洛克希德·馬丁 (LMT) 2013 Q3 法說會逐字稿

Good day, everyone, and welcome to the Lockheed Martin third-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, Stephanie.

And good morning, everyone.

I'd like to welcome you to our third-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.

I'd like to remind you the statements made in today's call that are not historical fact are considered forward-looking 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 Marilyn.

Thanks, Jerry.

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

I hope you've all had a chance to review our third-quarter earnings release and financial results.

The results directly illustrate the continuation of our strong operational and financial momentum.

And enabled us to increase our financial outlook for 2013.

The focus and efforts of our Lockheed Martin team continue to position the Corporation for delivery of solutions to customers and value to shareholders.

I offer my congratulations and appreciation to all of our employees, and especially to those employees directly affected by the government shutdown, for their outstanding achievements and performance while operating in a challenging and dynamic environment.

While there were numerous financial accomplishments in the quarter that Bruce will outline in his comments, I want to offer my thoughts on key strategic achievements this quarter.

From my perspective, beyond the program execution and financial results that remain exceptional, other accomplishments can be seen in three key strategic areas.

These areas are backlog expansion, international growth, and cash generation.

We have continued to describe our portfolio as the best positioned in the sector, with unique and direct alignment to many of the essential programs identified by customers as they satisfy their national security requirements.

Many of our programs have provided these solutions to customers over several decades because they are proven and they are cost effective.

A direct validation of this alignment and positioning of our programs to customers' needs is visible with our achievement of increasing levels of annual backlog for the past three years, ending with over $82 billion in backlog at year-end 2012, while operating in a challenging global and domestic economic environment.

This quarter our portfolio alignment and product offerings resulted in $15 billion in new orders, an expansion of our backlog to nearly $79 billion.

We continue to execute on the forecast we outlined to you at the beginning of the year, that our backlog expansion would resume in the third quarter.

Looking forward, the new business pipeline remains robust, with significant domestic and international awards expected later this year on many of our legacy programs.

With the establishment of a continuing resolution for fiscal year 2014 in place through January 15, we remain on the path previously outlined to you to further expand our backlog in the fourth quarter to a year-end estimate of at least $80 billion.

Our ability to continue the expansion of our backlog is strategically important, as it helps solidify our business, and provides visibility into our future financial outlook.

Our strong backlog, consisting of multiple years of prior fiscal appropriations, driven by our longer-cycle production programs, provides a level of financial stability and strategic differentiation in this era of potential government budget uncertainty.

Another area within which we achieved significant strategic progress this quarter was in the international business arena.

As you recall, we have a stated goal to expand our international sales content to at least 20% of revenues in the next few years.

To achieve this goal, we have moved aggressively to build upon our long-standing in-country presence, and further strengthen relationships with international countries around the world through partnerships, in-country production, and establishment of in-country joint technology offices.

All of these actions are essential to enable expansion of international work for the Corporation.

Financial benefits to the Corporation are increased sales, cash flow, and earnings contribution.

Benefits to our customers are increased factory loading and our ability to improve cost through higher production throughput.

Specific events furthering our international expansion were seen across multiple business areas this quarter.

And included finalization of the multi-billion dollar award from the United Arab Emirates for our THAAD missile defense system.

This was a significant strategic event, with the UAE serving as the inaugural international customer for the THAAD system.

Demand for this proven system is only growing and has been expressed by numerous countries from the Asia-Pacific region to the Middle East.

Additionally, finalization of our LRIP 6 and 7 contracts on the F-35 program contained a growing component of international work, with inclusion of new aircraft awards for Australia, Italy, Norway and the United Kingdom.

Looking forward into 2014, Japan and Israel are scheduled to finalize new orders, which would further expand our international backlog.

Additional international work can be seen on the near horizon with the Netherlands' announcement of its first order to procure Joint Strike Fighters for its national defense.

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

Finally, we were pleased that South Korea plans to reopen the competition for their future fighter program, potentially providing us a new customer opportunity for a fifth generation F-35 fighter, and further growth in international activities.

Our international work is expected to grow and help mitigate domestic pressures in 2014, with growth visible and achievable due to our backlog of existing work.

Our international expansion is broad-based, is happening now, and we feel increasingly confident about our achievement of our stated goal of at least 20% in the near future.

Let me turn to cash flow.

Our ability to deliver consistently strong cash flows continues to be a strategic differentiator for our Corporation.

The importance of cash is embedded in our corporate DNA.

I was pleased that we were again able to increase our 2013 cash flow outlook this quarter.

Our strong and increasing cash flow enables us to invest prudently in the future of the Corporation, in areas such as capital expenditures and research and development.

While also providing the ability to pursue our cash deployment strategy for returns to shareholders in the areas of increasing dividends and share repurchases.

We continue to strongly believe in the return of value to shareholders through dividends and share repurchases.

As I look forward, our future cash flows are expected to be aided by increasing levels of customer advances from growing international work and recovery of our $8 billion in prior year's pension contributions.

