洛克希德·馬丁 (LMT) 2013 Q1 法說會逐字稿

Good day, and welcome, everyone, to the Lockheed Martin first-quarter 2013 earnings results conference call.

Today's call is being recorded.

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

Please go ahead, sir.

Thank you, Allie, and good morning, everyone.

I'd like to welcome you to our first-quarter 2013 earnings conference call.

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

Statements made in today's call that are not historical fact 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 today that we plan to address during the call to supplement our comments.

Please access our website at www.lockheedmartin.com and click on the Investor Relations link to view and follow the charts.

With that, I'd like to turn the call over to Marillyn.

Thanks, Jerry.

Good morning, everyone, and thank you for joining us on the call today.

Before I begin, I want to offer congratulations to our Lockheed Martin team for their outstanding performance that enabled the achievement of strong first-quarter operational and financial results, while operating in a dynamic and challenging environment.

Their focus and efforts have our corporation poised for continued success in delivering solutions to customers and value to shareholders.

While Bruce will cover the financials in more detail later on in the call, I would highlight some noteworthy financial performance in the quarter that included growth in earnings per share to $2.33, 15% above last year's first-quarter level; expansion of segment operating margin to 12.1%, achieving an increase of 20 basis points above last year's level; and generation of $2.1 billion in cash from operations.

Our continued strong cash flow is key to our cash deployment strategy to generate value to shareholders through share repurchases and dividend payments.

In the first quarter, we repurchased over 5 million shares of stock for approximately $460 million.

And paid slightly under $400 million in dividends.

These combined cash deployment actions returned over $830 million to shareholders in the quarter.

We continue to execute our strategy through solid performance on our core business.

And by winning key competitive and follow-on awards to extend our franchise programs.

We also expanded our international business activities, and continued our measured pursuit and exploration into adjacent new businesses.

Let me begin with a brief summary of our key order bookings in the quarter.

Noteworthy awards included Aeronautics receipt of an IDIQ award on the F22 program for a 10 year fleet modernization and extension under the Raptor enhanced development and integration program with a potential value of almost $7 billion.

And LRIP 8 long-lead funds for 29 new F-35 aircraft for the US government.

Additionally, we were awarded funds for long-lead acquisition of four F-35 aircraft for Japan.

Mission Systems and Training received $700 million for two additional Littoral combat ships, increasing our LCS work backlog to six vessels.

And our Aegis team successfully won a competitive award for the Combat Systems Engineering Agent program.

This award extends our multi-decade legacy and leadership on this important missile defense system.

Finally, our Space Systems team won a long-lead contract to begin construction of two additional spacecraft on the SBIRS military satellite program for the US Air Force.

This award brings our backlog to four spacecraft, and on this critical national program that provides worldwide early-warning detection or ballistic missile launches.

These new awards and our backlog of future work are direct indicators of the close alignment of our portfolio of products with customers' strategic priorities and requirements.

And serve as a foundation for the future.

Turning to operational performance.

Our five business areas continued to execute with exceptional focus and skill in providing critical services and products to customers.

While the quarter contained numerous accomplishments, I would like to highlight two notable successes and provide a brief update on F-35 key events.

First, as part of the national strategy to pivot to the Asia-Pacific region, our Littoral Combat Ship, the USS Freedom, began its deployment to Southeast Asia.

We are extremely proud to have our ship chosen to do the inaugural deployment of LCS class vessels to Southeast Asia.

It is a testament to the maturity and capabilities of our innovative multi-mission ship.

And we look forward to her contributions to the seventh fleet.

While visiting leaders at Pacific Command this quarter, I had the opportunity to go onboard Freedom while she was docked in Pearl Harbor en route to Southeast Asia.

The pride of the crew in their ship and her capabilities was inspirational.

And only serves to reinforce our critical role to provide these revolutionary war ships to the Navy.

The next key operational achievement was accomplished by our Space Systems business, with their successful launch of the second SBIRS satellite for the US Air Force.

I had the privilege to be at the launch site in Florida in March with our customer to watch the event.

This satellite joins the currently deployed SBIRS spacecraft.

And expands the constellation of early-warning missile detection satellites.

In this era of increasing proliferation of ballistic missile threats from rogue nations, SBIRS provides vital intelligence and defense warning to our country and allies.

We are honored to be providing these critical national assets to our country.

And look forward to delivering the remaining four satellites in our backlog.

Moving to F-35, key accomplishments in the quarter were deployment of CTOL aircraft to Nellis Air Force Base for operational testing and evaluation.

And completion of the first operational mission conducted by Air Force pilots.

The first operational short takeoff vertical landing at Marine Corps Air Station Yuma.

Successful completion of the three-year wing flutter testing program on the CTOL version with clean results.

And the first night-time vertical landing of a STOVL aircraft at Patuxent River Naval Station.

These accomplishments highlight the increasing maturity of the program.

We are providing increasing levels of aircraft capability and performance to the multiple service branches to enable expansion of pilot training and operational evaluation of this revolutionary platform.

I'd like to now turn to the status of DoD budgets.

Since we last spoke in January, the President signed into law the Consolidated and Further Continuing Appropriations Act of 2013.

This act extended funding for the operations of all federal agencies through September 30, 2013.

It included full-year appropriations for defense, military construction, and veterans affairs.

This continuing resolution will fund all other government agencies at last year's levels.

With the approved FY '13 DoD appropriations of $527 billion, our key programs continue to be supported and funded under the full-year appropriation.

