洛克希德·馬丁 (LMT) 2006 Q1 法說會逐字稿

Good day, and welcome, everyone, to the Lockheed Martin first quarter 2006 earnings results conference call.

Today's call is being recorded.

At this time, for opening remarks and introductions, I would like to turn the call over to Mr. Jerry Kircher, Vice President of Investor Relations.

Please go ahead, sir.

Thank you, Sheila.

I'd like to welcome everyone to today's call, and also mention that it is a pleasure for me to be a part of the call this morning.

With me here today is Chris Kubasik, our Executive Vice President and Chief Financial Officer, and Meg VanDeWeghe, our Senior Vice President of Finance.

As in the past, we have posted charts on our website which supplement our comments today, including our Safe Harbor statement.

These charts may be obtained on our website.

In today's call, statements that are not historical facts are considered forward-looking statements, and are made pursuant to the Safe Harbor provision of Federal Securities Law.

Actual results may differ.

Please see today's press release and our 2005 Form 10-K for a description of some of the factors that may cause actual results to vary materially from anticipated results.

The charts posted on our web page include definitions and reconciliations for the non-GAAP financial measures referenced in today's call.

Excel spreadsheets are also available on the website to facilitate analysis and modeling.

Today's call will also be made available on our web page for downloading in MP3 format, as a Podcast.

Please refer to our web charts for today's call, as they are intended to be reviewed with the conference call audio.

With that, I'm pleased to turn the call over to Chris.

Thanks, Jerry.

And good morning to everyone.

Let me start the discussion by introducing 2 members of our management team who are joining me this morning.

First I'd like to introduce Meg VanDeWeghe, who recently joined Lockheed Martin as the Senior Vice President of Finance.

Meg has more than 20 years of experience as an investment banker and a consultant.

Her broad and diverse background brings additional expertise to the Corporation.

Meg will be responsible for all elements of the finance organization that have interaction and communication with the capital markets, including investor relations, treasury, mergers and acquisitions, and our pension fund investment group.

Much of Meg's efforts since joining the Company have been focused on executing our balanced cash deployment strategies.

You have already heard from the other member of our team, Jerry Kircher, our Vice President of Investor Relations.

As many of you know, Jim Ryan is now the CFO of our newly formed Enterprise Operations organization.

Jerry joins Investor Relations from our Integrated Systems and Solutions business area.

He previously led our Corporate Financial Planning group, and has had numerous operational roles within Lockheed Martin.

My focus this morning will be on updating our strategic and operational progress, and briefly highlighting our first quarter financial results.

Meg will then update you on our continued actions to increase shareholder value, focusing on our acquisition process, cash deployment, and financial strategies.

Turning to the first quarter, we continued the positive momentum, strategically, operationally and financially, that we maintained throughout last year.

Our results continue to reflect the outstanding performance of our operating companies.

We have been delivering on the strategy of disciplined growth that we outlined several years ago, and our results today reflect continued achievement of that strategy.

Strategically, we are continuing to focus on our core business, which includes the Department of Defense, Intelligence Agencies, the Homeland Security Department, international customers, and civil government agencies, with a specific focus on information technology.

During the quarter, we strengthened our portfolio by winning follow-on business and new orders, such as the FBI Sentinel program, which is designed to transition the FBI from a paper-based case management system to an electronic records system.

We also won a program called TMOS to manage space-based assets, and we were selected for large, indefinite delivery, indefinite quantity contract to deliver engineering, logistics and business operations for the U.S. Army.

This contract vehicle is known as Strategic Services Sourcing, or S3.

Each of these awards provides continued validation of our organic growth vision and strategy.

Throughout the quarter, the Corporation's operational health remained strong.

Some of our milestones in the quarter were the decision to proceed with low rate initial production on the F-35 Joint Strike Fighter, the initial operational certification for the F-22 Raptor, the seventy-eighth consecutive successful Atlas launch, and successful tests of THAAD and JASM missiles.

We remain one of the more diversified government contractors in the industry, with approximately 60% of our revenue coming from the traditional Army, Navy, Air Force and Marine customers, with the other 40% coming from intelligence, civil, Homeland Security and international customers.

During the first quarter, we continued our strategic pursuit of adjacent market opportunities to support our growth strategy.

Our identification of adjacent opportunities centers around 3 areas.

The first area of adjacency is moving into new lines of business.

With the Presidential helicopter and the Littoral Combat Ship program wins, we successfully moved into rotary wing aircraft and shipbuilding.

In 2006, our adjacent market pursues have expanded to include military vehicles.

To date, we have been successful in this area with 2 recent events.

We were 1 of 2 contractors down-selected for the phase 2 Future Tactical Truck System procurement, and also we received a contract award to build the light-weight Prime Mover.

Our successful entry into this new line of business was aided by innovative design technology and intellectual property that we obtained from a recent acquisition.

Our second form of adjacency deals with capabilities.

Looking specifically at information technology, many of our capabilities that we have been focusing on, either through organic growth or acquisition, deal with business process management or outsourcing.

Several contracts for business process management were awarded this quarter.

Further examples of capability expansion includes record retention and data retrieval awards.

We cover the full spectrum of the IT vertical, ranging from desktop management to complex architectural design activity.

And finally, we look for adjacencies by forming new customer relationships.

Each of these new relationships can be seen by the recent contracts we won with the National Archives of the United States, the New York MTA, healthcare clients within the Federal Government, and the Center for Disease Control.

