Lockheed Martin Corp (LMT) — Q1 2016 Earnings Call Transcript

Thank you, and good morning, everyone. I'd like to welcome you to our first quarter 2016 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 description of some of the factors that may cause actual results to vary materially from anticipated results. We have posted charts on our website today that we plan to address during the call to supplement our comments. Please access our website at www.lockheedmartin.com and click on the Investor Relations link to view and follow the charts. With that, I'd like to turn the call over to Marillyn.

Thanks, Jerry. Good morning, everyone, and thank you for joining the call today. We're pleased to have you with us as we review our first quarter results and full year outlook for 2016. As today's release details, we had a very strong quarter financially and operationally. The Corporation continued to perform at a very high level in delivering critical solutions to customers while returning value to stockholders. I want to highlight a few key items in the quarter, including an update on our Sikorsky activities as well as the current status of the strategic disposition of our Information Systems & Global Solutions business to Leidos. Turning to the quarter. Our team continued to deliver broad based results across the Corporation, with achievement of first quarter financials that exceeded all of our internal plans. This strong year-to-date performance enabled us to increase full year 2016 guidance for sales, segment operating profit, earnings per share and cash from operations. As a reminder, the guidance continues to assume inclusion of full year 2016 financial results from the Information Systems & Global Solutions business. We will adjust our financial outlook when the disposition of IS&GS is completed, which we continue to anticipate will be in the third or fourth quarter of this year. Bruce will provide a detailed review of the guidance and assumptions in his comments and web charts. One of the standout items in our financial results is the strong performance of cash from operations. Consistent cash generation is a financial hallmark of our Corporation and enabled us to return over $1 billion to stockholders this quarter through dividends and share repurchases. I would also note that share repurchases year to date have reduced the outstanding share count to approximately 304 million shares and this lower level illustrates the progress we are achieving on our goal to reduce outstanding shares to below 300 million by the end of 2017. This longstanding goal does not consider the additional share reduction opportunities from the pending disposition of IS&GS. We anticipate further share reductions will be accomplished by a stock exchange contained in the deal transaction. Additionally, the $1.8 billion special cash payment to our Corporation at deal closure also provides cash deployment and share reduction opportunities. For the full year of Sikorsky operating as part of our Mission Systems and Training business area, I'd like to offer my high level perspective on their activities. Integration actions are progressing well as we work to transition Sikorsky operations into Lockheed Martin. As we perform the integration, we continue to evaluate the best-in-class processes, procedures and tools. Our goal remains to identify and apply the best practices across the enterprise throughout the integration process. We continue to see cost reduction and efficiency opportunities emerging as we work as one team with Sikorsky. Areas like supply chain where multiple business areas procure similar materials have allowed us to look at where we can realize better buying power and align procurement specifications. By utilizing best-in-class processes from across the Corporation, further efficiencies can be achieved and will help ensure we capture the synergies identified from this acquisition. Moving to an operational perspective. Significant progress was achieved on the CH-53K program for the US Marine Corps. The second prototype test helicopter achieved first flight in February, providing additional assets to the flight test program and expanded our ability to achieve future critical milestones. We look forward to demonstrating the maturity of the aircraft through the current development phase. Since the end of the quarter, we received a contract from the US Navy for long lead items required for the first two CH-53K helicopters on low rate initial production Lot 1. These initial units are part of the naval aviation procurement plan to field 200 helicopters on the program in coming years. In the area of commercial helicopters, we're seeing some emerging interest from other customers beyond the oil and gas sector for S-92 platforms and we are pushing aggressively into the search and rescue, VIP transportation and international military segments. We also see a significant potential to create additional value in these sectors in sustainment. To pursue this area, we recently opened a state-of-the-art customer care center in Connecticut, that is designed to enhance platform reliability and ensure 24-hour availability to customers’ aircraft needs. Overall, I remain enthusiastic about the opportunities for long term creation of the rotary aircraft business to customers around the world. Turning to our Information Systems & Global Solutions business area. Key events associated with the pending strategic disposition included successful clearance of the Hart-Scott-Rodino regulatory review in the United States, satisfying one of the key conditions to deal closure. The only remaining review of competition impact is in process in the United Kingdom. We also filed the required registration statements last week with the Securities Exchange Commission. This filing and a comparable filing by Leidos initiate a review process by the SEC staff. Once the review process is completed, a prospectus describing the terms and conditions of the exchange offer and transaction will be provided to Lockheed Martin stockholders. Switching to some brief comments on the F-35 Joint Strike Fighter. Overall the program continues to progress on satisfying remaining development activities while also ramping up the production rate. Several noteworthy events were achieved this quarter and included completion of the first Transatlantic F-35 flight from the Italian final assembly and checkout facility to the US to enable commencement of training for Italian pilots, surpassing 50,000 flight hours of the F-35 fleet, demonstrating the increasing level of flight operations. And lastly, we also successfully conducted first flight of the software required to achieve initial operational capability of CTOL aircraft to US Air Force. Achievement of this milestone enables the program to progress towards IOC scheduled later this year. I will conclude my remarks by recognizing the difficult but necessary workforce reduction actions implemented this quarter by our aeronautics and IS&GS business areas. As stewards of the enterprise, it is a business imperative that we remain agile and competitive in our cost structure. In response to dynamic business conditions, these businesses implemented voluntary and involuntary headcount reductions. While these reductions resulted in a special severance charge in the quarter, they also significantly improved our competitiveness and ability to win future new business opportunities with a leaner cost structure. I’ll now turn the call over to Bruce to review our financial performance in more detail and then we'll open up the line for your questions.