Examples of that support were seen with the appropriations increasing C-130J procurement to 16 aircraft from the previously planned level of 7. And funding of almost $400 million for the continuation of the MEADS program.

However, funding appropriated through this act remains subject to the automatic budget cuts outlined under sequestration.

We are encouraged by recent alternative budget proposals offered by various members of Congress to modify or eliminate the level of DoD budget reductions required under current sequestration.

One version proposes no additional budget reductions to defense budget levels.

While another version proposes approximately $250 billion of reductions from defense over the next nine years.

Adoption of either of these competing budget versions would represent a significant improvement over the current $500 billion in budget cuts required under sequestration.

Beyond FY '13 actions, the President submitted his fiscal year 2014 budget proposal earlier this month.

The proposed level for the baseline FY '14 defense budget was outlined at $526 billion, a level essentially equal to the current FY '13 appropriations level.

Initial insight into program priorities contained in the President's FY '14 request show strong alignment and budget support for a number of our key programs.

Such as the F-35 Joint Strike Fighter, Littoral Combat Ship, missile defense systems, and higher quantities of C-130J aircraft.

It should be noted that the FY '14 proposed budget does not account for the implications of sequestration that went into effect in March 2013.

The impact of sequestration on our business has been minimal to date.

And Bruce will provide some modeling sensitivity on our 2013 financial outlook of sequestration in FY '13.

Turning to the global security environment, rising tensions and threats on the Korean peninsula, coupled with ongoing conflict and instability in the Middle East, only reinforce the complexity of maintaining global security.

The need for a spectrum of flexible and effective products to help maintain global security is growing more acute each day.

Lockheed Martin products are foundational assets in the preservation of global security.

Recent deployment of our products by the Department of Defense into the Southeast Asia region include placing F-22 fighters in South Korea.

And deploying the THAAD missile defense system on Guam, the Littoral Combat Ship with the Seventh Fleet, and Aegis missile defense systems.

These deployments highlight the key strategic value and deterrent capabilities of our unparalleled products to national defense.

Our portfolio remains in direct alignment with this global security mission.

And we look forward to providing critical defense and security solutions to domestic and international customers.

I want to turn briefly to our focus and activity with the international customers this quarter.

Expansion of international revenues remains a key component of our corporate strategy.

And we are on a path to grow international sales from approximately 17% of total revenues last year to at least 20% in the next few years.

As we've outlined previously, key drivers of that expected growth will be higher levels of international work on the F-35, with growing levels of aircraft deliveries to our partner countries.

Plus C-130J aircraft, F-16 aircraft, and missile defense solutions such as THAAD and Aegis.

Direct in-country interaction and listening to the needs of customers are essential components to successful international relationship building.

This quarter, I had the opportunity to meet with key customers in Israel, United Arab Emirates, Saudi Arabia and Italy.

Discussions centered on how our corporation can help them with their diverse spectrum of security needs that range from fighter aircraft to missile defense systems to cyber security.

While in Saudi Arabia, we inaugurated our new in-country headquarters that will enable development of partnerships to create products and enhance our offerings in technology, aerospace, and security sectors.

The common theme of the meetings was the universally-held belief that the global security environment is only becoming more complex.

And there is a widespread desire to utilize many of our products and leading-edge solutions to solve their most critical requirements.

Before I ask Bruce to give you some color and details on our financial performance, I want to close my comments by providing some insight into three emerging technologies and adjacent pursuits of the Corporation.

As we have outlined in the past, one of the new technologies we are examining is in the sustainable and alternative energy generation field through a process called Ocean Thermal Energy Conversion, or OTEC.

This technology uses the temperature variations of ocean depth layers to power thermal exchange equipment and generate electricity.

We have created unique intellectual property and expertise in thermal exchange.

And recently signed a memorandum of understanding to utilize our intellectual property and begin exploration of the design feasibility of a plant to generate electricity on a commercial scale.

This agreement is expected to lead to a contract that will fund our development efforts for a 10-megawatt pilot plant anticipated to be located off the coast of southern China.

We are excited about the potential future prospects of this technology to generate clean, renewable electricity.

The second adjacent market I'll give you an update on is our expanding commercial aircraft pilot training activities, using simulators from our SIM-Industries business that develops and manufactures full-motion and fixed-base civil aviation flight simulators for airline customers in independent pilot training centers worldwide.

As a leader in commercial simulators for Boeing 737 and Airbus A320 aircraft, SIM recently extended its product line with simulators for the Airbus A33O and Boeing 767, 777, and 787 aircraft.

SIM-Industries' broad product offering enabled us to offer a very affordable training solution to the US Air Force's next generation KC-46 tanker program.

These growing activities and opportunities in this area demonstrate the synergy that exists between the unique low-cost commercial offerings from SIM-Industries and their applications to future DoD programs.

The Air Force is currently evaluating competitive bids for pilot training on the KC-46 tanker, with a decision on the winning bidder expected later this year.

The third new business opportunity area I'll highlight has recently emerged from our Advanced Materials studies group, and is in the area of water purification.

We recently received a patent for Perforene material, which is a molecular filtration solution designed to provide clean, potable water.

The Perforene membrane features holes that are 1 nanometer or less in a graphene sheet.

And are small enough to trap sodium, chlorine and other ions from sea water, while dramatically improving the flow-through of water molecules.

This flow-through is 100 times better than current reverse osmosis systems, making it more effective at desalination at a fraction of the cost.