We remain committed to exploring other opportunities to grow the Corporation.

Let's now focus on financials.

I believe that in order to have good financial results, you need good people, good processes, and good controls.

We continue to invest time and resources in our leadership development programs.

We continue to develop and implement additional training courses across the Corporation, focused on specific actions towards improving shareholder value, and centered around returns on invested capital.

Our first quarter sales were up 9%.

Earnings were outstanding, with all business areas achieving margin expansion, and total segment margins exceeded our 10% goal.

Our continued focus on cash flow enabled the Corporation to generate $1.2 billion of cash from operations for the quarter.

I understand there may be some confusion relative to our first quarter earnings per share.

I want to highlight that we beat the consensus by $0.20 a share, $0.08 due to the Inmarsat gain as a result of the sale in March.

The additional 14% -- $0.14 of an unusual items was disclosed in our January 26th press release and in our prior guidance.

That was $0.11 related to our January sale of Inmarsat shares, and $0.03 related to our Space Imaging asset sale.

In view of our positive first quarter performance, we are increasing our outlook for 2006 in the areas of operating profit, cash from operations, return on invested capital, and earnings per share.

In regards to our forecast of EPS for the year, if you exclude the first quarter unusual items, our expectation is that each of the subsequent 3 quarterly EPS amounts will be consistent with our first quarter results.

In summary, the first quarter was consistent with our expectations.

We had a great quarter, and we're off to a good start for the year.

I will now turn the discussion over to Meg to provide additional insights into our strategies to provide attractive returns for our investors.

Meg?

Thanks, Chris.

I would like to provide some addition insight into the activities in which Lockheed Martin is engaged, as we continue our focus on improving value for our investors.

Strategic deployment of free cash flow is obviously of critical importance to our investors.

We have identified 3 primary strategies for deploying free cash flow.

The first strategy is pursuing mergers and acquisitions.

Our merger and acquisition philosophy is very straightforward.

Overall, we look for companies which will be good strategic fits, and will provide high returns, solid growth and attractive risk reward ratios.

In examining a potential acquisition candidate, we look at strategic and operational fit first.

In order for us to be interested in an acquisition target, we must be confident that the business will help us either leverage core competencies, or enhance capabilities or customer relationships.

We also must feel comfortable with the quality of the management team, their products and services, and their reputation as a company.

Furthermore, we must determine that the company does not have certain types of risks, such as Foreign Corrupt Practices Act violations, or conflict of interest risks.

If we decide we are comfortable with the strategic and organizational fit, we then examine the financial fit.

We look at the expected internal rate of return as one of the most important financial measures.

We also look at the impact an acquisition would have an our margins, ROIC and growth rate.

If a company passes our test for strategic, operational and financial fit, we will move forward with a potential candidate.

During the quarter, we closed on 2 acquisitions.

In January, we acquired HMT Vehicles Limited, the United Kingdom based developer of designs for military vehicles.

Their innovative designs have been incorporated into light to medium high mobility, wheeled military vehicles in the U.S. and the UK.

This purchase strengthens our military vehicle design capabilities and has already helped us in winning some of the new business which Chris described for you a few minutes ago.

Also in January, we acquired Aspen Systems Corporation.

This acquisition continues our portfolio expansion as a provider of business process management and technology solutions.

This also has helped us to win some of the business Chris described.

Both of these acquisitions align with the Corporation's cash deployment strategy of acquiring companies which enhance our capabilities, and position us for future growth.

We believe the 2 acquisitions we completed in the first quarter solidly satisfied all of our evaluation criteria, and we look forward to these acquisitions contributing to the Corporation's financial performance.

I also should note, that consistent with our merger and acquisition philosophy, we looked at other acquisitions in the quarter, and declined to submit bids for a variety of reasons.

The second strategy on which we are focused with regard to deployment of free cash flow, is our share repurchase program.

During the quarter, we repurchased 11.8 million shares of our stock for $872 million.

And we finished the quarter with 429.5 million shares on our balance sheet.

We continue to execute our share repurchase plans, consistent with our analysis of appropriate financial returns, and our commitment to reduce our share count.

The third strategy we will continue to utilize as we deploy free cash flow, is our dividend strategy.

Over the last few years, we have raised our dividend several times to reach the current level of $1.20 a share annually.

Our goal is to remain competitive as we return a portion of our cash to shareholders through dividend payments.

Our practice is to review our dividend level in the second half of the year.

In addition to our shareholder focus, we also have continued to focus on our bond investors.

During the quarter, we received 2 ratings upgrades on our senior unsecured debt.

In January, Moody's raised their rating to "BAA1" with a stable outlook.

In March, Fitch raised their rating to "A-" with a stable outlook.

These ratings upgrades reflect our strong balance sheet and the significant financial flexibility we enjoy as a result of having paid down $2.5 billion in debt over the last 4 years.

The rating upgrades also reflect our strong operating performance, margin expansion and cash generation, which benefits all of our stake holders.

I would like to finish by saying that I'm excited to be a part of the Lockheed Martin team.

I have worked with the Company for over 20 years as an outside advisor, and I now look forward to being part of the management team working to enhance shareholder value.

With that, I'll turn back to Chris for some final comments.

Chris?

Thanks, Meg.

Before we go to your questions, I want to remind you that our annual shareholder meeting will be held this Thursday, April 27th.

