洛克希德·馬丁 (LMT) 2007 Q2 法說會逐字稿

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

Today's call is being recorded and at this time for opening remarks, and introductions, I would like to turn the program over to Mr.

Jerry Kircher, Vice President of Investor Relations.

Please go ahead, sir.

Good morning.

Thank you.

Good morning, everyone.

I would like to welcome you to our second quarter 2007 earnings conference call.

Joining me today on the call is Chris Kubasik, our Executive Vice President and Chief Financial Officer.

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

Actual results may differ.

Please see today's press release and our SEC filings for a description of some of the factors that may cause actual results to vary materially from anticipated results.

We have posted charts on our website which supplement our comments today.

With that, I would like to turn the call over to Chris.

Thanks, Jerry.

Good morning, everyone.

Welcome to the call.

Consistent with our expectations, we had a strong quarter and are continuing to build momentum as we progress towards achieving long-term goals.

Our results reflect a solid performance of operations across the Corporation and our ongoing focus on program execution with financial discipline.

Let's start with a brief recap of the DOD budget deliberation and the global security environment.

The House and Senate continue to work on finalizing the '08 appropriations bills with the majority of our programs receiving strong backing.

Bipartisan support to replace aging assets through recapitalization activities should provide ongoing growth for a number of our programs such as the C-130J aircraft transport and the F-35 joint strike fighter.

We continue to believe the global defense and security environment will require significant expenditures for the near term in areas such as missile defense, intelligence, and Homeland Security resulting in increasing baseline budgets through the end of the decade.

World events driven by current and emerging threats will require wide ranging solutions to address the global security needs for our country.

As we respond to these environments, we continue to make progress on our strategies to deliver operational and financial performance, to differentiate and to diversify our portfolio.

Our strategy will enable us to build upon our demonstrated success in generating shareholder value.

In aeronautics, the F-35 joint strike fighter continues to make progress on all three variants under the development contract.

Flight tests are continuing on the conventional takeoff and landing aircraft as we expand the flight evaluation program that began with a successful first flight in December.

The second aircraft variant known as the short takeoff vertical landing variant also continues to make progress in fabrications as we prepare for first flights next year.

The third aircraft, the U.S.

navy carrier configuration recently completed air system critical design review, verifying the design maturity of the aircraft and associated systems.

This was a significant milestone in retiring risks and enables the program to move forward.

Information systems and global services achieved successful deployment of the first phase of the FBI sentinel next generation information management system.

This system enables data sharing and paperless information flow across the agency.

In electronics systems, four successful missile defense tests were conducted using both the terminal high altitude air defense system and the Aegis system.

These successes further demonstrate our expanding capabilities in the area of missile defense systems.

Additionally, in early July, the presidential helicopter program successfully conducted the maiden flight of test vehicle number two, moving the program one step closer to delivering this new aircraft to the President in 2009.

Finally, space systems had a number of successes.

The Trident fleet ballistic missile recently achieved the 119th consecutive successful test launch for the US Navy, a record unmatched by any other large ballistic missile or space launch vehicle.

Space systems also delivered our first commercial satellite in 2007 which marks the 32nd consecutive success of our A2100 spacecraft.

While demonstrating success and expertise in deployment of critical space assets for commercial satellite customers, we have continued to exercise financial discipline in pursuing new awards.

As a result of our selective approach to new commercial satellite opportunities, we expect a decline in 2008 with regard to commercial satellite revenue.

These operational successes represent a small number of the milestones that we accomplish daily in support of our customer's critical mission.

They also serve to remind us of the imperative to redouble our effort for flawless performance on all programs.

Our solid operational performance draws our financial results.

As you saw in our press release this morning, we had a strong second quarter financially.

As we discussed in our April call, we expected our sales growth rate to improve in the second quarter and it did.

We achieved an actual growth rate of 7%.

Quarterly sales profiles may continue to be somewhat volatile based on program composition and timing of delivery.

We remain on track to achieve our new full-year sales goals.

Segment operating margins were over 11%, an increase from a year ago and were driven by margin expansion across all of our business areas.

Successfully achieving certain performance milestones also contributes to the volatility of quarterly earnings.

Operating cash flow is $1.4 billion, achieved by higher earnings and improvements in working capital.

The $2.9 billion of cash from operations in the first six months of this year is a new record for the Corporation.

Based on our solid year-to-date performance, we're increasing our financial guidance for the year reflecting an improved outlook for additional growth in sales, earnings, cash flow, and ROIC.

We increased 2007 annual earnings per share guidance by $0.45 and annual operating cash flow by $200 million.

You'll note our backlog was down in the second quarter due to the cyclical nature of our business.

We continue to expect our 2007 ending backlog to exceed $70 billion for the seventh consecutive year.

Delivery of strong operating cash flow differentiates us from peers and positions us for disciplined cash deployment.

During the quarter, we repurchased almost 7 million shares of our stock.