Access to clean drinking water is becoming more critical as the global population continues to grow.

We believe that this simple and affordable solution has the potential to be a game changer for the water industry.

We are also investigating other applications for Perforene, such as biopharmaceutical separations, and removal of chemical substances and compounds from water used in oil and gas wells.

The pursuits I've highlighted today are only a few of the innovative and expanding portfolio of intellectual property and products that offer future growth prospects for this Corporation.

We will keep you apprised of our progress in these areas.

I'll now ask Bruce to go through some of the details of our financial performance.

And then we'll open up the line for questions.

Bruce?

Thanks, Marillyn.

Good morning, everyone.

As I highlight our key financial accomplishments, please follow along with the web charts that we included with our Earnings Release today.

Let's start with chart 3 and an overview of the quarter.

Sales in the quarter were $11.1 billion, down slightly from last year but ahead of our expectations at the beginning of this year.

Segment operating margin was strong at 12.1%, a 20 basis point improvement over the first quarter last year.

Our earnings per share were $2.33, up 15% from last year.

We generated $2.1 billion in cash from operations.

And we repurchased 5.1 million shares in the quarter.

So I think we're off to a good start in 2013.

Chart 4 shows our sales for the first quarter this year versus last year.

Aeronautics' sales decreased by about 14% compared with last year.

However, this was slightly better than our expectations when we spoke in January as we had higher aircraft deliveries than planned in the quarter.

Our sales in the other four business areas were also stronger than expected, particularly in Missiles and Fire Control, which also benefited from additional product deliveries and volume in the quarter.

I should point out that with the implementation of sequestration delayed until March 1, we saw minimal impact to the quarter, but would expect that impact to grow as we go forward.

I'll discuss sequestration in greater detail in subsequent charts.

Moving to chart 5 and our first-quarter segment operating results.

Our segment operating profit was comparable to last year's level, with the increase in margin offsetting the impact of lower sales in the quarter.

We continue to have strong program execution and are taking appropriate cost-reduction actions, as needed.

Turning to chart 6 and earnings per share.

EPS in the quarter was 15% higher than a year ago, driven primarily by the lower pension expense as a result of our contributions at the end of last year, and the benefits of the R&D tax credit.

You'll remember that we mentioned on the last call that the first quarter would have the benefit of the full-year 2012 credit, as well as the 2013 first quarter credit.

And that's what we're seeing here.

On a pension adjusted basis, our EPS grew to $2.56 in the quarter.

If you'll turn to chart 7, we'll discuss our cash from operations in the quarter.

As expected, our cash flow in the quarter was very strong at nearly $2.1 billion, more than $1.5 billion higher than the level last year.

Although last year's level was reduced by a roughly $500 million pension contribution.

We not only had strong operational performance but also had the benefit of a $540 million tax refund in the quarter, resulting from our pension contributions at the end of last year.

We expect that cash generated this quarter will be the highest for the year, as we have both pension contributions and tax payments planned in future quarters that did not occur in the first quarter.

On chart 8 we'll discuss our cash returned to shareholders.

We returned over $800 million to shareholders this quarter through our share repurchases and industry-leading dividend yield.

The level of share repurchases was almost double what we did in the first quarter last year.

And dividends were higher as a result of our 15% increase last September.

Moving on to chart 9, we'll discuss our updated view of the guidance we provided on the last call.

You'll recall that our January guidance did not consider the impacts of sequestration.

Since then, sequestration did become effective on March 1. But, as I said earlier, its implementation had minimal impact on our performance this quarter.

Unless revised by Congress, however, we would expect to see the effects of sequestration having impacts throughout the rest of this year.

We tried to model these potential impacts by assuming a peanut butter spread of expected reductions to our US government business awarded with FY '13 funds.

Or, said differently, we did not assume any flexibility on our customer's part to favor one program's budget over another.

Using that approach, we estimate a potential $825 million impact to our sales in 2013.

With the strong results of each of our five business areas in the first quarter, though, we believe our current sales outlook remains within the guidance range we provided in January.

And I'll explain that in more detail on the next chart.

Chart 10 shows the methodology we used to develop our estimate of the impact of sequestration on our 2013 sales.

At the mid point of our guidance, we would expect just over 75% of our sales, or about $35 billion, to be generated from our year-end 2012 backlog.

And we would expect sales to non-US government customers from orders received this year to be around $2 billion or so.

Neither of these amounts is expected to be directly impacted by sequestration.

However, our original estimate of $8.25 billion of US government sales from new orders this year is expected to be impacted by sequestration.

As we model the estimated impacts over the next three quarters, we project the reduction of around $825 million in sales primarily impacting IS&GS and MST.

On chart 11 we provide our updated guidance.

Assuming the modeling from the previous chart, and factoring in our better-than-planned results in the first quarter, we now expect sales will be near the low end of our guidance range.

Even with the lower sales expectation, we are maintaining our segment operating profit and cash guidance, reflecting our growing confidence in our performance for the rest of 2013.

And we are maintaining our earnings per share guidance range of $8.80 to $9.10.

Though I'll emphasize that this range does not include restructuring charges, if any, associated with sequestration, as they're unpredictable at this time.

And, finally, we have our summary on chart 12.

The first quarter represents a strong start to the year, with better-than-expected sales volume and strong segment operating profit and cash from operations.

These results continue to reflect strong program execution, the proactive cost-reduction measures we're taking, and the strength of our portfolio.

And we continue to focus on actions that create value for our customers and our shareholders.

