洛克希德·馬丁 (LMT) 2013 Q2 法說會逐字稿

Good day and welcome everyone to the Lockheed Martin second 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, Sayid, and good morning.

I'd like to welcome everyone to our second 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 fillings 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 Marilyn.

Thanks Jerry.

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

Before I begin, I want to offer my appreciation and congratulations to our Lockheed Martin team for their continuing outstanding performance.

And the achievement of strong second quarter financial and operational results.

As we continue to operate in a dynamic and challenging environment, their efforts and focus have our corporation poised for continued success in delivering value to shareholders and solutions to customers.

While Bruce will cover the financials in more detail later, I'll highlight some key financial achievements in the quarter.

That included growing earnings per share to $2.64, 11% above last year's second quarter level.

Expanding segment operating margin to a record level of 13.4% and achieving an increase of 110 basis points above last year's level.

And generating over $600 million in cash from operations after making $750 million in pension contributions.

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

In the second quarter, we repurchased 4.5 million shares of our stock, more than double the 2.2 million shares we repurchased in the second quarter last year.

We deployed $465 million for share repurchases this quarter and paid slightly over $370 million in dividends.

Through the first half of 2013, we returned over $1.6 billion or approximately 70% of our free cash flow to shareholders through dividends and share repurchases.

Overall, I would characterize the second quarter financial performance as broad based across all business areas with results exceeding our expectations.

This strong performance enabled us to increase our 2013 financial guidance for operating profit, earnings per share, and cash from operations.

Bruce will cover some of the specific drivers for the improved performance in his briefing.

Before discussing other achievements this quarter, I'd like to outline the status of DOD budgets.

Since we last spoke in April, not much has changed in the budget environment.

FY 2013 DOD budget appropriations have been enacted and incorporate the $37 billion in budget reductions required under sequestration.

While some budget reduction actions are being implemented by the government, they have yet to implement most of the required spending cuts.

To date we have seen minimal impact to our portfolio programs with actions taken primarily limited to our shorter cycle business.

Customers are continuing to determine how they will implement the cuts mandated by sequestration which they are required do before the end of the fiscal year on September 30.

And we are working closely with them as they explore a host of potential scenarios.

For FY 2014 congressional deliberations on the budget are continuing.

The President's proposed baseline defense budget remains at $526 billion without inclusion of the $52 billion in sequestration budget reductions that went into effect in March 2013.

The Department of Defense has finalized the strategic management review that re-examines policy and program priorities to account for the sequestration imposed cuts.

This review will be used to aid DOD in continuing to formulate decisions on post-sequestration program budgets for 2013 and 2014.

While future budget levels remain uncertain, the strategic need and support of a number of our key programs such as the F-35 Joint Strike Fighter, missile defense systems, Littoral Combat Ship and C-130J remains intact.

We will continue to work with customers and respond to changes as required when budget positions are finalized by the government.

Turning to the operational performance, our five business areas continue to execute with exceptional focus and skill in providing critical products and services to customers.

Of the numerous accomplishments in the quarter, I'd like to highlight our continued success in missile defense activities, provide a status of our expanding international work, and finish with an update on the F-35 Joint Strike Fighter program.

First, with the growing threat of ballistic missile proliferation, the need for proven, reliable interceptor systems is becoming more acute daily.

Providing defensive systems designed to prevent the catastrophic damage that can be inflicted on civilian population centers and national infrastructure by offensive missiles is essential to our nation and allies.

Our portfolio of interceptor systems consisting of Aegis, Patriot, THAAD and MEADS will provide layered coverage intended to defeat missile threats posed by rogue nations.

This quarter our Patriot 3 missile conducted a ripple fire test that successfully intercepted and destroyed two different targets at white sands missile range.

This test was the first time a multi-target engagement was performed against both a ballistic missile target and a cruise missile target.

And its success provided a clear demonstration of the design maturity and increasing capability of the PAC-3 configuration.

In addition to the Patriot test events, our second generation Aegis ballistic missile system successfully launched and guided a missile to engage and destroy a separating short range ballistic missile target.

This test validated the ability of the Aegis system to engage increasingly more challenging enemy threats.

It also marked an important milestone for the Phased Adaptive Approach to missile defense in Europe.

This approach will combine a land based Aegis Ashore site in Romania with a traditional Aegis system aboard Navy ships to his provide unique missile defense protection on the continent.

These multiple successful launch events demonstrate the accuracy, robustness, and technological advances we are incorporating into our missile defense products.

These advances will ensure we can provide defensive systems to customers that can respond to an ever evolving threat.

With customers depending on these systems in their times of need, it is an honor and responsibility to provide affordable and proven systems for our nation and allies.

The next area I want to highlight is the continued expansion of our international business portfolio.

This quarter we secured new awards and made deliveries to new customers as we extended our international presence.

New orders were received across multiple business areas and consisted of Aeronautics' receipt of an award for 18 additional F-16 aircraft for Iraq.

This award now extends the F-16 production line in Fort Worth, Texas well into 2017.

Mission Systems and Training secured new work for Japan to upgrade Aegis multi-mission signal processors and other equipment on their ballistic missile defense ships.

