Lockheed Martin Corp (LMT) — Q2 2015 Earnings Call Transcript

Thank you, Abigail, and good morning. I would like to welcome everyone to our second quarter 2015 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 facts are considered forward-looking statements and are made pursuant to the Safe Harbor provisions of federal securities law. Actual results may differ. Please see today’s press release and our SEC filings for a description of some of the factors that may cause actual results to vary materially from anticipated results. 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. I would also note that we are extending the call duration until 12:30 today to enable adequate time for your questions on our financial results and strategic actions. With that, I would like to turn the call over to Marillyn.

Thanks, Jerry. Good morning everyone and thank you all for adjusting your calendars and joining us on the call today. It’s a day earlier than planned, so given the short notice, we appreciate you joining us. With today’s press release outlining two strategic actions we are implementing to strengthen our competitive posture and position the corporation for profitable long-term growth, we accelerated the call to enable timely discussion of our second quarter financial results and the portfolio shaping items. Starting with our financial performance, we had a strong quarter operationally and financially, with all reported results exceeding our expectations, and we are progressing on achievement of our full-year financial objective. These results reflect the execution being achieved across the businesses as the Corporation operated at a very strong level in providing critical solutions to customers while returning value to stockholders. The year-to-date financial performance also enabled us to again increase our full-year 2015 guidance for segment and consolidated operating profit and earnings per share. In addition to these increases to guidance, we reaffirmed our earlier outlook for full-year orders, sales, and cash from operations. With these strong financial results, we continued to return value to stockholders in the areas of share repurchases and dividend repayments through cash deployment initiatives. I would now like to discuss the two strategic actions we announced today, and then I’ll ask Bruce to cover in more detail our second-quarter financial results and increased 2015 guidance. To assist our discussion, I would ask you to turn your attention to the charts we provided on our website. Starting on Chart 4, reshaping our portfolio. The first strategic action we announced is our signing of a definitive agreement to purchase Sikorsky Aircraft. Sikorsky is a natural fit for Lockheed Martin, and it complements our broad portfolio of world-class aerospace and defense products and technologies. This action will enable us to extend our core business into the $30 billion annual military and commercial rotary wing segment. The second major action is the commencement of a strategic review of our government IT infrastructure services work at Information Systems & Global Solutions and of our technical services work at Missiles and Fire Control. The strategic review will address the changing market dynamics affecting these businesses and will help us determine how to best position them for future growth and is expected to result in a spinoff or sale of the businesses. These actions continue our practice of continuously shaping the portfolio to secure the highest value creation for customers and stockholders. Turning to an overview of Sikorsky on Chart 5. Sikorsky is well-known as a world leader in the design, manufacture, and support of military and commercial helicopters. Their international presence is wide-ranging with operations in 20 countries, and their products are used in over 40 countries. Sikorsky’s revenue composition is shown on the pie chart with approximately 75% of their work for military customers and the remaining 25% for commercial users. With approximately 50% of their annual revenue derived from international customers, they will aid us in moving forward on our goal to expand international revenues. The acquisition rationale is outlined on Chart 6. Some of the important strategic benefits of this acquisition are that Sikorsky has familiar customers. This familiarity will assist the integration process through utilization of similar knowledge and interaction with common customers. They are also extraordinarily well-positioned with an established brand, and a robust backlog of future work. They also have a 40-year history as a frequent teammate of our mission systems and training business area, and today we collaborate on the VH-92 Presidential helicopter, combat rescue helicopter, and the Naval MH-60 Romeo helicopter. Their strong aftermarket business is also expected to provide a long-term source of earnings to the Corporation and another lever of value creation. The opportunity to access capital in today’s historically low interest rate environment is another significant contributor to the rationale and value creation of the acquisition. Beyond the strategic benefits I outlined, another key element of the acquisition rationale is the Section 338(h)(10) tax election for the transaction which is expected to provide approximately $2 billion in net present value for our Corporation and stockholders. Future growth prospects of the acquisition are outlined on Chart 7. One of the key elements of our strategic planning is to secure and extend our core defense business, and we feel confident that the addition of Sikorsky will contribute significantly to the growth objective. As the prime contractor for multiple current development helicopter programs such as the CH-53K, Presidential, and Combat Rescue, Sikorsky is well-positioned to grow as these programs transition into production scheduled in 2018. With their extensive presence around the world in over 40 countries, we see further expansion of our international operations as we will benefit from their international footprint and customer relationships. Sikorsky’s footprint in the commercial aviation segment is well-established with extensive activities supporting the oil and gas industry. While this segment has been under recent pressure due to low oil prices, it is expected to recover in the future and add value to the Corporation. We believe these current pressures enable us to make this acquisition at a low point in the economic cycle. All of these elements indicate significant opportunities for growth in the future and value creation potential. I’d now like to outline the transaction valuation on Chart 8. The agreement announced today outlined the purchase price of $9 billion and will be funded with a combination of new debt and available cash. It is important to note that our joint election of the 338(h)(10) tax benefit effectively brings the adjusted price of the transaction to slightly over $7 billion with an adjustment multiple of 10.3 times EBITDA. These metrics demonstrate that we are purchasing an active participant in one of the largest areas of DoD expenditures at an attractive price. I also want to reiterate that this transaction will not change our previously outlined plan to return cash to shareholders through dividends and stock repurchases between 2015 and 2017 and reducing our outstanding share count to below 300 million shares by the end of 2017. An overview of synergy is shown on Chart 9. While there are multiple elements of synergy that we have identified from this transaction, the largest contribution will be from the approximately $2 billion that we will recognize through the election of the Section 338(h)(10) tax treatment. In the area of cost synergies, we expect to achieve a steady-state level of around $150 million annually after integration actions are completed. In the area of revenue synergy, we see multiple opportunities by leveraging our relationships with international governments and our ability to match their security needs with a full spectrum of our security offerings. Sikorsky’s products and capabilities will aid our existing portfolio and enable us to offer an ever broader range of solutions to international customers. Before leaving Sikorsky, I also want to offer some additional perspectives on our new team members. We have similar cultures. We have a shared passion for innovation and a commitment to supporting the men and women who defend their freedom. Together, we will offer a stronger portfolio of helicopter and systems engineering solutions to our global customers as we accelerate the pace of new technology. At the same time, our commitment to bring the best we have to offer to our work with our helicopter manufacturers is absolutely – with other helicopter manufacturers is absolutely undiminished. I'm confident that Sikorsky will be an excellent fit within our mission systems and training business area and a strong contributor to the Corporation as we move forward together. I will now turn to Chart 10 and speak to the second portfolio action we outlined today. The strategic review of IT and services work in our IS&GS and MFC business areas. Let me start by saying that we have a proud legacy as a world-leading government IT services and technical services provider. However, market dynamics and trends have led us to believe that these businesses may potentially achieve greater growth which is good for our employees and create more value for our customers and stockholders by operating outside of Lockheed Martin. The metrics shown outline the businesses within IS&GS and MFC that comprise the strategic review, as well as those that will be realigned under other existing business areas. For your reference, the businesses under strategic review are expected to generate approximately $6 billion in annual revenue this year with a mid-7% margin. With a series of recent wins, the businesses under strategic review are well-positioned to generate value under an expected spinoff or sale. As I summarize today’s announcements on Chart 11, I’d like to conclude by reiterating that the two strategic actions we announced today represent powerful portfolio reshaping activities and provide strong opportunity for creating long-term value for shareholders. We believe there are opportunities for significant synergies and are confident that the risk of execution is low. Both of today’s actions will further position the Corporation for growth and value creation for investors and customers. I’ll now ask Bruce to go through our second-quarter financial performance and our increased 2015 guidance and then we’ll open up the line for questions.