With that, we're ready for your questions.

Allie?

(Operator Instructions)

Joe Nadol of JPMorgan.

Thanks.

Good morning and good performance.

Marillyn, I actually had a question for you on the extensive comments you gave on the non defense portion of your business, which is small but it seems like you're targeting quite a bit for growth.

And really just from two angles.

One, because, as you know, this has been a tough thing for defense companies to do in the past -- to diversify during a downturn.

So the two questions are, one, in your approach to the market, how are you orienting the Company to really to impact commercial markets, which has really been a difficult thing for companies to do?

And I just mean the difference in the customer base relative to the government.

Comments there would be good.

And then, secondly, from a risk standpoint, what kind of capital are you putting at risk?

And how are you considering that going forward?

Thanks.

Thanks for the question, Joe.

First off, I would say the things that you're seeing coming forward are things that we've been investing in for a number of years.

As a company, we're a technology leader.

We often talk about saying that we do hard stuff, we do difficult things, and try to work on big things that are affecting the global environment, the global security environment.

So we're always investing in the future in that regard.

And we have 60,000 scientists and engineers that are working on things, not only on our core products and services today, but also looking at ways to give our adversaries an advantage.

Or look at new areas that we can help in global security needs.

So, even as our customer budgets decline, we're going to continue to invest in these new technologies because we think that's really important that we do that.

In terms of orienting us to commercial markets, I would say that the things that we're doing right now are things that are, as I've said, we've been investing in for some time.

And while it is a different customer base, they are large projects, much like we do large projects across the Corporation.

In terms of risk, these are not big needle movers in the near term.

We're not looking at a large cash investment.

We've been investing in, for example, the Perforene and the nano technologies for the past seven years.

We've been investing in the Ocean Thermal Energy Conversion, we've been working on since the '70s.

We increased our investment in the past five years.

But it's measured and disciplined investment that we make in R&D, just as we do across the business.

So, from that standpoint, it's a matter of not putting any capital at risk but we do expect these to be fully funded.

In fact, if you look at OTEC, that pilot plant will be fully funded by our partner as we bring our intellectual property forward in that arena.

In terms of the Perforene, we got a patent but we are now looking for opportunities to partner on taking that one forward.

So we partner with companies in the commercial market.

That's what gives us the capability to go into those new markets.

And that's how we'll approach those.

Robert Spingarn of Credit Suisse.

Good morning.

Marillyn, Bruce, a very nice quarter.

If I could just go back to the sequester discussion for a moment.

I was going to ask Bruce if you could give us a little bit more color on why we don't see more of an earnings or margin impact from the lower sales.

Or is it simply that that's already embedded in the range?

And then, more specifically, Bruce, on your modeling discussion you talked about peanut buttering the GFY '13 funding that impacts this year.

But what percentage of GFY funding for Lockheed is beyond 2013?

I would imagine with the long cycle nature of your product lines, it could be a large percentage.

Let me try to address both those questions, Rob.

Why profit and cash are not necessarily impacted, or why we didn't change the guidance for those two elements versus what we did do for sales, a lot of it's because of the first quarter, quite honestly.

And, obviously, we were higher in the first quarter for sales, as well.

But we had good results pretty much across the board.

All five business areas beat our plan for them in terms of both sales and operating profit.

I think, as we look forward for the next three quarters, we do expect to see some pressures for the reasons that I described from sequestration.

As I said earlier, they've not played out at this point.

But we do expect them to happen in the next three quarters.

As we look out for the planned risk retirements and what we accomplished in the first quarter, we think those are stronger as we sit here today than maybe we thought they'd be at the start of this year.

And that's the reason we didn't change the profit guidance.

Cash flow, obviously, $2.1 billion in the first quarter, very strong.

Stronger than we had expected, honestly.

And that's the other reason why we think that's going to carry on through the rest of this year, as well.

That's the reason we didn't come down off of our cash, as well.

I think your second question was how much of the FY '13 carries over into next year.

I made the comment, Rob, that the sales that we got from our backlog at the end of 2012 is about 77%.

So think of that as new -- or, excuse me, FY or calendar year '13 sales originating, 77% of which come from the 2012 backlog.

That's not an unusual pattern for us at all.

I'll say next year we would expect it to look very similar to that.

So you should think of that as probably 25%-ish, maybe a little less than that, of our sales in 2014 will need to come from orders received in 2014 and manifested into sales in 2014.

So that pattern, as I look back over time, has been a fairly consistent one, not at all unusual for what we're experiencing in 2013.

Rob Stallard of the Royal Bank of Canada.

Good morning.

Quick question on capital deployments.

Do you expect there to be more consolidation in the defense industry as we see these budget pressures playing out?

And would you see Lockheed participating in that?

And also, to follow-on from your comments, Marillyn, about these adjacent markets, would you potentially be interested in acquisitions in more diversified areas, not just defense?

In terms of consolidations in the defense industry, I think as the spending contracts we would expect that there would be more consolidation.

It's just at what level?

And it's been communicated to us by our customers, they think that at the prime level it's about right in terms of the number of companies that are prime.

So it would probably be at the second and third tier or below that we will see consolidation.

But I certainly expect that because the economics will dictate that, with the contraction of the budget.

In terms of acquisitions into -- broadening our acquisitions -- we're going to stay into the near adjacencies.

We prefer to do joint ventures and teaming where it makes sense.

And we'll continue to look at our acquisition strategy, or the string of pearls approach.