Missiles and Fire Control received multiple international awards including an order from Saudi Arabia to provide LONGBOW Fire Control Radars for attack helicopters, an order from Finland to provide integration support of our JASSM missile into Finish fighter aircraft, and an award to provide Patriot missile defense equipment to Kuwait.

International deliveries in the quarter consisted of delivery of the first C-130J Super Hercules aircraft to both the Republic of Tunisia and to Israel.

The delivery to Tunisia marks the first to an African country, an entry into a new customer set.

Tunisia becomes the 15th country to select a proven, low risk and affordable C-130J for its air fleet requirements.

Expansion of international sales remains a key component of our corporate strategy, and we are on a path to grow international content from approximately 17% of total sales last year to at least 20% in the next few years.

Finally, turning to the F-35 program, multiple key accomplishments were achieved in the quarter, and you can feel the momentum accelerating throughout the program.

Last month I attended the F-35 CEO round table in Fort Worth chaired by Frank Kendall, the Undersecretary of Defense for acquisition and logistics, and a program status briefing by Lieutenant General Bogdan, the F-35 program executive officer.

Attendees included representatives from all nine partner nations and our teammates on the F-35 industry team.

The meeting reaffirmed just how much progress the F-35 team has made.

The customer expressed a renewed confidence in the future of the program, and there is a strong sense of partnership across the whole team.

We know a lot of work still must be done, and at the same time it's clear that the tremendous efforts of the team are paying off.

One of the key accomplishments this quarter was the declaration by the Department of Defense of initial operating capability dates for all three F-35 variants.

2015 for the STOVL aircraft, 2016 for the CTOL aircraft, and either late 2018 or early 2019 for the CV aircraft for the US Navy.

These dates reflect the confidence that the customer has in the Lightning II and in our team.

Our job is to execute on the program, to make sure we meet these critical dates for our customers and to deliver the capabilities of this aircraft to our war fighters and allies.

Beyond the establishment of IOC dates, the program achieved a number of key milestones in the second quarter including the delivery of the first F-35C Carrier Variant to the US Navy.

This delivery was important as all three variants are now at Eglin Air Force base, Florida where they're training pilots and maintenance personnel for this next generation fighter.

Completion of high angle of attack testing by the F-35A which is a key measure of aircraft maneuverability, completion of the first vertical take-off by an F-35B STOVL aircraft.

And the successful first in flight missile launch by the F-35A variant.

Production activities continue to ramp up with delivery of 12 aircraft in the quarter, and we remain solidly on track to deliver at least 36 aircraft this year.

Program tempo is accelerating, and we currently have our 100th aircraft in final assembly.

In the area of customer relations and contractual events we were pleased with the Australia's reconfirmation of its plan to procure 100 CTOL joint strike fighters for its national defense.

We look forward to providing these revolutionary aircraft to one of our key strategic partnered countries.

As we continue to work to bring down the cost of the aircraft, we were pleased with the reduction in acquisition and operating and support costs reflected in the 2012 selected acquisition report issued by the DOD in June.

This was the first year the cost reduction was noted since program inception.

And we will work with the F-35 joint program office to implement further cost savings measures to secure additional decreases in the total program costs.

The top priority of the government and contractor team is to continue to cost effectively build and deliver the F-35s unprecedented 5th generation capabilities to the war fighter.

I will now ask Bruce to go through some of the details of our financial performance, and then we'll open up the line for questions.

Thanks, Marillyn.

Good morning, everyone.

My comments will refer to the web charts that we included in our earnings release today if you'd like to follow along.

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

Sales in the quarter were $11.4 billion, 4% below our results from a year ago but higher than our first quarter results and, as with the first quarter, were above our expectations.

Segment operating margin was a record 13.4%, 110 basis point improvement over the second quarter last year.

Our earnings per share were also up significantly to $2.64, an 11% increase over last year's results.

We generated $623 million in cash from operations, well above the outlook I provided in the first quarter.

We returned over $800 million of cash to our shareholders including the repurchase of 4.5 million shares for $465 million.

And, as a result of our performance, we're increasing our outlook for operating profit, EPS and cash from operations.

So we're very pleased with our results for the first half of the year.

Chart 4 shows our sales in the second quarter this year versus last year.

Aeronautics' sales equaled our results last year as lower quantities of F-16, F-22 and C-130 aircraft were offset by higher volume of F-35 production contracts and C-5 deliveries.

IS and GS sales were lower due to reduced volume primarily in our intelligence line of business.

Missiles and Fire Control continued its strong performance with an 11% increase in sales coming primarily from air missile defense programs.

Mission Systems and Training sales were down 12% due primarily to the end of deliveries of the PTDS program last year.

And, finally, Space Systems was 13% lower than last year due primarily to the delivery of two commercial satellites in the second quarter of last year and none this year.

Moving to chart 5 and our segment operating results, despite our sales being down 4%, operating profit was up 4% driven by the significant improvement in operating margin of 13.4%.

Again this quarter we had strong program execution across all of our business areas as we will show in the next chart.

Chart 6 shows our segment operating margins by business area.

Three of our five business areas increased operating margin compared to the second quarter of last year with MST having largest increase due to settlement of certain contractual matters and better performance in our training and logistics business.

Missiles and Dire Control continue to have excellent results, and the increase this quarter was due to improved performance in air and missile defense programs, tactical missile programs and fire control programs.