Thanks, Marillyn. Good morning everyone. I will try to keep my remarks brief this morning so as to allow more time for questions during our session and my remarks relate to web charts addressing just the financial results for the quarter. Beginning with Chart 14, we have an overview of our second-quarter results. Sales for the quarter were $11.6 billion and were ahead of our expectations. We will provide more color on our sales results on the next chart. Our segment operating margin was also better-than-expected in the quarter at 12% and enabled us to achieve earnings-per-share of $2.94. We generated $1.3 billion in cash from operations, again a little better-than-expected and we will also discuss this further in a few charts. Our cash deployment actions increased over the first quarter with $1.4 billion of cash returned to shareholders, including nearly 5 million shares repurchased for more than $900 million. And with our strong operational performance, we are increasing our full-year outlook for both operating profit and earnings-per-share. So we feel good about how we ended the first half of the year and that positions us well for the remainder of the year. On Chart 15, we compare our second-quarter sales results for 2015 with our results in 2014. Sales are higher by about 3% compared with the second quarter of last year and while most of the higher volume in the quarter was due to earlier than planned deliveries, we will be watching this closely over the next few months to see if the higher trend continues. Chart 16 compares our segment operating margin this quarter with the second quarter of 2014. Segment operating margin was 40 basis points lower this quarter compared with the same period last year, but as I said earlier, this was higher than we had planned for the quarter and enabled us to increase our margin outlook for the year. Mission systems and training drove the higher-than-expected results with margin improving 250 basis points over the second quarter of last year. Better performance this year combined with the absence of performance issues last year led to this improvement. Turning to Chart 17, we will compare our earnings-per-share results this quarter with our result from a year ago. Our EPS of $2.94 was 7% higher than the results from last year and enabled us to increase our EPS for the year. Chart 18 provides details into share repurchase activity during the quarter. As we previously mentioned, we had significantly higher share repurchases in the quarter compared with the same period last year with $937 million spent. More importantly we’re $300 million ahead of the year-to-date amount from a year ago and have reduced shares outstanding by more than 5 million shares and we are well on our way to achieving or exceeding the $2 billion repurchase target we established at the beginning of the year. On Chart 19, we discuss our total cash return to stockholders for both the quarter and year-to-date with $1.4 billion in cash returned to stockholders in the second quarter, we returned just over $2.5 billion on a year-to-date basis and in both the quarter and year-to-date we returned 131% of free cash flow to our stockholders. On Chart 20, we provide our updated outlook for the year. We are leaving both orders and sales unchanged at this time. About 65% of our orders are planned for the second half of the year and while we think there is upside potential in our sales for the second half of the year we will have a much better feel for both of these metrics when we get to the third-quarter call. We are increasing our segment operating profit by $75 million due to our strong performance through the first half of the year, and as a result of our increasing profit, we are also increasing our earnings-per-share guidance by $0.15 to a new outlook of between $11 and $11.30 per share. Finally, we are keeping our cash from operations guidance unchanged. We mentioned last quarter that our cash would be significantly weighted for the second half of the year, and while that is still the case, our stronger second-quarter results have reduced that difference between the first and second half of the year. On Chart 21, we have our sales outlook by business area. Again, no change in our outlook at this time. Chart 22 shows our outlook for segment operating profit. We have a higher profit outlook in two of our business areas this quarter, increasing Space Systems by $45 million and Mission Systems and Training by $30 million resulting in the total outlook increase of $75 million. Finally, Chart 23 provides our summary of the quarter. We had a good quarter building upon our results from the first quarter and positioning us well as we look forward to the rest of the year. Our cash deployment actions accelerated in the quarter and we remain committed to the actions we discussed earlier this year. Our program execution was very good in the quarter and we look forward to adding to our portfolio with some strategic wins in the second half of the year. And last but certainly not least our decisions to acquire Sikorsky Aircraft and conduct a strategic review of our government IT and technical services business makes this quarter strong from both the tactical and strategic perspective. And with that, we are ready for your questions.

