洛克希德·馬丁 (LMT) 2014 Q3 法說會逐字稿

Good day, and welcome everyone to the Lockheed Martin third-quarter 2014 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, Shannon, and good morning, everyone.

I would like to welcome you to our third-quarter 2014 earnings conference call.

Joining me today on the call are Marillyn Hewson, our Chairman, President, and Chief Executive Officer; 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.

Our 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 that during the call, to supplement our comments.

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

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

Thanks, Jerry.

Good morning, everyone.

Thank you for joining us on the call today, as we review our financial results and key accomplishments in the quarter, as well as provide a brief update on some of our strategic initiatives.

As today's release details, we continue to drive towards achievement of our full-year goals, with another quarter of solid operational and financial results.

Although we continue to face global economic challenges, these results reflect the execution across all of our businesses, as the Corporation continues to operate at a very strong level in returning value to stockholders, while providing critical solutions to our customers.

The daily focus and efforts of our team are the foundation of our ability to deliver broad-based results across the Corporation, and I thank them for their ongoing contributions.

Turning to our financials, while Bruce will cover the results in detail later, I want to particularly highlight our continued exceptional cash generation.

This quarter, we achieved approximately $1 billion in cash from operations, bringing our September year-to-date cash generation to over $4 billion.

Strong cash generation is a long-standing hallmark of our Corporation, and continues to be a differentiator, as we return cash to stockholders through dividends and share repurchases, while also making appropriate investments in the business.

Our strong and growing cash generation, enabled by our Board of Directors, enabled them to approve two key cash actions this past quarter.

First, we increased our quarterly dividend to $1.50 per share, and $6 annually.

This action represents the 12th consecutive year that our dividend rate has been increased by double-digit percentages.

Second, we also increased our share repurchase authority by $2 billion, bringing our total current share repurchase authority to almost $4 billion, and providing additional flexibility to continue to make future share repurchases.

Beyond the Board actions, we recently completed our annual financial planning process, and projections of future financial metrics.

I'm excited about the robust cash generation that the plan projects going forward, and our ability to implement strong actions to deploy cash back to stockholders.

In light of our future projected cash flows, we are implementing a new cash deployment initiative, in which we anticipate reducing our total outstanding share count to below 300 million shares over the next three years.

Share repurchases of this magnitude, coupled with our dividend payments, would result in our returning the vast majority of annual free cash to stockholders over the next three years, and continue our long-standing strategy of disciplined cash deployment and value creation for stockholders.

Moving to operations.

While numerous Mission Success events were achieved across the Corporation, I want to highlight two major events achieved by our Space Systems business.

In September, our team successfully inserted the Maven spacecraft into orbit around Mars.

Space Systems constructed the spacecraft for NASA, and also provides flight operations control of the vehicle, as it surveys the upper atmosphere of Mars.

These surveys will provide vital data to scientists seeking to understand how the loss of atmospheric gas to space changed the Martian climate, and potentially provide valuable insight into atmospheric dynamics here on earth.

Another area where key accomplishments were achieved by Space is on the Orion program.

This quarter, the inaugural spacecraft was successfully fueled at the Kennedy Space Center, and is progressing toward integration with the Delta IV launch vehicle in November.

The program continues to progress, and is in the final stages of preparation for its initial unmanned test flight, scheduled later this year in December.

Orion remains an essential national asset, in returning the capability of manned access to space to our nation, in the coming years.

We are proud to be serving as the prime contractor on this program, and progressing on this critical capability for NASA and our country.

I'd like to briefly switch to our international activities and provide an update on noteworthy achievements in this strategically important area.

Progress this quarter was seen both in new strategic partnerships and new business awards.

In the area of new international partnerships, we opened a new space technology office in the United Kingdom.

This office will expand our in-country relationships with UK companies, government agencies and universities.

We're looking forward to applying our 50-year heritage of Space Systems expertise to develop opportunities in environmental monitoring, space exploration, global security, and secure space communications.

And we also opened a new space object tracking site in Australia, to construct a more detailed picture of space debris for both government and commercial customers.

This site will use electro-optical technologies, and will complement radar tracking systems, such as the US Air Force's Space Fence program that we were awarded last quarter.

Beyond our footprint expansion initiatives, new business awards from international customers this quarter included receipt of an $800 million contract from the Australian Department of Defense, to develop a centralized information processing environment.

This program will significantly improve the efficiency of data delivery, by consolidating the department's 280 data centers into 14.

Additionally, we were very pleased that the Republic of Korea finalized its formal selection of the F-35 for their fighter replacement program, and have announced their intent to sign the letter of offer and acceptance between the United States and Korean governments for 40 F-35 aircraft.

This program is valid in nearly $7 billion for aircraft and associated support activities.

These recent actions and awards are representative of the growing level of activity that our international strategic initiatives are generating.

I'm pleased to report that we are projecting achievement of 20% of International sales content by the end of this year, achieving a goal we outlined to you a few years ago.

Growth in international business content is an essential element in our ability to generate future sales for the Corporation.