Space Systems' margin improved primarily due to the increased equity earnings from United Launch Alliance, reflecting mix of launch related activities in the quarter compared with last year.

IS and GS' margin was flat relative to last year's second quarter results.

And Aeronautics' margin was down this quarter due to the absence of a favorable contractual resolution on the F-22 program which occurred in the second quarter of 2012.

Adjusting for the contractual resolution, Aeronautics' margins were similar to last year.

Moving on to chart 7, our EPS grew 11% over the results from the second quarter of last year to $2.64 per share, due primarily to improved operational performance.

And, on a pension adjusted basis, our EPS was $2.87 per share.

If you will turn to chart 8, we will discuss our cash return to shareholders in the quarter.

We returned over $800 million to shareholders in the quarter with share repurchases in excess of dividends paid.

Compare with the second quarter of last year, we repurchased more than double the amount of shares.

With the increase in our stock price in the quarter, we saw a higher level of options exercised, and, accordingly, we purchased additional stock to mitigate share count dilution.

On chart 9 we'll look at cash returned to shareholders on a year-to-date basis.

We've had a strong year-to-date cash -- we've had strong year-to-date cash from operations of $2.7 billion and free cash flow of over $2.4 billion.

Through the first half we've return almost $1.7 billion or nearly 70% of our free cash flow to shareholders.

And our share repurchases of over $900 million exceed the level of dividends paid thus far in the year and greatly exceed the roughly $700 million ascend in our full year guidance at the start of the year.

Moving on to chart 10 we'll discuss our updated view of guidance for the year.

As was the case last quarter, we saw minimal impact to our sales in the second quarter as a result of sequestration actions, and we are maintaining the sales guidance provided last quarter.

On the other hand, we are increasing our outlook for segment operating profit by $225 million to recognize the strong performance through the first half of the year.

As a result of the increase in our segment operating profit, we are also increasing our outlook for earnings per share by $0.40 to a new level of $9.20 to $9.50 per share.

And, also reflecting strong performance thus far, we are increasing our cash from operations guidance by $200 million to a new level of greater than or equal to $4.2 billion.

Chart 11 shows our updated segment operating profit outlook by business area.

We're increasing our outlook in four of the five business areas.

MST's outlook is now $75 million higher, Missiles and Fire controls is now $70 million higher and both Aeronautics and Space are $40 million higher than our guidance last quarter.

And turning to chart 12 I will summarize by noting that we are very pleased with the results for the first six months of the year.

And they reflect our program execution, the strength of our portfolio and the focus of our workforce during these dynamic times.

With that, we are ready for your questions.

Sayid?

Thank you.

(Operator Instructions)

And in the interest of time, we are limiting you to one question.

Please return to the queue for any follow-up questions.

Carter Copeland, Barclays.

Just a quick question on the order outlook.

Obviously, the book to bill was about 0.8 by my calculation, and it looks like obviously you have a plan to have a pretty big step up there in Q3 and Q4 to hit the levels you talked about on the previous call.

You said you hadn't really still seen any impact from sequester, but I wondered if you could give us an update on your expectations for orders, and if anything's changed since the last quarter, and how that will shape up for what you are thinking about 2014?

Thanks.

Thanks, Carter.

I will start off by saying -- actually we're slightly ahead of where we thought we would be at this point in the second quarter.

I tried to tee that up, I think, either the first quarter or the call at the end of the year last year.

But we're actually tracking about as expected, or slightly ahead of plan.

There are several items, and I should probably just run down the list by business area just to give you an idea of what we are expecting to happen over the next few quarters.

The single biggest item obviously is the closure of the Lot 6 and 7 negotiations for F-35.

And when that happens, Carter, think of the increase in orders as being somewhere in the $4.5 billion to $5 billion amount for just that one closure of contract negotiations, if you will.

We are expecting that to happen in the third quarter.

I think we are making good progress on that.

Marillyn can fill in some of the details for you, if you would like, at a later point in the call.

We also have a number of competitive orders we are watching in MST in the third quarter, including Space Fence and the Air Missile Defense Radar program, AMDR.

We also have an Aegis order for the basic Aegis program.

Collectively, those are about $1 billion, again, that we are expecting in the third quarter.

Missiles and Fire Control has both domestic and an FMS order for the THAAD program that's expected in the third quarter.

Think of this as the annual buy from the Army on the domestic side, and one of our international customers tagging onto that order.

And that's, I think I said, worth about $1.5 billion in the third quarter.

IS and GS as usual is nothing -- no one program individually significant, but the third quarter is expected to be higher than either the second or the first.

And then, Carter, as we look forward, I would expect that the fourth quarter as usual would be our highest quarter of the year.

Now, just to sort of summarize all that, I think the third quarter, you should think of us probably being back at a level maybe slightly higher than where we are -- or where we were in the first quarter.

And if all comes as I just laid out, including some of those competitions, we should end the year pretty close back at about the $80-billion level, like I have been talking about the past two quarters.

Rob Spingarn, Credit Suisse.

Bruce or Marillyn, this could go to both of you.

But I wanted to just talk about what we learned in the interim between last call and this call from DOD on sequester?

I think about $1 billion was taken from 2013 money for F-35, and it appears to cut, I think, five aircraft from the Air Force, and about two from the Navy and the Marine Corps, with the remainder of the $1 billion being RDT&E.