Thanks, Marillyn. Good morning everyone. As I discuss our key financial accomplishments, please refer to the web charts included with our earnings release today. Let’s start with chart 3, which provides an overview of our quarterly results. Sales for the quarter reached $11.7 billion, slightly exceeding our expectations. Segment operating profit was also above expectations at $1.2 billion, leading to earnings per share of $2.58, which accounted for about $100 million in severance charges related to planned headcount reductions. We generated $1.6 billion in cash from operations, marking a good start to the year. We returned $1 billion to our stockholders in the quarter, roughly divided equally between share repurchases and dividends. Due to our better-than-expected performance, we are raising our forecasts for sales, operating profit, earnings per share, and cash from operations. Thus, we are off to a strong start in 2016. On chart 4, we compare our sales and earnings per share for the first quarter of this year with last year's figures. Sales this year were about $1.6 billion higher than last year, primarily due to the inclusion of Sikorsky in MST's results for approximately $1 billion, and more than $600 million in growth at Aeronautics, driven by around $400 million from increased F-35 production volume as well as higher C-130 and C-5 aircraft deliveries. Earnings per share were lower compared to last year, but this year's results factor in the severance charges for reductions in Aeronautics and IS&GS, along with the challenges posed by Sikorsky's purchase accounting adjustment and integration costs. On chart 5, we will address the cash returned to our shareholders during the quarter. With nearly $1.6 billion from operations and slightly over $150 million in capital expenditures, we achieved $1.4 billion in free cash flow this quarter. With over $500 million each in share repurchases and dividends, the total cash returned to shareholders was 73% of free cash flow. Our first-quarter share repurchase levels keep us on track for our $2 billion share repurchase plan for the year. Please turn to chart 6, where we’ll present our updated outlook for 2016. Thanks to our strong performance this quarter, we are raising our annual outlook for all major financial metrics. We are increasing our sales outlook by $100 million and segment operating profit outlook by $125 million based on the first-quarter performance. We are also raising our earnings per share range by $0.05, which I will explain further on the next chart. Additionally, we increased our cash from operations outlook by $100 million, aligning with our improved profit outlook. Chart 7 reconciles our current and previous earnings per share outlook. The $125 million rise in segment operating profit results in a $0.26 increase in EPS, while the $100 million special charge from severance actions decreases our EPS outlook by $0.21, resulting in a net increase of $0.05 that I mentioned previously. Chart 8 illustrates our revised sales outlook by business area. The $100 million sales increase stems from the improved outlook for IS&GS following its better-than-expected first-quarter results. We are reaffirming the sales ranges for the other four business areas at this time. Chart 9 updates the segment operating profit outlook by business area. We raised our operating profit outlook for four out of five business areas, with Aeronautics, Space Systems, and IS&GS each increasing by $25 million, while Mission Systems and Training rose by $50 million. Finally, chart 10 summarizes our results. Our strong start to the year has led us to raise our outlook for sales, operating profit, earnings per share, and cash from operations. We continue to provide significant cash returns to our stockholders and are on track to complete the IS&GS RMT transaction later this year. With that, we are ready for questions.