We feel very good about our future cash and the potential for continued strong and increasing cash flows that will position the Corporation to differentiate from competitors.

Before turning to call over to Bruce to cover financials, I wanted to briefly speak about government budgets.

Last week agreement was reached to implement a continuing resolution to fund FY14 government expenditures through January 15, 2014.

This action enabled federal agencies to return to work and eliminated the partial government shutdown.

The agreement also extended the nation's debt limit authority until February 7, 2014, avoiding a default that could have occurred last week.

Additionally, Congress agreed to conduct conference committee discussions on FY14 budget levels and cost elements, with a goal for completion of a budget agreement by December 13, 2013.

These actions are a step forward as they enable resumption of full government and contractor operations during the periods outlined.

A resumption of normal work is the best path forward to eliminate disruptions to operations, enable cost affordability and savings initiatives to progress, and provide critical equipment and services to our customers.

There is still much budget work to be done by Congress to address the debt ceiling before February 7, and determine the level of funding for the entire 2014 fiscal year before the continuing resolution expires next January.

We continue to urge Congress and the Administration to focus on long-term solutions to confront the difficult fiscal issues facing our country, and avoid a repeat of the disruption that the nation recently experienced.

As part of those solutions, we also ask that they address and revise the across-the-board budget reduction policy required under the current sequestration law.

This non-strategic allocation of budget reductions is not good for our nation or our national security strategy.

With the closure of government fiscal year 2013, we can now determine that budget reduction actions implemented under sequestration will result in a limited impact to our portfolio of programs in 2013, with impacts seen primarily on our shorter-cycle business.

Our original estimate of $825 million in potential reduction to revenue was significantly muted due to our large backlog of work remaining unaffected by FY13 budget cuts.

This enabled us to refine our revenue outlook for calendar year 2013 to a new guidance value of approximately $45 billion, better than we projected on our July earnings call.

As we look forward into 2014, clearly there is no shortage of possible government budget outcomes.

These outcomes range from full implementation of sequestration cuts required under the Budget Control Act to less severe scenarios.

These multiple scenarios are challenging to predict.

However, with our anticipated strong year-end backlog I spoke to earlier, aided by growing international revenues unaffected by US government budget actions, we are expecting to see mitigation of financial impacts on our Corporation.

Accordingly, we are providing initial trend analysis for 2014 that projects our revenues to be only slightly below 2013 levels.

I'll now ask Bruce to go through some of the details of our 2013 financial performance and 2014 trend analysis, and then we'll open up the line for your questions.

Thanks, Marilyn.

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 $11.3 billion, down from last year but slightly ahead of our expectations.

Segment operating margin continued to be very strong at 12.8%.

And this strong performance contributed to a 16% increase in earnings per share to $2.57 from continuing operations.

We generated $900 million in cash from operations after a $750 million pension contribution.

We continued to reward our shareholders with almost $1 billion of cash returned through the repurchase of nearly 5 million shares, along with our quarterly dividend payment.

As expected, we received $15 billion in orders in the quarter, which brings our backlog to just under $79 billion.

And, finally, due to our operating performance, we increased our 2013 outlook for segment operating profit, earnings per share, and cash from operations.

Chart 4 shows our sales and segment operating margin for the third quarter this year versus last year.

Our sales were 4% lower than last year, but ahead of our expectations after sequestration was enacted.

Segment operating margin increased 70 basis points over the third quarter of last year to 12.8%, continuing the strong performance we've achieved thus far this year.

We'll show the breadth of the margin improvement on Chart 5, which shows our third-quarter segment operating margins for each of the five business areas compared with last year's results.

Segment margins were higher or comparable in four of the five business areas.

Improvements in Missiles and Fire Control resulted from improved performance across a number of programs, most notably in air and missile defense systems such as PAC-3 and THAAD, and fire control programs such as the LANTIRN and Sniper programs.

Improvements in Mission Systems and Training were also broad-based, with the largest improvement coming from our radar programs.

Margins in Aeronautics and IS&GS were slightly higher or comparable.

While our margin in Space Systems remains strong, but was 60 basis points lower than the third quarter of last year.

Last year's results were the highest level ever experienced in Space Systems.

And included significantly higher earnings from our United Launch Alliance and United Space Alliance joint ventures, the latter due to wind-down activities in 2012.

Turning to Chart 6, we'll discuss our earnings per share.

EPS from continuing operations in the quarter was 16% higher than a year ago at $2.57 per share, driven primarily by improved margins and a lower FAS/CAS adjustment this year.

On a pension adjusted basis, our EPS grew to $2.80 per share in the quarter.

On Chart 7 we'll discuss our cash from operations in the quarter.

We continued to have excellent cash generation, with $900 million in the quarter.

Although that is lower than last year's level, we made a $750 million pension contribution this year, while no contribution was made in the third quarter of last year.

We completed our planned funding of our pension plans in 2013.

And, consistent with our historical practices, we'll evaluate making additional contributions to our pension trust at year end, but only to the extent that these contributions will not impact our ability to generate $4.3 billion in cash from operations.