To what extent, if at all, does this impact LRIP VI and probably more likely LRIP VII negotiations, and how should we think about that -- those lost seven aircraft from the 29 aircraft originally funded in '13?

Thanks for the question, Rob.

First I'd say that our customer really has not come out with a definitive position on how they're going to take into account sequestration.

I know there has been a lot of speculation.

I'm not going to speculate with you on what they'll come out with.

We're working closely with them.

They're looking at different scenarios of how -- if they will address it.

One thing I will say is that they are very supportive of the F-35.

And we'll just have to see how it comes out.

We have seen, in terms of any impact that we might see on F-35, it will be backfilled probably by international opportunities because, as you can see, that's where we're going to ramp up.

In fact, if we look over the next five years, close to 50% of our orders will come from the international customers.

So we've got to just wait until they come forward with -- wait until the Department of Defense comes forward with what their plans are, and then we'll adjust accordingly.

Rob, I might just add a little bit to what Marillyn said.

I think the negotiations on VI and VII were clearly targeted to sort of keep the quantities sort of pre-sequestration.

So think of the negotiations that we hope to close fairly quickly here as being the same quantities we had embedded within the fiscal years themselves, not adjusted for sequestration.

I think Secretary Kendall has been pretty vocal in the press about trying to keep quantities, and trying to prevent sort of the reopening of contracts.

So we're optimistic that that kind of plays out well for that negotiation, that we're not impacted to the level that you talked about.

As Marillyn said, we're watching the FY '14 budget closely, but at least as we have sort of done comparisons, in particular the President's budget, there seems to be more reductions to non-aircraft elements of the program than aircraft programs, which we think from sort of a build rate and bringing the overall cost profile of the program down, is the right move from obviously our perspective.

So, Bruce, if I'm to understand what you both just said, it's not so much about quantities.

It's more about total dollars, and these dollars don't necessarily come off of unit price, but from other areas of the program?

I think you said it just right, Rob.

In fact, I have said -- we had a media event this morning, and I think I said in my prepared remarks that we've seen less impact from sequestration sort of writ large than we expected to through this part of the year.

I'll say, frankly, from our perspective, I can't speak obviously for all of the industry, but I think the Pentagon Secretary -- all the way up and down the Pentagon, have been very prudent in the way that they've managed the sequestration impacts.

And I think they've done a very nice job doing that from an industry's perspective.

Jason Gursky, Citigroup.

Bruce, this question is for you.

In the slide deck, you've got a line in there on chart 9 that says you're on track to exceed full-year cash return commitments.

You've done that on the repurchases, the $926 million versus the $700 million, but keeping in mind that the goal here was to keep the share count roughly flat and to offset delusion.

So can you just provide a little bit more update on what exactly you mean by on track to exceed full-year expectations?

Is that around the share count itself?

Or is that a comment more around the $900 million versus the $700 million?

Probably neither actually, Jason.

It's more of -- our long-standing goal is to give 50% or more of free cash flow.

I'll say we pretty much get there obviously with just the dividend, so in truth I was saying -- due to $700 million plus the dividends for the year.

So we have exceeded that already, you know, on a year-to-date basis.

And I think probably embedded in your question is -- so what does the outlook look like for the rest of the year, and how does that expect to play out?

I've got to believe with the stock sitting where it is today, and the level of options that have been exercised to date, that those will continue if the stock stays where it is today.

It's actually up $2, at least the last I looked at it today, which will probably continue that trend.

Just to give you some perspective there, we've had -- we had 4 million options exercised in the second quarter of 2013 compared to just over 1 million in the second quarter of 2012.

So if that trend continues, that will be obviously the motivation for us to continue the share repurchases at the level we've had in the past, but that will be dependent upon us watching that option exercise and its effect on dilution of the share count.

Robert Stallard, RBC Capital Markets.

Bruce, a follow on from Jason's question.

If you are obliged to carry on buying back stock at this rate, does this jeopardize or impact on your flexibility to increase the dividend going forward?

Well, I guess you can't do that to infinity without impacting the ability to pay dividends back, Rob.

But honestly, I don't think -- if you look at our track record in terms of what we've done with dividend increases, I think that's probably always I'd say the best indicator of what we'll do in the future.

The one thing that's kind of interesting about where we sit from the amount of options that are still outstanding and have yet to be exercised -- I want to say there is about $15 million -- 15 million, excuse me, shares of options that are outstanding, about 12.5 million or so are vested, and the other remainder are unvested.

But we've kind of weeded out, if you will, sort of the low-dollar option amounts.

So the options that are being exercised today come with option prices at the $80-plus per share, for the most part.

So think of the incremental difference between sort of buying back the shares to offset the dilution, and the price of the options that are being exercised as maybe less than they would have been years ago when we had some options at the $35, $45 level.

So that's helping to mitigate what you might think of in terms of the overall level of cash sort of required to continue the share repurchases.

And so, therefore, I think we've got the flexibility to do that.

We're still looking at -- with the guidance we provided this year, $4.2 billion, our overall capital somewhere in the $1 billion, maybe a little less, so free cash flow of $3.2 billion.

We started out -- I think we've got, what, $2.8 billion on the balance sheet as we ended the quarter.