Bruce, can you just give us potentially give us some more metrics that you are thinking about around Sikorsky, potential leverage that you see, the deleveraging, and then how you’re thinking about intangible amortization and accretion from the deal as you look out?

As we consider financing this deal, we plan to use some cash from our balance sheet, but the majority will come from debt. We're estimating around $1 billion in cash and $8 billion in debt. The average coupon rate for the various maturities, which may include some commercial paper, is expected to be about 3.5%. This translates to approximately $280 million in annual interest, resulting in an after-tax figure of around $180 million. Regarding intangible amortization, we're looking at about $3.5 billion in intangible costs related to trade names and customer relationships, which would drive a yearly expense of about $250 million. So, the after-tax interest of $180 million plus intangible amortization would total roughly $215 million annually. On a positive note, the 338(h)(10) is projected to provide nearly $2 billion in present value, correlating to about $450 million per year in tax deductions due to the asset step-up, leading to an estimated $160 million annual benefit. Additionally, we anticipate about $150 million a year in extra earnings. We know you asked about accretion and the timing of that. Our goal is to integrate this business as swiftly as possible. We aim to close the deal by late 2015 or early 2016, so most of the integration costs would occur in 2016. We want to complete the integration quickly to capture the related synergies, which means we will be GAAP dilutive in 2016. We expect to be slightly GAAP accretive from an earnings perspective in 2017 and then grow from there. I’ll stop there and see if there are any other questions.

It’s Finbar Sheehy for Doug. Turning to the other side of your strategic announcement this morning on the services and IT businesses, can you talk a little more about the criteria you’ll use to decide which ones you will keep and which ones you will divest? And as you talk about that, you mentioned that you have the opportunity to acquire Sikorsky at the bottom of the cycle and some of these IT and services businesses have been hurt by the budget controlled active sequestration. So how do you avoid, if you like, divesting these businesses at the bottom of their market?

We have been evaluating our IT infrastructure services and technical services for some time, conducting extensive analysis to enhance our competitiveness. With an increase in competition and shifting customer priorities towards being more price-sensitive, our focus remains on civil agency work and IT-infrastructure services. This includes enterprise IT services for various agencies and technical services related to our Missiles and Fire Control division. We aim to create value by potentially separating these businesses from Lockheed Martin’s structure, enabling them to grow independently. We believe we have a robust business with a legacy as a leading IT provider for the US government for over 21 years, showcasing strong performance and recent successes. We consider this a premier asset and see the potential for it to function as a standalone company or as an attractive acquisition opportunity at the right price.

Marillyn, Bruce, I wanted to know if you think you could be a better owner and operator of Sikorsky than United Technologies was. If possible, I'd like to know on how you might be looking at operating the business differently than UTX did, and how you might think that might be a benefit?

Well I will start out first and then Bruce, you can add to my comments. I think if you look at what is our core business, our core business is doing business with governments and its platform and systems integration. So that is the predominance of our business and I think in that sense bringing Sikorsky into our business is just a natural fit for us and its ability for us to bring or strengthen and running programs and government contracting and all of that expertise through the Sikorsky business. We also look forward to the opportunity to create value on the international side of our business from their footprint that they have around the world and the work that they are doing in a number of countries. So I think if you look at the potential synergies, we do think we are an excellent owner and a better owner for this business because not only do we bring our expertise, but they’re bringing in their footprint and their capability around the world has value that we can create as well. Bruce, do you want to add some?

Just a thought, Rich, so in terms of adding value greater than the parent, this is a business that’s been successful for however long it’s been in business, 90 something plus years. So they obviously are a national icon in terms of the capabilities that they bring to the rotary marketplace. So they do a lot of things well already. Where I think we can create value, I mean first off, we think this deal has pretty low execution risk from us. I mean I’d like to think of this as we’re buying a portfolio of programs versus sort of a new business model and new marketplaces and new customers that we've never dealt with before. This is all very familiar to us and I’d like to think of this as having sort of the power and backing of a $45 million business focused on government contracting versus one which was less focused perhaps in total than just on the piece of the Sikorsky business. I do think there are areas we can improve the business, particularly on the contracting side and maybe the focus a little bit on the cash flow side. I think in particular the international sales market is an interesting one for us where we – through the combination of our portfolios coming in having a discussion about the security needs of our international customers, whether it’s F-35, Littoral Combat Ships, now Sikorsky helicopters is a much more powerful discussion than what I believe the current parent could have in terms of bundling products and services together to go into the international marketplace. So I think all of those really add to our ability to help us better position this business going forward. We’re happy to have this business. We think it fits well into our portfolio, and this is what we do, and this is our core knitting.