Turning to Chart 8, we'll discuss our cash returned to shareholders in the quarter.

We returned almost $1 billion to shareholders this quarter through share repurchases and dividends.

The level of share repurchases was more than double what we did in the third quarter of last year.

And brings the total cash returned so far this year to more than $2.6 billion.

Moving to Chart 9, we'll look at our backlog and book-to-bill ratio since last year.

Consistent with the quarterly backlog profile we provided at the beginning of the year, our backlog grew to just under $79 billion this quarter, achieving a strong book-to-bill ratio of 1.3.

We continue to expect that backlog will increase further in the fourth quarter and end the year above the $80 billion level.

On Chart 10 we provide our updated guidance.

As we said on the last call, the effects of sequestration were not as great this year as we had initially modeled them to be.

And we now feel comfortable in saying our sales for the year are anticipated to be around the $45 billion level.

Reflecting our strong operational performance throughout this year, we're increasing our forecasted segment operating profit by $125 million.

Partially offsetting improvements in our segment operating performance is an increase in our unallocated expenses for severance charges related to a reduction in force announced last week in our MST business area, and a net increase in expenses for our deferred compensation plans.

The net increase in operating earnings results in an increase to our earnings per share guidance of $0.20 to $9.40 to $9.70 per share.

And, finally, we increased our expectations for cash from operations by $100 million to equal or better than $4.3 billion.

Chart 11 shows our updated outlook for both sales and segment profit by business area.

And ties to the guidance updates from the previous chart.

On Chart 12 we provide our initial view of our expectations for 2014.

We believe sales next year will be only slightly below the 2013 level, with growth in our Aeronautics business area offsetting reductions in our IS&GS and Space Systems business areas, while both Missiles and Fire Control and Mission Systems and Training are expected to be relatively comparable to their 2013 levels.

And we expect our segment operating margins to be lower than this year's record level, but above the 11.5% level in total as we experience the dilutive effect of F-35 production growth in Aeronautics, as we've described for several quarters, along with the absence of several nonrecurring benefits in the other business areas this year.

We expect our FAS/CAS pension adjustment will provide income of $150 million in 2014 after several years of reducing our reported earnings.

Our assumptions that led to the favorable adjustment are a 75 basis point increase in the discount rate to 4.75%, a low single digit return on assets in 2013, and $1 billion in pension funding in 2014.

Finally, we have our summary on Chart 13.

We've had outstanding performance all during 2013.

We expect that to continue and result in a very solid year, particularly in this dynamic environment.

With our current portfolio as well as our enhanced focus on international expansion, we like our strategic positioning heading into the next few years.

We provided outstanding value to shareholders this year from both a total shareholder return perspective as well as with cash returned to shareholders.

And while we're providing high-level trend information today, we'll provide our usual detailed guidance during the January call.

With that, we're ready for your questions.

Stephanie?

(Operator Instructions)

Jason Gursky with Citi.

Good morning, everyone.

Marilyn and Bruce, I was wondering if you could just walk us through the assumptions with your major programs that are embedded in your outlook for 2014, just so we have some of the building blocks and can track progress as we go along.

Jason, I'll give you a high-level view and if Marilyn has something to add, I'll throw in a couple of other -- she can throw in a couple of topics, as well.

Maybe just starting with the biggest business area, Aeronautics, probably the topic that you'd be curious about is the aircraft quantity changes, say, from this year to next year.

Think of the F-35 quantities, we're going to finish the year probably around 36 aircraft deliveries or so.

We expect that to grow somewhat next year to maybe 38, maybe a couple more than that, but somewhere in that range.

Our F-16 deliveries this year are 13 aircraft.

That's expected to grow perhaps to about 15 aircraft next year.

C-130Js, I think we're going to do about 24 to 25.

There's one that's on the bubble delivering this year or next year.

If it happens this year, it will be 25.

Even if that happens this year we still think we'll stay steady at about the 24 aircraft level next year.

And C-5, this one that's ramping up between 2013 and 2014, we're going to deliver somewhere between, I'll say, five to as many as eight this year.

But, in any event, we think we'll grow that number to 10 aircraft next year.

And the reason we're a little hesitant on giving the numbers for 2013 is because of some of the activities that led to the debook this quarter relative to some of the over-and-above work that we're experiencing in those aircraft that could cause delay of some of those deliveries this year.

If I think around the other business areas, you should think -- we're seeing a slight reduction in quantities of some of our air missile products associated with the PAC-3 program.

But that's more than offset in Missiles and Fire Control by increases in the THAAD production quantities.

Think of that both domestically as well as with the recently completed UAE international order.

We have no commercial satellites or commercial launches next year in our Space Systems business.

Obviously, no large programs that jump out on our IS&GS business area.

But we expect to see a continued downward trend within IS&GS, probably somewhere in the -- think of that as the high single digit range level between 2013 and 2014.

So that probably covers a bunch of programs, Jason.

There may be others you want to hear about.