So I still think we've got the fire power to continue to do that going forward, in part because of the reasons I just said with the benefits coming from those options when they are exercised.

Noah Poponak, Goldman Sachs.

If I move to the low end of the revenue guidance range, which you've indicated would happen under sequestration, for 2013, the back half of the year would experience something like an 8% organic revenue decline.

In that, what is your assumption for the growth rate of US DOD versus US non-DOD versus international?

And then, to the extent you're willing or able, can you talk about how much different we should assume those would be in 2014, if at all?

Help me with the last part of your question, Noah, if you would?

Tell me more about what you are looking for -- the comparison of '14 to '13 -- what was that?

Basically what I'm saying is -- is there any reason why we should not take those growth rates you've assumed in the back half of '13, and carry them forward into '14 in the scenario where sequestration is sticking?

So I think the first part of your question was -- if you kind of squeeze for the back half of the year, looks like we're down, I think you said 8%.

I think that's about right, though I don't have that off the top of my head.

I will say that, as I said to answer a previous question, as we look at the overall year and where we sit through the first half of the year, our sales were ahead of expectations in the first quarter.

Our sales were ahead of expectations in the second quarter, albeit not as much as they were in the first quarter.

So we are tracking better than expected through the first half.

The $825 million that we kind of came up with that would point towards the low end of the guidance was sort of -- as we have used in the past, sort of a parametric or a mathematically derived number that, frankly, we haven't seen materialize as quickly or as much as we thought when we did that calculation.

So I'm hopeful that we actually are closer towards the -- maybe a little bit higher than the low end of the guidance.

As I said earlier, we've got one quarter to kind of squeeze out the fiscal-year '13 impact of sequestration.

Seems like a lot has to happen that quarter for that sort of mathematical modeling to come into fruition.

As far as the build rate going into 2014, I think we're very similar to the situation that we were going into fiscal-year '13 in that we haven't seen truly the impacts in '13 that we'd expected, in large part because, again, I think the DOD and the Pentagon has done a fairly masterful job kind of deflecting some of that.

It's come at the expense of operations and maintenance and some readiness issues, which are not good by any means.

But in terms of the industry's perspective, I think it's been helpful.

We're kind of going to go into '14 similar to the way we went into 2013.

There I think we're going to have a similar story, as I said at the start of the year, where our long-cycle businesses will not see much impact, even if the '14 budget is hit by sequestration.

And our short-cycle businesses will have that impact.

I've got to believe the ability to continue to defer and push the sequestration impacts on O&M readiness and the like will be mitigated by '14.

So I think '14 versus '13 will be similar to what we expected to kind of happen as we entered the year '13, if that makes sense.

Rich Safran, Buckingham Research.

This question is either for Marillyn or Bruce.

Marillyn, on your comments regarding the -- on the second tranche of the F-16s, and extending the backlog out to '17 now -- I wanted to know if you could comment on other opportunities for the F-16?

And maybe also, if you could, make a comment here about what you are thinking about in terms of production rates?

And as long as we are on maybe legacy programs here, maybe you could also comment on opportunities and outlook for the 130J and production rates?

Sure, thanks for the question.

On opportunities for F-16, as I did say with the Iraq sale, that gets us out into 2017, but we also have opportunities in -- for the UAE potentially, or other Middle East countries.

We have opportunities in South America.

So our production rate today is about 13 aircraft per year, and it should continue on out through at least the '17 time frame.

Then as we see additional orders come online, we would continue to stay on whatever rate that would lend itself to.

We also have F-16 upgrade work that we're doing today, which is good work for us with the timeline upgrade of F-16s.

On the C-130J, our plan this year is to deliver 24 aircraft, and we'll continue on that rate.

We have a lot of international demand for the C-130J.

We are hopeful on moving through the multi-year opportunity with the US government, which would be up to 83 aircraft through that -- opportunities in Saudi Arabia, opportunities in India.

So the C-130J also has good opportunities.

Joe Nadol, JPMorgan.

Very nice margins.

I have actually just two quick ones.

One is -- Bruce, you talked earlier about the backlog, and what you expect to happen by the end of the year, about $80 billion.

Is funded backlog -- does that look at a similar profile?

In other words, you were at $55 billion I think at the end of last year.

Do you expect that to be roughly the same?

The second question is just on the F-35 SDD -- you took another reduction -- profit rate reduction in the quarter.

Could you just give some color on how you think that tees you up going forward on that contract?

What has to happen to make that the last write down?

Thanks.

Thanks, Joe.

I'll try to take both those on.

So the backlog, as you said, we're looking for a total backlog of $80 billion or so by the end of the year, and I think we are around $55 billion or so of funded backlog.

I wouldn't think -- I would think that relationship will sort of hold pretty steady, would be my guess.

Maybe a little bit higher, as I think about it, because I would think we'd get full funding for a good portion of that Lot 6 and 7 negotiation.

So that, on a percentage basis, it might actually be a little higher than it says today.

As far as the SDD, you're right, we did take a D book this year -- essentially similar to the one we took a year ago at this time frame.

The way I would describe that, Joe, is -- in the quarter, we finalized an agreement with the government, which they've been working for quite some time for the plan for earning the remaining fee on SDD.

You should think of that as being both for the remaining developmental milestones on the contract, as well as sort of an overall measure of performance that's an incentive-based measurement that will take place at the end of the contract.

