洛克希德·馬丁 (LMT) 2009 Q2 法說會逐字稿

Good day, and welcome, everyone, to the Lockheed Martin Corporation second quarter 2009 earnings 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, and good morning, everyone.

I'd like to welcome you to our second quarter 2009 earnings conference call.

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

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.

Please also note that we have posted charts on our website which supplement our comments today.

With that, I'll turn the call over to Bruce.

Thanks, Jerry.

Good morning, everyone, and welcome to the call.

I'd like to begin by stating that overall the corporation had a quarter of numerous operational and financial highlights but also contained some areas that fell short of our expectations.

Financial highlights included our Aeronautics business achieving strong revenue, operating profit, and margin growth.

Electronic systems continuing its exceptional margin generation above 13% and the Corporation generating cash from operations in excess of $1.1 billion.

Financial and operational performance in IS&GS fell short of our expectation this quarter and caused us to reduce its full year financial outlook.

Improvements from our other business segments and the benefit of our cash deployment actions enabled us to maintain and reaffirm our full year financial guidance for the Corporation.

Before I move into the specific elements of our second quarter performance, I want to provide an update on the budget deliberations on the Core Defense Authorization bill as well as actions taken this quarter by the Department of Defense to realign its program priorities.

Congressional budget committees continue to propose revisions to the administration's $534 billion FY 2010 Core Defense budget target.

Consistent with the revised program priorities outlined by the Department of Defense, the budget committees have shown strong endorsement of our F35 Joint Strike Fighter program.

The proposed 2010 budget contains over $10 billion in funding for continued development and lowering production activities, including funds for 30 new aircraft for the L-Rev4 contract.

Increased support of the Littoral combat ship was also evidenced with the budget containing funds to procure up to three ships.

Other programs identified for potential budget increases included Aegis, FAD and advanced EHS satellites with the balance of our program portfolio remaining well supported.

These program recommendations will be reviewed by the full Congress in the coming months as the budget deliberations are concluded later this year.

In addition to the ongoing congressional budget discussions, the Department of Defense began implementation of its revised program priorities outlined earlier this year by Secretary Gates.

DOD contractual actions taken on our programs this quarter included the termination of the VH71 presidential helicopter program.

This termination for convenience resulted in our stopping work on the program and reducing our backlog by approximately $1 billion.

The DOD also announced its intention to not proceed with the next generation transformational satellite, or TSAT program.

With the cancellation of the future TSAT satellite constellation, the TMOS ground segment contract work that we started performing in 2006 supporting the TSAT program was also terminated for convenience.

This termination action resulted in an additional reduction in our backlog of $1.6 billion.

The combined backlog reduction for BH71 and TMOS terminations was $2.6 billion and was reflected in our second quarter backlog value.

Solid new award bookings in excess of $12 billion in the quarter helped mitigate the impact of the program terminations and limited the net backlog reduction to $1.5 billion.

Our overall backlog at the end of the quarter remained strong at nearly $80 billion.

Turning to our second quarter results, overall, the Corporation achieved solid financial performance, won key new business awards and completed significant operational milestones.

Financial achievements in the quarter included sales growth consistent with our expectations and strong cash generation.

With second quarter activities generating over $1.1 billion in cash from operations, we were able to continue to make opportunistic share repurchases.

During the quarter, we repurchased 5.6 million shares of our stock for $453 million.

This brings our year-to-date share repurchase total to 13.7 million shares at a cost of $1 billion.

Our ongoing share repurchase actions have enabled us to reduce our fully diluted share count to approximately 391 million shares, achieving the lowest share level since the year 2000.

Let me now turn to a review of our business area performance.

Starting with our information systems and global services business, as I noted earlier, sales growth, operating profit and margin levels in the quarter fell short of our expectations.

Despite IS&GS's record of new business wins, protests by losing competitors on programs are preventing IS&GS from ramping up sales levels as quickly as projected.

We have also seen additional constraints on sales growth due to funding delays in other areas.

These pressures have caused us to slightly reduce the IS&GS sales outlook for 2009.

Operating profits were also significantly below our expectations.

Key drivers for the shortfall were award fees lower than anticipated, program performance levels that were not sufficient to enable planned profit booking rate increases and start-up issues on several new awards.

These items resulted in a re-evaluation of full year projections and caused us to reduce its operating profit for 2009.

We are applying additional resources to improving execution in this important business area and remain committed to setting and achieving high standards of operational excellence.

Looking at the new business performance of IS&GS, key awards this quarter included a five year contract from the Department of Energy to manage and operate the new mission support contract at its Hanford, Washington site.

The initial $1.5 billion contract has a potential value of over $3 billion if the additional five year option is exercised.

This contract was originally awarded in the fourth quarter of 2008 but was placed under protest by a losing competitor.

With successful resolution of the protest this quarter, we look forward to expanding our portfolio of work and partnership with the DOE.

IS&GS was also selected by the General Services Administration to compete for future information technology task orders under its next generation Alliance contract.

Alliance is a government-wide acquisition contract to provide IT services, products and solutions to worldwide client agencies.