If so, others can ask on the call as we go down to further questions.

Richard Safran with Buckingham Research.

Hi, good morning.

I was interested -- it's a two-part question -- on your comments, Marilyn, at the opening and on the 4Q bookings chart on chart 9. One, should we infer that there's very little risk from the government shutdown on 4Q bookings in terms of what the government's going to want to contract?

And then as a second part, I found it interesting that you had enough confidence in your outlook to talk about 2014 trends.

Could you discuss what's driving your confidence in our outlook, just especially given where the Congress and the Administration are?

Thanks.

Rich, I'll give a shot at both of those and we'll see if Marilyn has some color commentary to provide beyond that.

Fourth-quarter orders, we do feel very comfortable in stating what we said relative to expectations that we'll grow backlog between now and the end of the year.

And, in particular, the reason we feel that way is there are really very few competitive awards expected to occur in the fourth quarter.

And we have really no reliance on new start programs in the quarter either.

And just as importantly, while we're operating in a continuing resolution environment, we believe all the awards that we're expecting to receive in the quarter can be awarded under the continuing resolution.

Just to maybe name a couple of them that we expect that will lead to the year-end backlog numbers we talked, the most significant awards are occurring in our Space Systems business.

So think of that as the SBIRS spacecraft 5 and 6 contract definitization by the end of the year.

The annual, in this case the FY 2014 annual installment of the fleet ballistic missile award.

We expect to receive a pretty significant contract extension on the Orion program within NASA.

Those are probably the most significant, all of which are in space.

If I got to other business areas, we're expecting things like the normal FY 2014 award of the C-5 modernization aircraft this year.

We should close, hopefully, on the FY 2013 contract to finalize or definitize the C-130 deliveries for the US government.

And then we've got just a whole slew of what I would call the numerous funding from fiscal year 2014 funds becoming available for things like JASSMs, PAC-3s, sustainment contracts across multiple business areas.

So, again, we feel pretty good about all those happening.

Again, not anything that I would say is in a competitive award that could be pushed out or that we could lose in the fourth quarter that would diminish those numbers.

So that gives us a really good visibility as we go into 2014, as well.

I think you asked about the 2014 guidance, maybe and expressed some surprise that we were at the levels we are.

So maybe at a high level I'll just talk about what we're seeing in 2014.

As Marilyn said, we do expect sales to be slightly lower than 2013.

And you should think of that as we are going to see growth in Aeronautics.

That's primarily coming from the F-35 production program, as well as the C-5M delivery growth, and numbers that I talked about earlier.

And that's offsetting reductions in, as I said, IS&GS and Space and Missiles.

And Fire Control and MST, again, are fairly comparable.

Margins, again, we expect to remain above 11.5%.

And I've talked in quarters past about what I like to refer to as the algebra effect of the F-35 where we get higher volume on the F-35 program at lower margins than the overall margins of Aeronautics.

And that has the effect of lowering margins in Aero overall.

Missiles and Fire Control and IS&GS I would think are going to be relatively comparable to 2013.

Whereas space and MST probably a little lower than where we experienced this year but still very strong relative to recent history in both those business areas.

And this is due to a number of nonrecurring events, positive events, that occurred in 2013.

Space also has the lower equity earnings expectation in 2014 compared to 2013.

So, Rich, maybe just to sum up, 2014, I would say, from a margin perspective looks very similar to 2013 when we began the year, just without the performance improvements that we experienced throughout 2013 that we've yet to obviously experience in 2014.

Maybe one last note on 2014.

You should see the tax rate in 2014 increase a little bit over 2013.

You'll recall, we actually had two tranches, if you will, of R&D tax credit in the year 2013.

So probably more than you wanted to know there, Rich, but hopefully that covers your question.

Doug Harned with Sanford Bernstein.

Yes, good morning.

I'm interested in understanding the trends in IS&T a little bit better.

And I would put that in conjunction with the comments that you made around sequestration, in that sequestration, the impact this year was a little bit less than you had thought.

What I'm trying to get at is, is this largely a timing issue or have some other things happened that has strengthened the picture this year?

And then how does that link to IS&T which you've said will be weaker next year?

And does it play into the civil, the defense or the intell portions of it?

Doug, I would just say to that point, when we gave some insight earlier in the year about what we expected on the impact of the sequestration, it really was looking across all of our businesses.

We did recognize that our shorter cycle business like IS&GS would have a more significant near-term impact.

But that was just modeling that Bruce and his team did, just to take a look at what was the outlook for the year of things that could be impacted.

We have not seen that impact and so it wasn't really just because of IS&GS.

IS&GS, because it has a large IT infrastructure work and support in the information technology area, has been impacted because that's an area that the government can come back on pretty readily.

As I said, it is a shorter-cycle business.

Where we see growth there, potential growth for us, is in the cyber security arena.

But it's a fairly new area for us.

So we'll continue to see some offset of growth there.

Bruce, I don't know if you want to add some other comments.

Yes, maybe, Doug, I think you asked the question about where we're seeing that maybe by the LOBs, the civil, defense and intelligence.

