we've experienced top line growth over the comparable period.

We're on track for our fourth consecutive year of ROIC, return on invested capital improvement, and we're on track for our fifth consecutive year of overall margin improvement.

We laid out a plan and a philosophy several years ago.

We have and we will continue to successfully execute against that plan.

Also today we were pleased to raise our guidance.

Earnings per share is now projected at $3.60 to $3.75.

Driven mainly by improved performance in our systems and information technology group and our space segment.

We also realized a gain related to our Inmarsat investment which is now worth over $200 million.

Turning to ROIC, we are now projecting more than 14% return for 2005.

The 100 basis point increase is driven mainly by increased earnings.

The team here at Lockheed Martin embraces ROIC.

It's part of our culture, and it has taken hold enterprise-wide.

Turning to cash, we're maintaining our guidance of more than $3 billion even after the discretionary $450 million pension contribution.

This is effectively raising our cash guidance by $450 million.

As always cash will track or exceed earnings.

My remaining comments focus on our plan to generate shareholder value.

I want to emphasize that we are keenly focused on this initiative.

We see a three-part formula.

First -- organic growth and operating excellence.

Second -- deploying cash to our shareholders.

And finally -- selected acquisitions.

Organic growth and operating excellence begins with our focus on our federal government customers and our allies with emphasis in five areas.

First, in defense.

In addition to our core products and services, we're focused on adjacent market opportunities.

We most recently demonstrated this with the award of the Littoral Combat Ship in 2004 and the presidential helicopter in 2005.

Performance-based logistics is another avenue that we're focused on to increase our share of the operation and maintenance project.

Turning to intelligence agencies, we've been a leader in this area for years.

It is a core competency of the Corporation and there are several opportunities in the near term.

On the civil government agency front, we continue to be, for the eleventh consecutive year, the number one federal provider of information technology.

We're now focused on business process outsourcing as there are multi-billion dollar opportunities.

The fourth area is homeland security, and we were pleased that the Department of Homeland Security leadership recently underscored the need for system integrators.

Clearly our strength.

And internationally, which has historically been 15 to 20% of our business and we expect to continue in that range, is our fifth area of focus.

I particularly like our balance and flexibility to provide and demonstrate platforms and system capabilities.

This balance has allowed us to be competitive in the global market.

Our products are highly desired by the international customers as evidenced by our recent announcements.

We have a broad portfolio and we've demonstrated flexibility to adjust to changing customer demands and market conditions, thereby resulting in the growth we have experienced to date.

We define organic growth not only on the top line, but growing the bottom line as well.

Operating excellence, margin improvement and cost control all add value.

We'll continue to improve our productivity to innovate and to invest in research.

Just recently we opened a Center for Innovation in Virginia.

You will recall that this is the facility where we're trying to solve problems and develop concepts with our customers.

We've had over 2,000 visitors and the feedback has been very positive.

Our most discriminating asset however, is our talented workforce.

We're focused on attracting, developing and retaining the best employees.

We're recruiting the top college graduates.

Over 5% of all engineering undergraduates come to Lockheed Martin annually.

That's about twice the next closest corporation in this country.

Several years ago I told about you our investment in the Center for Leadership Excellence and we're training over 4,000 employees, a majority of which are managers, on an annual basis.

And our attrition is less than half the average of the Fortune 100 Best Places to Work.

We will continue to pursue organic growth opportunities and improve operational efficiencies.

Now turning to cash deployment to shareholders.

We've spent $2.5 billion in the last two and a half years on a combination of share repurchases and dividends.

We will continue to do so.

And in fact in the second quarter we repurchased 5 million shares as we continued on focusing -- we continue to focus on returning a majority of our free cash flow to shareholders.

And finally, acquisition.

I see an increased opportunity for financially sound and strategic acquisitions.

The pipeline is robust.

We will continue to focus on systems and IT companies with the goal of enhancing growth and enhancing returns.

The past couple of years we have had several acquisitions at a total cost of nearly $1.5 billion.

OAO, SYTEX, ACS Federal and Orincon, just to name a few.

These have all been easily integrated, met or exceeded our financial targets and have added value to Lockheed Martin.