Finally, IS&GS was selected by the US Army to compete for future task orders on the Army Battle Command System Management contract.

The five year, IDIQ contract has a potential value of nearly $800 million.

Contract task orders will be used to migrate existing Army command systems to a net centric, service oriented architecture that will enable interoperability with other Army systems.

In our Electronics Systems business, we won a $100 million international contract from Saudi Arabia to deliver sniper advanced targeting pods for its fixed-wing fighters.

This multi-year modernization program will provide the Royal Saudi Air Force advanced targeting pod technology that includes enhanced image clarity, long range target detection and real time targeting for weapons.

Domestically, the US Air Force selected Electronic Systems to perform on the IDIQ life cycle program support contract for the 810 Thunderbolt aircraft.

This contract has a potential value of $1.6 billion.

Our activities will center on providing systems engineering and program and configuration management to modernize and sustain the aircraft.

These modernization actions will ensure the long-term readiness and sustainment of the aircraft to the war fighter.

Electronic Systems also had key operational accomplishments this quarter in the increasingly important area of theater missile defense.

We achieved successful roll-out of the first production FAD weapon system.

This further positions our proven missile defense system for expanded availability to domestic and international customers.

The FAD system is expected to provide a pivotal role in the ballistic missile defense of our nation and allies.

FAD was highlighted by the DOD as an area of expansion in the revised defense priorities outlined earlier this year and also has received strong expressions of interest by multiple international countries including Japan and the United Arab Emirates.

Turning to our Space Systems business, our team also continued to win significant domestic and international contracts.

The US Air Force awarded a $1.5 billion contract for additional assets on the SBIRS program.

The new contract procures a third highly elliptical orbit payload, a third geosynchronous orbit satellite and associated ground modifications.

These additional assets will further expand the capabilities of this vitally important national program in providing early warning of missile launches while simultaneously supporting missile defense, technical intelligence and battle space awareness missions.

International new business awards included an award of a contract from JC SAT Corporation of Japan to build its next commercial JO stationary communications satellite.

The new spacecraft will utilize the proven design of our A2100 satellite bus and is scheduled for launch in 2013.

Before leaving space, we should not let a significant moment like the 40th anniversary of the first man landing on the moon pass without saying congratulations again to the NASA team.

Lockheed Martin and our heritage companies have been proud to provide their contributions to that momentous lunar landing, and we look forward to helping NASA with their future successes through their development or deployment of our next generation Orion crew exploration vehicle.

Moving to the Aeronautics business, our team delivered another quarter of strong performance as they continued to win international and domestic new business awards while achieving operational milestones across their portfolio of programs.

The C130J aircraft continues to be recognized by domestic and international customers as the most cost effective and proven air lifter of choice.

New aircraft awards for the C130J included an order for Oman for one aircraft and an FMS authorization to provide four aircraft to Iraq.

These international orders expand the number of nations that have acquired C130Js to 11.

In addition to the new aircraft orders, the US Marine Corps issued a Sole Source award for Aeronautics to modify three KC130J aircraft under the Harvest Hawk program.

This aircraft modification contract and new C130J aircraft awards demonstrate the unique qualifications and flexibility of our team in responding to a wide spectrum of customer requirements.

This flexibility and our proven product have the program solidly positioned to continue its growth in annual production rate to at least 24 aircraft in 2010.

Moving to operational performance, the F35 Joint Strike Fighter team continued to expand their low rate initial production work and retired development risk on the program.

Key milestone events accomplished this quarter include successful completion of hover fit tests on the BF1 STOVL aircraft.

The tests also confirmed that the engine generated more vertical thrust than DOD performance requirements.

These successful tests clear the aircraft to proceed with expanded flight tests followed by vertical landings and hover flights later this year.

Another critical success this quarter was completion of the static test program on the STOVL aircraft.

The static test required the aircraft to be tested to 150% of its design limit load and resulted in no structural failures.

This test confirmed the strength of not only the STOVL test article, but the validity of the design models used on all three variants.

We also took the structural test article to the point of failure at over 220% of designed load limits to validate the additional structural margin of the design.

Achievement of this structural test helps clear the full flight envelope and removes restrictions from the STOVL flight test program.

Additional risk retirement progress was achieved with the successful deployment of the cooperative Avionics test bed aircraft to Edwards Air Force base where it continued to demonstrate the robust qualities of the Avionics systems being developed for the F35.

Parallel testing of the Avionics systems using the CatBIRD is a key component of the ongoing risk mitigation activities on the F35 program and applies to lessons learned on prior legacy aircraft.

In the area of program funding, Congressional support for the program remains strong as evidenced by the Department of Defense award of $2.1 billion on the LRIP Plot 3 contract this quarter.

This contract provides funding for 14 US aircraft, plus two aircraft in the United Nations and one aircraft for Netherlands and brings our LRIP backlog to 31 aircraft plus long lead for an additional 30 LRIP4 aircraft.

International support for the program continues to build with announcements this quarter from two additional partner countries reaffirming their intention to purchase the F35.

The Norwegian Parliament approved the F35 as their next generation fighter, and Australia released their defense white paper outlining their intention to purchase F35 fighters.