We believe that the management team runs the Company with policies and practices which focus on corporate governance, while maximizing shareholder value.

And that our Board provides the appropriate oversight.

We listen and respond appropriately to input from our shareholders.

At our annual meeting on Thursday, you will be electing our Board of Directors and voting on proposals affecting shareholder value.

I would like to highlight 2 proposals, both of which are detailed in our proxy.

The first is number 4 on the proxy card, management's proposal to amend our charter to eliminate certain existing supermajority voting provisions.

The Board, as part of Lockheed Martin's continuing commitment to the best governance practices, evaluated and decided to remove the supermajority voting provisions for removal of a director and for approval of certain business combinations.

The second proposal, presented by a shareholder as number 6 on the proxy card, goes beyond eliminating supermajority provisions.

It seeks to require a simple majority vote on all matters.

We believe that the simple majority should be one of all shareholders, a true majority.

We do not believe it is appropriate to make major decisions affecting all shareholders using only a simple majority of the votes cast at a meeting.

Proposal number 6 refers to a simple majority of votes cast.

If implemented, as little as 25.1% of the outstanding voting power of the Corporation could be making decisions which affect all shareholders.

We do not consider this to be appropriate corporate governance.

For this reason, we are asking for you to support and to vote with the Board's recommendation on these proposals.

So with that, Sheila, I would like to open the line to questions.

Yes, sir.

Thank you. [OPERATOR INSTRUCTIONS] Heidi Wood, Morgan Stanley.

Nice quarter, guys.

Thank you.

Chris, I want to expand a little bit on the comments you made about your growing capabilities in IT.

Particularly, I wanted to see if you could add some fullness to the strategy for maritime sensors.

It's an area where you once dominated.

You are doing good work on the Virginia class.

But when you look at what happened with ACS, coupled with EP3 and P3 and U2 being handed over to the other guys, MMA lost, BMC Square lost, it sort of begs the question as to what your strategy is for Maritime Domain Awareness beyond LCS?

Okay.

Well, thanks, Heidi.

Relative to U2, we continue to work on that particular program.

So that one had not been handed over to the other side.

We have an Integrated Process team that works specifically on maritime control, and we are pursuing opportunities for upgrades of P3s, mainly in the international markets.

And we continue to look at C4ISR opportunities, and have some innovation and new ideas coming out of the skunk works in our Aeronautics business area.

So I don't disagree with your observations, relative to our prior performance.

But we have several business areas and entities that are focused on this area.

And we have a process to pull it all together at the corporate level to assure us that we are bringing the best solutions to our customers.

So I would keep an eye out for some announcements here, hopefully in 2006.

Okay.

And then getting to the quarter, too, you talked about where you beat consensus, it looks like by $0.20, and yet you only added about $0.10 to $0.15 to the full year.

What are the puts and takes that lead to this restraint, or is this just conservatism?

Well, let me give you the road map, relative to the $0.10 to $0.15 increase.

The first thing, obviously we had the $0.08 gain for Inmarsat, so that's just mechanical, and we obviously added that to the EPS outlook.

We did improve the EBIT in all 3 of our major segments that we talk about.

In Systems and IT, about $25 million of EBIT, rough numbers.

And a lot of that relates to our movement into adjacent markets, and new customers, including the FBI Sentinel program, as an example.

We increased about 25 million in Aeronautics, due to improved performance on the F-22 program.

And we increased our Space outlook by about $10 million as a result of some cost control initiatives that the team has put in place, and that we are realizing throughout the year.

So that's the operational improvement.

And then our tax rate, which we don't give specific guidance, but there is a slight increase in our tax rate, as a result of the research and development tax credit legislation being deferred.

And obviously under the accounting rules, we can't anticipate or build that into our models, and that probably cost us 100 basis points or so.

So the combination of those 3 items really come down to that $0.10 to $0.15 outlook, and we'll continue to look at it each and every quarter, and make adjustments as appropriate.

Just 1 last bit, and then I'll let someone ask a question.

But you did have this big ramp, pretty substantial ramp in Space, up 18% year-over-year.

But you were even up sequentially, which is not typically the case in Space, and so it looks like you are well on the course to do $8 billion or higher.

What happens to restrain that trajectory?

What are the offsets there?

Yes, absolutely.

Let me give you, at least as I look forward for the rest of the year on Space sequentially, I think focusing on sales obviously.

Second quarter will probably be flat relative to the first.

I see a dip in the third quarter on revenue and then a ramp-up again in the fourth quarter.

And this is the 1 business area where a majority -- where we have a significant amount of revenue that's contingent upon actual units of delivery.

And you should think of commercial satellite launches as 1 example, or Atlas or Proton launches as another example.

So the growth in revenue, this particular quarter was across the board.

Satellites, driven by both government and commercial, strategic and defensive missiles.

So it will be the lumpiness that we talk about, the timing of deliveries, especially commercial sats and launch vehicles.

And we're sticking with our overall revenue guidance that we had previously given on the Space business.

Steve Binder, Bear, Stearns.

Yes.

Over the last -- good quarter, by the way.

Over the last 5 years, your operating margin for the overall Company, pre-CAS/FAS, has been equal to, or below the full year average.

And you are kind of hinting that this would be possibly above the full year average, just by your guidance.

Can you maybe take us through why that's the case?

Yes.

Well, first of all thanks -- thanks, Steve.

It was a good quarter.