When we identify companies, we look for those that will supplement our competencies, will provide access to new customers, that have consistent core values and that have the appropriate financial returns.

There are a few examples that I want to highlight.

Recently, we wanted to strengthen our business process outsourcing capabilities to improve our competitiveness.

Several acquisitions were targeted at this capability.

It resulted in Lockheed Martin receiving the largest outsourcing contract ever for the FAA automated service flight service station.

We also wanted to enhance our professional services capabilities and competitiveness to focus on the O&M budget opportunities, and we did.

To date these acquisitions have been smaller, which I define as anything under $1 billion.

We will continue with this approach or consider medium sized deals given our cash and financial flexibility while being mindful of our credit standing.

We will be opportunistic and we do not plan to use our stock as currency.

We have a proven M&A process in place that assures strategic fit, operating concepts and economic value.

I'm very comfortable with this process and I expect it to have continued success.

So in summary, we're focused on organic growth and operating excellence, returning cash to shareholders and selected acquisitions.

I believe it is the combination of these three that are the basic underpinning that will drive the value of this Corporation over the next several years.

Amber, we're now ready for the questions.

Thank you. [OPERATOR INSTRUCTIONS] We'll pause for just a moment.

We'll hear first from Joe Nadol with JP Morgan.

Thanks.

Good morning.

Good morning, Joe.

Good morning, Joe.

Chris, I was wondering if you could help us a little bit with the electronics sector.

Sales were very strong in the quarter.

Margins were the best they've been for five or six years, I think, in any given quarter.

I'm just wondering -- obviously you gave some comments in the press release, but couldn't really interpret it too well.

I was wondering if you could give more color there?

Sure, Joe.

Let me give you an overview, and I'll ask Jim to get into some more specifics.

We've talked strategically for a couple years about focusing on our systems and IT group and of course electronics is part of that.

And what we wanted to do, was solidify our core businesses which we have done.

We wanted to expand into adjacent markets, which we talked about last year relative to helicopters, ship building, military communications and we wanted to make selective acquisitions.

And strategically, the combination of those three are contributing to the top line growth.

Relative to the profitability and the margins, I mean it really does come down to a couple items -- number one, cost control which we focused on; program maturity, we've talked about years past that we were a little more in the developmental phase.

And as these programs are maturing, we're reducing risk and we have the ability to reduce our profitability; and then the overarching contribution, clearly is execution.

We have to meet the milestones, we have to meet our customer commitments on time, on budget.

And it is the combination of that approach that we are seeing here on these financials.

And, Jim, you want to provide a little more detail?

Yes, Joe.

Sales were up across the board in electronic systems, maritime systems and sensors.

All lines of business were up including surface systems with Aegis, Littoral Combat Ship and Deepwater.

Tactical systems, radar, undersea were all up and our marine line of business was up with the vertical launch system.

In missiles and fire control, our combat vision, our fire control area was up, that includes Lantern (ph) and Sniper and the TADS/PNVS contract.

And air defense was up with PAC-3 and FAD.

And our platform training area, the third major area, platform integration was up with the presidential helicopter.

Simulation and training was up, the air traffic management, our transportation solutions business and also our postal business which is part of distribution technologies.

I'll also add, Joe, that if you just look at the first six months we had $5 billion of revenue and we're expecting sequentially somewhere in the 8 to 12% growth for the second half of '05 sequentially.

And we expect 10% margins each and every quarter for the remainder of the year at a minimum.

We'll now hear from Heidi Wood of Morgan Stanley.

Hi, good morning.

Nice quarter, guys.

Chris, a question for you, I took a look at that past history, Lockheed is seasonally strongest in the second half.

In fact, over the last eight years, 40% of earnings have come from the first half.

Yet, if I take a look at what you're guiding, you're basically only guiding 48 to 50% for the second half in terms of total EPS.

So can you talk to us a little bit about what happens in the second half that restrains earnings?

Why should this seasonality reduce so significantly?

Right.

Well, thank you, Heidi and we are excited it was a good quarter.

I think what we have here is a couple items occurring, at least for 2005. 2004 was a very busy year with new business opportunities and we started to see the ramp up of the revenue in the latter part of '04.