And look at what will line up with the capabilities that we need and the markets that we want to move into.

Doug Harned of Sanford Bernstein.

Good morning.

I would like to understand how you're thinking about the longer-term top-line outlook.

Because, on one hand, if I look at the backlogs as they played out in this quarter, as I look at it, IS&GS appeared to be the most worrisome.

And that obviously could get hit by sequestration.

When you talk about contraction in the budget, it sounds like you are looking at a shrinkage overall in your top line.

And if I pair that up against the new ventures you're talking about going into, I know that OTEC and the reverse osmosis purification programs, those were going on 15 years ago.

Are you looking at bringing those forward more as a substitute for a contraction in the defense revenues?

Or has something happened technologically that has caused those to leap forward and become a more prominent effort?

Thanks for the question, Doug.

Just to address where we see our growth, we do know that our core domestic defense business will flatten, potentially decline.

So what we're focused on is growing our international business.

That's where we expect that to offset that and continue to grow.

As I've said in previous calls, and today, as well, we're currently at 17% of our sales.

We expect to grow that to 20% over the next few years.

So we'll continue to focus on where that demand is for our missile defense, our TACAIR, our air mobility, a lot of our C4ISR satellite technologies.

A whole range of products that there continues to be a strong demand for internationally.

In terms of these adjacencies, and some that I've talked about today, these are not needle movers in the near term.

These are really things that we believe are long term with large application potentially in these technologies.

And they are not new to the horizon for us.

As I've said, we've been working on them for a number of years.

The fact that some of them have come to fruition, we're dealing with different partners and different customers and so they are ones that have come about in the last few months that have come on the screen.

And we thought it would be appropriate to share with you what's happening in those.

But, really, our growth, our top-line growth will be on our core and near adjacencies, both domestically and internationally in the business.

Doug, I might add just a little bit.

I think on your last question you asked about have the technologies aligned at this point in time.

And I think that's probably a fair characterization.

I think they have aligned here.

We've been experimenting with some of the early materials that led up to the Perforene product for probably the last seven years or so through our Advanced Materials organization.

And that's what's just come out here, I think at the end of 2012, is with a product that we think provides a capability that we've described with Perforene.

On the OTEC side, as Marillyn said earlier, we've been doing that literally since the 1970s.

We actually had a pilot plant in Hawaii, off the coast of Hawaii, that's been working.

It's much smaller scale than the one we're talking about building going forward.

But we've had that operating for probably the last five years or so.

Some of the technologies have come together.

Some it's just been the ability to scale those technologies, particularly on the OTEC side of it.

So I think that's what we're seeing.

It's the culmination of them, and coincidentally they're all materializing here at the same time.

Frankly, very opportune time for us because that's where we are seeing some pressure with our largest domestic customer.

Jason Gursky of Citi.

Good morning, everyone.

Just a clarification question and then a more meaty one.

On the adjacencies, can you talk about where you are from a percentage of revenue today and what your targets are?

And then, is this a question of potentially selling these intellectual property rights that you've developed here?

And then on the meaty question, Bruce, can you talk a little bit about the cadence for cash for the rest of the year, given all of the moving pieces with the pension contribution, the tax payment?

And then we also, I think, have got the DoD moving from a net pay of 15 days to 29 days.

And I'm just wondering if that's going to have any impact on the cadence of the cash for the rest of the year.

Yes, Jason, good question.

Let me try -- I'll answer both and we'll see if Marillyn wants to add anything to what I come up with.

On the adjacencies, how big -- you should think of that as being fairly small, literally below 5% of our overall sales right now.

We're hoping to grow that some going forward.

The biggest elements we've got right now are in our energy business, as well as our cyber security business.

And those are two that we've talked about fairly consistently on the calls.

You should think of those as, again, being, I'll say low single digits percent of the overall sales of the corporation, hoping to grow those going forward.

The products that Marillyn described in her prepared remarks would just add to that, but not significantly, I'll say, over the next five-year period of time.

We're just really trying to convey the message that, one, we like to think that we do difficult.

And all these projects that we're talking about have difficult in their middle name, if nothing else.

And we think we're aligning our capabilities and the innovative capabilities of our workforce with products or with problems that need to be solved on a big scale.

And that's what we were trying to tee up for you.

As far as the cadence of the cash, I'm glad you asked that.

I was hoping to work that in at some point in the conversation anyway.

So, obviously, we're not going to do $2 billion a quarter when we're outlooking $4 billion for the year.

You should think -- we had no pension contributions and a tax refund in the first quarter of this year.

We should be, over the next three quarters, we should have pension payments in the second and third.

We'll actually have two tax payments, just the way the calendar lines up in the second quarter.

And then tax payments in the third and fourth.

So what you should see, especially in the second quarter, is we'll have cash flow down considerably.

Probably to the point of, on a free cash flow basis, slightly better than positive we're hoping, but down pretty significantly.

And then I would expect it to grow up to the $800 million, $900 million in the last two quarters or so, is what the expectation is as we sit here.

You asked about the payment cycle and so forth.

And I'll tell you, I think the industry at large has seen actually pretty good performance out of the payment offices where we get the most, the bulk of our collections from our customer.

They've been paying typically quicker than the statutory rates that have been paid in the past.

What I am watching for going forward, in particular, Jason, is the effects of workforce furloughs on the part of the US government and particularly as that affects our paying offices.