We talked in January on the call about the variability or the lumpiness, I guess is the term I have used to describe the volatility, I guess in not only revenue, but the earnings.

And as a reminder, probably 30 to 40% of our revenue is recorded and the related earnings on achievement of milestones using unit of delivery accounting.

Or also service contract accounting.

So you see that volatility, and I tried to highlight or drop a hint in 1 of the questions, that I would expect that to occur in 2006, specifically in the Electronics business area and the Space business area.

And both of those events have occurred here in the first quarter.

Basically, as I look at the 5 business areas, Aeronautics, ISS, and ITS, I see as kind of in the 9% range.

I think they were close to that here in the quarter.

And I would expect that trend to continue, probably each and every quarter and for the full year.

Electronic's Systems business area was-- had just an outstanding first quarter, driven mainly by missiles and fire control.

But I would expect each and every one of those quarters to be in the 10 to 11% range.

And our goal and guidance is better than last year, and last year was 10.5.

So with some good work, some wins and performance, maybe we get close to 11.

And then the Space, of course, is the most volatile based on the timing of launches, and the unique pricing depending on the customer, again, and launches in commercial sats.

So this should be, based on our guidance and the start we're off to, our sixth consecutive year of segment margin improvement before FAS/CAS.

I think last year we did 9.2%, and this should be 9.5 to 9.8 range, based on what we have talked about.

So I kind of like coming out of the year with a good first quarter and getting the momentum.

So that's how I see it playing out.

All right.

And then with respect to cash generation, I think back on the fourth quarter conference call, you said that you still expected a $500 million burnoff in customer advances.

But that half of that would be made up by improvement in the net balance receivables, inventories, and payables.

And you are starting off the first quarter as a source of -- customer advances as a source of cash, and it looks like you used a little over $200 million in cash in those other working capital accounts.

Do you still expect that plan to be achieved in '06?

Yes, absolutely.

We had a little -- as you said a little growth in the working capital, mainly delivered by, or as a result of some timing, just having some receivables paid in early April.

So I'm still sticking with the 500.

Maybe 450, to 500, if you want to fine tune it, relative to the advance burnoff.

And clearly, clearly see the other working capital accounts offsetting that.

Okay.

And as you see, we did increase our cash from operations outlook for the year, based on the performance and our outlook.

So good quarter all the way around, and we expect a little better working capital turnaround in Q2.

All right.

Thanks very much.

David Strauss, UBS.

Chris, could you talk about the performance at I&TS?

If you back out the acquired revenues, it looks like that business was down again this quarter.

I thought at this point, the runoff at the NASA business was for the most part behind us.

Could you just talk a little bit about what is going on there?

Yes, absolutely, David.

Why don't I -- I'm going to ask Jerry to take you through the lines of business.

But I can assure you this is the last quarter that we will be talking about the NASA runoff and burnoff, because from here on out, it's a push.

But, Jerry could you give David a little more detail?

Sure, Chris.

David, as you can see on the release, the I&TS business in total had sales growth at greater than 9% quarter-over-quarter.

As Chris mentioned, obviously a component in there, which was some headwind we had to overcome, was NASA.

That business, as we communicated to you previously, continues to decline on us, and it's down materially from the quarter a year ago.

The defense line of business is a second line in the I&TS portfolio, and that's pretty flat from last year quarter-to-quarter.

The IT is I think where you're really centering the third line of business, actually reported sequential growth, or quarter-to-quarter growth of over 30%.

Now, to your point, some of that was from the acquired business on Citex and Aspen.

But even if you pull those out of there, we're still looking at mid single-digit organic growth.

So it's not down.

It's absolutely on a positive trajectory.

A couple of other points to be made, this is obviously the area that we won the FBI Sentinel program that Chris mentioned.

Here in April, we won the Information Technology Enterprise Solution ITES contract.

So we're seeing some additional help in this portfolio.

Okay.

Thanks a lot.

Chris, could you just comment as well, where we are on ULA?

Yes, I would be happy to David.

As you know, we announced this joint venture almost a year ago.

It was actually May 2nd of 2005.

Since that time, I think we have been responsive to all of the government requests.

And what we're planning on doing, is discussing this in detail with our Board of Directors.

We have a regularly scheduled Board meeting on Thursday, 2 days from now.

And at that time, we're going to review with the Board the status, and have the appropriate discussion.

So, that's our plan going forward.

Troy Lahr, Stifel Nicolaus.

Can you guys just give me a rough idea on what you guys are looking for for international sales this year?

I think last year it was around 13%.

Has that kind of creeped up?

Or are you still thinking in line?

And did you have more international orders this quarter, or more international activity?

Yes, Troy, we have -- I think you are right, it was around 13% last year.

We're probably looking in that 15% range, give or take a little bit.

We're focusing on the international orders.

A lot of those orders, dealing with Aeronautics, don't actually turn into revenue for maybe 18 months or 2 years, especially if they are dealing with F-16s, or C-130Js.

We're looking at other opportunities in the information technology arena, missile defense, radars, as other examples.

But I think we're going to be in that particular range.

And in that number, I include both the direct sales and the foreign military sales.

Longer term, as the Joint Strike Fighter moves into production towards the end of the decade, clearly you could anticipate significant growth from that.

But I'll stick with around 15% as the current outlook.

Okay.

And with that, on Joint Strike Fighter, it seems like we're starting to hear more complaints about -- from foreign suppliers about work content on that program.