We're actually seeing a little bit of growth in our defense business.

And a lot of that's because we've won -- going back to Marilyn's comment -- we've won several cyber activities from competitors.

We refer to it as playing offense, if you will, in that arena, that we've been successful on.

And that's one of the reasons why the defense business is growing this year over last year.

As we look next year, there's not as many of those sorts of competitions coming up.

I believe all three lines of business -- civil, defense and intelligence -- next year's numbers as we sit here today, Doug, we're expecting to reduce compared to 2013.

And I think that's just a combination of two things.

One, that is what the -- I've always said, when you're the largest provider of IT services to the federal government for 18 straight years now, I believe, that when the federal government's budget goes down you're likely to go down, as well.

We expect that to happen again in 2014.

And the other side of that is I'll say we have, within the numbers that I talked, within the ranges that I talked, and the trend information, considered an ongoing sequestration level impact this year, as well.

So, the combination of those two events is what we see happening within IS&GS.

I always like to close that by saying at some point IT spending has to increase.

You cannot continually reduce IT spending for the federal government, and expect to provide the services the population expects.

And at some point it will turn the other way.

Ron Epstein with Bank of America Merrill Lynch.

Good morning.

This is actually Elizabeth in for Ron today.

We've actually seen Boeing really emphasize recently their Partnering For Success program where they're trying to get 15% out of their suppliers.

We were just wondering, with all the cash that you're returning to shareholders and the DOD under so much pressure, at what point do you think the DOD tries to implement its own partnering for success and take 15% from the defense contractors?

I'll let Marilyn say it from her perspective, Elizabeth.

I don't think we've ever stopped trying to do what we think makes sense economically and from an affordability perspective with our supply chain.

And we maybe had a little different view of this than some, in that we think the real ability to influence supply chains starts actually with the designs that we come up with, and how we can make those more affordable to build and sustain going forward.

It's not something that we woke up overnight and realized that we had to cut elements of our supply chain to become affordable.

We're probably two-thirds of our cost of sales today are in the supply chain.

If we are going to be affordable it's going to have to include our supply chain -- and always has.

And that's a focus that we do today.

We have, I would argue, very good relationships with our supply chain.

We have annual sessions where we meet with them.

Actually, Marilyn has spoken to that group en masse to show the emphasis that we place on our supply chain, and expectations not just of affordability but of quality, of schedule, timeliness, and the like.

So, this is something that we put in place for quite some time that is not a new item for us.

I would add to that, Elizabeth.

I think if you're asking is our customer treating us as their supplier in a fashion that they were going to put some push on us to be more affordable, they have been.

They have been very clear that is a top priority for them.

They're dealing with very significant budget constraints and increasing global security demand.

So, they're challenged.

And across our industry they have pressed for us all to be more affordable in solutions that we provide them and how we manage our business.

It's not something that is new to us.

We've been very proactive as leaders in the industry to drive down our costs.

And we have taken actions to reduce our footprint.

We have had to take some painful actions in reducing our workforce at times to adjust to the business base.

We are investing in technologies to provide them with a more affordable product.

So, we take the weight out or we make it overall total cost lower.

A lot of things that we're doing to support our customers' drive for affordability.

And at the same time they offer incentive provisions to get at cost savings because it is so critically important to them.

So, in some of our contracts we have those types of incentives to encourage us to continue to drive costs down.

As Bruce said, we manage our supply chain.

It's an ongoing effort on our part to make sure that we get the best value from them in terms of costs, schedule, quality.

And, at the same time, we want to provide our customer with the most affordable solutions and the most technically capable solutions for what their needs are.

Cai von Rumohr with Cowen & Company.

Thanks so much.

And great performance again.

I have a two-part question.

First, you talked about sales being down modestly next year.

Could you talk about international, if that's growing, what growth do you see in international, and what are the key drivers?

And secondly, DOD, as it looks at the fiscal 2015 budget has some priority programs and some bill payer programs -- potential bill payer programs.

Included in those are C-130, C-5 and LCS.

Maybe you could comment on your thoughts as to whether those programs you think are at risk in the FY 2015 budget.

Thanks.

On the international growth side, we certainly continue to see growth in F-35.

In fact, over the next five years close to half of the orders will be international deliveries for the F-35 as we move forward.

On C-130J, there continues to be a demand for the C-130J.

And we continue to sell F-16s around the world.

We see growth in those areas.

Missile defense is another important element for us in our international growth.

Bruce talked about that and PAC-3, and of course we have our operations for Aegis Ashore.

And then we do see other opportunities for us as we look forward in the commercial satellite arena and cyber security and our IT arena for growth in the sale in international growth.

On the F '15 priorities you mentioned C-130, LCS and C-5.

All of those are part of the strategic management review that was done by the US government.

They are high priority programs.

And in addition to those, I think missile defense continues to be a high priority program.

The only thing I would add, Cai, is I was a little surprised to hear C-130 mentioned in that comment.