Through the first half of the year, we repurchased over 14 million shares and continue to reduce balance sheet shares.

These share repurchases coupled with our quarterly dividend payments demonstrate our commitment to return more than 50% of our annual free cash flow to shareholders.

At the end of the quarter, we still had authorization to repurchase shares that would represent approximately $2 billion of stock at current market values.

As is our practice, we plan to discuss the potential for additional share repurchase authorization and new dividend levels with our Board of Directors in September.

An additional component of our differentiation is reflected by the ongoing investment we're making in the development of our work force and next generation leaders.

Construction of our new center for leadership excellence facility on the corporate campus is progressing and we're on track to have the center operational by the beginning of 2009.

This state-of-the-art facility will provide expanded training and development programs to our current and future employees.

Retaining and recruiting new employees remains a strategic imperative for the Corporation.

In fact, this fall we'll be visiting campuses to recruit approximately 5,000 new employees, interns, and co-ops.

Developing our talent is critical as we continue to diversify our portfolio in terms of new capabilities and customers and expand our activities both domestically and internationally.

We also are benefiting from diversification into adjacent market businesses with budgets supported by a variety of domestic and International customers.

On the domestic front, we have expanded the business with our traditional defense customers in areas such as sustainment and logistics.

We recently received an award from the U.S.

Army for sustainment contracts worth more than $400 million to support the Apache helicopter and the HELLFIRE missile program.

We've also diversified our domestic customer base by securing new awards for information management and system automation with customers such as the FBI, the Department of Justice, FAA, and the Department of State.

Growth from International customers also continues to diversify our business portfolio.

We signed agreements for the sale of 30 F-16 aircraft to Turkey and four C-130J aircraft to Norway, further expanding our production lines on both of these programs.

Finalized contracts for these awards are expected in 2008.

In addition to the growth in aircraft program, sales increased in targeting a missile system with selection of our Sniper advanced targeting pod by our eighth International customer and the U.K.

joined the U.S.

in placing orders worth more than $600 million for the guided multiple launch rocket system.

We believe these orders further validate our leading edge technology in missiles and fire control and are evidence of the growing International demand for our products.

Looking forward, we also expect International sales increases in missile defense on a number of our programs such as the PAC-3 and THAAD.

In summary, our results reflect strong program execution, operational improvement, and financial performance.

These operational and financial accomplishments and the positive business outlook highlight just a few of the ways in which our 140,000 employees work to create value.

We're on track to sustain our momentum to continue to deliver solid results.

We're making progress on our strategy of delivering, differentiating, and diversifying and are proud of the value our employees create for customers and shareholders.

We're now ready for questions.

Thank you.

(OPERATOR INSTRUCTIONS) We'll take as many questions as time permits.

We'll pause momentarily.

Our first question will come from Myles Walton from CIBC World Markets.

Good morning, Chris.

Good quarter.

Hey, thank you.

Back in January, when Bob was on the call, you talked about some longer term goals and one of those was 100 basis point improvement in operating margins and I guess you're a victim of your own success here.

It looks like the top end of guidance, you'll almost be there by the end of the year.

Can you just assure us that the margin expansion story from here isn't over?

Absolutely.

I think what Bob talked about were two goals.

Improving our margins by at least 100 basis points and $5 billion of EBIT so we still have a ways to go on the second part.

Absolutely.

We've made great progress so far at the six month point.

We've increased our guidance and you'll see that telegraphs to the high end of 10% may be low 11 by the end of the year.

Then we'll obviously go into a mode of sustainment and continuous improvement, probably not at the same rate.

We think and believe it is sustainable and look forward to working toward the second part of Bob's goals.

And then as a follow-up, if it I could, on the backlog, you mentioned it lumpy.

You wanted to finish above 70 billion by year end.

The F-22 I know has been certified by the (inaudible) for the multiyear.

Can you give us the timing and the size of that contract for you?

Yes.

We're looking at the timing being in the August time frame.

It has to clear through the congressional process here over the next couple of weeks then we sign -- it should be an increase of over $3 billion to our backlog.

We have received some long lead funding so the incremental increase to backlog will be over $3 billion.

Great.

Thanks.

Great quarter.

Thanks again.

Our next question comes from Joe Nadol with JPMorgan.

Please go ahead.

Great quarter.

Thank you, Joe.

I guess my question is on the space side.

You've really increased your revenue guidance for I guess the second half of the year materially.

Wondering what changed there?

That's driven by our government satellite line of business.

Anything more specific than that?

What might have changed?

Well, we have a variety of programs there, both classified and unclassified and there is also some new business opportunities in the latter half of the year.

GPS-3 and T-SAT and we've tried to factor in all potential outcomes but we're pretty confident in that range that we've given you.

But mainly government satellites.

Okay.

Then looking at next year, I don't want to get too far in front of you but you said before that you're expecting another dip in aeronautics next year.

And you talked about commercial satellites, obviously a much smaller issue.