So we're looking at a much smoother quarter-to-quarter revenue stream and of course the earnings tend to follow the revenue.

With over half the Company being systems and IT, I think you're seeing a smoothing effect relative to the first half, second half.

I've seen the same statistics you referred to.

If you go back four, five years, you will see each and every year it's becoming closer to a 50-50 trend.

And we have basically -- if you look at our guidance, we still have more earnings in the second half of the year than in the first half.

You do recall we have $0.09 of unusual items in the first half you may want to back out just to look at the operational tempo.

So I would expect more earnings once again in the second half on an EPS perspective.

I'd expect sales growth in the second half and expect EBIT growth.

We'll now hear from George Shapiro from Citigroup.

Good morning, Chris.

Good numbers.

Good morning, George, thank you.

If you look at aeronautics, if you can just run through a little bit more detail, it looks like the margin was down maybe a little bit in what you booked on the F-35 program.

And if you just comment on how much, maybe, the F-22 was up.

And then the mix of deliveries in terms of the F-16 and where the deliveries might still go for the year.

Okay, George, sure.

As we outlined in the press release, we talked about flight adjustments both on JSF and F/A-22.

To give you an overview, the process we have is periodic contract status reports, where we look at our estimated completes, based on the most current information available.

On JSF we have historically been in the mid-single digit range.

And when we factored in the rebaselining and the replay on negotiation current status, we made an inception to date adjustment downward, and we are still in that mid-single digit range at complete.

On the F/A-22 program, through that same process, we've talked historically about the initial production lots being in the lower single digit profitability range.

We've completed all the lot 1 and lot 2 deliveries and we've started lot 3.

And again, with the hitting the milestones and the excellent performance on F/A-22, we were able to have an inception to date adjustment, basically, go in the other direction, upward that now takes us into the mid-single digit range or slightly above tha,t on that particular program.

So those two events kind of cancel out at the combat air level, when I look at the EBIT it is basically flat quarter-to-quarter.

But yet we do get the margin improvement due to the decreased sales.

Relative to F-16, we've talked about overall revenue for the year kind of being in the $3 billion range for '05 which is, 700 to $1 billion less than '04, which was almost flat with '03.

So we have 175 in backlog.

We don't disclose the actual deliveries, but we are on track.

I would expect that trend to continue as we forecasted for a couple years here as the program ramps down.

We'll now hear from Doug Harned with Sanford Bernstein.

Good morning.

Good morning, Doug.

Good morning, Doug.

On INTS, could you talk a little bit about what happened underneath the whole unit?

If you take out SYTEX and -- I'm trying to get an idea of what the organic growth is on the IT side.

Yeah, I would be happy to, Doug.

In the quarter, all the growth in INTS, which was $80 million, came from Lockheed Martin information technology, the IT line of business.

That grew almost a couple hundred million dollars.

Defense systems was relatively flat and NASA, as we have talked about, was substantially down.

So the organic growth on LMIT organically for the quarter, was 15%.

And, of course, if you factor in the acquisition, close to 33%, I think.

So that's for the quarter, the same trend obviously applies for the six-month period where all the growth coming out of IT, defense and NASA are headed down.

We'll now hear from Steve Binder from Bear Stearns.

Good numbers.

Thank you.

Chris, can you maybe just touch -- there is a lot of moving pieces and working capital in CapEx.

But CapEx year-to-date, your previous guidance is 900 million for the year and it looks like you are going to fall short of that.

If you can just touch on CapEx -- customer advances you said, negative 2 to 250, but you are up over 500 million year-to-date.

So can you maybe just touch on cash taxes -- whether you are still thinking 5 to 600 for the year.

Customer advance is still negative 2 to 250 and then CapEx of 900.

Can you maybe just touch on those three items?

Happy to, Steve.

Taxes -- we have previously talked about 500 to 600 million.

Now forecasting 6 to 700 million.

And that increase ties in with the improved earnings outlook.

Advances, I see flat for the entire year is our best estimate at this point in time.

We're currently up about $475 million mainly due to -- I'm sorry, we're up $550 million, space, electronic systems, international sales, all those are contributing to the increase.