Hey, good morning, Marillyn, Bruce. Good quarter. A couple of just quick ones on the margin. I noticed that the profit contribution from the C-130 that you called out on the $200 million and higher revenues is only $10 million and sort of implies a lower margin than we would think is normal for that. I wondered if there was a negative offset there? And then as a second one, in the guide I noted the sales in MFC have obviously been strong and benefited from I think some of the consumable stuff and some of the stuff you highlighted in the release. But the guidance didn't increase there and I wondered if there was again an offset to call out for the full year. Thank you.

Thank you for your question, Carter. Regarding your inquiry about margin contribution related to the C-130, we experienced a $190 million increase in sales and approximately a $10 million increase in profit, as noted in our earnings release. This aligns with what I mentioned previously about concluding a longstanding, multi-year contract for C-130s, which we executed successfully. We're now on the verge of new deliveries under a newly negotiated multi-year contract. This transition involves adjusting our initial profit booking rate on the C-130 contract. While I believe the financial terms of both contracts are quite similar, our standard practice has us starting the new program at a lower profit level than where we concluded the previous one. Regarding Missiles and Fire Control sales, you're correct that we haven't increased our guidance for the year. We're monitoring this closely. At this moment in the first quarter, we felt it wasn't the right time to adjust. However, I see potential upside, especially considering some encouraging signs with our Middle East customers, particularly with consumables. I'm keeping an eye on this to determine if it might warrant a revision later in the year, but not currently.

Thank you. I'd just like to follow up on the Missiles and Fire Control side, because you also in the release talked about it sounded like more a timing issue with contracts on missile defense, you referred to PAC-3. Can you talk about when you look at international contracts, particularly in the Middle East on missile defense, where you stand today in terms of the maturity of those programs? Because it appears you may be in some that are earlier stage and perhaps lower margin at this point than when they mature.

Doug, I will give that a shot. So I think the watch item in terms of the air missile defense programs for the Middle East are more in the orders expectation for this year rather than I will say the margin expectations. You should think of essentially all of international orders for both PAC-3 missiles as well as the THAAD program are sort of combined with US orders. So they will perform essentially at parity with US orders over that period of time. There is not per se any greater risk associated with the Middle East portion of the order than the US military portion of the order, if you will. And this again is somewhat akin to what I talked about just now in the C-130 where we have sort of a shifting from an older contract where we closed out a good performing contract and a newly negotiated contract where we are starting off at our typical pattern, probably a little more conservative than we expect to make. And that’s exactly what’s going on in both PAC-3 and THAAD programs as we negotiated some new contracts and they are starting off slightly lower margin than what we experienced at the end of the previous contracts that finished up. Again, economically I'm not sure there is a whole lot of difference between the contracts, but sort of from a booking perspective that’s the way that is playing out. But I wouldn't attribute that necessarily to any greater perception of risk that we have associated with those deliveries.

Thanks, good morning. I had a bit of a multipart question here on trying to get an update on the F-35 margin profile we should expect. So in 2016 I think you are north of about 8%. As you ramp up production and some of the low margin development work winds down, I want to know if you could comment on what the margin progression should be. How quickly do you think you can get to F-16 types of margins? And if you would, could you comment on F-35 sustainment and if that could drive upside to margins?

Hey Rich, I will also address that. The margins for the F-35 will fluctuate over time, but in general, we anticipate a sequential increase year over year. Last year, we expected a 100 basis point improvement in the overall margins of the F-35 program, and we achieved that. I mentioned either in October or January that we believed margins on the F-35 would be higher in 2016 compared to 2015, and we still expect that, although not at the same 100 basis point increase as in 2015. We expect this trend to continue into 2017 and 2018 as we move toward our goal, which is that by the time we reach full-rate production, the margins for the F-35 will resemble those of the F-16, F-22, C-130, and similar programs. I'm not deviating from that expectation. Interestingly, the production program had slightly higher pickups in the first quarter last year than this year, although we did see profit increases on production contracts this quarter as well. If I compare last year's first-quarter results, we were actually close to 10% on the production program. Margins will fluctuate depending on the timing and frequency of profit step-ups on multiple production contracts within a single quarter. However, we expect to reach margin levels similar to legacy programs once we achieve full-rate production. Regarding your second question about the F-35 sustainment margin, those are usually negotiated at levels comparable to the production program, so at this time, we don't see it as either a burden or an advantage. It’s growing rapidly, and we will soon begin separating some of the sustainment contracts from the production contracts as the volume increases. In the future, we might discuss sustainment independently of production, but currently, you shouldn't expect a significant difference in margins between them.