We're one of the few programs in the DOD that's actually being considered for a multi-year program to buy an additional 79 aircraft for a couple of the services right now.

I think that's got strong support.

It obviously has reduced affordability aspect to it versus buying them on individual fiscal years that has, I think, been well-received by our customer, and we expect that to happen.

So that's one that caught my ear a little bit, somewhat of a surprise when you had that discussion there.

David Strauss with UBS.

Good morning.

I wanted to ask you about back on sequestration.

When you say in the release that you've assumed all impacts known associated with sequestration, just so I'm clear, you're assuming inherently in that that sequestration as it relates to fiscal '14 comes through as we know now to another $15 billion to $20 billion cut off of the total DOD budget.

And then the last part of my question, maybe if you could walk us through -- Bruce, I think back in January, maybe it was in April, you put together that slide that showed us stuff in terms of the total revenues that would be impacted by sequestration (inaudible), like 20%.

What does that number move to in 2014?

In other words, how much of your -- what proportion, do you think, of your revenues will actually be impacted by sequestration in 2014?

Thanks.

Okay, thank you, David.

Good questions.

Let me give you maybe a long, windy answer on the sequestration impacts for next year.

I think I'll cover hopefully both of your questions in this answer.

If not, again, maybe you can come back on and ask the question again.

We still think sequestration, how that impacts 2014, is broken up from our business area perspective into the long-cycle businesses and short-cycle.

We always refer to Aeronautics and Space, for instance, as long-cycle businesses.

But there are also large parts of Missiles and Fire Control and Mission Systems and Training that are also really considered to be long-cycle businesses, as well.

You should think of those as, in my words, being relatively insulated from the effects of sequestration in FY 2014 because most of their calendar year 2014 sales are from prior fiscal year funded activities, or prior fiscal year funded backlog.

That also says there's not probably as much upside if sequestration improves over what our expectations are either in those long-cycle businesses.

Our short cycle businesses -- a primary one being the IS&GS but it also has smaller parts of Missiles and Fire Control and Mission Systems and Training, as well.

We've baked some pretty good reductions into the numbers that we're expecting relative to the trend information we've provided, to slightly less than 2013 sales.

Those reductions are planned in that outlook already.

And we think that pretty much captures what we think will happen under a sequestration environment, under a lot of different scenarios that we can think of.

And the reason for that is, while we say they're short-cycle businesses, each one of those businesses -- IS&GS, the services part of MSC, the services part of MST-- have backlog from prior-year funding that's actually greater than one-time sales in each case.

So, though it's not as long or it's not as significant in terms of the backlog as the long-cycle business, there is definitely more current year award to current year sales going on in those business areas.

It is more insulated than, perhaps, you might think.

And I think we experienced that ourselves when we tried to do the modeling at the start of this year, that we actually have more insulation, in my words, than maybe we would have otherwise thought we had at the start of the year.

There's also the aspect next year that we don't want to lose track -- back to Cai's question -- we do expect international growth to occur next year, both in terms of absolute dollars, as well as on a percent of sales basis.

So that helps to mitigate any downside we're seeing from a sequestration impact, as well.

And, finally, at least as we've looked at it, we think there is minimal, if really any, reliance on 2013 unobligated funds balance that's left outstanding at the end of the fiscal year to become 2014 sales for Lockheed Martin.

So, if those funds were to evaporate, if those funds were to be used to offset FY 2014 sequestration reductions, we think, again, we are again insulated from that aspect, as well.

So, hopefully that covers the two questions you had there, David.

Noah Poponak with Goldman Sachs.

Hi.

Good morning, everybody.

I'm trying to figure out how to pars -- to me, revenue being down slightly is a positive surprise, given what the budget's doing and that you're the bellwether in defense.

And I hear you saying, and I know that you have well-positioned favored programs.

And I also hear you saying and know that it's a long-cycle business.

I'm trying to quantify or pars out how much of each of those two items it really is in 2014.

Because if it's almost entirely just favored programs, that would suggest you could move back to actually growing sooner than later if sequestration is the last cut.

Whereas, if it's more being long cycle than it is favored programs, that would suggest you actually have several more years of not really being able to grow the top line, even if sequestration is the last cut.

Interesting question, Noah.

I'll see if I can pars my answer to the way you parsed your questions.

As we look into 2014, I think one of the things that may surprise some folks going forward is that we're actually probably seeing more growth in the F-35 program in next year, in the number that we are trending towards, the slightly less than $45 billion next year, than maybe a lot of people would have expected.

Just in big numbers, an F-35 is going to be 15% or 16% of the sales of the corporation in 2013.

And F-35 jointly between the development program and the production program, but all the growth coming from the production program is probably going to grow some 15% year over year from 2013 to 2014.

I think that's one of those programs, Noah, that I would characterize as both long cycle and the right priority.

I think the prioritization has been demonstrated continually throughout the past year, both domestically and internationally, with the support that we're getting on the program.

And obviously by definition it's a long-cycle program.

I think we've got other programs of that same ilk.