I'll just say that both criteria, the developmental milestones, they're linked to specific dates and accomplishments through the remainder of the SDD period.

And even more so, I'll say the sort of overall performance measures at the end of the contract, which you should think of as being tied to both schedule performance and cost performance between now and the end of the contract, both of those I would characterize as very tough criteria for us.

So this is our best estimate of how we're going to perform against that criteria.

I'd like to say that this is -- well, I'll just leave it at that.

I think this is our best estimate of how we'll perform against that criteria.

And it is a little tough maybe than what we were thinking it was when we set the numbers a year ago at this time.

Bill Loomis, Stifel.

Just staying on F-35s, you talked about the productions, the quantities are still undecided, but from a revenue standpoint and the work you're doing, is it still running at that 15%?

Do you expect that to continue?

Then, just as another question on IS and GS, with the backlog showing sequential decline, and you had two big wins last year with GSM and Polar, and we're still declining.

When do you think we might see some stability in IS and GS?

Thanks.

Bill, I'll answer those.

So we are at about 15% of total revenue for the F-35 program.

I think that number continues to increase over the next few years.

I think we were somewhere in the 13%-ish or so range -- I've lost track where we were last year.

We had about a 2% increase, if memory serves me right, in the percentage of total F-35 versus our -- compared to our total sales.

That number, again, I think increases going forward.

How much -- I'll say maybe not as much as the 13% to 15%, but still increasing between 2013 and 2014.

IS and GS, the sequential decline, again, kind of as expected, and the reversal I think that you talked about, Bill -- this is still a business that's very much sort of orders -- excuse me, backlogs similar to the sales level.

For us to get there, you know, we would expect to have a greater fourth quarter, which is the historical trend for IS and GS.

And what I would expect to have happen is that we'll see, from an orders perspective, higher orders in both the third quarter than we saw in the first two, and the fourth quarter will be higher still than the third quarter.

Peter Arment, Sterne Agee.

Bruce, maybe this question is for you, or maybe Marillyn can take it.

In general headcount levels, you guys have been out in front on reducing your overall cost base quite a bit over the last couple of years.

And, according to my calculations, it looks like headcount has come down by about 8% during that period.

Are you still seeing a lot of opportunities for that, whether it's early retirement programs or productivity or just in general mandated by the overall budgets?

Thanks.

We have taken the headcount down from about 146,000 employees about two or three years ago, to 116,000 now.

So you're right, headcount has been coming down.

We have taken some direct activities when we took out a number of management, back when we did our voluntary separation program at that time.

We have been continuing to adjust our Business to what's happening in our business base.

So that's what a lot of what you are seeing is just the budget environment, and adjusting to contractual delays or reductions that come with that.

Those are the types of actions we'll take.

What we don't know is what sequestration will bring.

Certainly if we have a significant impact on our programs from sequestration, we'll see additional reductions to that.

We basically size our Business to the environment that we're operating in.

We're also coming out of book [trend].

We've done a lot, as you have probably seen, to reduce our capacity, both shutting down facilities as well as moving out of lease space into our own space.

And that's something that we've done for the past several years.

It's just an approach we take to managing our Business to make sure that we get our infrastructure and our labor force aligned with the business base that we have.

Myles Walton, Deutsche Bank.

Quick one, and then one on pension.

The quick one was -- the EAC's revisions nonrelated to revenue for the year -- it looks like you'll come in roughly flat year on year.

Is that currently what's built into the guidance?

Then one on pension -- Bruce, if you can kind of give us a little color?

Obviously, the rates moving higher here is going to help you pretty significantly if they stick around.

I think on a sensitivity basis, I have it as a potentially $300 million or $400 million help for you for next year versus what you previously told us.

As well, can you comment on if that's changing your attitude towards cash contributions -- the remaining $750 million you still have as discretionary for the rest of the year?

Thanks.

Thanks, Myles.

The EAC revisions, I think, as usual, Myles, your math is right.

We're kind of spot on, maybe a slightly different, little bit down from the first half of this year compared to the first half of last year, in terms of our overall EAC revisions.

Looking forward for the rest of this year, the second half, at least in the plan we kind of expect that the level will be similar to a little bit higher than where we were last year.

And that could obviously change as sort of risk retirements happen quicker than we had planned them obviously.

But as we sit here today, overall we would expect to still be -- I think last year we were about 34% overall -- our EAC revisions versus our total earnings.

We're going to be right in that ballpark, maybe a little higher, 35%-ish, 36% is kind of what I would expect to see.

On pension, you asked about the discount rates, or the interest rate changes and so forth.

I'll give you a little bit of perspective.

Obviously, we won't set this until the end of the year, but clearly there have been changes to rates through the first half of the year that warrant some discussion.

So, interest rates so far are up probably about 75 basis points, and our asset returns are also slightly positive as we sit here this year.

But as you know, our pension adjustments that we're talking about are much more sensitive to changes in the interest rates than changes in our asset return.

So, you did some calculations, just to remind everyone else on the call, I think the sensitivities that we provided in previous 10Q and 10K filings are still appropriate.

So, for discount rates, every 25-basis-point change is worth about a $145-million change in our FAS expense, whereas for asset returns, it takes a full 100-basis-points change to be about an $18 million change in our FAS expense.