With these announcements, three of the eight partners have reaffirmed their intention to purchase future production F35 aircraft.

With steady progress and risk retirement, strong funding support and growing international customer commitments, the F35 program remains on track to ramp up production.

Lastly, we did close on an acquisition in the quarter with our purchase of IMES Strategic Support Limited.

Based in Scotland, IMES provides engineering, maintenance, repair and support on the UK Royal Navy's Trident strategic weapon system program.

This acquisition expands our fleet ballistic missile franchise into the UK and will enable us to offer a broader set of solutions to both our US and UK customers.

This acquisition will be managed within our Space System business area.

These highlights demonstrate our strong win rates and continued program operational execution as we work to continue to deliver increased value to shareholders and customers.

Finally, we were proud to be recognized by Aviation Week and Space Technology magazine for the second consecutive year as the best performing large cap aerospace company in its recently released top performing companies study.

This award underscores our daily focus and commitment to provide value to shareholders and is a direct reflection of our talented workforce.

I'd now like to open up the lines for your questions.

If you would, please open up the lines.

Thank you.

(Operator Instructions).

We'll take our first question from Peter Arment with Broadpoint AmTech.

Good morning.

Good morning.

Could you talk a little bit about IS&G, just in growth going forward?

I think you were looking for 10% growth for the year, at least sequentially in the back half of the year.

Can you just maybe give us a little more color there?

Yes.

I think as we sit here today, maybe what I ought to do -- I'm sure there's going to be several questions on IS&GS, is just kind of give a rundown on a number of points I want to make there.

And I'm going to start, if you would, with the second quarter sales for IS&GS which were up $160 million over last year, about 6%.

Most of that growth occurred in our defense line of business within IS&GS.

As you recall, we operate in the Civil Defense and Intelligence LOBS in that business area.

The other two LOBs besides Defense were fairly flat.

And really what's driving that flatness, especially in the Civil side, is protests and to a lesser extent, some customer funding delays.

I'll just give you an interesting stat I was looking at as I was getting ready for this call.

We've had 88 awards within IS&GS this year.

Five of those 88 awards were protested.

And of those five, three of those would have been from the outlook at the start of the year within our top 10 contracts for sales in 2009.

So although 5 out of 88 might not sound like a big number, they were 3 of the larger programs that we were expecting to generate sales for the whole year.

Talk to a couple of specific ones there.

DOE Hanford contract, I mentioned on the prepared remarks, we won in December of 2008, it's really just now starting up.

Similarly, the SOSA contract which we reported last quarter as a win, that's likely going to be a new competition and expectation at this point is that competition won't be settled until the 2010 time frame, which essentially says zero sales for that contract in 2009.

On top of that, we've had some activities within our Department of State work that have been slow to get funded, primarily because of staffing by the customer in this area.

EBIT is down for the quarter about $25 million, about 9% from last year.

The loss was down 130 basis points.

Couple of things driving that in the quarter.

Mostly again, within Civil.

We had a performance adjustment that we took in 2008, think of this in the $10 million to $15 million range.

We had no such adjustment in 2009.

Although we had been hoping to have similar adjustments occur in 2009, they did not occur.

We've also had some start-up issues on a couple of our new contracts, as I mentioned in our prepared remarks in Civil.

And lastly, I talked also that we've had lower performance in our Intelligence business that we are currently working to correct.

So probably more specifically to your direct question, Peter, the sales in the second half of the year, particularly given the protest impact that we already see, we're probably expecting more like 8% growth year-over-year, second quarter -- second half of '09 compared to second half of 2008.

And what that really indicates is we don't expect to make the volume loss due to delays or protests.

I think it's also important to say that we're expecting the fourth quarter to be a much higher quarter sales-wise than the third quarter.

If you look back at the history of IS&GS, you'll note that the fourth quarter tends to be a higher quarter.

This is more the seasonal nature of the IS&GS business.

Fourth quarter calendar year is the first quarter of the fiscal year and we tend to get a lot of contracts, especially the product contracts with short-term sales opportunities in the fourth quarter.

You didn't ask about margins in the second half, but I'll go ahead and address that as well.

I think margins in the second half, I would look to be probably similar to those in the first half, and really what that entails is we're expecting some of the second quarter issues that led to the second quarter downer that I talked about previously to also dampen the last two quarters of the year.

We had also hoped when we started the year, there were a couple of contractual matters that we had hoped would be settled in the second half of this year.

As we sit here today, both of those are likely to be pushed out and both worth less than we had expected at the start of the year.

So, probably a broader response to the question you asked, Peter, but I wanted to give you the full color there.

No, I appreciate that, thanks Bruce.

And just -- so either way I understand it, is for reaching your upper end of your guidance range, the margin trend going forward is going to have to still ramp somewhat also in terms of the run rate that we're at this quarter.

Within IS&GS?

Yes.

Actually I think we'll be fairly consistent with the first half of the year for IS&GS is my expected outlook, Peter.

Okay.

That's it.

Thanks, Bruce.

Thank you.

And we'll go next to Itay Michaeli with Citi.

Great, thank you.

Just going back to second half margin, particularly for Aeronautics and Electronics.