But I'm forecasting that to come down in the second half, so it should be a push -- December '04 to December '05.

And CapEx, historically about 50% of the expenditures are in the fourth quarter and two-thirds in the second half.

I think that trend will continue.

It is our focus on ROIC at the Company level and the business area level, I'm sure is contributing to holding off on the capital expenditures as long as possible.

And I believe that is a good thing and a right thing to do.

Overarching we will continue to have the cash equal or exceed the underlying earnings.

So I'm sticking with that commitment.

We'll now hear from Howard Rubel with Jefferies and Company.

Thank you very much.

Nice numbers, Chris.

Thank you, Howard.

But though, on the observation of numbers, there's sort of some things that I'm not sure I understand completely.

One is, you've previously disclosed F-16s and you didn't in this period and the same with C-130s.

And then also, could you go back again and talk about the organic growth in info tech?

Because I think if you back out the acquisition, that whole business segment actually was -- showed a slight decline.

Sure, I'll be happy to do that, Howard.

C-130Js, I would be happy to tell you that we delivered three in this quarter compared to two second quarter of '04.

That cumulatively gets us to seven for the six-month period compared to six from the prior year, six-month period.

So, that accounts for a little bit of the increase in air mobility.

F-16s we haven't disclosed those for a couple months -- I'm sorry, couple quarters.

We talk about the revenue.

It is just for -- request of customer and customer sensitivity.

We do give you the revenue trend there.

And of course we have the POC-POT accounting which just adds to the confusion.

So we're trying to be as disclosive as we can relative to the trend.

To go back to INTS, info and tech services, again there are three lines of business.

Information technology, defense services and NASA.

And if I just look at the -- just look at the quarter, by far the largest segment is IN -- information technology.

That accounts for more than half of the $1 billion of revenue in the quarter.

NASA is less than 10% now, where it was previously close to 15% and defense services is always in about a third of it.

So, when I look at the numbers here, we had almost 150 to $200 million in growth in IT in the quarter and we talked about SYTEX having about $100 million a quarter.

You can take that out and do the math.

You'll get the 15% number.

NASA, as we forecasted and have talked about, is down significantly.

We'll be lucky to have 250, $300 million of revenue for the full year for NASA, compared to just a couple years ago when we were over three-quarters of a billion dollars.

So I hope that helps a little, Howard.

And now I'll take a question from Joseph Campbell with Lehman Brothers.

Hi, Chris.

This is Betsy [inaudible], Joe is traveling.

Good quarter.

Thank you.

I just have a question on the cash flow from off guidance.

Full year is 3 billion plus, in the first half you already did 2.2.

Can you give some color on the second half?

Or should we be expecting a much higher number than 3?

Thanks.

Sure, thank you.

No, your numbers are correct.

We do have 3 billion outlook for the full year.

We've done 2.2 at the halfway point.

I think the actual guidance is greater than 3 billion.

I think it was Steve that asked -- we will see the advances burning off.

Again, we are up 550 million halfway through the year.

I kind of see 450 to 550 burning back off.

Again, we're forecasting sales growth and there is a little element of working capital growth when you grow the top line.

So maybe the receivables will have a little bit of absorption there, and we are continuing to focus on the inventory and the payables.

Those are pretty much the big drivers for the second half.

We'll now hear from David Strauss with UBS.

Hi, Chris.

How are you doing, David?

Good.

Could you touch on a couple programs and progress you are making?

You talked about good growth in Deepwater revenues.

Could you just give us some color on how that program is progressing in terms of meeting expectations and your customers' objectives and also touch on ACS as well?

Absolutely, David.

Let me first -- I'll comment on ACS and I'll ask Jim to give you a little more insight on Deepwater.

ACS is the Aerial Common Sensor that was awarded in 2004 and I think it has been pretty well publicized that there has been some weight growth relative to the integration and at the request of the customer we are looking at aircraft alternatives.

We are working closely with the customer.

That is being reviewed and we would expect an announcement in the near term relative to the platform.

And other than that the program and our aspect -- or our part of it, is continuing as planned.

There will be more news coming on that shortly.

But the program is continuing, it is funded, it's a joint program and it's well supported.

Jim?