But any kind of sense on the top line what you think next year might look like?

Overall?

Yes.

I obviously do.

I guess maybe I can talk a little bit about all of '08 and 2009 trends.

As you know is our practice, we'll give that detailed guidance on our next call in October.

On the top line, we are continuing to forecast the $1 billion decline in the '08 revenue from aeronautics that we talked about now for a couple of years.

Highlighted this morning, the headwinds from commercial satellites.

So, overall '08, I look at flat to low growth on a consolidated basis but clearly improving in 2009 driven by aeronautics returning to a growth mode.

Margins, as I mentioned, for Myles, that we'll see solid double digit margins.

We believe those are sustainable for the foreseeable future.

No change there.

EPS still looking for continued growth year-over-year.

When you eliminate the one-time nonrecurring items which, in our case, generally tend to be gains, I still see a path for double digit EPS growth on a recurring basis.

Cash remains very strong.

Our goal there is to have a track earnings and we've done that for several years.

I don't see any reason why that can't continue.

Then the other metric we talk a lot about is ROIC and I plan to continue our industry-leading position and maintain that in the 15% to 20% range.

That will give you some directional ideas as to how we're currently looking over the next year or two.

Thanks a lot, Chris.

That was actually a lot more than I expected.

Appreciate it.

Okay, good.

Our next question comes from Heidi Wood with Morgan Stanley.

Please go ahead.

Chris, nice quarter.

Thank you.

I want to go back to this margin question and address it on the ES and Aero realm specifically.

Can you talk to us about what you see as being the three to four structural reasons which would prevent ES and Aero being in the 13 to 15% margin businesses within the next two to three years?

Well, let me start with Aero.

First of all, as you know, we had just over 10% in the first quarter.

We're now over 12% for the second quarter.

Inception to date through six months at 11.4, we think that something close to 12% for the next two quarters is sustainable.

And doable.

Structurally, we've made great progress over the years as these programs transition from development to production, it is the goal that we've set for ourselves.

I still see potential upside.

As we transition into development, from development, International, continued risk retirement so I don't know if that answers the aero piece.

Relative to electronic systems, we're now at 13% which is a huge increase from where we were years ago when 10% was deemed to be almost unachievable.

So, I mean we're already at 13.

Another percentage or so.

Anything is possible.

But again, as you win new business, most of these new programs are, in fact, cost reimbursable and they tend to have lower margins.

As I've always said, I look at the combination of all of our metrics, I like the return on invested capital being sustainable and solid.

I like to win new business even it is at lower margins with infinite returns on invested capital.

It is a blend.

I'm very comfortable with where we are and I think we can continue to do better.

Based on your question, I guess the answer is no I don't see any impediments to continue the growth.

Yes.

That's what I was -- just with International growing as a percentage of sales and the transition to production on a number of your programs and the volume benefits that I was trying to get a sense of the sustainability, particularly in ES.

It sounds like you wouldn't characterize this quarter as a one off event but the beginnings of an upward trend?

I wouldn't characterize it as a one off.

In fact, when you look at the guidance increase that we've had, there is volatility quarter to quarter as we've talked about in revenue.

But it also occurs with the earnings based on program performance, inception to date accounting and such.

I really just look at the trends and momentum.

The trends are upward and the momentum is positive.

It is a good position to be in.

Then last question, can you talk a little bit about what you're seeing on the M&A front.

You were relatively quiet in the first half.

I am wondering if you expect any change in the tenor in the second half?

We haven't seen a big change in the market.

I think we have great leadership and processes in that area.

We're continuing to look at opportunities.

We're getting incoming calls from companies which I think is always a good sign that people want us to look at them.

We continue to have a selective process and as I've said before, we don't set specific goals.

If they work and they make sense strategically, operationally and financially, we'll pick up a few companies.

If they don't work for whatever reason, we just move on.

So, the process continues and I'm indifferent as to whether we do them or we don't.

Depends if it's a good deal, I want to do them, if they're not good deals, we'll just keep on running the business and worry about it at a future date.

Great.

I'll let somebody else ask questions.

Thanks a lot.

Joe Campbell with Lehman Brothers.

Please go ahead.

Yes, good morning.

It is actually Carter Copeland.

Good quarter, Chris.

Thanks, Carter.

I wondered if you could touch on IS and GS a little bit, the growth in the quarter was particularly strong and it looks like on an organic basis you were in the sort of midsingle digits after a flat Q1 and a couple of the pieces in there being down last quarter.

Were there particular areas of strength that you would note or anything that we should be noticing here in terms of trends in this business that give you sort of confidence in the back half of the year?

Absolutely.

Good question.

We had talked in April, a fair amount of questions and discussion on the growth in IS and GS.

I think at that time I had said that I had high confidence we would grow at least 15% in the second quarter and as you stated, we grew 17%.

About half of that is organic when you adjust for the four acquisitions, MSDS and PAE in Savi.