And so you can imagine a scenario where people will be furloughed -- I think the current thinking of the government is one day for 14 weeks in the months ahead -- and the question is, so is everyone paying contractors as efficient in four days as they are in five.

I've got to believe that's not going to be the case.

I would say, though, that that's expected to be an impact in the fiscal year, and not necessarily for the calendar year, because obviously the fiscal year will end in September, and we would expect the next calendar year not to have those sorts of furloughs.

At least as we sit here today.

Rich Safran of Buckingham Research.

Good morning.

I wanted to ask you about book-to-bill.

So if I did it right, it looks like you had book-to-bill of roughly 0.6.

And I think that's about what you did one quarter last year.

So I thought maybe you could comment on expectations for book-to-bill this year and how you feel about full-year book-to-bill being either 1 times or higher.

Yes, I'll try that one, as well, Rich.

I think your math is right.

It was a 0.6 book-to-bill.

Actually, as we looked at the first quarter orders, we actually did better than we expected to do, pretty much across the board, for orders for all of our business areas.

And in particular, I'll say I think that's one of the reasons why some of our short-cycle businesses, like IS&GS and the services component of MST, actually fared better in sales in the first quarter is because we did actually receive slightly higher orders in the quarter than we had expected to.

Going forward, I think second quarter is going to be the lowest quarter, from a backlog perspective, of the year.

And then we'd expect it to rise thereafter.

So we expect second-half orders to be higher than first half.

And the fourth quarter to be the highest quarter of all the quarters, if you will.

And that's our typical pattern anyway.

There's a couple things I'll point to that you might be watching out for in the second quarter.

We have a few high dollar items, mostly within our Aeronautics business area.

So we'd expect to get the second order for -- close the second order for 18 aircraft, F-16 aircraft I should say, for Iraq.

Probably get an order for a couple of C-130s from Saudi Arabia.

There's a possibility we'll close on the Indian C-130, a second C-130 buy for India for six aircraft.

We still have six international aircraft on lot six for F-35 that have yet to be fully funded via an undefinitized contractual action, or UCA, that we would hope would happen in the second quarter.

We should get additional funding for even greater aircraft on LRIP 8 for F-35.

And then switching to MST, we should be getting finalization of the MH-60 Denmark helicopter contract and some ground radar business within MST.

So those are the dollar awards that you'll want to watch, the high dollar awards.

Strategically, there's a couple of big items, as well, almost all of them within MST in the second quarter.

The Air Missile Defense Radar, AMDR, program, we expect to be awarded in the second quarter, as with Space Fence.

This is the space debris tracking radar, if you will, from earth, that we expect to happen in the second quarter.

And then, lastly, within MST, the KC-46 training activity that Marillyn mentioned in her prepared remarks is also something that we would expect either late in the second quarter or early third.

The rest of the year we're hopeful.

Obviously, we've got some missile defense products, PAC-3s and THAADs, for a number of customers within the Middle East.

And then recently, if you saw some of the FMS activity that just came out, we're hopeful to have some weapons on F-15s and some capabilities for helicopters with Saudi Arabia.

As well as the potential to sell additional F-16s to the UAE.

Whether that one will happen between now and the end of the year, may be a little bit sporty, but we're focused on that and hopeful that that could occur.

I should mention probably that we've also got activities within Singapore and South Korea for the F-35.

Again, not sure if those will happen this year or not, but they're on the cusp and ones that we're watching very closely.

George Shapiro of Shapiro Research.

Good morning, Bruce.

One just little one and then one I'll put together.

You mentioned a contractual settlement on the F-16 in the quarter.

Could you ballpark how big that was?

And then my more macro question is, if you look at historically defense outlays, and track them against military contractors, very rarely does a military contractor vary a heck of a lot from the numbers.

And if you look at for '14, the outlays for procurement and R&D are probably going to be down at least 10%.

So I ask the question, why wouldn't your revenues be down similar to what you would expect (technical difficulty)?

George, I'll take those.

So the F-16, the contractual resolution, you should think of that being in the -- I'm not even sure it approached $10 million, but think of it in the $10 million-ish range.

Maybe a little less than that.

So, not a particularly huge item but one that's been outstanding for quite a while.

And we're glad to have it finally settle.

I literally think this is one that's probably been around, as have quite a few of these contractual resolutions we've had settle in the past, for probably close to a decade.

So it's good to get that one behind us.

As far as the outlays, you were looking at the defense outlays versus the contractor, I'll remind you again that 61% of our sales, roughly, last year were from the DoD.

So there's a full, almost 40%, that's non-DoD.

Obviously the biggest component of that is the international.

We do expect, as Marillyn said, to grow the international component of our business, which would help maybe explain why we don't go down to 10% you're talking about there.

And then what I would suggest, George, is that even within that reduction in the procurement in R&D, you have to look at the individual programs within the DoD budget.

Because not every program within the DoD budget is going down 10%.

And it ties into the priorities of the customer and our alignment of our portfolio with those priorities.

So we would expect the F-35 to grow, our air missile defense programs to grow, and help to offset that.

And on the international side, obviously, as we mentioned earlier, the air missile defense components especially growing over the few several years, it helps to offset that reduction I think you're seeing in the high level math that you described.

Howard Rubel of Jefferies.

Thank you.

I want to ask more of an operational question.

For example, if we look at Aeronautics, Marillyn, you were able to hold the decline, for example, in the C-130 to about $10 million, despite seeing $175 million decline in revenues, which is a pretty impressive sort of action.

And if we look across some of the other businesses, despite difficult revenue numbers, the margins were pretty darn good.