The C-130 I mentioned with the multi-year, the air missile defense programs, where they're both long cycle and high priority.

LCS is another one that I'd fall in that category.

I'll tell you, and I'll let Marilyn opine here also on it because I know she feels strongly about this, but we've said all along we think that we have the best portfolio in the business.

We think we have the opportunity to sell that portfolio internationally, which helps to mitigate or mute the impacts of the domestic reductions.

And so I don't think that this scenario you described where we would expect to see growth depending on how sequestration plays out in 2014 is unrealistic at all.

I would just agree with what Bruce has outlined for you.

We've talked, as you said yourself, we have a well-positioned portfolio of programs.

And, as Bruce outlined, where we see the growth opportunities in 2014, if there is an impact from sequestration, if there's a full impact from sequestration we've walked through what the impact would be on the shorter-cycle businesses.

If we don't see that same significant level, we should expect to have some offset there.

And then the longer-cycle businesses, we do see growth, continued growth in the air and missile defense and the F-35, and even F-16 upgrades, and a number of other opportunities on C-130Js internationally as well as the multi-year.

Joe Nadol with JPMorgan.

Thanks.

Good morning.

Couple of green eye shade type questions for you, Bruce.

Just on the margins, maybe it would help if you quantified a little bit the two items that you say might pressure segment margins next year.

How much pressure do you see on the F-35 becoming a bigger part of the mix?

Because you're at 12.8% year to date on segment margin.

And it just seems like 11.5% -- there's a lot of room to come in ahead of 11.5%, even given some of the pressures.

And the second part of that is just on MST in particular.

You highlighted radar programs as being a big driver of upside EAC adjustments in the quarter.

Are you getting into a situation there where you could for a few quarters get some upside, just given the opportunities on those contracts?

Or is this truly do you think not sustainable?

Thanks.

Thanks, Joe.

The F-35, in the reference to what's happening with the F-35 growth and its impact on Aeronautics margin, first off, I know you're looking at the 12.8%.

But I think if you -- that's where we ended the quarter, I think that's the highest quarter we've ever had in the history of the Corporation -- if you go to the full year, I think we're looking, if you go the midpoint of guidance, probably in the 12.3%, 12.4% range.

So I'm not going to debate to whether that's going down or up relative to 11.5%.

It obviously is but it may not be from the 12.8% that you're starting from.

The other thing I tried to emphasis on a previous question was that the 11.5% that we're talking about actually looks a lot like where we started the year 2013.

I forgot what our guidance was when we started the year but it was somewhere in the 11.6% or 11.7%, if I recall.

It feels like a similar level to me as where we started in 2013.

Most years we have had positive performance improvements throughout the year that have enabled us to have benefit.

We don't count on those happening every year when we provide the initial guidance.

But I think our track record for most years would say that's been where we've been successful.

So, as I look at Aeronautics I would expect that reduction to occur.

From a margin perspective, 2013 versus 2014, I think if you go to the midpoint, they're probably in the 11.4%-ish range.

I would think that we'll still see somewhere in the 11% margins even with the dilutive effect of the F-35 and the C-5 increases in Aeronautics.

The point I tried to make in my prepared remarks was that, in particular within MST, we had, I believe in the second quarter, that was the highest margin in the history of MST.

And we had a few contractual resolutions there that we did describe in both the press release and the Q that you should think of being $75 million-ish or so.

On top of that, we have had very good performance.

You mentioned the radar programs.

Those are very good.

I think that's a business that stays in the 11%-ish range on a go-forward basis.

And then you didn't ask about it but the one I mentioned previously was the Space Systems Company with the joint venture in equity earnings.

We've had some high equity earnings this year, really associated with launch related activities.

Those are expected to come down a little bit next year.

Could we see the same experience with some performance out of ULA next year as we saw this year?

Yes.

But are we planning on that with our guidance?

Not at this point in time.

Space Systems, I'm very pleased with the margins there.

Again, this is probably the highest year in the history of Space.

I think that's a business that probably stays in the 12% range going into next year.

So, as we sit here today, we're not at all displeased with where we expect the margins to go next year.

And I'd say we have the same sorts of opportunities to increase those margins next year as we did this year.

Robert Stallard with Royal Bank of Canada.

Good morning.

On the F-35, on the most recent contract you signed, I was wondering if you could give us some color on how the contractual terms might have changed and how your discussions with the customer have progressed, particularly the US government.

Rob, the first thing is we negotiated Lots 6 and 7 combined, if you will.

They're separate contracts but we did do them essentially concurrently.

And we did so in about six months time versus Lot 5 where we probably took about 18 months.

I think we're on a good path there.

As far as contractually speaking, we do have essentially a fixed-price contract.

And I say essentially because there is a little bit of potential share on under run there between the government and ourselves.

There's no share on the overrun.

So think of a fixed price in that regard.

And I'm trying to think, Rob.