About half of the 17% is organic.

I think the information systems line of business is the one that we highlight the most and I think is of the most interest.

In the quarter, information systems grew 16% on a reported basis and 11% organically.

So, we've talked about double digit growth for the full year for information systems.

And IS and GS both reported it in organic.

I don't see any reason why we would change that outlook.

In fact, we've been successful in winning new business.

There continue to be new opportunities and as I mentioned, the entity is performing very well on all their programs and that brings in new business and new growth opportunities.

So very pleased with the IS and GS results.

We expect that to continue for the next several quarters.

Great.

And then switching gears here a little bit.

We're now halfway through the year.

When you think about pension and the possibility of potentially putting more cash in there than required contributions would be, are you thinking about that differently now, halfway through the year, or still waiting and seeing -- how are you thinking about pension as we head towards '08?

It is always a possibility.

It is one of the several options we have in our cash deployment toolbox.

I tend to start to focus on it, more into the late third to fourth quarter.

I think we prefunded since 2003.

It is always a possibility, there's's a lot of cash on our balance sheet.

Just need to constantly understand the ever changing rules in pension reform and how it impacts the risk of the DOL, the tax deductibility, and the government allowability.

So, it is kind of a complicated model.

We'll look at it again and not averse to doing that based on prior experiences.

Great.

Thanks.

Great quarter.

Thanks again.

Our next question will come from George Shapiro with Citigroup.

Good morning, Chris.

Good morning, George.

Nice numbers again.

Thank you.

If you look at the space business and you take out what looks like maybe 200, $225 million because of the taking out of ULA and stuff, can you break out then how much growth there actually was in the satellite business and how much growth we might have seen in the crew contract?

Yes, let me have Jerry give you the details.

The 2% reported decline is actually 4% organic for the quarter.

On a year-to-date basis, our 5% decline is 6% organic but let me have Jerry give you the line of business details.

Sure, George.

The government stats in terms of growth between the years is up about $300 million, a little over and a little north of that.

As you know, the commercial stats caused some headwind when you compare to second quarter George, because we had two launches last year and only one this year.

So there is a negative comparison that we're having to cover there probably a little north of $100 million of headwind.

As Chris also noted, one of the comparisons that is causing our negative sales to show for space is the ULA joint venture accounting treatment which caused about another $100 million or so of headwind.

So between us, it is a couple hundred million dollars of pressure that causes the negative comparison, but if you adjust for all of those, George, to your point, I think the fundamental space business is performing very well with positive sales contribution that is actually closer to 9 or 10% of the total portfolio level.

So, it is doing very well.

Okay.

One follow-up, Chris.

You had about a $400 million increase in advances which obviously helped the cash flow.

So, where do you look -- where do you look for advances to do in the second half of the year now?

I look for advances to decline in the second half of the year.

You want to put a number on it?

I think I've missed this number for years on end, given the volatility and the timing but I'm going to give Jerry an opportunity to put his number.

I look at top line.

I like more cash than earnings and I like to manage the working capital as a portfolio, but Jerry, you want to make a prediction?

This is the second quarter in a row you've asked for a prediction, Chris.

I think the answer is as George knows, we've been saying that we expect a second half burnoff.

One of the benefits for the first quarter and why we're $300 million year-to-date for the first half of the year is the customer advances have been very strong, but George, we're expecting a burn off in the back half but the punch line is we still for the fourth year in a row, will have working capital management yield favorable cash contributions to the Corporation.

So, it is still positive in the back half of the year from a working capital standpoint.

$500 million is my prediction, George.

Maybe a little less, Chris.

Because I don't recall Jerry giving you a number.

Chris, is that what is baked into your cash flow guidance?

Absolutely.

So, that's another number you'll probably beat.

Anything's possible, George.

Okay.

Thanks.

We move now to David Gremmels with Thomas Weisel Partners.

Good morning.

Good morning, David.

Chris, can you just give a little more detail on the great margin performance at aeronautics in the quarter?

Was there any cumulative adjustment in there?

In terms of guidance, you guided up the high end of aeronautics earnings by 12%.

What's improved so dramatically over the last quarter?

There clearly were step ups in inception to date accounting mainly in the -- well, our two lines of business here driven by risk retirement and a very strong performance.

We're doing a much better job with our subcontractor management with our cost performance.

We're hitting our key milestones.

Retiring the risk, making the deliveries.

These programs continue to gain in momentum based on their maturity, but in combat air that was the main driver of our earnings increase and F-22 in particular had a -- continued to have a very solid quarter and a solid year and we're now in the upper single digit margins on that particular program.

F-16 remains very solid.

And even the C-130J.

So, the key here is to have a smooth and consistent production flow and when I look at those three programs, the F-16, the F-22 and the C-130J, the team in aeronautics, Fort Worth and Marietta, and Palmdale are doing an outstanding job and we're seeing it in the results.

So, we got the step up here in the second quarter and then we'll sustain those booking rates obviously in Q3 and 4.