Bruce, I wonder if you could just talk about kind of Sikorsky performance relative to expectations at this point from a revenue and margin standpoint. And then also, just as you look into 2018, I think that’s when the required contributions start again for the pensions. So just based on current assumptions can you talk about what the contribution could be in 2018?

Sure, Joe. Thanks for the question. I would say Sikorsky is still in the early stages of integration into our results, so I'm still figuring out how to describe Sikorsky and what expectations should be. I think the first quarter performance was mostly in line, perhaps slightly better than we anticipated, in terms of both revenue and margin. We are expecting some challenges early in the year due to customer lien rights that have impacted sales from products recognized before our ownership, which will primarily affect the first half of this year. We anticipate sequential growth in Sikorsky's sales quarter over quarter, with the fourth quarter expected to be the highest. Similarly, we foresee an increase in Sikorsky's margin profile quarter over quarter, again with the fourth quarter being the highest margin quarter. Overall, this aligns with our expectations for the first quarter, and we'll monitor it throughout the year and provide updates as we progress. Regarding your question about 2018 pension funding, we previously indicated that we would have a three-year cash funding holiday in 2015, 2016, and 2017. Unfortunately, this holiday ends at the close of 2017, and we will need to start making cash contributions to the pension plan in 2018. Currently, I estimate this will be over $1.5 billion. However, this shouldn't be viewed as simply reducing our current cash position by this amount. By 2018, we expect significantly increased cash flow from the Sikorsky acquisition along with contributions from other business areas that will cover most, although not all, of the pension expense. Additionally, we will benefit from tax advantages associated with this. So, the impact in 2018 should be more manageable than a drastic fall from 2017.

Good morning. Could you please go over the upcoming competitions that we should be aware of? We are familiar with Trainer and it would be helpful if you could provide some insights on that. What else should we be looking out for?

Hi Ron, this is Bruce. Did you say competitions or just bigger awards coming up or do you –

No, competitions, yes, competitions, right. So we have got Trainer and what else do we have on the horizon?

There aren't many significant strategic competitions expected soon, with Trainer's decision likely happening in 2017 instead of 2016. We're also keeping an eye on JSTARS, which is probably not a 2016 decision either. In truth, most of the strategic competitions that are central to your questions probably won't occur until 2016. These include the long-range strike or LRSO competition and the ground strategic ballistic deterrent. However, those are likely for 2017 and beyond regarding major strategic items. One competition we are monitoring closely, though I wouldn't really label it as such, is MEADS in Germany, which we hope to finalize possibly toward the end of the year. I'll let Marillyn provide further details on what I've mentioned.

The only other ones I would say that we are watching are some of our international partners making their decision on F-35 purchases. Denmark is progressing through their process and Canada will eventually do the same. We believe the best choice for them is the F-35, but they will follow their own decision-making process.

Good morning. I wanted to ask really a two part question on IS&GS if I could. First, I think as you both stated, the business is doing a little better than perhaps you guided for and you have tweaked up the guidance there. So wanted to talk about whether that is just timing on some of these program closeouts or pricing environment which I think you cited pressure in. Maybe it’s little better than expected. And then separately, Marillyn, the deal was contemplated I think on what the business will look like at the time of transaction. But of course that’s a nine-month period. And so, from the time of announcement, how do we think about some of the puts and takes and strategic things that you are doing with regard to headcount vis-à-vis that new management team? Are these things that were negotiated? How do we think about that? Thank you.

I’ll address the first part of your question about IS&GS performance. Obviously, we have increased our outlook for both sales and profit, which has exceeded our expectations. There are a few factors involved, some of which are a bit subtle. Predicting sales in this business is challenging because it's uncertain which competitions we will win or lose. In some cases, protests occur even after a loss, which can stretch out sales. We are currently experiencing multiple scenarios simultaneously. I am especially pleased with our better-than-expected earnings and margin performance. Despite a significant write-off from an international contract this quarter, we still surpassed our expectations and have increased our guidance for the year. There are at least three major reasons for this, in my view. First, we anticipated several re-compete activities for some of our larger contracts this year, and we bid these contracts more aggressively than during the previous incumbency. Because these contracts are being protested, we are able to continue performance on older contracts, which tend to have higher margins. This is beneficial for both sales and margins. Second, we have performed well during the closeout and transition of some programs we lost, with these transition periods generally extending over time. We have managed to reduce costs during these phases more than we expected, leading to higher margins. Lastly, there has been strong overall performance from the IS&GS team, and credit goes to them for maintaining focus. They are a well-run organization, and the entire team understands the critical nature of their mission for their clients, regardless of who they work for. We are witnessing this commitment firsthand. Now, I’ll turn it over to Marillyn to address the other question you asked, Robert.