I think, off the top of my head, I think most other terms and conditions that we negotiated with Lot 5 carried over into -- I'm looking at Marilyn here, she was very engaged in Lot 5 -- carried over into Lot 6 and 7. I don't think we had much to speak of that changed of anything there.

So, I'll probably leave it at that.

Yes, I would agree.

Robert Spingarn with Credit Suisse.

Good morning, everybody.

This is actually Ross Cowley in for Rob.

I just want to touch base on the AMDR contract, and specifically find out how surprised you were when the award went to Raytheon.

And how the debriefing is going, whether this is something that you could protest.

I'll answer that.

From an AMDR standpoint, we were disappointed on the decision by the government.

We did get it debriefed last week so we're in the midst of evaluating the information.

But we've been engaged on it, the Aegis system, for the past 42 years.

So, we had deep understanding of that program and of the mission.

So, we were certainly disappointed.

But we're still in the midst of evaluating the information that came out of the debrief.

Myles Walton with Deutsche Bank.

Thanks.

Good morning.

Bruce, the cash into 2014 outside of the pension tailwind and net income, how should we think about advances, cash taxes, any other working capital sensitivities?

I'm trying to look up some paper I've got in front of me, Myles, in terms of advances.

Typically, what we project going forward is that our advances will come down.

We don't have a huge number of direct commercial contracts planned in the 2014 time frame that would bring typical advance payments with them.

Most of our international growth next year comes in the form of foreign military sales contracts.

So I wouldn't expect to see the same sorts of advances that we've had in the past that would result in our advance balance growing on the balance sheet there.

Working capital-wise, I think we're going to see some improvement there as we go through the production.

And we obviously have some withholds associated with the business system rule for things like the earned value management system, that have been made pretty public, that we expect to finalize.

And that will improve the working capital position associated with those.

I think, from a thinking or planning perspective, you should think of next year's number, I think, being higher than the level of cash that we're going to generate in 2013.

I know I said either in response to a question or in my prepared remarks, we talked about the potential for looking in the fourth quarter at additional pension contributions.

Even with that, I said we would stay above the $4.3 billion level in 2013, and I think we'll be north of that in 2014.

George Shapiro with Shapiro Research.

Good morning, Bruce and Marilyn.

The question I've got is two-part.

Last year's ending funded backlog was $55 billion versus the $82 billion that you quote.

Given that the funding is less assured these days, what do you figure the funded backlog will end this year?

And then my second one is, I know you've given some color to try and mitigate why sales are only down a few percent next year.

But just conceptually, you'll be down 4% to 5% this year.

And next year the budget's worse, the sequestration impact is worse.

So maybe a little bit more clarity on why you think you'll actually decline less next year than this year.

Thanks.

George, good questions, as usual.

I'm doing this a little off the top of my head.

US-funded backlog at the end of last year, funded at the end of this year and maybe embedded in your question was -- don't you have more risk, the difference between funded and unfunded.

I think the key distinction there is what's obligated versus necessarily what's funded.

The real issue from a sequestration perspective is taking those unobligated funds and those are the ones that's are really at risk.

That's the reason I made the comments before about, again, why we think we have in 2014 a pretty good handle on what our revenue's going to be, is we don't have that reliance on unobligated funds turning into sales in 2014.

I don't particularly see an issue with the funded backlog balance at the end of this year.

I think it will be comparable on either a percentage basis or an absolute basis to where we ended last year, on a percentage basis relative to the ending backlog amount.

So, I don't think that's an issue that I'm particularly concerned about as we sit here today.

Going forward, you asked about -- I'll paraphrase -- why we feel comfortable with saying we're going to be relatively comparable to the 2013 sales even though it appears the budget is going down more.

You're absolutely right with that.

Going back to the question I think Noah asked, it is a function of our portfolio.

It's the things that I talked about when I described the sequestration impacts.

We do expect international sales to grow both on a percentage basis and on an absolute dollar basis.

Our single largest program, the F-35, as I said, is expected to grow 15%.

We have other growth, in particular in air and missile defense products, at Missiles and Fire Control.

And so for all the reasons that I went around the horn earlier by each business area, we feel pretty good about that.

The things that I would think could change that dramatically, George, from what we're expecting to see now is if obligated, under contract programs were terminated or partially terminated.

And if that were to happen all bets are off.

But that's not a scenario that we're counting on or guiding towards at all when we give our trend information for 2014.

Stephanie, I think we're maybe a minute past the hour here.

I'm going to maybe turn it back over to Marilyn for final thoughts.

Thanks, Jerry.

As we conclude today, I believe our third-quarter results and increased guidance illustrate the solid position and performance of the Corporation to provide solutions to customers and value to shareholders.

In an uncertain budget environment, our strong backlog of work, our solid balance sheet, our robust cash generation and the exceptional execution of our employees will continue to propel our Corporation forward.

I'm confident in our future because of the outstanding performance, innovation and integrity of our workforce as we support our customers and their essential missions.

Thanks again for joining us on the call today.

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

Stephanie, that concludes our call today.

Thank you.

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

You may all disconnect.

And have a wonderful day.