Does that help?

It does.

And so you mentioned F-22, F-16 and C-130J.

No mention of JSF in there.

Can you just maybe touch on the JSF margin trend in the next milestones?

You mentioned the first Stovall flight earlier.

Wondering what other things we should be looking for.

Yes, the JSF, as we've talked about in the past, continues to be mid single digit margins.

We had more earnings this quarter from JSF due to the volume, the sales volume increase, but mid to single digits for $25 billion program, Stovall is probably that first flight in the first half of 2008 is probably the most visible part as I reported, I think, back in April and even January, great teamwork and cooperation from the International partners.

In fact, Bob Stevens was just over at a CEO conference with JSF with government officials from around the world and our partners and teammates.

Again, status is very strong.

And favorable reports.

So, Stovall will be the most noticeable.

We'll be sure to give you updates on a quarterly basis as to what's going on.

But very pleased with that program.

Thanks and congratulations on the quarter.

Great.

Thank you very much.

We move next to Troy Lahr with Stifel Nicolaus.

Thanks.

Electronic systems, I think the maritime systems and sensors business first quarter had some growth and then the second quarter it had sales decline.

What's moving on there?

Second quarter sales continues to be -- we're up 8% obviously in the quarter.

Maritime systems is now basically flat on a year-to-date basis and we're seeing good control or good growth in missiles and fire control and the platform training and energy businesses so, 6% growth top line year-to-date.

We're projecting all of our businesses or lines of business to grow for the full year to get us kind of in that 4 to 6% range.

So just kind of a lumpy quarter for maritime?

In the second quarter?

Yes.

Yes, I guess that's a good way to characterize it.

I mean nothing unusual.

We still have in that line of business, unit of delivery, passage of title accounting.

I'm looking at these maritime growing 5, 6% for the full year.

No concerns there.

Okay.

And should we expect a contract closeout on I guess maybe it's lot four on F-22 in the fourth quarter?

I don't know about a contract closeout but we're -- oh, lot four?

Well, we're making deliveries on F-22 from lot five.

And all the lot four aircraft were delivered last year but I must be misunderstanding.

I don't see any significant step-ups or positive or negatives as a result of lot four.

We continue to have warranty and other costs that we incur.

I think it is going to be invisible and not significant to the outside world.

So, you don't expect -- I think fourth quarter of last year, you had a contract closeout adjustment on F-22.

You wouldn't expect that again in the fourth quarter of this year?

I wouldn't think so.

I think last year may have been just finishing delivery and stepping up the booking rate but I think we had a pretty strong fourth quarter in deliveries and I think your memory is right.

We just completed the deliveries and obviously had a better estimate of our actual costs but no, I wouldn't expect anything like that this time.

Okay.

Thanks.

We take our next question from Rob Spingarn with Credit Suisse.

Good morning, Chris.

Good morning, Rob.

Just going back to aeronautics for a moment and then a question on ES, but you've upped the guidance there on the EBIT side, I think maybe 30% from where you started back in October.

You talked a little bit about the sequential increase from this latest quarter for March.

But what is it that's happening differently in each quarter that keeps this incremental push upwards that maintains that?

What is it that you can't foresee further into the future?

Well, I think I can foresee a lot of things in the future but you still have to have the performance and the factory and the production and eliminate the risk and achieve milestones as these programs transition whether it is follow-on work, technical milestones, subcontract management and such.

I'm pretty comfortable with where we are now and we made a substantial move, as you suggested, based on what we're seeing and the statistics that we monitor coming out of our factory and our production flow.

So, this is my best estimate for the remainder of the year and I would expect that the aero team can deliver.

It is not easy to get close to 12% (inaudible) on this portfolio.

And they are doing it.

So, again, it comes down to performance and making deliveries on time.

As you know, these are large, complicated programs.

And I'm pleased with it.

Again, a lot of this deals with momentum.

I think we have positive momentum.

Chris, is there anything specific you can point to that they're doing so well that has exceeded your expectations?

Well, as you know, our business model on a lot of these programs, it is bringing forward the best team throughout the world on these programs.

I think we're very pleased with the performance of our teammates and our subcontractors on a variety of these programs.

It is important that they meet their commitments and milestones whether it is innovation, technical or schedule and they're in fact doing that.

I think on the cost control, we're doing a great job.

Mike Joyce heads up our operating excellence LM21 continuous improvement.

It is a culture of continuously improving and trying to do things better and we've been able to do that.

I guess those would be the two that I point to.

But again, these programs are in production or transitioning in production and the flow of the factory and the inventory management, all of those pieces, the underlying systems that support those are critical to making this work and they are, in fact, performing very well.

Okay.

And then just finally, on -- in electronics, this was touched on in an earlier question.

You said there were no one offs.

Were there perhaps any award fees baked in there?

The award fees we come through on a percentage of completion basis in accrued so you really don't get the volatility.