Is this just kind of a normal -- normal kind of complaining?

Or is this actually kind of worrisome for you?

And kind of what are you doing to kind of -- kind of ease some of those complaints?

Yes, I don't think I would like to refer to our partners and potential customers as complaining.

I would say this is just the normal posturing, and completely as expected as we have been working on this program.

We have one of our dedicated executives, Tom Burbage, who has great relationships around the globe working with our partners and customers.

And we're very satisfied with the progress that we're making, and addressing everybody's concern.

And again, focused on best value.

That's been our mantra, and we'll continue with that.

And hopefully by the end of the year, we start hearing some other comments relative to potential orders and quantities related to that program.

So we're satisfied with the progress we're making, and we'll keep you abreast if that changes.

Anything in particular that you would highlight now that we should look for at the end of the year on that program?

Well, I would say the first flight is a pretty big milestone.

So that should occur towards the end of the year, and I'll make sure it's appropriately highlighted, and we'll get a fair amount of press.

So that's probably the big milestone that would be visible to the outside.

And of course internally, there's all sorts of processes, reviews, design reviews and such.

I think the international agreements as I alluded to, may also start to get signed and highlighted.

So you can use that as another benchmark to follow the progress we're making.

Cai von Rumohr, Cowen & Co.

Yes, not wanting to beat a dead horse, but your margin fall-off from the first quarter. specifically, Electronic Systems, where you did 12.3 and Space where you did 9.8.

You'd mentioned milestones.

Can you be a little bit more specific in exactly why those margins were as good as they were in the quarter?

Sure, Cai, I would be happy to.

We've worked for a half a decade to get 10%, so I would like to at least acknowledge that accomplishment before we start talking and the fall-off.

I guess in Space specifically, what we had there was about, I think about $40 million of additional earnings, and 20 of that was from the Strategic and Defensive Missile line of business, specifically with the fleet ballistic missile, and some of the other programs in that line of business.

And the other half dealt with launch vehicles.

As we were able to reduce risk and definitize the EELV launch capability contract.

And that allowed us to update our estimates to complete and make the appropriate accounting adjustments.

Specifically, in Electronic Systems business area, that deals with our international air defense missile programs.

And those achievements or milestones -- milestones tend to be deliveries of technical data, testing successes, or other agreed upon milestones that we hit.

So I would just characterize it as good contract performance, and very consistent with what we had expected, and what we tried to T-up back in January.

So if we can keep Electronic Systems business area in double-digit margins, which we have done for several quarters, and are forecasting to do for the remainder of the year, I think we're very satisfied with that performance.

Okay.

Follow-up on stock.

You bought 11.8 million shares, and yet your share count didn't go down.

It looks like slightly over 11 million shares were either option exercises.

Could you comment on where you expect option exercises, where those might be for the year?

And kind of your strategy for share repurchase in light of those higher option exercises in the quarter?

Sure, I would be happy to.

We can't, obviously, predict what sort of stock options will be exercised.

That's an individual decision made by those people who are exercising the option.

Having said that, I will tell you that we are committed to pursuing our share repurchase program, and to reducing the number of shares outstanding.

As we said earlier, we ended the quarter with 429.5 million shares on the balance sheet, and it would be our expectation that we would have fewer shares on the balance sheet at the end of next quarter, and end of the year.

Joseph Campbell, Lehman Brothers.

Yes, first I wanted to say, we love this automatic transcript that's on the web.

That's pretty cool.

Oh, well great.

I wanted to ask about the-- , go back to the same old thing you have promised us and told investors that you would do when you have met these commitments to return about half -- at least half of the free cash flow to investors.

And as Cai pointed out, you have pretty much hit that milestone in Q1, if we take the dividends out of about half the cash flow guidance, subtract the dividends, you would just be about done.

On the other hand, the M&A activity is pretty, I would say, small, relative to the size of the cash flows.

Can -- does -- do we really expect to be able to do half of the cash in the M&A?

These seem like very tight standards.

And then the other is, if you are going to have that many options exercised, you'll really probably have to do a lot more than half, in order to make a serious dent in the share count.

So I'm just wondering if maybe we should update for this year that 50/50 expectation?

Okay.

Well that was a rather comprehensive question.

Let me see if I can try to hit the high points.

I'll answer the free cash flow question, and then maybe Meg can talk a little bit more on M&A.

We have met these commitments for several years and, as I've said the -- what we have said is the majority of our free cash flow will go back to our shareholders.

I think our lowest year ever was 55% of the cash.

We have gone as high as 72% of the cash.

And I know the desire for a specific formula and dollar amount, but we like to stay flexible, relative to all of our opportunities.

And I think over the last 5 years, we can all agree that the cash deployment has been, in my opinion, pretty well thought out and generated a lot of value for our shareholders.

We elaborated, I think maybe it was the third quarter of last year, to further clarify that in addition to returning at least 50% of the cash, we would also start to manage the share creep.

And in a quarter like this, where we had, I think close to 9 million options exercised, we tried to address that with a very aggressive share repurchase program.

So it's really a 2 step committment.

Number 1, the 50% commitment.

And then overriding that, of course, would be the offset as a result of the share creep.

And that is easily measured and determined by looking at the balance sheet.

I understand the fully diluted share calculation gets a little bit more confusing, but at the end of a quarter, it basically self-corrects.