Marillyn, have you had a chance to get initial feedback from the DoD in the proposed acquisition particularly as it applies to broader consolidation in the industrial base realizing the Army is not a huge customer proportionally to Lockheed Martin, maybe that’s not as much but at the DoD there may be some issue?

We reached out to our customers as we do with any acquisition. I had the opportunity to speak with senior officials in the Department of Defense and offered to provide any additional information they might need for their assessment. They have consistently indicated that they will evaluate the situation, ask questions, and conduct a thorough review, and we are prepared to support them throughout that process. Looking at this acquisition, we are not decreasing the number of competitors in the helicopter segment at all. Therefore, there shouldn't be any concerns, as our portfolios are very complementary with minimal overlap. In that regard, I expect this will not be a concern for them moving forward. Regarding the services business, there are numerous competitors in the IT services field. Thus, our effort to position this business for greater competitiveness should be viewed positively. Both of these factors are favorable. Additionally, there are concerns about consolidation leading to one entity becoming larger than another. However, considering these two strategic actions we are undertaking, UTC has reported that they anticipate sales for Sikorsky to reach $6.5 billion this year, while the segment we are evaluating to divest was around $6 billion. Ultimately, we may find that our sizes are roughly comparable, possibly a bit smaller or larger, but basically similar with these strategic moves. Therefore, I don’t believe there is increased concentration at Lockheed Martin in that sense.

Just two quick clarification questions. One on what Marillyn just spoke of but with regard to the strategic evaluation at IT, the question there is you’re talking about this as a single $6 billion business, or at least that’s my interpretation. But might you consider doing different things with different pieces, selling some and spinning the other? And then for Bruce, is the $150 million in synergies net of things like profit on profit?

In response to your question, there are several possible scenarios we are considering. This is why we aim to conduct a strategic review by the end of the year to identify the best options for these aspects of the business. As you mentioned, this could lead to one or more transactions, and our focus is on how we can provide greater value to our customers and shareholders throughout this process. The strategic review will determine the final outcome, which could involve multiple transactions.

Rob, the second part of your question, $150 million steady state going forward, that is considered to be net of fee on fee or profit on profit if you will, just to give you— not to confuse you perhaps but just to give you some insight. The level of sales that we see, the overlap that would need to be adjusted out, if you will, once Sikorsky becomes part of the portfolio for our business that’s being conducted within mission systems and training. You should think of that being about $150 million a year. I mean there is obviously price business right now that carries on for some period of time for things like our work on the combat rescue helicopter or the Presidential helicopter, that wouldn’t have a negative profit impact in the near term but we eliminate the sales obviously of that going forward. And then so sneak – think of them when we get to the steady state, that is net if you will of that consideration of fee on fee.

Congrats, guys, on some bold moves. Guys, how do you think about the strategic fit of Sikorsky’s commercial helicopter business?

Well, I think for us it’s a nice fit in the sense that as I mentioned in my remarks at the outset, it’s predominantly in the oil and gas side which is not an area that we are in. And while we’ve got some near-term pressure there just because of what’s happened with oil prices, we see an opportunity in a few years for that to turn and so a real opportunity for growth there as we move forward. And then the other side would be—on the commercial side would be on the sustainment. There are commercial aircraft that are already in the base among these 40 countries that I mentioned that have to be maintained and sustained, so that’s a good strong healthy business. When you look at it from a Lockheed Martin standpoint, I mean we sell our products and services to heads of countries, so they buy both military and commercial platforms and systems and sustainment activities, so I think that that is a nice fit where we bring all of that together in our customer relationships around the world.

Yes, Bruce, I just want a little more clarification. You have commented about Sikorsky. So you're saying in terms of the profit on profit that you're going to be getting for the programs as if you’re a subcontractor to Sikorsky, that's about $150 million currently or that's what it's going to be?

No, George, that was revenue. Profits are a much, much smaller number.

Okay. And that's because a lot of their programs that you're a subcontractor to really haven't started to ramp up yet?

That’s correct, George but I will tell you the absolute dollars on our side don’t deviate a whole lot from that number for the work that we are doing today and for the near future.

And then similar subject, Bruce, how much subcontract work do you do for other helicopter manufacturers that might be at risk since they may not want to deal with a competitor?

So we do quite a bit of work, George, actually as we sell direct to the US government, a lot of the work is not directly to the helo manufacturer themselves. So a lot of our integration activities is actually done direct to the government as opposed to directly to the other helo manufacturers; if you will. We have relationships with everyone domestically and internationally in the helo marketplace. Our intention is to maintain those relationships going forward. That's something that we would obviously have to consider relative to our discussions with the DoD as far as going forward this incorporation of the business, and that’s something that we would intend to do just out of a pure economics perspective, nothing else, but that’s just the right thing for us to do going forward.

Hi, thank you. I'm going to turn to the boring things of talking about the business for a moment, Marillyn. You had a couple of nice positive developments in terms of operations. Were there some things that you could address both in space and, frankly, in aircraft that either you brought to bear to change the profit trajectory?