There are certain programs that have very specific milestones and maybe incentive fees as I would look at them.

I mean, there's several programs that come to mind.

I tend to not like to get into -- with 3,000 programs, specific ones, but there are some very visible events that are reported that usually involve missiles that are clearly successful and when they are, it is not unusual to have earnings associated with those types of milestones and as I said, we had a very good quarter relative to mission success and hitting these particular targets that improved our credibility.

Thanks, Chris.

Sure.

Steve Binder with Bear Stearns.

Please go ahead.

Good quarter.

Steve.

Chris, can you maybe just touch -- just a follow-up on electronic systems.

The words improved performance seem to dominate your release.

Can you maybe single out programmatically what some of the big drivers were?

It seems like it was fairly broad-based, the margin of improvement there.

How much of that was milestone driven versus just good cost performance in the margin improvement?

And while you're touching on electronic systems, just a little nitpicky point, amortization of intangibles did fall in ES in the quarter from where you were in Q1.

I'm not sure why.

Well, to answer the nitpicky one, that goes back to an acquisition that I think we made 11 years ago and the contract intangible that we identified is now fully amortized.

So, I think it was the Loral acquisition to be specific.

But if I recall we gave it a (inaudible) life and the 44th quarter came to an end.

That was the minor improvement there.

I guess across electronic systems, it is really across the board.

If I look at the three lines of business we talk about, maritime systems, missiles, and fire control and the platform training and energy business.

On profitability we continue to perform well in the energy business whether it is the atomic weapons establishment or the Sandia National Labs.

So, those are M&O type management and operation contracts where we basically get award fees and those are doing quite well.

Missiles and fire control, the THAAD program, if you want an example of a program by name had some very visible successes and that particular contract is structured to have incentive fees where we're incentivized to hit the target and we make more money when it hits than when we miss.

With that type of performance, that's why I characterize it as improved performance at missiles and fire control.

Maritime systems, there is some sustainment training work that we do there, mainly in support of aeronautics that aeronautics customers, F-16s that performed quite well also.

Those would be the big ones.

We talk about growing our sustainment on logistics.

You recall, we got a contract for the Marlin helicopter I think over a year ago.

All of those types of things working as a broad portfolio are doing quite well.

All right.

The other thing is with respect to working capital, I mean you talked about record cash flow for the first half of the year but if you look at working capital it was not as large a source in the first half as it was last year, would you expect -- can you maybe give us some sense of the second half of the year?

Do you see working capital being a source of cash?

Yes, I'll let Jerry give you some more details.

It was almost 300 million in the first half which I think is a great effort by the team.

Especially where many have thought there was no more juice to get out of this orange, I think we continue to find ways to do it.

The full year will be a plus.

Second half of the year will probably be pretty close to flat but again, we've told the team more cash and sooner is always better.

So, again, we're growing the top line and we do need some working capital to have the kind of growth we're having.

To continuously improve I think is a good accomplishment.

Jerry, you want to maybe give more details?

Sure.

Steve, you remember the first quarter, we had $70 million favorable working capital.

That improved another couple hundred million here in the second quarter so we're sitting as Chris said at $300 million favorable.

Second quarter performance was primarily driven by improvements in customer advances that we alluded with George earlier.

That was probably on the order of north of $500 million or so.

It is a meaningful amount of advances.

Primarily coming in in the electronics systems business area, Steve, as they expand their higher International activity both in missiles and fire control and maritime systems and sensors.

So encouragingly we're seeing more International business which brings more advances.

That was partially offset by some timing growth in accounts receivables.

I mentioned earlier, we expect those receivables timing to improve in the back half the year as the advances burn off a little, as Chris mentioned.

So, net-net, I think the receivables in the back half will improve by about the value -- not quite cover the value of the burn off of the advances Chris mentioned which is why we're probably slightly positive for the fourth year in a row.

But it will get a little less positive than it is in the first half.

Lastly, can you maybe just, Chris, touch on LCS the first ship, just give us an update on where you're at and how you feel performance is going relative to your last statement?

Also, do you think that you still have a chance, and society seems to be very interested in LCS, do you think you have a chance to compete Internationally?

I'll take the second half first.

We believe we have an innovative solution here in the International market, I see no reason why we cannot compete Internationally.

Historically, the International customers tend to follow our domestic policy so our goal currently is to get that first ship through the sea trials and delivered and have the best vessel available for the Navy.

I think we're making good progress on that front.

The team has focused on that one ship and we're working well with our partners and teammates in trying to ramp up the staffing to make sure we meet the time schedule.

Once we get that deployed successfully, the International market should be more interesting and available to us.

But that's our number one priority is to get that vessel to the Navy and then from there we'll look at other business opportunities.

Great.

Thank you.

(OPERATOR INSTRUCTIONS) We move now to Doug Harned with Sanford Bernstein.

Good morning.

Good morning, Doug.