Could you talk a little about, with some detail, some of the things you're doing, whether it's headcount or floor space?

Because no matter what happens with the sequester, I think there's just going to be a relentless pressure on the business for a while.

We're definitely focused on operational performance.

I think you characterized it well in terms of talking about it being operational.

Because not only are we driving improvement, even as we reduced the rate on the C-130J, we were able to hold our position relative to profit on the program.

So I think you're seeing the results of that.

And at the same time we're very much, across our business, working on reducing cost and increasing efficiencies and productivity in the business through a lot of activities.

Not just operationally with a particular program, but all of that flows through to all of our programs.

So things that we're doing in getting out of facilities and reducing our overheads, and the efficiencies that come with just having a laser focus on cost across every element of the business, is helping us to bring in better performance.

And then within the C-130J, as it moves through its courses you have a learning curve.

And so continuing to have productivity improvements as we continue with the rate of that program.

Howard, just an interesting little tidbit there.

I know my aeronautics friends have pointed this out to me as we've done reviews with Marillyn and the leadership team there.

We've actually, for the past few C-130s, since we started building them at 24 aircraft a year, the hourly rate, or the hours it takes to assemble that C-130, we're actually performing better than we were when we were delivering 34 aircraft a year.

That's no small feat when you're on number 2,500 aircraft through the line.

And it's this stage of the product development or product manufacturing cycle that we've been able to make that.

Those are real live reductions.

And just one of several instances that we can point to where we're taking the right actions, particularly on the manufacturing side of bringing down the product cost in line with the shrinking volume that we're seeing.

Myles Walton of Deutsche Bank.

Thanks.

Good morning.

First one is a clarification.

Bruce, I think you had previously talked about $80 billion in backlog ending the year.

I can't recall if that was with sequestration or without, and if that number had changed.

Myles, I think what I've tried to tee up is that we always expected we'd take a downturn in the first quarter, probably get further down in the second quarter.

I think at the start of the year I said we hoped to get back around the $80 billion mark.

That's still, obviously, a goal that we have.

But I think it's going to be tougher, assuming that the next three quarters are hit by sequestration.

So those numbers, you remember them right.

It was the $80 billion.

But I'll say that's probably a tougher putt as we sit here today because that did not consider the effects of sequestration.

And, of course, you would think that orders in the fiscal year, since we had more of our orders obviously coming from fiscal year '13 funds, would be more significantly impacted than would sales in calendar year '13 because less of those come from fiscal year '13 funds.

So it would be a bigger number than the $825 million of sales impact, is what I would expect from an orders perspective.

But we're not yet at this point giving up on that.

And hopefully as the quarters go by, Myles, we'll have a better idea what that looks like and we'll be able to update that for you as we go through the year.

Cai von Rumohr of Cowen and Company.

Yes, thank you, and great performance.

Bruce, one of the things you highlighted was that EACs were better than expected.

It was 470, 35% of sales.

That's substantially higher than it's been in any of the last couple of years.

Where do you expect it to be for the year?

And -- two questions -- give us some color on the quarterly pattern, as you did with the cash flow.

And then where notionally can this number go in the future?

Is it likely to come down to more normal levels or is it still sustainable?

Thanks so much.

You bet, Cai.

EACs, at least as I look at it, Cai, we actually were a little bit lower in terms of profit adjustments in the first quarter of this year as compared to what we did last year.

So think of it still in the mid 30%-ish range but slightly less, I think about $15 million or 20 million less this year versus last year.

You asked for the pattern going forward.

We would expect to be probably within the 30% to 35% range each and every quarter going forward.

Probably down a little bit from last year overall.

But of course the sales and the segment profit are expected to be down this year compared to last year.

So that's probably following suit for the lower volume that you see there.

Nothing really jumps out as I look at it as far as spikiness, as we sit here today, in terms of the pattern going forward.

That obviously changes as we do risk retirements.

We do them when we retire the risk, not when we necessarily plan to do the risk.

So when I described the pattern going forward, it's what we plan to do but we could obviously do better or worse than that.

We really don't have a reason to believe the future is necessarily going to look any differently than the past.

I know that's been the subject of a lot of writing.

But it's the same methodology we've used consistently for a long time.

And that's been our pattern.

We've described that over time.

I think last year was a bit odd in a couple of quarters because we had some large contractual resolutions that jumped out that were not in our historical levels.

But going forward what we see is still in that 30% to 35% range and not much change from that, Cai.

And then you mentioned that it was better than you expected.

How much has that changed?

You mentioned that as a plus for the full year to offset the lower sales.

How much better does it look now, approximately?

I don't know that I've got the numbers off the top of my head, Cai.

But I would say we were not expecting -- we got the benefit of both volume, obviously.

I think on the last call I had teed up that we were probably going to be down $1 billion year over year in the first quarter.

We ended up being down about $800 million.

Again, across the board, all five business areas were better in sales, better in profit.

The sales obviously brought volume in terms of profit on those sales.

If I had to guess a number, I would probably offset maybe about $50 million-plus-ish is probably what I would guess that happened earlier.

And somewhat higher than we'd expected, Cai.

And that's a little bit off the top of my head.

And we'll see what that looks like going forward.

But, again, I don't see a huge pattern shift as we go forward the next three quarters from what we did in the first quarter.

David Strauss of UBS.

Good morning.

Bruce, going through your sequestration math as it relates to 2014, is there anything besides international that would offset overall revenues potentially being down in the high single-digit range?