Projected international sales growth will help offset the impact of US Government budget pressures on domestic sales levels.

With growing International demand expected for our products, such as the F-35 fighters and missile defense systems, I am increasingly confident that our annual international sales content could increase to 25% or higher in the next few years.

Before turning the call over to Bruce, I wish to note that we are very proud to have recently been named to the Dow Jones Sustainability World Index, and to two carbon disclosure project climate change management indices.

We are the only US aerospace and defense company to earn a spot on the world index.

And our CDP awards marked the fourth consecutive year our Corporation has been recognized for exceptional performance.

These prestigious awards reflect our continuing pursuit of sustainable practices, through innovation, transparency and sound governance.

They also reflect the broad commitment of our workforce to help engineer a better tomorrow.

I'll now ask Bruce to go through the details of third-quarter and full-year financial performance, and our 2015 financial trend preview, and then we'll open up the line for your questions.

Thank you, Marillyn, and good morning, everyone.

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

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

As I'm sure you're aware, shortly after the second quarter earnings call, the Highway and Transportation Funding Act of 2014, or HATFA, was enacted.

And because this legislation extended the methodology for determining the discount rates used for pension contributions established by the MAP-21 legislation in 2012, it will have a significant impact on our results for the quarter, the year, and longer-term as well.

We'll describe the impact this had on the quarter below, but we'll also spend quite a bit of time in upcoming charts describing these future impacts to you.

Sales in the quarter were $11.1 billion, in line with our expectations, though down slightly from last year.

Segment operating profit was also as expected at $1.3 billion, with our segment operating margin remaining strong at 12.1%.

Our net earnings from continuing operations increased 5% to $888 million, and this is where we first see the impacts of the HATFA legislation.

The effect of the legislation lowers our FAS/CAS income for the year by slightly more than $70 million, and requires a retroactive adjustment in the third quarter amounting to $55 million, or $35 million in net earnings.

Without this adjustment, net earnings would have increased by 10% to $923 million.

We'll see the remainder of the $70 million adjustment hit in the fourth quarter.

Our earnings per share from continuing operations increased 7% to $2.76 in the quarter, and again, these results were dampened by the impacts of the HATFA legislation in the quarter, which amounted to $0.11 of earnings-per-share.

Without this retroactive adjustment, our EPS in the quarter would have been $2.87, about 12% in the quarter.

Our cash from operations continues to be very strong, with just under $1 billion generated in the quarter, stronger than we had expected.

So I think we had another solid quarter of results, and we're well-positioned to finish the year consistent with our guidance.

If you'll turn to chart 4, we'll highlight just how strong our cash from operations has been this year.

Our cash generated in the quarter was almost $1 billion, and this represents a 10% increase over our level from a year ago.

And on a year-to-date basis, our results are even stronger, with $4.1 billion generated in the first three quarters, up 13% over the comparable time period last year.

Chart 5 shows our cash deployment actions through the third quarter.

With dividends to date of almost $1.3 billion and share repurchases of approximately $1.7 billion, we've returned nearly $3 billion to shareholders through the first three quarters, representing 82% of our free cash flow through the same time frame.

And as Marillyn said in her remarks, we also increased our dividend in the quarter by 13%, the 12th consecutive year we have increased our dividend level by 10% or greater.

This payout level begins with our fourth-quarter dividend.

On chart 6, we will explain the impacts of the HATFA legislation enactment in more detail.

As I mentioned earlier, the legislation was enacted after the July earnings release, and in simple terms, it impacts us by extending the methodology used to determine discount rates for ERISA contributions that was put in place with the MAP-21 legislation.

That methodology was an attempt to recognize the unprecedented low interest-rate environment we were experiencing, which would have required making significant cash contributions to pension plans.

The impact of the MAP-21 methodology decreases each year, and would have phased out by 2016.

Under HATFA, this methodology will now be extended, so that it will begin to decrease in 2018, and phase out by 2021.

It has the effect of lowering CAS costs, as well as ERISA contributions from what they otherwise would have been, had MAP-21 not been extended.

As you will see, the impacts of these changes are somewhat mixed.

They result in reduced pension funding requirements in the near-term, but also lower recovery of pension contributions, as it lowers our CAS costs in the near-term.

And, while lowering near-term CAS costs improves our overall competitiveness and lowers the required level of customer funding, it also will lower our reported earnings per share in the near-term.

I'll get into more specific detail of these impacts on the next page, but overall, we think these changes provide relatively neutral economic impact, while having a negative impact on near-term GAAP earnings.

Chart 7 provides more detail into how the HATFA changes will affect our pension recovery and funding requirements over the next three years, as these projections are based on the underlying assumptions for our pension plan, as shown on chart 14 in our appendix web charts.

Focusing on the column labeled Before HATFA, we were expecting to recover more than $7 billion through our CAS pricing between 2015 and 2017.

We also would have had $3.5 billion in required contributions over that same period, resulting in a net $3.8 billion in pretax pension cash recoveries.