Overall, if we were to set the mark today, we would expect to have a positive adjustment to FAS/CAS, again, if those results held.

I will remind you that between now and the end of the year we typically do actuarial studies that look at the current population of employees to see what has changed.

That population, as we do reductions in force, some of the dynamics of that actuarial study do actually change in terms of the composition of the workforce upon which that liability is built upon.

One of the bigger changes, and it may not happen between now and the end of the year, but we are watching it closely, is we are expecting a new sort of standard mortality rate to come out, which, I guess from the good-news perspective, says all of us are going to live longer.

Sort of from the bad news perspective, it says your liabilities are likely going to be increasing for pension because people are living longer.

So that will have a bit of a mitigating effect on what we just described there in the numbers that you said.

But again, we'll set that up -- we'll try to give you the same sort of preview, if you will, in the third-quarter call that we do typically every single year, and that's when I'll give you probably a little more detail into that.

As far as cash contributions, we've actually already made, in the third quarter, the second tranche of the $750 million, for a total of $1.5 billion pension contribution.

So that is done for the year.

And as usual, we always evaluate whether or not the need arises to do any more towards the end of the year when we sort of see our cash from operations playing out on a full-year basis.

We'll try to give you some insight into that, Myles, again when we talk again in the third quarter.

Howard Rubel, Jefferies.

I think this is kind of a two-part question, half for Bruce and half for Marillyn.

If we look at the outlook for you, Bruce, and we kind of split the revenue forecasts, and look at what you've done for segment profit increase, it would appear as if margins are going to be down almost a couple hundred basis points in the second half versus the first half.

It looks like most of the increase in the outlook was attributable to the pick up.

Maybe, Marillyn, you might be able to address some of the productivity initiatives under way that have enabled you, first, to do as well as you have in the first half?

And then maybe also address why it wouldn't stay at the same rate, other than that one large contract adjustment?

Howard, let me try to address -- you asked a pretty specific question there on segment operating margins in second half, and what's expected to happen.

So we did have a couple of things happen in the first half of the year including, as you saw within our MST business, a couple of contractual resolutions.

They were of good size.

Obviously, if you look at the margins for that business in particular, that's a record level of margin, and it was obviously -- or maybe not obviously, but it was driven by those contractual resolutions.

Those are not expected to replicate in the second half of the year, so that's one item that will bring it down first half relative to second half.

Secondly, Space System's also up a little bit first half of the year.

Think of that as some of the phasing and the mix of where we are seeing some of the ULA equity earnings, and we expect to see a little bit of a reduction in that in the second half of the year.

I think you did the math exactly right in the guidance we have, Howard.

The wild card in all this is we have a certain level of planned, I will say, risk retirements that we expect to occur in both third quarter and fourth quarter.

And just as we had some benefits beyond what we were planning in the first and second quarter, if those occur as they did in the first and second, then it may be able to mitigate some of that reduction you see or you are talking about.

If they don't, then we won't see that happen.

It's kind of that simple.

I will flip the call back over to Marillyn for, I think, the second half of your question.

I think your question about -- what do we see in terms of continued cost reduction -- I would just point to the fact that we've had -- we've been very proactive, as I said earlier, in the last several years on just getting ahead of the budget cuts by reducing expenses and headcount.

But we have very seasoned leaders that don't just manage programs.

They manage their business on an ongoing basis.

They have very strong cost control discipline in the business.

So we look at that and monitor that on an ongoing basis.

As I said earlier, we try to keep our structure in line with the business base that we have.

The other thing, though, that is driving the performance of the businesses is just consistent performance on the programs.

We don't -- we are performing well across all of the business areas, with very deliberate management of the programs, and making sure that we perform and meet the cost targets that those contracts drive, and continue to look at ways that we can improve our margins on the programs.

So I think it's just good -- straight-up good performance by our leadership and our teams across the business in executing on programs that they have.

Sam Pearlstein, Wells Fargo.

I wanted to ask something.

Bruce, your discussion about the options just triggered something, which is just -- in terms of the incentive compensation, and thinking about things on a going-forward basis, I know that TSR is an important metric.

But if a lot of people start cashing out of options, do you need to do something to continue to incent people on a go-forward basis, is kind of part one.

Part two, the higher stock price itself, what is that going to do for the remainder of the year in terms of the Rabbi trust or any other sorts of I guess compensation programs and the shares outstanding as a result?

Sam, I'll address the first part.

So, if you've read the proxy, what you've seen happen in the past few years is we've actually been lowering the number of options that are paid, not just to the senior leadership team, but to leadership in general.

And in fact, at the start of this year, we eliminated option as a component of our executive compensation program.

So, all of our equity compensation going forward is either in the form of RSUs or performance stock units.

So, one of the things that I don't think we necessarily have complete understanding amongst all of our investors is that some of the dilutive aspects that have been occurring that have been needing to be offset through share repurchases have been because of the level of option exercises.

So if you track the number of outstanding options over the past few years, that's come down fairly significantly.

And I guess it's kind of a good news/bad news.

As the stock price increases, we have more option exercise, which increases the dilution effect, but it also gets rid of those options at a faster clip, such that going forward -- and I don't have this off the top of my head, but I want to say on an annual basis we were probably providing somewhere in the 5 million-ish, maybe 6 million shares or so of options on an annual basis -- maybe more like 7 million shares.