Yes, I will pick up on the second part where you asked about at the time of transaction how to think about some of the puts and takes and the headcount and how we think about it. First, I just want to build on what Bruce said. I mean this is a management team that’s running a business. They have outlined some commitments for the year and they are performing the commitments and the whole entire team in IS&GS is making sure that their cost structure is in line with the business base that they have. So, as they look at what they need to do to be competitive in a very competitive environment that they operate in it is ultracompetitive. And it’s an area that you have got to constantly be watching your cost and you have to manage to that. There is close coordination with Leidos as they make headcount reductions. Certainly we have an agreement as we are going through this process to closing the transaction. So actions that we take on the Lockheed Martin side, they are aware that we are going to take those kinds of actions. But it is our job to continue to run the business to perform well on the business. It’s in all of our best interest and we will continue to do that with an excellent team that’s working that every day.

I have a couple of questions in one. First, can you discuss the delivery of only six F-35s this quarter? Was that in line with your expectations, or did it fall short? Additionally, regarding Sikorsky, it appears that you are expecting EBIT to remain relatively flat for the remainder of the year. However, as you previously mentioned, improvements are anticipated at Sikorsky. Are you still aiming for Sikorsky to be neutral to earnings in 2017? Thank you.

Thanks, David, good questions. The six F-35s were likely delivered at a lower rate than we anticipated, and there are several reasons for that. However, I believe that by the end of the second quarter, we will be back on track. We are still on target to deliver the 53 aircraft we mentioned in our last call in January for the year. There's no issue with that. Some delays occurred due to the transition between lots and the acceptance of new software, but from a production standpoint, there are no problems; it was more of a process issue. Regarding Sikorsky within MST, the guidance indicates flat earnings for the remainder of the year. That's what we expect, and even with the $50 million increase in guidance from an earnings standpoint with MST, we are monitoring it closely. It’s still early in the year to provide more than that, but I see potential for upside based on our current numbers. If you analyze the forecast as you did, David, and include the Sikorsky increase for the remaining three quarters of the year, you might arrive at a similar conclusion. Finally, regarding Sikorsky being neutral in EPS, this relates to the share reduction from the Reverse Morris Trust transaction and anticipated costs associated with the transition and integration. We still expect it to be neutral going into 2017, considering all the positives and negatives involved.

Bruce, I have a question about the backlog. You reached a record level in 2015, but we've seen a slight decline this quarter, likely due to timing. For IS&GS, you are going to lose that. Should we anticipate a specific number for the backlog by the end of the year? Also, Marillyn, how are you viewing the international front? While oil prices have dropped significantly over the past 18 months, we haven't observed a major impact on your awards. Are you noticing any behavioral changes? Thank you.

Peter, I'll address the backlog question. We experienced a decline this quarter after reaching a record backlog at the end of last year. In fact, we were ahead of our plan in the first quarter by a few billion dollars. Although the backlog was down, it wasn’t as much as we had anticipated. This year, we may see an atypical pattern in backlog; we are not expecting as large a fourth quarter for orders as we typically do. The third quarter will likely be our strongest, largely due to the potential finalization of the LRIP 10 contract for the F-35, which is of significant value. Depending on the timing of that and the disposition of IS&GS, we could see a rapid decrease in backlog, potentially down to about $100 billion. My estimate is that it will land between the low $90 billion range and $95 billion by year-end. We were initially anticipating a drop of around $4.5 billion to $5 billion, maintaining stability with IS&GS included. Once IS&GS factors out, it could stabilize around that $90 billion mark.

Peter, I will address your question about the impact of oil prices on our awards. We frequently monitor this situation. We are not observing a reduction in vital national security assets that these countries require. What we are noticing is that a couple of them are on our radar. One order that we are closely monitoring is the Qatar THAAD order, which we hope to finalize this year as part of our plans; however, it may face delays. I don't think this indicates an unwillingness to purchase; rather, it reflects the need for them to manage budget pressures related to oil prices and what they can afford. We may see some effects, possibly in terms of lowered volumes or delays in orders. The key point is the ongoing conflict in the region and the global security challenges they confront. Given their expanded security responsibilities since the US presence has diminished, they need to procure equipment to safeguard their citizens. We expect consistent demand, though some orders may be postponed. This is not uncommon in the international market, even when conditions are favorable. Sometimes, they need to prioritize multiple procurements serially, completing one before moving to the next, and we must navigate that process.