As you can see in the column labeled After HATFA, we now expect to have CAS pension receipts of $5.8 billion, while reducing our required pension contributions to $1 billion over this time period.

Resulting in a net $4.8 billion in pretax pension recoveries.

As you will see in a couple of charts, we intend to make this required $1 billion contribution in the fourth quarter of 2014, creating a three-year pension funding holiday, and allowing additional cash deployment opportunities to shareholders over the next three years.

The bottom two bullets on the chart describe what these changes mean, relative to our approximately $10 billion of pension pre-funding amount.

By 2017, we will have recovered just under $5 billion of that amount, and by 2020, we will have recovered a total of just over $8 billion.

With this level of pension recoveries, we would expect our cash from operations to be greater than or equal to $15 billion over the 2015 to 2017 timeframe.

On chart 8, we provide our updated outlook for 2014.

We're maintaining our orders outlook for the year.

While we're ahead of our orders plan for the first three quarters, we had the largest C-130J multi-year order plan in the fourth quarter, which could slip into 2015.

We're providing point estimates for both sales and segment operating profit, as we are increasingly comfortable with our ability to achieve these levels, and both of these are both the midpoints of our prior guidance.

We also provide our usual sales and segment operating profit outlooks by business area in the appendix to our web charts today.

Our FAS/CAS pension income is lower by about $70 million as previously discussed, but we now expect our other unallocated expenses to be lower by a similar amount, resulting in $5.6 billion of operating profit.

We are now guiding our earnings-per-share to the high end of our previous guidance at $11.15 per share, which includes the negative impact of $0.14 for HATFA.

And with the additional $1 billion contribution to our pension trust this year, our cash from operations is now expected to be greater than or equal to $3.8 billion.

On chart 9, we provide our preliminary look at our 2015 financial trends.

We expect our 2015 sales level will decline by a low single-digit rate from our expected 2014 level, a little lower than we had previously expected.

We had previously thought 2014 would represent the trough year of sequestration's effect on our top line, but that has now moved out a year, as we continue to see downward pressure, primarily in our services businesses.

We expect our segment operating margin will remain strong, at between 11.5% and 12%.

Our FAS/CAS pension income grows to about $650 million in 2015, after the effects of the HATFA legislation.

And assuming the discount rate remains at 4.25% at year-end 2014, our return on assets is 8% in 2014, and based on the additional $1 billion in incremental pension funding in the fourth quarter of 2014.

Again, that would allow for no required pension contributions from 2015 to 2017.

Beyond 2015, with these same assumptions for our discount rate and return on assets, we would expect FAS/CAS income to continue to grow to about $1 billion in 2016, and $1.5 billion by 2017.

And because we are eliminating our previously-planned $1 billion pension contribution in 2015, we anticipate increasing our share repurchases to at least $2 billion, about $1 billion more than the level required offset the amount of share creep expected during the year.

This would be a good start to reducing our share count level below the 300 million share amount within the next three years, that Marillyn mentioned earlier.

Finally, on chart 10, we have our summary.

Our third-quarter and year-to-date performance continues to be very solid.

Our results leave us well-positioned to achieve the full-year guidance we have provided, and we continue our long-standing commitment to returning cash to our shareholders.

With that, we're ready for your questions.

Shannon?

(Operator Instructions)

Carter Copeland, Barclays.

Good morning.

A couple of quick ones.

Just first on the sustainment weakness you called out in aeronautics in the quarter, I wondered if you might give us some color about what that related to, and whether that was tied to in-theater operations or something else?

I'll take that one on, Carter.

So, the sustainment weakness in there, was really think of it as predominantly F-16, although a little bit in our Kelly business as well.

The F-16, you should think of a couple of things going on there.

We have a couple of large international F-16 mod programs that are starting, but they started later than we had anticipated, or they will start later in one case, than we had anticipated.

And while we previously expected to have some existing older mod programs feather in to these newer mod programs, we now have a bit of a lowering point, or a trough before we start to see the new programs pick up speed, and that is what is driving the numbers down a little bit in F-16.

On the other hand, for the F-22 program, this is bit of good news can also be bad news in some respects.

We provide the sustainment of the F-22 aircraft in the field, and the aircraft are actually performing better than our expectations, and I believe better than the customer's expectations.

And so, because of that, because our readiness levels and the like are up higher than we expected them to be at this point time, we're actually seeing a diminished level of spares requirements and other sustainment activity to support the aircraft at that level.

So, while that's terrific news for our products, terrific news for our customer, it does result in a little bit lower sales for us in 2015 than we previously planned.

Jason Gursky, Citi.

Good morning, everyone.

Bruce, a question for you on the cash flow outlook over the next three years.

You're going to do $3.8 billion this year, which includes roughly $2 billion in pension contributions that won't be there in the 2015 through 2017 period.

That would suggest on average $5.8 billion, and yet you're guiding on average $5 billion in cash flows 2015 through 2018.

Can you talk a little bit about the puts and takes that are going on with cash flow outlook?

Yes, sure.