As you know, David we don't give out precise numbers by program, but Deepwater was in the rough range of a couple hundred million dollars on a run rate if you look at the second quarter, year ago.

And in the second quarter of '05 it is in the 3 to 400 kind of range.

So we had some significant growth in the Deepwater program.

We'll now hear from Cai von Rumohr with SG Cowan Securities.

Yes.

You're -- despite buying 5 million shares in the quarter your share count was up.

Could you tell us, when did you buy the shares and what should we be looking for for the full year in terms of the share count?

Okay.

Thanks, Cai.

You are correct.

The share repurchases were back end loaded within the quarter.

A majority of those were actually purchased in June.

April, as you know, we're blacked out due to the earnings.

So it was the latter part of May and June.

You'll see when we file our 10-Q, which we will probably do tomorrow night or Thursday morning, that some of the structured share repurchase transactions were in fact triggered I think about $75 million worth, 1.2 million shares.

And those all by design were 30, 40-day maturities.

So they all matured at the end of the month, the last two weeks.

And that was the date that we obviously recorded the repo.

Offsetting that within the quarter were the option exercises and the employees contributing to the 401(k), buying the stock and the Company match, of course, adding that.

For the full year, we've always talked, kind of in the 448 million, $449 million range.

I think as the year progresses these early benefits of the repurchase will come in just through the averaging mechanics.

So, we're committed to returning a majority of the free cash flow to the shareholders and this is one of the avenues by which we will do it and will continue to do it.

We'll now take a question from David Gremmels with Thomas Weisel Partners.

Thanks, good morning.

Morning, David.

Chris, your other unallocated expense had a 52 million swing in the quarter and that's -- I'm not talking about the pension or Inmarsat, but that other unallocated, what accounts for that swing?

I think that would be the interest income on the cash balance.

Okay, just straight up interest income.

Sure.

And then as a follow-up, the slides talk about a lower tax rate factored into your '05 plan.

What is that, new lower tax rate?

The newer -- it is about 30 to 50 basis points lower and was driven by the Medicare subsidy that we've now factored into the '06 outlook, because the corporations have the ability to get subsidized for their Medicare program and basically that subsidy's tax-free.

It has the effect of just drawing down the effective rate.

So, we're probably in that 31.2 to 31.4 range.

And also the increased earnings help with the permanent items that have the effect of change in the rate.

We'll now hear from Byron Callan with Merrill Lynch.

Good morning, gentlemen.

Chris, I just want to go back on some of your introductory comments on acquisitions.

Were you signalling -- you said you've got a pretty robust pipeline and kind of very comfortable with the process.

Is there more interest today than there was at the last quarterly conference call?

And you talked about smaller size acquisitions being less than $1 billion.

I'm just curious what's medium sized if that is also an area you will be hunting in?

Absolutely.

First of all, good morning.

I don't know if I would say there is more of a appetite.

We've talked for several years that that was one of our five or six uses of cash.

I just thought I would try to narrow down to what I foresee in the next couple years as the two main uses of cash outside the internal investment.

And that really is returning a majority to the shareholders and the acquisitions.

I've always believed that a company this size with our enterprise value or our revenue, whatever metric you want to look at, clearly $1 billion or below would meet my definition of a small acquisition.

I guess I look at large acquisitions as probably in the $5 billion or above range.

So by default, 2 to 4 billion becomes, I guess, our new term now will be a medium sized acquisition.

When I look at our cash flow and the outlook, the ability to do 3 or $4 billion of acquisitions over the next couple years, fits well within anybody's modeling or forecasting based on cash generation and other sources.

And I guess what I was basically signalling is, we could continue to do ten acquisitions at 400 million a piece.

We could do four at $1 billion a piece or we could do two at $2 billion apiece.

And we're going to make what we think is the best acquisition based on the strategic fit, the operational concept and, of course, the financial returns.

And there is nothing in the near term pending.

But when we look at the pipeline and the opportunities, we're seeing them all different sizes and shapes.

And I just thought I'd communicate to the group here what we're seeing.

CIBC World Market's Myles Walton has our next question.

Hi, thanks.

Good quarter.

Good morning.

Thank you, Myles.