Could you talk about the cadence that we should be expecting there?

Looks like the revenue should be accelerating in the second half and just how you feel about potential upside there in the second half of the year.

For Electronics and Aeronautics you said?

Yes, please.

Let's start with Electronics.

Electronics came in with a fairly flat to down quarter in the second half of this year compared to the -- I'm sorry, the second quarter of this year compared to the second quarter of last year.

Last year, second quarter was a bit of a tough compare with this one because it was the largest quarter of the year for electronic systems, and there were a number of timing deliveries, particularly of missiles and fire control, that happened in the second quarter of this year -- or excuse me, the second quarter of last year that we don't expect to be replicated in this year's second quarter.

Although the Electronic Systems is down just a tad from second half last year, other than the missile and fire control being down, the other two lines of business within Electronic Systems, the MS2 and the P&T LOBs are both up in the second quarter.

As I look towards the second half of the year, I honestly think the third quarter is probably going to look very similarly to the second quarter.

And then we're expecting to have very strong growth in the fourth quarter and a couple of things are driving that.

One is we do expect to have a much higher level, just as we did second quarter of 2008, a much higher level of deliveries in the fourth quarter of 2009 compared to third quarter.

Think of this as factory missiles, HELLFIRE missiles and the like.

We also have, and I know you guys have read about this, we also have had delays in getting the JASSM missiles accepted because we haven't completed the acceptance testing on that.

We hope to have that complete later the third quarter or fourth quarter and when that is complete, that will free up a lot of the JASSM backlog that's been waiting to be booked from a revenue perspective, if you will.

I should also point out that with the T for C, the termination for convenience on the VH71 program, that program probably had about $300 million of sales in the second half of the year outlook, prior to the termination.

So my guess is that electronic systems will probably come in closer to the lower end of the range as we currently have it than even the middle part of that range.

Does that help?

That's very helpful.

And a quick follow-up on Space.

In the past, you've talked about sort of a flattish topline growth outlook beyond '09.

Looks like the backlog is coming in -- is growing pretty nicely.

Do you think there might be some upside to that, or are you still looking at more of a flattish topline outlook?

I think there is -- I realize I didn't answer your Aero question, so I'll come back to that in a second.

I think there's probably some nominal upside, particularly on the classified areas where we have some potential for growth there.

In the second half of the year for Space compared to the second last year, is actually going to have very strong growth, probably about the 8% range if you just look at where we are from a guidance perspective.

Most of that's because we had -- we have two satellite events in the second half of the 2009 time frame and we had none in the first half of the year -- I'm sorry, satellite and a launch vehicle in the second half.

We had none in the first half of the year.

I would also think margins are likely going to be a little bit up in the second half for Space as well.

And I would like to go back if I could to Aeronautics.

You asked about the same question on Space, just what the outlook is for the second half, is that right?

Correct.

Second half of the year in Aeronautics is going to look very strong, we believe.

I think the total for the second half is probably going to be at the 10% sales growth or so over the second half of 2008.

And what I would expect to see is that we'll have sequential growth quarter-to-quarter, so the fourth quarter will be obviously above 10% and the third quarter maybe a little below or not -- or probably a little bit below 10% in the third quarter.

What's driving that?

We have three additional F16s and four additional C130s in the second half of the year as compared to the first half of the year.

So I think we're going to see some growth there along with the continued uptick in the growth on the F35 program in the second half of the year.

Great.

That's helpful.

Thank you.

Thank you.

And we'll go next to Brian Ruttenbur with Morgan Keegan.

I have some housekeeping questions so I get to ask two at once, I think, is the plan.

First of all on the repurchase of stock, if you could tell us what you base your estimates on, along with the tax rate on the year.

So those are both my question and my follow-up is about the stock share count that you plan to have at year end and the tax rate you have to have in the second half of the year to be in guidance.

Yes, our guidance on the share count is essentially flat from where we are now, about $391 million and tax rate, probably looking -- I would guess somewhere about -- a little in the low 31s, 31% to 31.5% for the entire year is what we're outlooking right now.

Right, so you don't plan to purchase any more stock in these numbers; right?

Not in the guidance; that's right.

Okay.

Thank you very much.

Thank you.

And we'll go next to George Shapiro with Access 342.

Yes, Bruce?

Hi, George.

How you doing?

I want to go back to IS&GS.

I mean, it looks to me like you were at least from my expectation about $50 million short in profits and you took down in effectively the second half of the year by $80 million.

So most of what you saw in the second quarter you're expecting to recur in the third and the fourth quarter.

So if you could just go through a little bit more rationale than you did as to why that occurs?

Sure, George.

Look, you're very perceptive.

If we would have had kind of the 10% growth in sales in the second quarter that we were hoping for and maintained the margins at about the level of last year, you're spot on.

It's about a $50 million miss from what our expectations would have been in the second quarter.

And you're also right, that says about $85 million is what's left for the second half of the year.

I think hopefully I explained the first half well enough to be understandable.

The second half, again, is -- this is going to get in a little bit of accounting stuff, but this is -- on our service contract accountings, which this business area has probably 55% of its total sales is in service contract accounting, when we record an issue on a contract it's not like your standard accounting on, say, an F16 contract where you take a provision for today and you take a provision for future issues as well.