Where might we come under, where might we go over?

Yes.

Let me try to take a shot at that, Jason, so, I think you're -- the back of the envelope math you did would be exactly right.

$3 billion with $2 billion pension contribution, why wouldn't that equal $5.8 billion next year?

This short version answer to that is, think of that as primarily cash taxes.

So the additional $1 billion that we're contributing in 2014, think of that as about a $350 million swing, that we won't get that tax deduction, if you will in 2015, and somewhat seems old at this point in time.

But we also had a tax refund in the first quarter of this year, about $250 million.

So between the two of those, think of that as $600 million-ish or so.

I think the one thing I would add that may help a little bit in the discussion also is, while we are saying greater than or equal to $15 billion, we do expect 2015 cash flow to start with a 5, obviously, at this point in time, but I would expect that year-over-year, our cash from operations would actually increase over that number between 2015, 2016 and 2017.

So we're actually feeling good about the statement of greater than or equal to $15 billion.

Rich Safran, Buckingham Research.

Hi, good morning.

Let me ask you a different question on cash flow here.

Marillyn, I heard your opening remarks, and I just want to get a little specific.

Previously, your stated goal was to return 50% of cash to shareholders.

I recognize you been doing more than that, but the $2 billion in share repurchases on the slide, plus the dividend indicates now you're looking closer towards 100%, assuming my math is correct here.

So I want to know if I'm thinking about this right, and does it represent a change in your cash deployment strategy?

Should we be thinking now that you're going to return more like 100% of free cash flow to shareholders?

Well you've got the math exactly right, Rich.

That's exactly how that totals up, and so we are indicating to you that we are going to be returning more cash to the shareholders over the next few years.

As Bruce just outlined, we're going to have a good, solid cash flow, so we intend to be more focused -- as we look back, we have been providing more than 50% for the last few years, but we intend to continue to do that.

So we continue to still expect to have strong dividends.

We still then, as Bruce has outlined, we're progressing toward a share level, outstanding shares of 300 million.

Bruce, do you want to add anything to that?

Yes, Rich, maybe just a couple of moving pieces that may not be readily apparent there.

So we have about -- we're probably in the year about 316 million shares or so outstanding, and so, we also have, at the end of the year, or as we sit here today, about $6 million-ish -- excuse me 6 million-ish options outstanding as well, that we would expect to be exercised over that three-year period.

Plus, as you know, we provide executive compensation, RSUs plus matching on our 401(k)s and the like.

That will probably add another 10 million shares or so.

If you just think of it in terms of what the absolute number of shares would have to be there, it's probably the 16 million shares to get down to 300 million, plus some of the creep that we just talked about.

So at least as we look at it, and we look at our operating cash flow over the next three years, I think your math is pretty much spot on.

It does pretty much require us to do about 100% of free cash flow over the next three years, and that would be our intention.

Noah Poponak, Goldman Sachs.

Bruce, if I assume every segment except IS&GS has the same top line rate of change in 2015 versus 2014, as it did in 2014 versus 2013, I would need IS&GS to be down about 10%, just to get the total Company down 1%, and the low single-digit comment suggests it could be more than 1%.

Is that the right number for IS&GS next year?

Or, is there another segment that is incrementally worse than what you previously thought for 2015?

And if you just give a little detail on why IS&GS is still dragging at that decline?

Yes, so let me give -- maybe just go around, try to touch on all five business areas, at least at the top line, Noah, because I think you're not quite right in the way you did the math to come up with that number.

I think IS&GS, if we look at 2015, will probably be down mid single digits, maybe slightly more than that.

And that is probably pretty evenly split between our civil and the defense and intelligence lines of business there.

And what we're seeing there is, this is a portion of our portfolio that has -- always has been, I should start with that, but always has been, and seemingly has gotten increasingly competitive in nature, to the point where we're even seeing our follow-on contracts, where we're the incumbent, and we win the follow-on contract, those are being awarded at lower levels than the prior contract were being awarded at.

We're also seeing the disaggregation of some contract opportunities, and the multiple elements of that contract, that enable additional competition.

So that's a little different environment than we had expected to be in, as we're trying to forecast what 2015 would look like a year ago, but that's the reality of where we are today.

I think the piece that you're probably missing a little bit is we're going to be down somewhat in the missiles and fire control, probably more than you're expecting.

So missiles and fire control in total is probably going to be down about a similar amount, maybe a little bit less than IS&GS, and most of that is because we do have a pretty good-sized services business within the missiles and fire control, our technical services business, and that is also experiencing a similar hypercompetitive elements that we're seeing over in IS&GS.

So that's going down.

We're also down slightly, or expect to be down slightly in 2015 in our air missile defense volume.

This is both PAC-3 and THAAD [nesh].

That's just simply reflecting the lower quantities of missiles that were left a couple of years ago, if you look in the sequestration timeframe, that are finally playing out in 2015.

I think aeronautics is probably, and I think you got this one right, aeronautics is probably pretty comparable to where we'll finish 2014, although that's probably a little lower than we had expected it to be, primarily for the reasons that I described to Carter's question.