Well this is B2 our major program, BF-35, we’ve made really good progress over the past quarter on that program. I had the opportunity to attend the CEO conference in Norway for the F-35 program, where all international partners participate in that. Secretary Kendall had strong support for the program itself and the fact that Secretary Kendall after that discussed a potential block buy for the program which would be for at least 450 to maybe 500 aircraft in FY18, FY20 is a strong statement about the trajectory of the game and the outlook for the program moving forward. If you think on that, if you have been tracking the performance in the program toward the marine corps initial operating capability, the Marines have finished their operational readiness, and they are now in the midst of their assessment of their operational readiness and are on track. They appear to be on track to announce their IOC this month and we look forward to that. That’s a huge milestone; this program – there is the first service to come to declare that aircraft combat-ready and I think that sends a strong message to everyone that this program is on track. We delivered 11 aircraft in the second quarter; we’re on track to deliver 45 in 2015 and we’ve gotten long lead for LRIP 10, so that’s for 94 aircraft. So the program is ramping up in that sense. I think it’s well-supported in the budget proposals that are out there. So in that sense production is ramping up, software completion and all those things are on track and so that’s what I would say on the 35. You mentioned the space program, I mean they are performing well on our government satellites and NEOs, for example, just launched the third NEO satellite and that program is moving forward and then you’ve seen the reports out that we have put forward a more cost-effective approach going forward and it was greatly embraced by the US government on diversions. So we will continue our path along them. In the missile defense arena, I hope you saw that Germany has announced their intent to select MEADS for their air defense system and that’s truly a strategic win for us. I mean legacy systems are aging and they need replacement, they went through a very thorough assessment of what system would best fit their needs and they selected MEADS and I think it sets the tone for other countries, we will be looking at this important selection by Germany and we expect other countries to look at MEADS as their choice for the most modern and capable missile defense system for their countries.

Hey, thanks. Good morning. Bruce, could you discuss whether the proceeds from the spin-off or sale will contribute to your capital deployment plans, or should we view that as being directed towards the balance sheet?

So you are right, it is hard to predict, I mean those are obviously two completely different scenarios in terms of the cash that we would receive from that versus spin versus a sale. A spin obviously being a lot less, we’ve got a fairly low tax basis in that business, at least as we look at it, not unlike what UTC was probably looking with Sikorsky, now you’ve got a low tax basis, so your ability to get cash out on a spin basis is limited from a tax-free perspective. So we get a lot more cash back from a sale perspective. I hate to speculate what that could be and we will get into further detail as we get into the latter part of this year and early part of next year as far as when we start to close on our decision as to which path we go down. I would suspect in terms of cash deployment, the near-term cash deployment would probably be paying off some of that I mentioned as far as some of the debt that we are doing to do the Sikorsky deal, which would likely come in the form of commercial paper. We’d probably pay that off pretty frequently and bring debt down, and then the rest, Joseph, we will wait and see what we’ve got and what needs we have at that time and as usual try to be opportunistic in all our cash deployment actions as we always are.

Yes, thank you. Congratulations, Marillyn and Bruce. I want a clarification. Sikorsky, will that be an independent segment or are you going to have it on a standalone basis or will it be folded in as part of aeronautics or one of the other segments? And then if you could also give us, Bruce, just regarding the quarter, Marillyn mentioned that you're going to be delivering 45 F-35s this year. Can you give us a rundown or just kind of the planning for deliveries for this year and maybe a sneak peek on how that looks for next year? Thanks.

In terms of Sikorsky, our intent is for that business to report directly into mission systems and training. That’s our business where Dale Bennett is the executive vice president, so he will be a director for a line of business in that business and we intend to maintain its name and its brand, so we will preserve that brand identity. We think it is very strong for Sikorsky and so we will continue forward with that. So whether it will be Sikorsky or Lockheed Martin company, we will report into mission systems and training. Now our plan is to move forward. Bruce?

So Peter, just talk about deliveries. We said 45 this year. That’s about what we are expecting to have for the year. I think we’ve delivered 19 on a year-to-date basis, so obviously that ramp rate picks up in the second half of the year. Just going down the entire portfolio, the C-130, again we talked in the past about that being a very steady build rate of about 24 aircraft a year. We had 10 deliveries in the first half of the year which would obviously imply 14 in the second half. Right now those are more weighted just for FY purposes towards the fourth quarter than they are for the third quarter. I’d like to think there is some potential to move some of those aircraft into the third quarter, although that’s actually making our sales if we just were to profile our sales for the rest of the year, it makes our fourth quarter look a little bit bigger than I think it actually is going to be as we sit here today. C-5 deliveries, we have expected about 9 for the year, we had 5 on a year-to-date basis. So 4 for the rest of the year, unless we pull in one for next year, and these aircraft are getting to be a very good pattern from a performance perspective. We were actually earlier on the deliveries all throughout the first half of this year. So we are going to be watching that but that’s not within our current plan, it’s not within our current guidance. Next year, I don’t have the numbers off the top of my head, Peter but definitely the aircraft deliveries on F-35 are going up. I am sorry, let me back up for a second. I didn’t talk F-16, I apologize. F-16, 11, 12 aircraft in the year, we did 6 in the first half of the year, 5, 6 in the second half. So let me maybe start with the easy ones. C-130J, 24 next year, F-16 similar levels of sales in terms of quantities next year. F-35, greater than the 45, now I don’t have that number off the top of my head but it’s a pretty good increase, Peter, from what I’ve got in my memory there. And then C-5s a very similar number to what we are seeing in 2015. Hopefully that helps with the question now.