Hoping to push your hand a bit on 2006 guidance.

Last year you gave us the '05 guidance in January of '04.

And I'm just wondering why you haven't provided the '06 yet or if you can give us some flavor on what you are looking into next year.

Okay.

You're correct.

We have not provided detailed guidance for '06 at this time and we don't plan on doing so today.

I will be looking at that as a possibility in October.

The biggest driver, of course, is the GAAP earnings per share and as we all know, there are several significant noncash items that you need to get closer to the end of the year to forecast and of course that would be the pensions, the noncash pension, the noncash stock options.

I guess I could give you some sense directionally if that's useful, some of the key metrics -- sales I would expect modest sales growth on a consolidated basis.

Systems and IT, I don't see any reason why that trend would not continue.

Space of course, we have go to factor in the United Launch Alliance accounting, as we convert that to equity accounting upon closure.

And aeronautics we don't see growing consistent with this year.

EBIT, we expect to grow, margins we expect six straight years of margin improvement.

We've talked about and continue to commit to cash equalling or exceeding our earnings.

I don't plan to step back from that commitment and return on invested capital should be greater than 14%.

So, that's a little bit of directional for you.

And again I want to emphasize it is not detailed and we will take a hard look at getting that out in the October time frame when the EPS items are a little better known.

We'll now hear from Rob Springarn with CSFB.

Good morning.

Wanted to know if you could update us on the con -- on a potential contract structure change on the C-130?

And then as a follow-up also, on the O&M side, we've heard from some other folks, perhaps some weakness in the second quarter on growth -- on organic growth on the O&M side, if you had any comment there, what you saw?

Okay.

Thanks, Rob.

On the C-130J we are obviously working with the Air Force.

We have jointly targeted the fourth quarter -- November as the date to convert that from a FAR/FARC (ph) 12 to a FAR/FARC 15, quote, "more traditional government contract."

So the teams are working well together, exchanging data and we would expect to meet the mutually agreed upon deadline.

And we'll keep you informed as to what that does relative to our guidance.

But I can't imagine it would alter anything we've put out to date for '05 or '06.

On the O&M side we continue -- you kind of cutoff a little bit.

I think you said you said others had said there was a weakness in the O&M.

We continue to see, spares and support, whether it is for the Apache fire control systems, some of our tactical aircraft is being pretty consistent quarter-to-quarter.

And I don't see any major trend that is impacting us.

Jim, do you want to give a little more color on that?

Clearly we have indicated that we are pursuing performance-based logistics.

There's some potential there.

It is obviously a very, very emerging market, but we are certainly looking to grow that over the longer term.

We'll now hear from Nick Fothergill with Banc of America Securities.

Good morning.

Nice quarter.

Two questions, if I may.

The first is on the QDR and the second on F-16.

On the QDR, Chris, what are your general thoughts on it at this stage?

I know there is a time before that comes out, but are there any programs that you feel that you may have to bat quite hard to protect?

That's the first question.

And the second I will follow-up when you've answered on F-16, if I may.

Okay.

Hopefully they will keep you on the line, there.

First of all good morning, and thank.

Relative to the QDR, obviously we don't have any specific insight that anyone else wouldn't have.

I think the framework and the philosophy here is going to be be to look at a couple different scenarios from a national security perspective and, you will hear terms like traditional adversaries, irregular adversaries, catastrophic and disruptive outcomes or threats.

And I think all of us, as you would expect, in industry tend to have the products and services more aligned with what's been traditionally viewed as traditional adversarial threats.

And in our case that is tactical aircraft and airlift and some of the Littoral Combat Ship, Aerial Common Sensor.

But the good thing with some of the other adversaries or threats that are being evaluated, whether they are again, in any of those three categories, is that the solution will probably be information technology-based or systemic in nature.

And with over half our Company being in the systems and IT arena, $30 billion of backlog in systems and IT, and our past practice of being able to control -- to grow the Corporation as our customer changes, we feel pretty confident that we will be able to adjust.

There is a lot of work that we do in the intelligence agencies, border security, sensors, disruptive technologies like directed energy.

All those I think could come to bear and be beneficial, not only to our customer, but also to the Corporation.

Do you have a follow-up, Nick?