I will point out that may not be clear, we are down we always were expecting to be down in aeronautics for F-16 deliveries from about 17 in 2014 to about 11 or so, so think about it like one a month of F-16 deliveries next year.

And that combined with the sustainment activity that I mentioned to Carter is the reason why we're actually seeing a flat.

I'll try to make this before my voice quivers here.

We're making a flat year-to-year situation.

What's lost in all of that is we have a pretty significant reduction in SDD on the F-35 program, but the F-35 production program is drawing it faster than a 10% rate from 2014 to 2015.

Space is down slightly.

Next year, you should think of that as low single digits.

That's primarily because we had two launch vehicles that we recognized the sales for in 2014, we will have no such launch vehicles in 2015.

We also had a slightly lower government -- we actually had one large vehicle, we also had the Orion ETF, which is yet to take place.

That will take place in December of this year, so that's a the higher volume for Orion as well, compared to 2015.

We also have lower government satellite volume expected next year, and that's partially offset by the volume from our Zeta acquisition, but net-net, space is still down.

Lastly, the one outlier in all of that discussion is MST, and we're actually expecting MST to have potentially a little bit higher sales, maybe low single digits, higher than last year, and you should think of that as primarily because of the new start activity on some of our programs, such as the Space Fence program, the combat rescue helicopter, and the Presidential helicopter.

So hopefully that gives a little more added color there.

Joe Nadol, JPMorgan.

I would like to hone in on the F-35.

It looks like your margin on the LRIP contracts in aggregate was down a little bit year-on-year for the second straight quarter.

I'm just wondering if you could highlight what your expectations are there, is there any risk reduction activity in Q4 and going into next year, and maybe just more qualitatively comment on what's happening?

Thanks.

Joe, I will take a shot at that.

So, I think the primary reason that F-35 looks that way is we actually had some retirements in the year before that were not replicated in 2014, and we're obviously booking those now at the higher rate that resulted from those step-up in 2013, but we have no similar level of step-ups in 2014.

Actually, as we look in 2015, I think the F-35 production volume, in part because we do expect to make some step-ups next year that we didn't have in 2014, we would actually expect to see the production volume, or the production return on sales actually increased next year, as opposed to decrease.

So we're slowly getting there, and it's a bit of a slog to go take a program as large as F-35 from a development to a low rate initial production to a full-rate production program, but we're getting there, and little step-ups depend on risk retirement events, and the phasing of those things changes practically with every single lot.

I am happy that we just finished all the F-35 LRIP 5 deliveries, and we're going to start delivering LRIP 6 aircraft this quarter.

Doug Harned, Sanford Bernstein.

Thank you.

Good morning.

On missiles and fire control, when you look at the next year, and backlogs were down in this quarter, you talked about the service part of this.

But if you look at the broader business, both not service but both the US and international, since that's a big part of it, can you talk about how the backlogs look for those pieces, and if you're seeing the order flow come in, in the time frames you would have expected to?

Are we going to see those parts of the business up some in 2015?

Just to be clear, Doug, you're talking missiles and fire control by itself, and the international content there?

Yes.

Missiles and fire control, if you considered the services portion of it, the US equipment portion of it, and then the international part How are those moving in terms of orders, and when we should see the revenues from those orders?

Yes, so Doug, as I said previously, the technical services piece is definitely going down, and accordingly, the backlog associated with the business is going down.

That's almost all US dominated services, if you will.

The international business is expecting to increase, both backlog and sales going forward.

We've already got, in fact, hopefully you saw there's -- today's announcement we had the turret contract for the UK Scout vehicle.

This is a subcontract arrangement to -- actually our facility in the UK was awarded today, that's worth about $1 billion.

That will be recognized as an order in the fourth quarter.

We also had the PAC-3 order for the government of Qatar that occurred in the quarter, that's already happened, that's about $0.5 billion.

As we look forward, there's quite a few international air missile defense activities.

Those, as you can well appreciate, those tend to be lumpy and a little bit hard to predict, but we would expect backlog in missiles and fire control to grow in 2015 compared to 2014, and we would continue to expect the international content, both in terms of sales as well as backlog, to grow from 2014 to 2015 as well.

Hunter Keay, Wolfe Research.

Thanks for taking my question.

Bruce, I was wondering if you could dive in a little bit about talking about the components of some of the margin erosion you are expecting to see next year at the segment level?

Is this -- maybe parse it out for us between how much of it is a pricing issue with regard to mix shift, maybe the customer's renegotiating some fixed-price contacts that are rolling off, you're just getting some more development work, or is it more a volume-driven efficiency issue?

I don't think it's as simple as either one of those, Hunter.

I probably should have done this when Noah asked this question, but let me try to address that here with you.

We're guiding towards, or at least the trend information that we provided, we said we would probably come between 11.5% and 12% next year.

The biggest reason for that, the biggest single reason for that is, we're expecting close to about $100 million of lower equity earnings from our United Launch Alliance joint venture.