Hey, good morning, guys. If you could just quickly go through, if possible, in a little more detail where you expect to pick up the $150 million of cost synergies. Are you going to be moving facilities, is it just back office take-out? How are you thinking about that, Bruce?

So it’s a combination of probably all the things that you would think would happen in this sort of transaction. So some of the bigger abilities to – so we believe we can get some long-term synergies are in the supply chain particularly with the overlap of the procurement activities, especially within our aeronautics business activities but also within MST as well in terms of systems overlap there. So you should think of the synergies coming in the form of supply chain synergies, a little bit of facilities perhaps rationalization and some headcount rationalization as you would expect as well. And collectively that adds up to more than 150, we think the 150 is sort of what sticks to the bottom line after consideration of price business and disclosing under cost and pricing data on our government business. The thing that interested me or that caught my attention when we looked at this business is more of it stays with us longer term, I think because this probably has a longer tail of price business than I would have expected before we went into the diligence phase. I mean about $16 billion worth of price business, so obviously you get to keep it on that part of the business and also the commercial and the sustainment particularly on the supply chain savings, the headcount savings and the like obviously those are less cost base driven in terms of pricing and more of the synergy you get from a cost side there stay for longer as well. So that’s how I think about those three buckets: facilities, supply chain, headcount and for the reasons I just said they stay with us for longer than you might otherwise think.

Thanks for taking my question. As we think about the evolution of Lockheed here over the next 12 months, how should we think about how IRAD will maybe move around a little bit, getting rid of some of the short-cycle stuff, and laying in Sikorsky already in a little bit of an upward trajectory year over year. Should we think about maybe R&D trending at or above the 2% of sales level once everything gets done with?

So I will take that, Hunter. So it’s an interesting swap. Marillyn talked earlier about a sort of big picture perspective where we are losing $6 billion worth of business on our IT tech services side, which you should think of being much, much, much significantly lower IRAD intensive than the rest of the business, and this I think speaks to the need for that business to have as cost efficient structure as is possible in order to survive in the environment that we are currently operating in there. Sikorsky operates in a much more IRAD intensive environment but not unlike what the rest of the portfolio of Lockheed Martin looks like when you exclude the IS&GS and the tech-services piece. So I can actually try to do some quick math myself, Hunter, I think we get close to 2% or so of R&D when you kind of get to the new sales level of the combined company minus that which is spun or sold and you add in the IRAD for all the remaining businesses plus Sikorsky, it’s actually probably a little bit north of 2%.

Bruce, you mentioned there were some franchise wins you were looking to achieve in the second half of this year. I was wondering if you could give us an update on those and which ones you think your chance are best at.

Sure, Rob. So when I talked about franchise wins in the second half of the year, I am really talking about the long range strike bomber and JLTV. We are watching as are our partners, I am certain Boeing is watching very closely, the expectation is that, that will probably be decided sometime in the August, September timeframe. We still like our offering there and we feel good about that. We’ve had lots of discussions, I think we are good partners for each other; we bring very capable collaborative skill sets to the fray. And so that’s the first one that we are looking at, Rob and again I think we like where we sit there. JLTV is the other one. JLTV is maybe in some people’s views a little bit tougher putt because they don’t necessarily associate Lockheed Martin with being in the combat vehicle business, but I think we’ve got a tremendous offering there. And it would put us into a new segment within the DoD that we don’t have a lot of business, other than sort of putting some of our weapon systems on top of combat vehicles. This would be actually building the contract of the combat vehicle itself. So it’s sort of exciting to have that opportunity. Again we think we’ve got a great offering. They look different in terms of the orders this year, the bomber would be a bigger order, initially the JLTV would be a much, much smaller order initially in the current year. Both of them have very long, think of it as decades-long sort of production track once you get past the development side. In terms of just sheer dollars that we are looking for, not so much in the franchise wins, that we’ve got big dollars associated with primarily two aeronautics programs that we are needing to close and definitize those contracts on finally the C-130J multi-year and 9 for the F-35 program, both of those are big dollars in the second half of the year in terms of orders. As I still sort of look out for the rest of the year, even though we are light, and I know there was an earlier question about where we are sort of in orders from a year-to-date basis, but I still think we are marching towards about the $80 billion that we set at the start of the year given all the puts and takes we see going forward.

Yes, thank you and congratulations on the Sikorsky transaction. So a question, I was surprised that you only have $150 million of intercompany sales given your participation on the CRH, Naval Hawk, Presidential, and combat and rescue. So could you give us a sense as to where that number goes in the future, and then maybe give us two sort of nitty questions on what the cash flow of Sikorsky looks like given they have a very heavy near-term development mix and whether you expect to use contract liability amortization for accounting of the Canadian maritime helicopter?