And if you have fewer shares on the balance sheet, your fully diluted shares will go down mathematically.

So that commitment will be met, and as you suggest, may have already been met in the first 90 days of the year mechanically.

But we are not stepping back from the share creep reduction.

And I'll ask Meg, maybe to talk a little more about what we're seeing in the M&A front and what we are doing there.

Sure.

I have to say, I think some people on Wall Street were concerned when I got this job.

If someone was going to be running M&A, and also in charge of corporate treasury, they might have the fox in the hen house.

And I'm happy to report that that is not the case.

That they should not be concerned.

We have very disciplined approach to M&A.

Part of the reason that we have an opportunistic share repurchase program, and use it as an open market program, rather than doing what some of our competitors have done, is that we will be looking at our cash deployment, and thinking about what opportunities are in front of us.

As I'm sure you understand, we see hundreds of potential M&A transactions every year.

But, we only are going to pursue those opportunities that meet our strategic operating and financial goals.

They have to be M&A transactions which will indeed provide additional returns and growth for our shareholders.

And we are seeing some attractive opportunities, but we are not going to pursue anything which is not going to improve shareholder value.

So we will at least contribute 50%, possibly more of our free cash flow to our shareholders.

And if we kind the acquisitions we hope will we find, we will make some impressive acquisitions and add to shareholder value.

Well, thanks for the comprehensive answer.

Byron Callan, Prudential Equity Group.

I just want to follow-up on kind of the margin issue in general.

Because earlier this year, there was a GAO report, and then some congressional hearings on award fees to defense contractors.

And I think Ken Krieg is on record as saying the criteria for fees are going to be tightened.

I'm just curious.

I mean, has this affected your thinking at all about how margins could trend, not just this year, but next?

Are you seeing any evidence of this sort of change washing through the Department of Defense?

Or is it just a non-issue?

Well, I think it's getting a lot of coverage both by the GAO report.

It is characterized sometimes in the press and otherwise as a bonus.

And I just want to make it clear, that that in fact is the profit that we earn, based on our performance.

So I think sometimes it may be mischaracterized when we enter into a contract.

The fixed price contracts are pretty well known and understood.

The costs are estimated, and it's our responsibility to execute to the schedule and cost and that generates our profit or loss, based on our abilities.

On the cost reimbursable contracts, the award fee is generally the compensation and the profit that we earn.

It's clear that everybody understands the need to have returns above our weighted average cost of capital.

And we're continuing to monitor this.

But I guess we haven't seen an impact yet, and I guess when I look at our guidance, it doesn't factor in any significant change relative to government policy.

So as long as we meet the customer commitments, the contractual milestones, I think it's appropriate that we receive, as well as our competitors, an appropriate return.

As we have talked about for decades, the need to attract talent to this industry to keep it healthy and viable is in the best interests of this country.

And I think everybody in the government understands and appreciates that.

And I would not expect any policy to be a step back from that.

Okay.

Good.

And then just a housekeeping follow-up.

Competitions upcoming.

You have still got CEV and I guess, CSAR-X.

These are probably now more in the August, September time frame.

Anything else that's in the "bigger than a bread box" category?

Bigger than a bread box.

I guess we're seeing a fair amount of these IDIQ, indefinite delivery, indefinite quantity.

We have had a couple of early wins here in April.

One known as ITES 2S, just an acronym that is Information Technology Enterprise Solutions for 2 Services.

We're hoping to hear on the Army Corps of Engineers.

We think that would be a good opportunity for us.

Department of Homeland Security has a contract known as Eagle.

You already mentioned the combat search and rescue.

There's some radar opportunities for the CGX.

Those are probably small diameter bomb.

We just won a down-select a few weeks ago.

Those are all in the second quarter.

One that we may hear early next week or later this week, is the Advanced Precision Kill Weapon System, also known as APKWS.

And then of course, in the third quarter, assuming everything stays on schedule, the Secure Border Initiative could be an exciting opportunity for us.

And fourth quarter, maybe a follow-on to the Littoral Combat Ship, Joint Tactical Radio.

All of those types of programs.

So we have got a pretty good pipeline that we'll keep you abreast of.

David Gremmels, Thomas Weisel Partners.

Chris, on your Commercial Satellite business, you had 1 delivery in the quarter.

I think previously you talked about shooting for 7 for the full year.

Is that still your expectation, and do you have a guess as to how they'll be split out across the year?

Yes, I think what I said back in January was 5 to 7 for the full -- for the full year.

You are right, we had 1 in this quarter.

We just had a successful launch here in April, that was both in Atlas, our seventy-ninth consecutive Atlas.

And that was one of our commercial satellites.

So we have already delivered 1 here in the second quarter.

And I don't have the manifest in front of me, but I think they are pretty- -- , pretty evenly distributed throughout the year, kind of 1 or 2 a quarter.

And these things have a tendency to slip, based on launch availability and weather, and all of the other uncertainties in space.

Okay.

That's clear.

And just a clarification on the share count discussion.

The 429.5 at the end of the quarter, is that the-- I just want to confirm, that's the diluted share count, correct?

No.

That is what is on our balance sheet.

The fully diluted shares for the quarter were 441 million.

Average fully diluted shares, 441 million for the first quarter of '06, which is less than the first quarter of '05, and which is less than the full year average fully diluted shares for all of '05.

So of course the difference relates to the timing of the options versus the share repurchase.