This has to play out over time and so we expect the impact that we're seeing in the second quarter to also occur through the rest of the second half of the year, just because of that accounting nature and as I said in the response to the earlier call, we had two contractual items planned in the second half that we really thought we were going to get some fairly sizable improvements on.

Neither one of those now looks like it's going to happen in the year so we pushed those out.

Both of them as I said earlier are a little less in value than we expected them to be at the time we set their guidance up in the first place.

And Bruce, just in general, since it seems like most of the issues are more in the civil side versus the defense side, I mean, obviously some of the delays are on the defense side, I mean, does it make you think -- question the kind of strategy of growing in some of these civil areas?

And is anything changing as a result of that?

No, look, I still think civil is where we're going to see some of our strongest growth within this business area and I think I don't want to lose track of the fact, if I look back to the 2006 time frame with this business area, we've grown this business area by $3.5 billion in sales since that time and over $300 million in EBIT.

I mean, it was an important part of Lockheed Martin then.

It's become an even more important part now and I suspect that will be the case in the future as well.

So no, I don't regret that we're in the civil business.

I think, again, that's going to be a big part of our business going forward.

And then just one quick one, if I might.

On the first quarter call you actually said that you thought the margin in IS&GS would be a little higher than average this quarter to make up for the relatively weak first quarter.

So given that that call occurred, three weeks into the second quarter, I mean, is this an area then that you don't have the same degree of predictability as you would like or is this just unusual that something happened to occur from when you made those comments in Q1?

This business is heavily dependent on -- it's probably the most heavily dependent on award fee within any of the four business areas.

Most of those award fees tend to happen in the second and fourth quarter in this business area.

When I made that comment in the first quarter, I had expected us to kind of have the normal award fee scoring that we would expect to have in the second quarter, as we did last year, for instance.

And it wasn't until late in the quarter, and those things typically come in in the May, June time frame.

It wasn't until late in the quarter that we saw those materializing at the lower levels there.

So that was probably the surprise from my perspective, George.

Okay.

Thanks very much, Bruce.

Thank you.

We'll go next to Troy Lahr with Stifel Nicolaus.

Thanks.

On the lower award fees, is this you just kind of missing some milestones or do you think the customer's getting a little tougher in paying out some of those award fees?

I want to be real clear on this.

This has nothing to do with a tougher score card.

This has nothing to do with acquisition reform, someone challenging the high levels of award fees.

This is -- we didn't perform as well as we were capable of.

The customer reflected that in their scoring to us and we've got to fix that on our side.

It's nothing else than that.

Okay.

And then so you had some execution issues.

You have the startup issues there also.

What changes are you implementing and how much confidence do you have that these are just kind of some near term issues that you can get your hands around so that they don't become this problem quarter after quarter after quarter?

It's a fair question.

Look, we really kind of brought in -- I can speak for my own organization specifically, our finance organization.

We've kind of thrown subject matter experts from the other three lines of business along with some corporate staff and kind of descended upon IS&GS to take a look at some of the practices there.

That's a business that as I said earlier has grown up very quickly in the last few years.

We want to make sure all our processes are very sound so this doesn't happen going forward.

This is an interesting business in that if you take a look at the backlog for IS&GS, it's just a little more than the sales for IS&GS.

So literally, this business kind of reinvents itself, practically on a quarterly basis, definitely on an annual basis.

So one of the good things or bad things, given that scenario, is we'll get a chance as these contracts kind of play out, very quickly to bid new contracts and see if we can't start off on a better foot with those new contracts.

I mean, I'm looking for more sizable orders in the second half of the year than the first half of the year.

And given the rapid turnover of these contracts, that's where we're going to see if these performance items are fixed or not.

So the added resources you're talking about, that's just putting more people on the program?

It's putting people and I'll say much more focus at a fairly senior level including Bob Stephens.

Thanks, guys.

Thank you.

We'll go next to Noah Poponak with Goldman Sachs.

Hey, Bruce, how you doing?

Hi, Noah.

Last quarter you were asked about where you see red programs.

I realize you guys have thousands of programs but your answer to that question alluded to some things in space and to some things in ES and you didn't even touch on IS&GS.

So how was it that this was kind of not on the radar screen and really snuck up on you?

I think we had a pretty thorough process by which we evaluate -- we literally categorize all of our programs.

We kind of put them into piles based on similar sized programs and we grade them green, yellow, red, just like a stoplight chart, as you would probably expect us to do/.

IS&GS, I don't believe since IS&GS has been created that we've had a red program within IS&GS.

In the second quarter we had two of them pop up, very surprisingly.

One was in a classified area in the intelligence business, as we talked about previously, and the other one was a fairly large contract within our civil business.

So while we had yellow indications on a number of programs, none of them turned red until the second quarter.

Whereas the others I alluded to in the previous call I would say were already categorized in the red category.

Okay.

And you guys obviously have this very differentiated Aeronautics story.