And you should think about as being probably about three or so fewer launched vehicles in 2015, compared to what was launched or what is expected to be launched in 2014.

And it's also the mix of those vehicles.

Not every launch vehicle that gets launched by United Launch Alliance has the same level of profitability.

It depends on which vehicle, and when that vehicle is actually contracted for.

So again, because of quantities of mix changes, think of that as being about $90 million lower.

We're also seeing lower margin expectations back on the IS&GS from the competitive pressures that we talked about earlier in the sales discussion.

So I would expect to see IS&GS margins down probably 20, 30 basis points, somewhere in that range.

About half of it due to competitive pressures that we see, that are affecting the sales, as well as the bottom line there.

Then probably the other half is, this is probably a little bit of a good news story, the other half of margin pressure comes because we've won quite a few large international multi-year contracts, so think of this as programs like -- for the Australian Department of Defense, where we're providing the IT services for them, think of it as a number of command-and-control programs for international customers.

And whereas the vast majority of IS&GS business tends to be very short-cycled in nature, these are a little bit more longer-term contracts, and as you might expect we'll start booking those contracts at lower profit rates, in part because they're new customers, and they're longer direction contracts as well.

I'll also mention that we have about $50 million of higher expenses next year, 2015, because of intangible amortization and transaction expenses, associated with the deals that we were closing this year, and we also have within that $50 million, about $20 million or so of research and development expenses that are hitting the bottom line for our Sun Catalytix R&D efforts.

This is -- you may have read about this, this is our energy storage pre-revenue business that we acquired.

It does require some continuing R&D expenditures, and this is a non-FAR, non-DoD business, where the R&D hits the bottom line.

So collectively again between the transaction expenses and Sun Catalytix about $50 million higher next year than last year.

Despite that, I actually went back and looked at what we provided last year at this time, and last year for 2014 at this time, we were guiding towards about 11.5%.

I'll say the same thing this year that I said last year which is that, as I look forward, I think we have similar levels of opportunity to do better, as we did in 2014, as we sit here looking at 2015.

But we have to make those happen, and that's the reason -- we haven't made those happen yet, and we'll see how that progresses throughout the rest of the year.

John Godyn, Morgan Stanley.

Thank you for taking my question.

Marillyn and Bruce, there's no doubt that Lockheed has a differentiated core competency in aerospace, and particularly, if you assume that you win the long-range strike bomber like we do.

But when you look out a few years, at a certain point, you'll have effectively capped out of the organic growth opportunities that the Air Force, so to speak, has to offer.

3 And I wonder if you could talk a bit about how you see the shape of the Company evolving in the longer-term?

Where do we find the growth from there?

Do we start looking more closely at M&A, or do we evolve more into a pure cash return vehicle?

What's next?

I think as you talk about the outlook for aircraft and aerospace in general, it is still a very positive for us.

We're going to have -- continue to see F-35 growth well into the future.

We often talk about how it's very similar to the F-16 program.

Today, we have a program for record of over 3,000 aircraft and the F-16, we sold something like 4,600 of them, and we still have continuing demand for the F-16, and that is how we expect the F-35 to go.

So while there is a program of record with the US Government on the number of aircraft that they are going to buy, we have a lot of interested countries internationally, that have yet to come online in that procurement process.

A lot of partners, as you know, partners around the world, now three FMS customers with Israel, Japan and now South Korea, and we expect additional customers.

Plus some of those customers are early on in what their needs are, and I expect that they will look at additional tranches of aircraft over time, much as they did with the F-16 program.

So we will continue to be a strong aerospace company, going forward into the future.

It will be a major element of our business.

Likewise, the missile defense arena is going to be a continued demand.

That's a very important element of our business, and there's strong demand internationally.

Even as we look at our needs domestically, we expect there to be additional opportunities to use domestically, but if you look at FAD, PAC-3, Aegis, Aegis Ashore, even MEADS we expect, going forward.

Another area that we are moving into and have invested significantly in, and have a tremendous product for is the Joint Light Technical Vehicle.

That is a big opportunity as we look forward.

Littoral combat ship, and the work we're doing in that arena.

There is interested international customers for that.

In fact, we just launched the latest LCS in Marinette Marine this past week, and we had international customers that attended that ceremony so that they -- they're interested in our products.

We think there will be a demand for that as we go forward.

The C-130J, that aircraft continues to be in demand.

We've got a solid backlog of aircraft, and we expect that there will continue to be others, and now that we've rolled out our commercial version, we expect those commercial customers, that today are flying L-100s to fly the LM-100J in the future.

So that -- we'll continue to look at variants of the C-130J, just as we have for many, many years, going forward.

I walked around some of the top products in our portfolio, but as Bruce mentioned earlier, big opportunities in Mission Systems and components on various other platforms, such as the combat rescue helicopter or the Presidential helicopter, the MH-60 Romeo we are selling around the world we do the mission systems for, out of our mission systems.