Can you talk a little bit about ULA? You had said you thought it would be flattish this year; it looks like it was down a little in the first quarter. And at least the press talked about a further headcount reduction this year and then again next year. So trying to just think about how severance would flow through. And then if I could follow up with a second one. Just in your proxy you removed the orders category from some of the incentive comp and just want to talk through why you would have made that change at this point?

Yes, I will address the ULA question. ULA's equity earnings were down in the first quarter, but this is mainly a timing issue. We actually anticipate that ULA's earnings will exceed those of 2015 in 2016. This expectation contributes to the increase in guidance for Space Systems. As for the severance charges related to ULA, I don’t expect them to significantly impact the numbers because the severance costs will be offset by the reduced expenses once the personnel are no longer part of the company. Therefore, this should be somewhat neutral for 2016. It’s too early to predict what 2017 will look like, but we are optimistic for 2016. Regarding orders in the proxy, we had extensive discussions about this, and Marillyn can also provide insight. The Board and our compensation committee were concerned because orders can be quite unpredictable. For instance, if we had won the bomber program in 2015 but it was delayed to 2016, should we credit someone for winning it or consider it a missed opportunity? These are some real issues we discussed. We ultimately concluded that sales, earnings, and cash flow are more accurate measures of actual performance than orders, which can be influenced by factors beyond our control. Also, we have an incentive compensation metric tied to our focus programs. The idea is that winning the right programs is more crucial than the exact timing of events, such as whether the fiscal year LRIP 12 for the F-35 occurs in December or January. Therefore, we chose to concentrate more on these critical competitions instead of the timing uncertainties surrounding orders that do not significantly affect the company's financial situation.

Let me just add to that. I think Bruce has covered it well, but if you look at how we have outlined our incentive compensation, we have clearly defined it in terms of financial metrics like sales orders and cash. The orders also play a role in the strategic and operational areas, which remains a part of our compensation strategy. We assess it more in relation to focus programs, as Bruce mentioned, or initiatives necessary for contract growth that we need to maintain momentum on. As we communicate these metrics throughout the organization, everyone will still be tracking their orders and working to meet financial performance targets related to those orders. So, this aspect hasn't been eliminated; we have just taken a more realistic approach to what we should be compensating for in our incentive structure. It still plays a role, but it is not specified as a mandatory requirement.

Bruce, I wanted to pursue on the F-35 margin, you said last year was 10% obviously including the one-time catch ups. Given that this year the profit was only up $30 million on $400 million sales increase, obviously that relates to having lower pickups. Could you tell us though what the F-35 margin actually was this year and maybe kind of what the run rate has been going at?

Yes, George, it’s slightly lower. The reason I mentioned the first quarter of last year is that it was likely the peak for any quarter in the history of the F-35 program. We expect to eventually standardize a double-digit program moving forward, similar to the F-16s, F-22s, C-130s, and other programs. The first quarter of 2016 was a bit less than in 2015, but not significantly less. We still had strong performance, and you should consider that even though the increases were lower, the program's run rate is higher. Therefore, it's almost comparable to what we achieved in the first quarter of 2015 compared to 2016. As I mentioned earlier, I don’t recall who asked the question, but we still expect margin improvement across the entire program, including the development contract. The total F-35 program this year is likely about 50 basis points higher in margins than it was in 2015. So, while it's a nice progression, it's not quite at the 100 basis points we discussed last year, but it is still progressing well and is in line with my previous statements about reaching double digits by the time we hit full-rate production.

On the F-35 program, we recognize that significant progress has been made, yet challenges remain. If the development phase were to extend into 2018, I believe the financial impact to you would be minimal. However, could this lead to concurrency issues? For instance, if the program encounters further delays, would there be a risk of needing to revisit and upgrade the aircraft? Can you discuss how concerned we should be about this, if at all?