When we look at what's going on in the budget environment, what kind of two to three year growth rate can the non-Aeronautics part of the business see, particularly as we recalibrate for this pressure on IS&GS which you guys had previously kind of highlighted as the next best segment after Aeronautics?

For the next how long did you say, Noah?

Next kind of two to three years as the administration's priorities really start to flow through the budget.

I think I've said on many occasions, you excluded Aeronautics but I'll hit that one anyway.

The Aeronautics we expect to be driving the growth of the Corporation over the next few years, driven predominantly by the F35 program in that period of time.

IS&GS, even at the outlook we're looking at now is 8% growth and that is good growth, I think by anyone's measure.

And we still think that is sustainable.

Again, from a topline perspective, the reason we came off that is not because we're losing contracts.

It's because contracts got protested.

I think that environment will improve going forward.

I still think that as I look at the marketplace that IS&GS participates in, we still think that marketplace is expanding.

If you remember, that marketplace goes well beyond the DOD marketplace.

So those two business areas of the four I still think are going to grow at fairly rapid clips, much faster than the DOD budget.

I would think Electronics is still probably mid single digits growth for the foreseeable future and one of the reasons it will potentially go higher than that is because of the international growth, primarily on air missile defense.

Space as I said kind of earlier, I think we're going to have some nominal growth there.

The wild card there could be some classified growth but I'm not sure if I know enough at this point to tell you how much more that could be.

Total corporation, we still think it's somewhere in the mid single digits, maybe a little higher than that for that period of time you're talking about.

I'll also say, it's probably a little premature as you might expect.

We are going to provide the 2010 guidance in October.

I'll give you hopefully a whole lot more detailed picture at that time frame.

When we look at what F35 is doing, does that imply sort of very close to flat total growth for the non-Aeronautics part of the business?

No, I'm actually expecting some fairly significant growth in the C130 program during that period of time as well.

So you've kind of got some mitigating, probably two programs.

One, the C5 program with the re-engining on that strategic air lifter and the C130 program are both going to grow.

Think of that as--.

I'm asking for the three segments that are not Aeronautics.

I'm sorry.

I misunderstood your question.

Does what you're saying imply that the non-Aeronautics part of the business, the other three segments in aggregate are kind of a flattish business over the next two to three years?

Not at all.

That's not what I was saying at all.

I still think IS&GS is going to go faster than probably the Corporation in total.

I think Electronic Systems will probably grow pretty close to the Corporation's average and I think Space will grow a little bit lower than the other four, the other three business areas, but in any event I still expect to see some nominal growth.

Fair enough.

We'll go next to Rob Spingarn with Credit Suisse.

Good morning, guys.

Hi, Rob.

Question on F22.

With the seven aircraft up for vote, is there anything significant about that number?

Clearly, $2 billion is a sizable number.

But is this a figure that allows you to bridge to an export program, perhaps to Japan, and where do you see that standing at this time?

I think the short answer to your first question is no.

It would not allow us to bridge to a Japanese sale or any other international sale at this time.

I'm not sure we've got a good answer for you as to why seven aircraft, to be perfectly frank with you.

I'm sorry, the latter part of your question was?

The latter part was about the export opportunity and where you think that stands on the Hill at this point?

We still say kind of precluded from being able to sell because of a Congressional amendment.

So until the amendment is rescinded, if it's rescinded there's no likelihood of international sales.

I know there's been discussion on that but it would literally take the act of Congress to repeal that law before we could sell them internationally.

I'm not particularly positive on the ability for us to make that happen in the next few years.

And Bruce, where does production on long lead products stand at this point, the very early stuff, and then as my follow-up, if you could just refresh us on the top competitive opportunities for Lockheed, let's say over the next couple of quarters.

When you said the production, Rob, I guess you were talking about F35?

Well, no, I'm talking about F22 but in terms of the real early, smaller components on that program, have they ceased production at this point?

From a supply based perspective?

Yes.

I didn't understand the question.

It's getting real close.

Think of this as kind of three year cycles from contract award to aircraft delivery.

And our piece of that is probably in the last 12 months or so of that three-year cycle.

So suppliers tend to be the much longer legged portion of that effort.

Think of that, the early part of that, mostly with metals, think of specialty titaniums and the like.

So those folks are literally probably at the end of this year will start seeing some impact if nothing's turned on.

Okay.

And then the other part was just on competitive programs.

Competitive programs, in all honesty third quarter is probably going to look a little light.

We were heavily weighted in the fourth quarter.

There's a number of competitions happening then.

I would like to think we would see an F16 Egyptian order by that point in time.

I'm also optimistic about a couple of C130J international opportunities happening in the fourth quarter.

I think this could be a big year.

The only question is whether it happens before the end of the calendar year or not but we're expecting some big things happening on the C130J international front as well as domestic front in the not too distant future.

Other big programs, competitions -- not competitions I guess it's actually a sole source at this point but we expect a large order within Electronic Systems on the PAC3 for Taiwan.

We also expect -- we do this -- we have previously done in both Singapore and the UK kind of a turnkey training activity.