Simulation and training, continues to be a strong demand for that, and as over time, they'll continue to be in -- and as you mentioned, our teaming with Boeing on the Long Range Strike-Bomber, we expect we're very well-positioned to win that opportunity.

Rob Stallard, RBC Capital Markets.

Thanks very much.

Marillyn, a question for you.

There have been some comments out of DC that maybe the US defense industry is not investing enough of its own money in R&D, and perhaps returning too much money to shareholders.

I was wondering if this is a comment that you've heard from your customer, and how they might respond to your latest announcement today on the buyback?

Well yes, we have heard that from our customer, that a concern by our customer that we lose our technological superiority in this period of time when there are budget pressures, and it's a down market.

I would tell you, from a Lockheed Martin standpoint, we have increased our R&D from last year to this year by 13%, we are going to increase another 5% this year or so, and will continue to -- so we're at the highest percent of sales that we've ever been in terms, of our research and development, and we'll be higher in 2015.

We will continue to invest.

But I do think, in open communication with our customer, especially in the Department of Defense, is really important.

And we are in constant dialogue with them on what areas we want to invest in, and how that aligns with what they see as their priorities in the future.

A lot of our products, as you know, require a lot of development on the front end, such as F-35 or as we look forward to JLTV that we talked about, and a variety of them.

So as we come out with products, we're constantly investing, but we're investing in new technologies.

We're looking at how do we help our customer get an advantage over adversaries, we have things going on that we can't talk about on this call, but certainly there's a lot of investment in new materials and new capabilities, that we think our customers will need.

So yes, we're hearing it, and I think from the Department of Defense standpoint, because they recognize that, I think they will in turn be looking at making sure that they invest in new technology, and we expect to participate in that opportunity.

We do cooperative research and development with universities and with other government labs, as well, so when you look at our percent of IRAD, you have to add to that the things we're doing there, and collaborate CRAD and type of things.

We are a major provider to DARPA, so the work that we do with DARPA is another example.

So when you total it all up, you can't just look at one number on the balance sheet.

You have to take into account the type of work we do, the complexity of the products that we produce, and how much Research and Development that takes on the front end, in the domestic phase, as well as our independent research development in our work with DARPA and our CRAD.

Myles Walton, Deutsche Bank.

Thanks, good morning.

I was hoping, Bruce, maybe you could touch on the profit adjustments not related to volume, and what's baked in to 2015, it looks like, maybe for this year.

We have you running somewhere 32% to 33%.

And also, you just clarify of the sustainability of unallocated expense being at this level?

Thanks.

So, I think you're about right, Miles.

I don't quite have the number in my head but we were a little bit lower in the fourth quarter in terms of our profit adjustments, so I would expect that we probably rebound a little bit, at least as we look at the planning for the fourth quarter.

I mean, obviously those can move out if we don't accomplish all of the events that we hope to, that result in those risk retirements.

But as we look here today, we would expect to bounce back up a little bit.

That would end the year at about the level you said, somewhere probably in the 33%, 34% of total profitability.

I would think next year is probably fairly comparable, we have tossed out the 30% to 35% is where we expect to be, we were a little bit higher than that last year, but that's about what we expect to be going forward.

And then as far as the other unallocated, I would not expect it to be quite at the level we are forecasting for this year, in part because I mean there's a lot of moving pieces in that, as you can well appreciate.

But we had some questioned corporate cost that got resolved in our favor during the quarter.

There was a fairly -- the largest piece of those moving pieces, and I would not expect that to replicate in future quarters, so this is a bit of an outlier.

Rob Spingarn, Credit Suisse.

This is actually Ross on for Rob.

I was just hoping to get a quick update on the expected timing for the signing of LRIP 8 on F-35, and any of the details you could provide, regarding that contract?

Well, LRIP 8, we are progressing well and the negotiations, so I think that we expect to see closure on that in the near-term.

It's for 43 aircraft is the number of aircraft in that lot, so we'll see a larger number of aircraft in LRIP 8. So we're -- it's progressing very well we've had some good discussions with our customer, and we expect to conclude the negotiations in the near-term.

Cai von Rumohr, Cowen & Company.

Yes, thanks so much.

So Bruce, if you could comment on aeronautical with respect to, I think you took a contract reserve in the third quarter, and also maybe update us on the C-130 deliveries this year and next year, given there was a slip on the F-16?

And the implications of that F-16 slip, profitability next year?

Thanks so much.

So actually we had two.

We said they were contract reserves, they were probably better stated as legal reserves.

One was to resolve a legal matter, the other was to create a provision for a legal matter.

Two different items about the same quantity of each of them, so a total of about $30 million in the quarter, I think we released that in the earnings release.

C-130 deliveries, we do expect to end the year about 24, we're at about a 24 aircraft build rate, and you could possibly have one slip here and there between years, but I don't expect that to happen in 2014, we're tracking well to that schedule, and I would think 2015 would be a similar level at the 24 aircraft.

And I think your last question was on F-16 and what's the profitability of that?

Because we're losing volume of aircraft quantities, obviously the profit dollars associated with those aircraft quantities will go down.