We'll now hear from Troy Lahr of Legg Mason.

Thanks.

I'm wondering if you could give some clarity on your space business.

Your sales guidance stayed the same, but you increased your EBIT guidance, little bit there.

Can you talk about what is going on?

Absolutely, Troy.

The main driver there was in our improved outlook for our government launch vehicles.

Specifically the Titan launch vehicles, some cost reduction initiatives, and a little bit from our joint venture with United Space Alliance that obviously just launched the shuttle earlier this morning.

Okay.

And a follow-up on the commercial business, the space business, do you expect it to be weak for quite some time or are you looking for a rebound there anytime soon?

Well, there are two commercial businesses.

We have the launch vehicle which has historically been just a couple launches.

I don't see anything changing there significantly and obviously that's interrelated with the commercial satellite business.

The forecasts continue to be in the 15 to 25 satellites a year.

Five corporations competing for that business.

Don't see a whole lot in the immediate near term.

We are breaking even in that business.

There could be some satellite replenishment, but nothing significant.

This is a couple hundred million dollars, obviously a quarter, if we even have a delivery.

So it is not significant to the Corporation overall.

But I don't see any change in the underling market dynamics.

We'll now hear from Jared Muroff with Prudential Equity.

Thank you.

Very good quarter.

I was hoping you could give us your thoughts on some of the static that's been coming out of Washington in terms of some -- possibly some procurement reform.

Been some more talk on the LSI concept and where that is going.

As well as what is happening with the Deepwater project, the Coast Guard and the Congress fighting over funding there.

And there has also been talk about whether or not the way the contract is currently managed is appropriate.

Just hoping you could give your thoughts on where you think that might take us.

Right.

No, I would be glad to give it a try.

Thanks.

I guess I'll just start with acquisition reform.

Clearly there's been some changes in the administration.

It really is an ongoing process and has been for probably not only years, but decades.

We, as others in industry, have been consulted.

We provide our input and feedback on the acquisition reform.

I'm not 100% convinced what the thrust of that will be, but we're working, submitting our ideas and of course we will comply with whatever the new rules are.

Relative to LSI, Lead System Integrator, we are the lead system integrator on Deepwater.

I know that's one of the areas that is being looked at, that's a Coast Guard program.

There is clearly a strong need.

There's been strong support, and our Washington operation group is continuing to work closely with the customer through the process.

The program is funded and it is really just a matter of how much at this point.

So, overall you're right.

There is a lot of activity as there is all the time in this industry and we are adapting and responding and we'll work through it.

We'll now take a few follow-up questions, starting with George Shapiro with Citigroup.

Hi, Chris.

I was wondering if you could talk a little bit about the space business.

Because given that you had no Atlas launches two and no commercial satellites versus one, it implies that the underlying government satellite business grew quite rapidly, like maybe 15% or so.

So I was just wondering If you'd comment on what's going on there and is that kind of growth going to continue for a while?

Sure, George.

Your math's pretty close.

We had for the quarter, government sats is the growth engine, it is a couple hundred million dollars of growth just alone in the quarter.

Just like we had in the first quarter.

So government sats alone is 350 to 400 million of growth on a year-to-date basis.

If you look at the trend, full-year and go back to 2003.

Government sats was maybe half of the space business at $3 billion range.

We had about 10% growth in '04 and we'll probably have 15+% growth in '05.

Combination of the maturation of the advanced DHF satellites, continued work on sivers (ph) and classified programs.

So all those are continuing to move along and that's what's driving the growth.

We'll now hear from Steve Binder with Bear Stearns.

Chris, I was just wondering if you can follow-up on Byron's question about your robust pipeline and you're looking more at medium sized deals and you were quoted at a number of interviews today about possibly 4 billion -- as much as a $4 billion deal.

How do you put that -- how do you tie that into the increased focus on ROIC in the sense that, you are raising the bar with ROIC.

It keeps on going up, you're at 14% now or greater than 14% in your projection.

If you do a big sized deal, it is going to put some diluting effect on an ROIC.

You have been trying to focus on high return acquisitions.

SYTEX being a good example.

How are you able to do a larger deal and not dilute your ROIC by doing that?