And then of course, you have to factor in the dilutive effect of the options that are in the money.

So that's the reconciliation for the balance sheet of 429, to the income statement of 441.

And we would expect both those numbers to trend down, second quarter and throughout the year.

What share count are you assuming in the EPS guidance?

Well, we're kind of in the 440 million average fully diluted share range, give or take a few million.

It's not very sensitive to those numbers, but in that range.

And clearly a reduction over the prior year, by at least 5 million.

Thank you.

Doug Harned, Sanford Bernstein.

Could you talk a little bit more about Electronics?

And I know you mentioned before, international air defense was part of the good margins that we saw in the quarter.

But could you talk about the individual components and where you are seeing margin improvement, and if there's weakness somewhere there as well?

Yes, why don't I do that.

We really have 3 major lines of business within Electronics that we talk about.

The maritime systems and sensors, the platform training and transportation solutions, and then of course, missiles and fire control.

When I look at the revenue, first of all, we had almost $400 million of revenue growth.

MS2 was up about $100 million, the Platform business was -- and then -- MS2, part of that would be driven by the Littoral Combat Ship, and the Deep Water program for the Coast Guard.

The platform, TTS, of course, would be where we have the Presidential helicopter, which would be generating again, the revenue growth.

And then, missiles and fire control was in the $200 million range, for a total quarter-over-quarter growth.

Relative to the actual earnings, same trend, each and every one of the 3 lines had actual more dollars of EBIT, and more margin.

I guess I would call out missiles and fire control as possibly -- because, again, of the air defense missile programs, the international business having the higher margins of the 3, MS2, both of those being double-digit for the quarter, and for the full year.

And then the platform business, more systems integration, less investment, tends to actually have higher returns on invested capital, and lower margins, part of that being the cost plus nature of some of their key programs.

But that's kind of how I see it, and then in total, solid double-digit when combined.

And when you look forward, is this something that you see -- I mean in each of these areas, is this something that we expect stay at about these levels across these areas?

Yes, I would say that's probably a fair assumption.

I mean, also I think there's close to 2,000 contracts, just in our Electronic System business area.

We see sequential growth quarter-over-quarter in Electronics, when I look at the top line, and I think that's a key driver.

We should hit over 3 billion of revenue in the fourth quarter.

And with that will bring the appropriate earnings.

But this is a business area where we have won a lot of business in '04, '03 and historically, we had talked about it when there were questions as to why we couldn't get to 10%, I think that was back in '03.

We had a fair amount of cost plus work, a lot of developmental work.

And through the natural life cycle and progression of these programs, we're starting to enter into production.

We're starting to enter fixed-price contracts.

We're starting to sell some of our products and services abroad.

Each and every one of those traditionally bring with them higher margins.

So I guess as the business area matures and the programs mature, we're seeing that in the bottom line, exactly as you would expect.

And again, just outstanding performance across the board.

They have very difficult technology that they are working on, and doing a great job.

George Shapiro, Citigroup.

Yes, Chris, if I look at the Space business, I mean the margin's up from last year, and you gave the reasons.

But you had additional -- you had a commercial satellite launch, which I assume is still around break-even for you, and you had 1 less Atlas, which is a fairly profitable contract.

So when you go forward, why would the Space margin actually come down from what we see in this quarter?

Well, your assumption on commercial satellites is generally correct.

So, I did say in answer to an earlier question, that there would be 5 to 7 commercial sats.

So if those are break-even, I guess we have 4 to 6 to go, thinking 4 or $500 million of revenue without significant margins.

So that, in and of itself, would be dilutive.

I think the assumption on the Atlas profitability may not actually be accurate.

Those-- especially -- well, those just aren't like they used to be 5, 10 years ago.

Those tend to be just above break-even on the commercial launch and the government launch, which is why we have talked about the ULA joint venture.

So I would just look at those.

I mean, the core government satellite business is performing well.

That is solid.

Strategic and defensive missiles are solid.

I would attribute it, again, it to the launch vehicles and to the commercial sats.

I think on a to-go basis, each and every quarter is going to be right around the 9% range, which, again, if I go back 2, 3, 4 years, I don't think anybody thought was possible.

We continue to focus on identifying, mitigating, and reducing the risk.

And when we're able to do that, and hit these commitments and have the mission success events, we tend to see better earnings, which I think is the way it ought to be.

And if I look at Aeronautics, you had a 9% margin.

Only 2 C-130s, and you are probably going to average better than in subsequent quarters.

You boosted the margin on the F-22.

I'm not sure whether it's higher than Q4, or just higher than Q1 last year?

So why wouldn't the mix be more favorable going forward in Aeronautics so you wouldn't exceed the 9% you reported this quarter?

Well let me take them one by one.

C-130J, we have given guidance of 11 to 13 deliveries.

So, we have 2 out.

I guess that's 2 to 3 a quarter from here on out.

Those tend to be right in the double-digit, 10% or so range.

So that's really not going to move the needle too significantly.

Again, Joint Strike Fighter, we have talked about being mid-single digits.

We are seeing sales growth in JSF '06 over '05.

So that pretty much offsets the J, relative to the revenue.

And of course, the dilution relative to the earnings.

And then F-22, we're now in the upper single-digits, which is an increase over the first quarter of '05, relative to the fourth quarter of '05.

I don't think there was much of a significant change in the booking rates.

So I will mention that we did also increase the outlook for the year.