I first wanted to ask about some of the programs that have been more difficult and you talked earlier about -- you just talked about LCS and you mentioned the Presidential helicopter earlier.

The president helicopter, right now do you see things as pretty much resolved with the Navy on this program?

I would say that both ourselves and the Navy and the White House believe that we're making good progress.

And most of the discussions relative to this program are driven by the requirements, not by the performance of Lockheed Martin.

So I think everything that's been disclosed and discussed previously is on point.

There was a very aggressive schedule from day one, there is an urgent need for this helicopter.

It is a very demanding mission.

We're all working together to make sure we can get the best aircraft possible for the President.

I think everybody is kind of on the same page and working well together and jointly with the objective of having the first delivery by October 2009 which is our -- initial operating capability date.

Good progress as I mentioned July 3, with the first flight of the test vehicles.

So I don't think there is a lot of separation between the key constituents as to what we're trying to accomplish.

Where we are, and again, my comment on trends and momentum.

The trend is positive and the momentum is strong and we're quite satisfied with the progress we're making.

There's more work to do.

We'll keep you apprised as we move forward.

If you switched over to the JASSM Program, where does that stand now and how do you see that impacting performance, if at all, going forward?

Well, relative to JASSM, we were able to get, the program was endorsed and we have jointly worked with the Air Force to develop a missile reliability program.

We're sharing the costs of that reliability program with hopes of having the program recertified under [MON McCurdy] in the May 2008 time frame.

And any impact or investment has already been factored into our guidance for the full year.

So, our goal there is again to make sure that we get the Air Force the missile they want and deserve and we have high confidence that the reliability on this missile will improve and this program will continue going forward.

Then lastly, if I can ask one last piece which is, you've talked a lot about the O&M budget in the past and you've talked a little bit about it today.

How do you see that going forward as the contributor?

In other words, what do you see the size of the O&M budget that you will have access to?

Do you see this growing over the next few years?

It is a fair question.

It kind of reminds me of the discussion several years ago in information technology where the budget itself on the surface may be growing low single digits but the addressable market, given the buying patterns and behavior of our customers and in fact growing.

In the IT analogy, we talk about outsourcing and business process opportunities.

Here in sustainment, we have a great working relationship with the DLA, the Defense Logistics Agency.

We just turned on the aircraft logistics system for the F-35 that we call Alice.

There are tens of billions of dollars that are addressable and some of the successes we had so far this year are highlighted by our HELLFIRE and Apache.

But we're currently doing work in the logistics form on the F-16, on fleet ballistic missiles, on the aircraft logistics center in Kelly Air Force Base in San Antonio.

The Merlin upgrades I mentioned and with the acquisitions of PAE and Savi, those are other opportunities and it may be a more innovative way to tap into those marks.

I guess I see it in the tens of billions of dollars as an addressable market.

Our goal is to grow that virtual line of business, if you will, high single digit to double digits and I think we're making progress.

I like the market and I think we're well positioned to take advantage of it.

Thank you.

Our next question will come from Cai von Rumohr with Cowen and Company.

Two quick housekeeping.

What do we now look for for the tax rate for the year?

Just under 32%.

31.5% to 32% range on a recurring basis.

Then on a GAAP basis, it is closer to 30 to 30.5% when you factor in the unusual items.

Okay.

So that that's gone down a little bit.

Then if I look at--?

That's a good thing, right?

That's definitely a good thing.

And a great quarter.

If I look at ES, and we take the top end of your guidance, it really assumes that the margins get worse in the second half from where they were in that second quarter.

Now, I know you alluded to kind of award fees.

Missile related milestones.

But was that an abnormally high level in that quarter or is that -- because the number looks low based on your performance there in the second quarter.

I mean you have it going down to around 12.4 for the rest of the year if we take the top end of your guidance.

That's a fair assessment.

With the -- there were several different programs and contracts.

We have service contract, accounting which we talked about several years ago that contributes to a fair amount of volatility especially in that line of business in the platform training and energy business.

I would say there are a lot of programs that had a lot of either step ups or incentive fees.

All occurring in that 90-day period and obviously we make the appropriate adjustments based on the most current facts and circumstances.

I think that's fair.

Inception to date, for six months, I guess we're at 13%.

Our guidance would have you back at the upper end of 12.

Again, I remember all of the questions I used to answer when we would get to 10.

Now, we have guidance at 12.5 more or less.

I think the team has gone a great -- has done a great job and it is nothing to be embarrassed about.

It is caused really by the volatility of those timing events.

Again, I look at it in management, manage it on an annual basis, if not longer and the trend I see is 50 or so basis point improvement over '06 in [ESBA].

In fact, margin improvement in all four business areas year-over-year and the volatility is really more a factor of the accounting requirements and that's how I see it.

Okay.

And the last one, if we look at aeronautical, your margins stepped up to 12.1, it looks like you've got them flat to up as we go through the rest of the year.

But there you did have a pickup of more than F-16s I guess than you expect for the last part of the year.