We expect sort of the next follow-on of that within Singapore called the Singapore Fighter Wings course to occur in the fourth quarter and then on top of that there's probably, as I was looking at just the other day, there's probably close to $3 billion of follow-on business, not competitive, but follow-on business within Electronic Systems that we expect to materialize in the third quarter -- or excuse me, the fourth

Did you mention at all before when you were talking about opportunities with F35 partners, the timing on some of those orders?

Timing of the orders?

I would -- I don't know that I have a real good answer for you there as far as my expectations.

I would think we would start seeing those orders probably in the next year or 2011, early 2011, one or the other, Rob.

All right.

Thanks, Bruce.

Yes.

We'll go next to Joseph Nadol with JPMorgan.

Thanks.

Good morning.

Hi, Joe.

Bruce, just back on IS&GS just for a moment.

What I hear you saying is that we had some protests and then a couple performance slip-ups during the quarter that are going to impact us not only in the quarter but the rest of the year.

But at the same time, several of your competitors out there, large and small, have had some issues year-to-date in services and of course we all hear some of the things coming out of the government on in-sourcing and there's been more pricing competition, et cetera.

I mean, how much of this do you really think is just a couple slip-ups and how much of it is just a structural change that's happening in the services business, big picture?

I don't think any of the sales impact that we are seeing has anything to do with the items that you described, the in-sourcing or even the competitive, more price competitive.

I think we have a very competitive offering across the board within our IS&GS business area and again, I don't think the in-sourcing will impact the sales at all.

If you look at the EBIT side, the earnings side, I would characterize those as our issue, not driven by any other externalities.

We didn't perform as well as we are capable of and that's ours to fix.

So it's really in your view nothing that would prevent you, assuming you get back to your performance last year or in 2007, nothing to prevent your margins from getting back up to the mid-9s?

There's nothing kind of structurally as I look at it now that says it can't be done.

We've got to correct the things that we slipped on and continue to win new -- as I said earlier, this is a business that turns over, practically every year.

Continue to win new contracts at the kind of margins that would allow us to do that.

I think it's that simple.

Have you examined the OCI language that's been -- that's out there and determined whether there's going to be any conflict of interest issue to your business, whether you might have to divest any businesses, any lines of business, et cetera?

We wouldn't get into either acquisitions or divestitures but we have examined the OCI language.

We don't think we have a lot of exposure there, less I would say probably than a lot of our competitors.

But it is something we're watching closely and we'll continue to watch going forward.

Okay.

And then just for one quick follow-up.

On F35, just given all of the budget things going on right now in Congress, all the moving parts, can you just give what level of sales you expect for that program next year versus this year, even sort of a round number?

I would hate to even hasten a guess, Joe.

It is going to be significant growth in the F35 program next year.

I think if I talked -- I know I talked to some of you folks at the Paris Air Show and a couple of the sessions over there I talked about the long-standing commitment that says we probably could have a $20 billion Aeronautics business within -- by year 2015.

If I could just put and say that probably 75% plus of that $20 billion we expect to be the F35 program in 2015.

And if you kind of play annual compound and annual growth rates on those numbers, it's going to grow in excess of 20% a year to get though that level and we still feel confident about that number in 2015.

Hopefully that helps.

We'll go next to Doug Harned with Sanford Bernstein.

Good morning.

Good morning, Doug.

I wanted to stay on IS&GS.

The thing that I find difficult is that we've got multiple issues here at one time and a unit that's really performed very well over recent years.

From what you're saying, I understand that we've got two red programs, one in civil, one in Intel.

Right.

There's a slow start with some State Department work which I assume is in global services?

Correct.

And then you have five protested programs and those are mixed civil and defense.

Is that correct?

Those are the ones that -- those are delayed and slowing revenue growth.

Is that correct?

Correct.

Well, then what I'm trying to understand is, is it a coincidence that these things have happened or is there something overall in IS&GS since they're across multiple units that you feel needs to be addressed here?

That's an interesting question, Doug.

I don't think that I see anything that is kind of like the common denominator across all of the things that you mentioned there.

I think the funding delays have more to do with the administration, not necessarily having the right people in place in the areas where we had some growth last year that we've seen some slackening off this year.

I ultimately think that's going to get fixed with the right people in place and we'll get back on board there.

The protests, the only -- maybe the only commonality, I think we've been hit harder within IS&GS probably simply because they compete for more quantities of contracts than any other business area of the Corporation.

We've been hit with a higher percentage of those protests maybe than we have previously and they've all kind of come in fairly short order.

AND as I said earlier, the big thing is they hit some of our more sizable contracts as well.

We're protested all the time in this business area but oftentimes they're on contracts that you don't necessarily watch or follow or that don't make that big a hit to us.

It sounds like--?

Go ahead.

I'm sorry.

It sounds like the execution issues are two pretty separate ones.

I mean, those are pretty different businesses and from what you're saying in the State Department work, I'm assuming when you say the administration getting people in, this is not an issue with this administration, it's an issue of the transition to a new administration that slows that down.

Is that --?

You said it well.

Then the one other aspect of this is that you said how the business does tend to turn over more quickly and I noticed the backlog has come down some.

As you look forward here, you're constantly tending to deal with some new customer sets within the Federal Government.

Right.