And then, Marillyn, a question for you in terms of sizing the business for sequestration.

You obviously highlighted here further restructuring in IS&GS.

Can you just talk about maybe broadly how you view the business size-wise, headcount, from a headcount perspective, if sequestration does go through in full effect?

Thanks.

David, you asked me the first part of that question.

So again, what I tried to tee up, and I won't just simply repeat myself, but we do tend to have a very similar pattern as far as the amount of sales that we derive from backlog year over year.

So, as we've talked in the past, our long-cycle businesses, Aeronautics and Space in particular, get 90%-plus of their sales in the following year from the backlog from prior years.

That goes down.

Probably IS&GS is our lowest business that gets -- in terms of the percentage of sales that are derived from previous years' backlog.

But think of that as probably 65%-ish or so.

35% comes from new orders turning into new sales in the year.

The thing about 2014 that I think we all have to remember is, 2013 is the peanut butter or across-the-board cuts.

2014, with the new President's budget, there is no peanut butter cut.

So they can actually cut whatever, I'll say, aligns with the strategy, starting in government fiscal year '14.

That's different than what we saw or what we will see in fiscal year '13.

And where I would offer up, this is the proof of the pudding of whether or not your portfolio aligns to the government's strategic interests or not in terms of the DoD's priorities.

We think ours does.

We think ours has more staying power in that environment than in a peanut butter environment.

And that's what I think, David, I think is maybe not all that well understood, but I think does make a difference as we look into FY '14 versus '13.

And, Marillyn?

To address the sizing of the business for sequestration, we are going to size the business as we get more clarity from our customer.

But frankly, it's difficult to forecast.

I know Bruce talked a lot about modeling, but it really was the best we could do to model what that impact would be.

Until we get better insight on their planning for sequestration, it will be difficult to say which programs get hit and, therefore, which programs -- what kind of headcount might be modified accordingly.

So there's a lot of uncertainty here.

As Bruce said, though, when you look at the budget request for FY 2014, it does certainly support not only the national security strategy, but it also very much aligns with our portfolio.

We'll continue to invest in new technology.

We'll continue to drive down our costs.

And I think we remain well positioned to succeed in this environment going forward.

Sam Pearlstein of Wells Fargo.

Thank you.

Bruce, can you discuss a little bit about the sales?

Before you had said sales for the quarter would be about $1 billion below.

I know you came in a little bit better on aircraft deliveries.

But it looks like almost across the board MS&T, M&FC, IS&GS, Space, all were running ahead of what you said you would be doing in the 10-K in terms of the full year.

So, is there a reason why there was so much front ended?

And what does that mean for the progression of the different quarters?

Yes, good question, Sam.

I tried to tee that up, I think, with Cai when he asked the earlier question, that we were higher in the first quarter than we expected.

I teed up being about $1 billion down.

We actually ended up being $200 million down.

So there was $800 million of goodness there.

Think of it as $200 million within Aeronautics, probably for a couple of C-130s earlier delivered than planned.

The rest of it was volume.

Missile and Fire Control was up, on just a percentage basis, like 13% year over year in the first quarter.

Most of that was the phasing or timing of deliveries of products there.

So think of it as in particular tactical missiles, JASSM, missiles, the multiple launch rocket system activities there.

That's earlier than planned but not necessarily an upper for the year as we look at the end of the first quarter.

We also saw higher volume, just I'll say cost volume, from a couple of awards, including within SOFSA CLS and the LANTIRN sniper activity within Missiles and Fire Control.

Some of our short-cycle business, I'll say we were very pleasantly surprised in the first quarter.

I mentioned earlier that we were going to -- that we actually exceeded our orders expectations in the first quarter.

Even though you were looking at that as a 0.6 book-to-bill ratio, that was actually slightly better than we expected.

And on our short-cycle business, we think that did translate into higher sales in the quarter, as well.

Not sure if that will last throughout the year.

That's one of the reasons we put the guidance out that we did.

But we're pleased to have that impact in the first quarter.

I think some of that is because we, frankly, saw, I'll say, a sense of urgency to get things under contract prior to the end of last year when we thought sequestration was going to start in early January.

I think we experienced a similar phenomenon at the end of February when the customer thought that sequestration was going to get in effect on March 1. A number of customers thought that obligated funds would not be subject to sequestration if obligated prior to that.

I think we got a bit of a rush to get those under contract and I think we're seeing the benefits of that on our short-cycle businesses.

Maybe just to finish off my long dialogue here.

Going forward the next few quarters, I think our sales level are going to be similar in the second and third to what we experienced in the first quarter, maybe down slightly, because sequestration's largest impacts, at least as we look for the rest of the year, are going of to occur in the second and third quarters.

Because you're squeezing the full government's fiscal year, sequestration cuts into the last two quarters of the fiscal year.

So, for us, that's the second and third quarter of the calendar year.

I think we'll see bigger reductions there.

I do think fourth quarter will be a larger quarter, the largest quarter of the year going forward, even with the potential reductions that have yet to be announced in fiscal year '14 from sequestration.

So that's how it ties up.

Think of, again, the next three quarters similar, maybe a little bit down because of sequestration to the first quarter, and then a pop-up in the fourth quarter.

To wrap up, I'd like to thank you all for joining the call today and for your questions.

And we look forward to speaking with you in July.

Thanks.

Ladies and gentlemen, that does conclude today's conference.

You may all disconnect and have a wonderful day.