If you recall in January, we gave guidance below $1 billion of EBIT, and we're now committing to at least $1 billion of EBIT, up to 1 billion 25.

So we've tried to factor in that good performance.

And again, the F-22 program is doing very well.

We have in fact -- if you look at zero defects, we have recently had 5 jets delivered to date, that have had no quality findings by our customer.

And to have 5 zero defect aircraft is something we're very proud of, and I think it's something that is quite unusual in a tactical aircraft program at this stage of it's production.

And then something that may not have been well-known deals with a Congressional commitment.

I think, George, you may have remembered, it was back in 2004 that Congress mandated that we deliver 37 F-22s between August 2004, and January 2006.

And I think there was a lot of doubt and concern as to whether we could do that.

And we're very proud of the fact that we were able to achieve this as planned, and the program is back to its contractual delivery schedule.

Which again, is indicative of how well this program is performing, and how well the team is focused, as well as our partners, on meeting our customer commitments and delivery schedules.

So all of those things combined are contributing to the 9%.

And again, I think this is probably the fifth straight year we have improved these margins.

And when you are talking about a 10 or $11 billion entity, 20, 30, 40, basis points is not as easy as it would appear.

And I think the team is doing a great job, and we look for that to continue in subsequent years.

And 1 last probably little one, Chris.

But if you looked at other in the unallocated corporate break down, it was minus 12.

And your previous guidance had been that that would probably run something positive, maybe 5 to 10 a quarter.

So what caused that to swing to the negative number from the positive number?

And I noticed you took your guidance down for that -- for that sub piece, a little bit as well.

Yes, there's not much there.

I would just characterize it as timing.

We expect the next 3 quarters to be positive.

Little less interest income, as we have been very active in share repurchase, and timing of corporate expenses.

So nothing unusual there.

Howard Rubel, Jefferies.

Just a couple to wrap things up.

First, if you go back to Space, the fact it looked like took a charge in commercial satellites in the quarter, so the numbers would have actually been a little bit better.

Chris, is there something there that you are either doing to expand the business, or was it a glitch, or could you just elaborate for a moment?

Yes, there's nothing really there.

All we do is, given the commercial nature of the business, is we -- as I talked about before, we expense our G&A, as that can't be recovered, and put on to the contract, just using GAAP accounting.

So it's the ongoing operations of that business, just have a burn rate really related to G&A.

We talked about the launch being basically break even.

So nothing unusual there.

I wouldn't call it a charge.

I would just say expensing the ongoing cost of the business.

Could you talk about your win rate for a moment?

It looks like some of the things you highlighted clearly indicate you are winning well north of 60% of what you are pursuing.

And does that sort of have some implications for sort of some further acceleration in growth in the IT, and the IS -- IS -- what the heck -- you know what I'm talking about.

The information systems area.

Yes, ISS.

Thank you.

Yes.

I got to tell you, when it comes to competitive win rates, I have always been amazed at all of us somehow win 70% of the business, which mathematically, can't be possible.

So how you measure that metric is always -- .

Is fun.

-- [inaudible] and you either win or you lose.

I can assure you that one thing we are focused on is opening the aperture, and not only staying in our comfort zone and giving existing products to existing customers, we're looking for new products, new systems, new customers.

We have had lots of examples over the last 18 months.

And we rather the team go out, be innovative, be creative, try to get some of these opportunities that people don't normally think of Lockheed Martin as bidding military vehicles or trucks or national archives work or FBI work.

And if we have a lower win rate as a result of that, we are not at all discouraged by that.

But I think your assumption that we're satisfied with our win rate, whether you measure it on number of contracts or number of dollars is fine.

But we're very satisfied with the progress, and there will be a couple of big opportunities in the next quarter or 2, and we'll see how those play out.

Sheila.

This is Jerry.

I think we're coming up on time.

I'm going to take 1 more question.

Myles Walton, CIBC World Markets.

Good quarter.

The lower F-16 volumes that you talked about in the press release.

I realize it's higher deliveries.

Is this a [spares and support], or is it a mix of percentage of completion in unit delivery?

It's the latter, Myles.

And it's about just in the $100 million range for the quarter.

And nothing unusual.

Okay.

And the only other question I had to wrap it up, was on the LCA program.

So you anticipate putting an offering into that program?

I'm sorry you broke up -- .

The light commercial-- the light cargo aircraft.

The light cargo aircraft.

We're currently looking at that opportunity, and haven't made a decision.

We have got the normal process that we're going through.

I think, it's too early to say at this time what we're going to be doing on that particular opportunity.

Okay.

Thanks.

Okay?

Well let me just wrap up in summary, and say I believe it's clear to me that the management team continues to focus on shareholder value through consistent strategic and operational performance, through strong cash generation, through margin improvement, and through ROIC efficiencies, and risk reduction through improved processes over the enterprise.

Our approach to meeting the future challenges and opportunities is to continually widen the aperture, to be innovative, to be creative, and to be forward thinking.

We intend to expand our addressable markets as we did last year.

To achieve this expansion, we believe it's essential to build and maintain the trusted relationships with our customers by delivering on the commitments today, while offering additional value from the capabilities for tomorrow.

So as always, we thank you for your support of Lockheed Martin.

We look forward to speaking with you again in July.

Thank you, Sheila.

Thank you, sir.

And that does conclude today's presentation.

We thank you for your participation, and you may disconnect at this time.