Some maybe new types of projects.

Is this in any way contributing to more risk, you're in some different areas, is that a possible?

Some of this that we talked about in the intelligence is absolutely in our core, has been in our core for a long, long time.

I would hate to characterize it as because we're casting too wide a net, if you will.

There's some basic blocking and tackling that kind of got away from us on a couple of these things that we've got to fix.

I don't think any of it's earth-shattering.

I think it's all fixable.

We've just got to rededicate ourselves and take the actions necessary to fix it.

When Linda Gooden talks about the double-digit growth that she expects, I think it's on more of a multi-year basis, I mean, this is still in your view very much intact.

Is that--?

I still think IS&GS will be amongst our highest growth business area going forward.

I mean, I literally sat through a briefing here not a few weeks ago where there were -- we do see opportunities outside of the current marketplace that are growing very significantly that we think we have a very good opportunity to plan and I think we've demonstrated just by the success of the past that we can play in the markets we're currently in and grow very considerably as well.

Again, most of that has come by outstripping the growth in the markets at this point.

We've really kind of done that through taking market share from competitors.

We still think that's possible because this business area operates in a marketplace that is incredibly disaggregated.

It's a very far-flung area.

The basic activities that we do, though, in those different marketplaces, are not all that different between and amongst themselves if that makes sense.

Okay.

Yes.

That's very helpful.

Thanks.

You bet.

We'll go next to Sam Pearlstein with Wells Fargo Securities.

Good morning.

Good morning, Sam.

Bruce, you mentioned the backlog changed with some of the terminations like VH71 and TSAT.

What should we thing about in terms of the second half in terms of any P&L impact from those in terms of contract closeouts and termination fees, et cetera?

Just to be clear, you said TSAT, It was related to TSAT but it was actually on the TMOS; it was on the ground cement portion of TSAT.

And I wouldn't expect to see any earnings impact from those going forward.

Okay and did the new AEHF that's supposed to go in, have you seen that order yet in terms of moving into backlog?

Let me think if that has.

I believe it has.

Okay.

Just to follow up completely separately, is given the market recovery we've seen in the second quarter, can you talk a little bit about the pension performance in the second quarter and where you stand year-to-date versus the assumed return on asset?

You've seen the marketplace just like we have and I would say that we are ahead of where we would be on a normal trend to get to the 8.5% level that we produce for the annual return on our pension plan.

So as we sit here today, what is it, July 21, I think we're ahead of schedule on that.

Can you quantify what that return is?

No, it's going to bounce around between them.

We'll obviously tell you by the end of the year and we'll give you an outlook in October for the 2010 time frame.

I'll just say we're at this point ahead of where we would otherwise be if we were just tracking to 8.5%.

Okay.

Thank you.

Thank you.

I think we have time for about one more question here.

We'll take our next question from Heidi Wood from Morgan Stanley.

Hello, Bruce.

Hi, Heidi.

I've got to belabor the IS&GS question in a slightly different way.

It seems that IS&GS is one of your shorter cycle businesses, so it would stand to reason it would be more susceptible to the after-effects of both a change in administration and tighter budgets and you've taken great efforts to stress that it's internal performance.

But just to be devil's advocate for a moment.

If we looked at tighter budget conditions ahead wouldn't we be expecting tougher grading from customers, more protests, and a slower ramp up on programs and slower awards versus what you were -- what you encountered in the last eight years in the Bush administration?

I would like to think that as we go forward with a new administration and a new outlook and a new expectation of what is right in the acquisition process, I would like to think the number of protests would diminish as opposed to increase or even stay constant.

And that may be overly optimistic on my part but I still think that's good for the industry.

If we in fact can get the protests kind of back so they're not as prevalent as they are today.

On the other part of your question, relative to the scoring and so forth, it hasn't happened to this point, Heidi.

Again, I have tried to make this characterized as these are our issues to fix.

There's been lots of talk and discussion about that relative to the acquisition reform but nothing that has come up that I've seen that talks about different levels that would cause me concern of what's been written at this point I guess is the best way to say it.

All right.

But then because I think many of us are concerned as we look at this, as this business has grown, I don't think we've challenged the growth.

I think it's more whether the growth can be accompanied with 9% margins or whether the future ahead is sort of 8-ish.

But maybe you can give us color on whether civil margins because that's an area of focus, does that have the structural ability to go higher than overall segment margins?

Overall segment margins for--?

IS&GS.

IS&GS in total?

Yes.

In all honesty, I would think the answer is no, to be perfectly frank with you.

And look, where I sit today, we've had these items that kind of popped up in the second quarter.

We've taken I think the right actions to try to fix them.

What I think I need to do is to see if these actions do in fact kind of stem the performance issues that we saw in the second quarter, see if we can't mitigate them somewhat going forward and then by the third quarter I'll have a whole lot better feel for what new business we have won at that point in time and I'll be able to give you a much better outlook in 2010.

Thanks very much, Bruce.

Thank you, Heidi.

Okay.

With that, I'd like to close by thanking you for joining the call today and for your questions and we look forward to talking to you again in October.

And once again, that does conclude today's conference, we thank you for your participation.