And if you're just providing the same amount of executive compensation, it takes a lot fewer shares to do that with RSUs and performance stock units.

On an annual run rate, we're going to see less dilutive opportunities, if you will, from our executive compensation program than we've had in years past.

That's a direct reflection of some of the conversations we've had with investors who have raised that point to us, and we made that change accordingly.

I think your second question was the higher stock prices -- higher stock price in the second half of the year, and its impacts on the Rabbi trust.

Really, there is not an associated impact there, as I think of it, Sam.

Our Rabbi trust, you can put it in essentially the same sorts of options that 401(k) opportunities are for our employees.

And we try to match that from a liabilities perspective.

So I'll say it's more targeted to overall market performance, if you will, than directly to the Lockheed Martin stock.

Doug Harned, Sanford Bernstein.

On aeronautics, if you look forward, and you've had about 12% margin levels recently.

But when you look forward, you are going through a fairly significant mix change with F-35 growing in its share of revenues.

But at the same time, you've got more and more sustainment coming from F-22, F-16, C-130J.

How do you see those two things playing out going forward?

Should we see Aeronautics margins tend to stay at the kind of levels they're at today?

Doug, I'll try that one.

Yes, we've said for quite some time -- I always sort of describe this as the algebra of this business when it comes to Aeronautics margins.

So, going forward, even though the overall F-35 margins are expected to increase going forward, we have a bit of a mitigation impact there because we just lowered, if you will, the go-forward booking rate, if you want to think of it that way, for the SDD contract by virtue of what we did with the adjustment we took this quarter.

So if you kind of throw all those things into the mix, what I would expect to see is that the margins of Aeronautics will come down a little bit in the future, as we have predicted probably for the last two or three years, simply because of the higher F-35 volume.

Even while the F-35 on a stand-alone basis is kind of increasing year over year, it still has a dilutive effect on the overall margins of Aeronautics because some of the volume that it is offsetting was higher-margin C-130 and F-16 work.

Just to give you a little bit of perspective, I think I've been fairly consistent saying -- we'd like to see the F-35 production contract sort of get into a double-digit margin level by the time we get to full rate production.

If we just strip out the SDD performance from the overall F-35 program and focus more on the production contracts, we should think of it as we're kind of in the higher-single-digit levels today.

So that program, I will say in general, is kind of performing in line with our expectations.

SDD clearly -- we don't like to have back-to-back adjustments like we had in the second quarter of last year, the second quarter this year.

That hasn't been performing, from a margin perspective, as well as we'd like it to.

That has a bit of a drag, as I said.

But I think the production programs are actually performing pretty well.

But that still is what is causing, again, what I call sort of the algebra effect on Aeronautics margins.

Sayid, I think we're coming up on the hour -- maybe one last call or one last question.

George Shapiro, Shapiro Research.

Two quick ones, probably for you, Bruce.

Following up on that F-35, in the quarter you had commented you had a $50-million increase in profit, and revenues were up $175 million.

Could you break out how much of that was inception-to-date pickups versus just maybe a bit of margin improvement itself?

And then in the space area, you had a $50-million increase in the ULA profit, which struck me as a big number.

Could you kind of just go through what caused that, and is there any way to forecast what that might be going forward?

Thanks.

George, I'll try to address both of those.

So, you're right, I think the press release identified the amounts that you talked about in terms of the $50 million and the $175 million.

You know, maybe the simplest way to think of that, George, is sort of go into the mid-single to upper-single-digit levels on the volume and -- on the sales volume, and take everything else and assume that that's sort of the step up in the quarter.

I don't have the number off the top of my head, but it's a pretty good chunk of that overall $50 million on that $175 million sales increase.

But again, I don't have the split exactly in my head.

The $50 million ULA, [it is an upper] -- that's one of the things I talked about earlier in terms of one of the reasons why the margins in Space Systems are higher.

That's a couple things; again, we mentioned the mix aspects within ULA.

ULA margin -- excuse me, the mix is supposed to be better this year than last year in terms of profitability of some of the launches, and the volume will be up as well.

So we would expect to see, for the rest of the year, not probably quite a comparable level as the first half, but pretty close to that level in the second half.

I think the thing that stuck out, and the reason it [stuck] so much in the second quarter of this year is because actually last year, due to some opposite issues, the mix issues and the phasing within the year, last year's second quarter was by far the lowest quarter of the year for ULA from an equity earnings perspective.

So that made this quarter, although it is higher than maybe it has been historically -- it made the difference between second-quarter last year and the second-quarter this year appear even greater.

So, let me wrap up our call today by, again, highlighting that I believe our second-quarter results and increased guidance illustrate the solid position and performance of the Corporation to provide value to our shareholders, and solutions to our customers.

Even in an uncertain budget environment, our program portfolio, strong balance sheet, robust cash generation, and the exceptional execution by our 116,000 employees will continue to propel our Corporation forward.

So, I want to thank you again for your interest and for joining us on the call today.

We look forward to speaking with you on our next earnings call in October.

Thanks.

Ladies and gentlemen, thank you for participating in today's conference.

This concludes our program.

You may all disconnect, and have a wonderful day.