What a mouthful, Cai. You've certainly got your money's worth. Regarding the $150 million, it's not quite intercompany yet. This amount is primarily for the combat rescue helicopter and the Presidential helicopter. It's important to understand that this is a fairly consistent figure, not something that will start low and grow significantly over time. I'm recalling from memory, but this amount is stable every year, both in the near and long term. Some confusion may arise from the MH 60 helicopter, specifically the Romeo work, where we operate as co-primes. We do not subcontract with Sikorsky for that work; it consists of two prime contracts, which might be the source of some misunderstanding. So consider that the combat rescue helicopter and the Presidential helicopter are related to the VXX program, and they are not as large as many might assume in terms of business size. For Sikorsky, I believe you have it right: for a couple of years, you should anticipate some inventory buildup. I won’t dive into specifics about Sikorsky sales moving forward, but I expect to see inventory and working capital buildup for the new programs I mentioned, including the combat rescue helicopter and the presidential helicopter. They also have a loss contract for the Canadian maritime helicopter contract, which will likely affect cash flow negatively. Therefore, I wouldn't expect near-term cash flow to be exceptionally strong. This is a long-term business strategy; we're investing in this for the next three decades rather than just three years, viewing it through the lens of a long-term acquisition cycle. As for your final question on the accounting treatment for the Canadian helicopter, we will adhere to Lockheed Martin's practices. This will be settled through conforming accounting and purchase accounting adjustments, and any expected losses will be reflected at the time of acquisition, essentially becoming negligible from an accounting standpoint afterwards.

I’ll just add, the structure that we have as I said we are going to integrate the Sikorsky business into mission systems and training, that will be a standalone line of business and we like that model. We like that kind of a co-prime model like we have on MH-60 Romeo as a good approach going forward.

I'm going to see if I can sneak two in also. The first one is just, Bruce, can you talk about what the cost will be to extract that $150 million in savings, especially in 2016? And then, secondly, on the IT side, I just wanted to understand what's changed. It seems like some of the areas, like commercial cyber, you were still making acquisitions last year. You made the Healthcare IT Systems Made Simple acquisition late last year. Is it have to do with Sikorsky that you are now looking at other parts of the portfolio, or did something else change about the business that forces it now?

So Sam, let me try the first one. And I may take a shot at the second one, but Marillyn correct me later on. So the cost to extract in 2016, if we close the deal at the end of this year, obviously, I'd like to think of the cost here as sort of transaction costs, integration costs, you've got the intangible amortization, you got interest on net debt. I think I've talked most of those but I haven't necessarily talked the integration costs. So, if the deal gets closed by the end of this year, obviously hopefully most of the transaction costs will be behind us in 2015 whenever it does close ‘15, or ‘16 that's when the bulk of the transaction costs will hit. As I said earlier, we intend to rapidly integrate Sikorsky into our business that would require some acceleration maybe from what you're thinking in terms of the integration costs. I don't know that we've got those totally nailed down at this point in time, Sam but you should think of those $80, $100 million a year kind of level in 2016 as just the integration costs there. Again hopefully, we can get these behind us and get them integrated and enable us to have the synergy impacts having that much quicker. The second question as far as the IT and what’s changed. You know, it’s funny I think as you continually go through a process of competing for new business, even after we acquired some of the companies we acquired, for instance, SMS, some of the new competition that SMS were competing for, we saw some different actions on the behalf of some of our customers than we had been expecting. Things like splitting out parts of the contract, things like splitting out procured costs from the contract that frankly were another sort of twist to that business going forward that was sort of a culmination over a number of years of how that business, and the dynamics of that business has changed. You know when Sikorsky became available, and when we looked at that and said that’s the business that's probably more down the middle of what the rest of the Corporation is, frankly we didn't think again just to reiterate what Marillyn said that we could necessarily compete in the environment and with the sorts of expectations that customers had in the IT and government services business successfully. And in the interest of creating value for the Corporation and actually giving our employees the greatest chance for growth in the business that they love. That's the reason for the separation. So I’d say it's not one or the other, it’s probably the combination of the two that led to that.

We have carefully reviewed the work that we are placing under strategic review compared to our entire portfolio in IS&GS. We acknowledge that this work is increasingly challenging for us to remain competitive. While the work being done is valuable and crucial for our customers, it does not align well with our standard business model, making it hard for us to compete effectively. An example would be the commercial cyber segment. We are not exiting the cybersecurity sector for the US government and other global governments; this remains a vital part of our business where we provide significant value through our advanced multilayer cyber defense capabilities. We continue to focus on areas that align with our core market and where we can compete effectively. However, much of the work we’re considering for strategic review has become highly price-sensitive. Despite potentially delivering top-tier performance, if another company offers a lower price during a re-competition, customers may opt for a new, untested competitor. This is the reality of the environment we are navigating.

Thank you very much. Good morning. As mentioned, Sikorsky is one of several key Department of Defense programs that should help drive sales growth in the future. However, I know this may be a bit challenging, but could you outline a rough trajectory? You have new programs on the horizon, but there are also pressures on legacy programs and a new multi-year contract for Black Hawk. Could you provide an outlook over the next few years regarding earnings, where things might bottom out, and how the key drivers could elevate that as we approach the end of the decade?

Seth, welcome to the call. I want to share some thoughts, primarily focusing on the top line while allowing you to interpret the bottom line implications. Regarding valuation, the commercial helicopter market tied to the oil and gas sector has significantly declined, impacting not just Sikorsky but the entire market. From the peak of sales in 2014, we anticipate a drop in commercial sales moving forward. While I don't have the precise figures memorized, I believe they achieved around $1.5 billion in commercial helicopter work in 2014. I can't recall the expectations for 2015 offhand, but we project that figure will be closer to approximately $0.75 billion going forward. This change is likely to exert some pressure on the top line revenue from 2016 onwards for a couple of years, especially as the commercial market tends to be more profitable, which will also affect the bottom line. We expect some improvement in the commercial market and the oil and gas sector around late 2018 to 2019. This period also aligns with the transition of several developmental programs into production, particularly the 53K. Consequently, we anticipate a recovery in both top line and bottom line performance, with margins aligning based on the commercial market conditions.