Is the mix a little bit not quite as good as we get to the second part of the year?

With fewer F-16s or are you going to deliver more F-16s than expected?

It is an awfully close call, right?

I mean we're at 11.4 for the six-month period and projecting an increase over the 11.4 for the full year.

If you look at the 12.1 stand alone for the full quarter, some of this is pretty close to rounding.

I really see the F-16s decreasing in the second half of the year as you said, but again, the F-22 had solid performance and we expect that to continue.

That's contributing in a positive way as is the C-130J and actually the sustainment business which we don't talk a lot about but we will be going forward, is a strong contributor to the margins again mainly on the air facility front.

Okay.

Excellent.

Terrific quarter.

Thank you very much.

We'll take our next question from David Strauss from UBS.

Thanks, good morning, Chris.

Good morning.

Looking at aeronautics, it sounds like now you're talking about the business having about $11 billion in revenues in '08.

I think before we had been talking closer to 10.

Is there a bit of a change there?

I know you upped the sales guidance a bit for '07.

Right.

It is the same $1 billion but if you recall in February, when we established the information systems and global services business, we did move the aircraft logistics line of business into aeronautics which we thought strategically and operationally was a better fit.

In effect, we transferred I think it was $700 million or $800 million of revenue out of the old IT and GS business into aero.

But it is still the same $1 billion decline.

And of course, we've gone back and adjusted or restated for comparability to prior numbers.

Think of aircraft logistics, Greenville, Kelly Aviation, causing that increase but it came out of another line of business.

Got it.

Does that make sense?

Yes, it makes sense.

Okay.

And then could you just give us an update on your vehicle strategy.

Obviously since we last spoke, your JV partner and JLTV is in the process of being acquired.

It looks like the Marine Corps is reopening competition on MRAP with this MRAP 2 and your name has been mentioned as possibly looking at that.

Can you just give us an update as to where you stand right now?

Absolutely.

We're currently obviously executing on the lightweight prime mover that we have under contract.

Relative to our partner on JLTV as we've talked about previously, the teaming arrangement we have in place survives the acquisition so we're excited to be able to continue to work with Armor Holdings and their parent company once the acquisition is closed.

I think we'll have a very strong team and a very competitive offering on JLTV.

I can see where that program maybe slips into the '08 time frame.

And MRAP our name is being thrown out.

We are exploring every and all options trying to validate the opportunity and see the core competency that we can bring forth.

Whether it is in logistics, sustainment, production, or what.

We do have a lot of capabilities.

A lot of people have been calling and trying to see how we can work together.

So, it is a good situation to have.

It is unclear at this point exactly how or what we will do.

But we've got a lot of people looking at it and thinking about it.

We'll be sure to let you know when we come up with a strategy.

I guess we probably ought to take one more question.

Our final question will come from Howard Rubel with Jefferies.

Thank you.

Just a couple of things, Chris.

First, a very crisp call.

I appreciate that.

Thank you.

Nice numbers.

Second, just to talk about sustainment for one second.

Is there -- you talked about higher margins.

Are you talking about -- is it because things that are happening in Iraq and just a usage of all of the cargo aircraft that you're supporting?

It is not Iraq-related.

Could you be a little more specific?

Sorry.

Oh, okay.

We've always had the ability to support and sustain mainly the C-130Js so whether it is in the -- the replacement parts or the normal maintenance, you tend to get higher margins at least on the spare part pieces of sustainment vertical and we continue to see the demand for those as we have in years past, but it has picked up as we've had more new aircraft delivered.

So--.

Growth of the fleet.

I understand.

It is a fleet growth issue.

Good way to put it.

And then last -- the number of -- what appears to be red programs continues to come down.

Can you talk for just one moment because I know people are probably gone.

What it is that you're doing that is sort of bringing the closure -- the risk items?

Yes, I think it is the systemic fundamental changes in our processes.

Bob Stevens has asked Mike Joyce who has been very successful in our LM-21 operating excellence and in conjunction with our new Chief Technology Officer to enhance our processes and tools and keep the lines of communication open so we can identify potential problems early and the one thing I think we do as well as anyone is deploy the resources and the talent to solve problems early enough before they become catastrophic.

They'll open clear and timely communications with the right tools and processes.

Outstanding leadership by the business area EVPs is making all of the difference in the world.

So it's those types of sustained investments, some of the results we're seeing in this quarter a result of decisions made back in '03, '04, especially in aeronautics.

Now we're starting to see the fruits of those investments pay off.

So there is no quick fixing this stuff.

It takes the right people, the right processes, the right systems, and we're investing in those and continuously improving them.

You just brought to closure a lot of risk.

Okay.

Thank you very much, Howard.

Thank you.

Well, with that, I would just like to thank everybody for calling in today and for their questions.

We look forward to talking to you again in October.

Thank you.

Thank you everyone for your participation in today's conference.

You may disconnect at this time.