That's clearly one of the thresholds.

I don't want to say I was misquoted.

What I've tried to communicate is there is the opportunity for 4 -- about $4 billion to be spent over the next several years based on our cash balance and our ability to generate cash.

And what I was communicating is, when I look at what's out there and where we may want to take the Company and continue to focus on systems and IT, there are some medium sized companies that come up on the radar screen.

ROIC will be a consideration and it will be -- it will be something that we will take quite seriously and factor into the analysis.

We are not stepping back from our commitment to improve ROIC.

And to be the industry leader in that metric.

And obviously it will have to be pretty stong financial terms.

And the market is still a little expensive, but we will be opportunistic, and it reminds me of a couple years ago when we put in our share repurchase program.

We didn't do anything with it and six months later we started buying back and now we're excess of 30 million shares.

Same with what we've done with debt repurchase.

We had the authority.

We waited for the rates to raise and that ended (ph) a situation.

And a year later we took out $1 billion.

So, nothing on the horizon this week or this quarter.

Just trying to -- I wouldn't overanalyze it.

I would just lay it's out there and it is something we're being considered.

We are looking at strategic operational and financial hurdles and those are unchanged from our prior thresholds.

We'll now hear from Nick Fothergill with Banc of America Securities.

Chris, yes.

Just a quick follow-up on F-16.

You've done very well to win the Greek order recently and Pakistan and India are obviously, still to go.

When would the Greek order go into production and if Pakistan and India were to materialize, roughly when would you anticipate production for those two countries as well?

Okay.

Well, thanks, Nick.

We -- after this we will have time for one more question.

I wanted to wait until you got back after being cutoff there.

The Greek order, as we look at it, we're hoping to get -- we're working toward getting some long lead funding, probably in the early 2006 time frame.

Again, this is government to government.

This would be a foreign military sale so our government would obviously be selling it to Greece.

So probably '08 is when the deliveries and the revenues would come in.

But there is no order yet.

There is nothing in backlog and -- and late '08, '09 deliveries would begin there.

Relative to Pakistan, again, we're working towards trying to get some long lead funding the latter half of this year.

Again, no order has been booked.

It is still in the government to government phase.

India is a little longer term.

So what we've talked about previously was a need to get orders by the end of this year, otherwise the 175 aircraft run out in the late '08 time period.

By obtaining one or both of these orders and getting the long lead funding most importantly, but then ultimately converting it to a contract in '06, we should be able to extend that line production to the 2009, 2010 time frame which then gives us another year or so for the India and any other countries that would be interested.

So good progress.

Over 4,400 F-16s in our history and it just keeps going.

So it's good progress by the aero team.

Amber, one more question, please.

Thank you.

That question will come from Heidi Wood of Morgan Stanley.

Great.

Chris, your net debt-to-cap ratio at the end of the quarter was 20%.

Just kind of taking your guide -- your talk -- this discussion about about a $4 billion over the next couple of years, if I sort of roughly apply that between now and '07 that still gives us a net debt-to-cap by year-end '07 of between 15 to 20%.

So can you talk to us about your thoughts on what would be an optimal net debt-to-cap structure?

Sure, Heidi.

I can't argue with your math, especially given the strong cash flow that we've had and our focus on deploying it wisely.

Right now we're at 39% gross.

We're currently and continue to focus on our credit standing.

What we're finding more and more is that the rating agencies really are looking more at the coverage ratios.

The leverage ratio with the OCI and the pension accounting and some of the other nuances in GAAP accounting make it hard to be as useful as it was historically.

But I guess I will kind of say, in the 30 to 40% range doesn't strike me as inappropriate.

But that's not at all to suggest we are going to lever up to get there.

We are generating the cash, the Company is operating well and we're very satisfied with the way we're going.

So, Amber, with that being the last question, I want to thank everybody for taking the time to call in today.

I think I mentioned during the call, but just so everybody knows, we will be filing our 10-Q for the second quarter, the middle of this week and we will have a lot more detail in there that may address some of the question that were asked.

And look forward to talking to everybody again in October.

Thank you very much.

And that does conclude today's conference.

We do appreciate your participation.

Have a great afternoon.