Thanks for taking my question again. Bruce and Marillyn, you've talked about this Sikorsky deal, seen as relatively low execution risk. But obviously Sikorsky has run into some problems with CMH, with 53K. Can you just talk about your comfort with the execution risk that you are taking on here?

So I would say as Bruce commented earlier, I mean we run government programs, we run platform and systems programs across our entity. I have never seen our company performing better in terms of how – of the programs that we are operating on today and so in that sense, similarly Sikorsky has a long track record of success and in new development programs, there are times when any company, if it’s the complexity of it is going – we are going to have some challenges on the front end but I think we bring to this strong program management expertise and coupling that with Sikorsky performance and their innovative technology, that’s where we think this is a low risk. I mean it is right in our core market, we know how to build, we both design and build platforms and so it fits right in our sweet spot.

The only thing I would add, David, is this is nothing new. I mean what I believe – I am not there on the ground obviously but there is no technical show stoppers that we saw, this is just a hardcore fact of going from development into production. We have all companies probably emphasized with that more than anyone else on the planet probably. But it’s how you look at what we have done in our history, where we are finally on the F-35 program going from development to production, where we have taken the fad from an infant position of trying to figure out this hit to kill air missile defense at the levels we are talking about actually work or not, to where it’s now a production fielded facility or application, just taking the PAC 3 missile to its next generation of the MSC, taking satellites, MUOS advanced DHF, SBIRS from development to production, we’ve got the scars, we know what this is like, so this is not a surprise to us and look, we think when we get Sikorsky into the fold, we are people who’ve sort of been through this a lot of different ways, who can help with that process and we have really, really good production people and not to say that Sikorsky does not because we are very impressed by the production team there, now we think we have some synergies coming out there as well.

Thanks. Just a follow-up on the overall long term. You mentioned you're buying over three decades. You're on the joint multi-role helo effort today with Bell, and then Sikorsky is on the team with Boeing. Is there anything, when the companies are combined, that's going to preclude you from being on both teams, or is this effectively improving your odds obviously?

Well, our intention is to maintain the relationships that we have today on those programs. We have – we want to bring the best solution to our customers, we have some good partnerships that we are working on, and we intend to continue those partnerships going forward.

The other thing I would add is that program, especially the JLTV – the future vertical lift, not JLTV. Future vertical lift is so far out in the future, you tell me when it’s going to happen, the quantities and so forth, there is a lot of chance between now and then for people to change ideas, thoughts, requirements, et cetera. So whether that ends up being the program that we think it is today or not, is anyone’s guess. And so it’s hard for me to get just too excited about where we sit today with something that’s probably not going to come at the full rate production for 15 or 20 years.

Bruce, on the F-35, was there a margin pick up there? Because you mentioned that you had $30 million higher profit on about $280 million in sales, which obviously would be a higher margin than what you're currently booking on that program.

Yes, George there was. This is a second straight quarter where we’ve grown up booking rate on some of our LRIP contracts. I think this is just recognizing the progression we are going through, I believe this one – I am trying to think, recall from memory, George, I believe this was on LRIP 6 and you should think of that as being associated with the completion of deliveries over this period of time. So we are starting to get a cadence there. I like to think, I mean I think LRIP 6 is on an uptick, was on an uptick, I think LRIP 7 is also on an uptick, we need to see that cadence sort of continue going forward but I feel really good about where we are on the production, back to my earlier comment going from transitioning from development firms to production we are right there, and I think we are doing pretty well on that right now.

And on the C-5, Bruce, you've been booking near zero with your comment that deliveries seem to be running a little better than expected. What's the outlook for getting better profitability on that program?

So George, we have a planned step up in the second half of the year reflecting the good performance that we are seeing today. I hope that, that’s something that we are going to actually do better even than what we had planned in the outlook there. And I know you and I have talked specifically, George, about the potentiality of a claim associated with the over-and-above work we have on the C-5 program, that’s still just to be clear, it’s still not considered within anything that I have talked about at this point in time. And again, that’s something we feel very, very strongly about in terms of entitlement and we will see how that plays out down the road but that’s not a factor in anything that I just said earlier.

Bruce, just a real quick accounting question for you. The $2 billion in tax savings that you guys get, is that just straight line over 15 years?

It is, Ron. It’s a high degree of certainty because the tax benefits can be used for the combined company. So those are take them home, I mean those are benefits that are going to accrue to the corporation.

I'm going to miss this, guys, but with all the puts and takes on the Sikorsky deal, are you expecting it to be free cash flow accretive in 2016?

Yes, it’s going to be a little bit neutral is probably the way I would describe it in 2016 as our expectation, Pete, and then we’ll probably get plenty of time to start talking about the years thereafter but I think for near-term purposes and like obviously some of that depends on whether it happens at the end of this year, early next year, a little bit later but I think if it were for the whole year we think of it as being fairly neutral for us next year.

Thank you. Well, let me just conclude. I appreciate all of you being on the call today and I will just conclude by saying we had a strong quarter of financial results and the strategic actions that we’ve announced are expected to position the corporation to deliver even higher value to our customers and stockholders in the future. So thanks again for joining us on the call today. We look forward to speaking with you in October in our next earnings call.