I wouldn't expect to see a huge drop-off from a margin perspective year-over-year because of that.

I mean the aircraft quantities that are being delivered, I still think we'll have comparable margins and the sustainment activity including the model work we do, is also fairly comparable to the aircraft business that we have there.

So it may not be as self evident as when the quantity drops, the profitability also drops, or the profit and the margin also drops, and I don't think that's the case there.

George Shapiro, Shapiro Research.

A couple little ones, I'll patch together.

C-5 deliveries next year, and do we get there any chance of getting above the 0 margin?

And then on the F-35, if you could break out the revenues by the different LRIPs and if there's any international revenues starting to pick up next year?

Yes, George I'll take that one.

So, C-5, we are expecting to increase the rate.

At think we'll do probably six, maybe seven C-5s this year.

We're actually performing well in that program.

I think we grow that number to about nine expected deliveries next year, so we will see some volume increases associated with that.

I do think, I think there's a chance that we'll must see some profitability increase, George, on that.

We're performing much better as we perform throughout 2014 towards the end of the year than we were even at the start of the year.

And assuming that trend continues into 2015, I think that creates the possibility for that.

I think we talked on a previous call about -- there's definitely some -- what we call over and above work that we think we have entitlement to, that we do believe we can get reimbursed at some point in time.

That has not yet played out that, but we continue to believe we have that entitlement, which would allow more than what I'm talking about, just through ordinary program performance improvements year over year.

So I'm feeling better about the program going into 2015 than I was into 2014.

The international revenue, on the F-35, the quantities are growing.

And just roughly, I think if we were to pull out a number, just a little bit off the top of my head, but we're probably somewhere between $1 billion or $1.5 billion in international revenue this year and we would probably expect to grow that number above $2 billion of the total F-35 revenue for next year.

So it's growing at a fairly fast clip by itself.

Again, the program in total, the production program is growing more than 10% year over year from 2014 to 2015, so internationally, we would expect to do that as well.

Sam Pearlstein, Wells Fargo Securities.

Good morning, it's Gary Liebowitz for Sam.

Couple of quick ones.

First, for your three-year cash flow outlook, how should we think of capital expenditures over that?

You should think of those as being fairly similar to the level we had in 2014, Gary.

We're right at around $1 billion between PP&E, capital expenditures, and our capitalized software, and that's about the level we see in the future, it could be a little less than that, maybe a little more than that, but for planning purposes, think right at about $1 billion a year.

Great.

And my second question, I apologize if you addressed it already.

The sales outlook in space that you took up to $7.9 billion this year, what was behind that increase?

So we're getting, again, I think at the beginning of the year, we had probably a little more conservatism for some of the later in the year delivery events that were going to occur, including the Orion ETF launch, which should be pretty spectacular, by the way on December, in the early part of December of this year.

So that, and we feel highly confident that's going to occur.

That was one of the reasons we were probably a little more conservative with our guidance earlier in the year.

We've also made two acquisitions in the year, Zeta Associates, which is the larger of the two, and Astrotech which is little smaller, but we're getting additional revenue from both of those as well.

Shannon, this is Jerry.

We are coming up on the hour.

Maybe one more question?

Joe DeNardi, Stifel.

Bruce, I'm wondering if you could talk about, given some of the budget uncertainty obviously we've got over the past couple of years, I think there's more confidence that bottoms out in 2015.

Does that change the way that you think from a cash deployment perspective balancing the dividend, buyback and M&A?

Clearly the M&A side hasn't been a big piece of it the past couple of years.

Do you see that changing at all over the next few years?

Yes, I sure hope, Joe, that we do see the bottom out in 2015.

We teed up, we thought that was going to occur in 2014, and we were at least a year off there.

So as we look today, I think that we do expect that to bottom out for us in 2015, and we get back to a period of growth in 2016.

It's what the budget would indicate.

I'm watching, in particular, the FY16 budget requests, and whether or not they stick within the sequestration levels, or actually potentially base it more on the actual threats than the strategic direction that the DoD needs to go into.

I think that's going to be an interesting one to watch.

As far as how that plays relative to our cash deployment, I don't see that having any necessarily large impact on how we would think of cash deployment activities.

I think we've given a little more insight into that by what we talked today with the higher share repurchases that we plan, over the next three years at least.

And as I always say with the dividends, I think our track record on dividends is the best indicator of what we'll do going forward.

So, I'll probably leave it at that and turn the call back over to Marillyn at this point.

Thanks, Bruce.

We'll just wrap up now, I want to thank you all for joining us on the call today, and conclude by reiterating that the corporation had another solid quarter, and we continue to be well-positioned to deliver substantial value to our customers and shareholders, as we progress towards a successful closure of 2014.

Thanks again for joining us, and we look forward to speaking with you again on our next earnings call in January.

Shannon, that concludes our call today.

Thank you.

Ladies and gentlemen, this concludes today's conference.

Thank you for your participation and have a wonderful day.

You may now disconnect.