Yes, that's a great question, Seth. I appreciate the opportunity to provide a thoughtful response. The challenges we face in the development program are easing as we navigate through various changes. Regarding the potential impacts related to concurrency changes if the development program extends, we should have a clearer picture by the end of this year or mid-next year as we finalize the fatigue testing and multiple useful life testing for all three variants. I don't have the exact current status in mind, but all three variants have exceeded a single useful life in terms of durability, and I believe we are now at 150% of useful life in testing. I don't anticipate significant concurrency impacts from most structural items. However, there may be some changes stemming from software upgrades related to testing, particularly with armament testing later in the development phase. I don't typically consider those as concurrency issues. We are still on track for the Initial Operational Capability (IOC) of the USAF later this year, and we are making solid progress on the necessary software to achieve that. The Atlas program is also a focus, as it serves as the main sustainment vehicle for the F-35 program. The extensive software work we are doing there is important as well. We expect this will support the IOC, which is scheduled for the fourth quarter of this year. Just a reminder that the development contract is still cost reimbursable. While your question leaned more toward concurrency, we believe most concurrency risks will diminish significantly once we complete these tests later this year and move into early 2017.

Bruce and Marillyn, I think you talked about top-line organic growth targets of the company going forward in the 3% to 5% range with the outside contributor at Aeronautics. But that’s also where you did the headcount reduction actions. So two kind of subpart questions. One, is that growth rate still the right growth rate to think about? And two, is this more of a reactionary headcount to some of the ongoing negotiations as it relates to F-35 and/or other internal DOD competitive pressures?

Let me start by saying that once we exclude IS&GS and focus on Lockheed Martin's core business, we can expect organic growth of about 3% to 5%, primarily driven by the F-35 program and Aeronautics overall. Additionally, while there are some contractions in certain areas of our DOD business, our international growth is projected to rise from around 21% this year to about 25% in the near future, which will also support that growth. Regarding the workforce reductions, they are not a result of any pressures from the DOD. Instead, as we consider the lifecycle of our programs, the development phase is winding down while the production phase is significantly increasing year over year. This transition is shifting our workforce from a focus on engineering to a broader manufacturing base. The reductions are related to the decreased need for personnel in development as production ramps up, which does not require the same level of staffing as development did.

Yes, I think you are correct, Bruce. Additionally, the nature of the work for the indirect personnel is also changing. As we move into the production phase and increase production, fewer people will be needed in certain roles.

Marillyn, I noticed you didn't mention Pakistan and F-16s, and I suspect there are additional opportunities there. Additionally, could you discuss the items in the HASC mark that seem relevant to your expertise, such as the F-22 restart or new air defense system opportunities?

Thank you, Howard. I appreciate your question. Regarding F-16, we are actively seeking opportunities. Pakistan has completed its congressional notification, and we look forward to that potential. We also hope to have an opportunity with Bahrain in the future. In India, we are continuing with upgrades for the F-16, including significant modification work similar to what we are doing in Taiwan.

And the potential line started in India.

That's correct. We discussed that India is evaluating its tactical fighter competition, and we have submitted an offer to relocate a production line there. Regarding the recent defense bill from the HASC, they have included an additional 11 aircraft for the F-35. We observed an increase last year in the FY16 Omnibus, and it's crucial to see that trend continue. Many of our programs are well supported within the budget itself, along with potential increases as new opportunities arise. Concerning the F-22, there has been dialogue about restarting the program, and we are prepared to provide any necessary information. The tooling still exists, and as with most programs starting from scratch, there will be a need to understand the costs involved. However, it's important to note that the aircraft shouldn't be built the same way, so upgrades and modernizations will be necessary, incorporating lessons learned from the F-35 and other programs. We are ready to support this effort. Ultimately, I believe our programs are well backed in the President's budget submission, and there is potential for additional support. We understand that the budget process has a long way to go, and it’s still early in the process. We remain optimistic that our programs align with the Department's strategic priorities, ensuring continued support.

Yes, thank you. It was a good quarter. I appreciate the information on Sikorsky earlier. I was wondering if you could provide an update on your expectations for intangibles amortization this year and integration costs. Additionally, how quickly do you anticipate these will decrease in 2017 and 2018?

Thank you, Pete. I'll address that. Regarding intangibles, we mentioned in the January call that they might fluctuate. We have about a year to finalize those figures. We're very close, and there is a slight improvement in the intangible amortization. By slight improvement, I mean that the intangible amortization in 2016 is a bit slower and smaller than we initially discussed, but it's not significant enough to get overly excited. I still believe that most of the integration costs will be wrapped up in 2017, with some possibly extending into 2018. As it stands today, I think we are on track with what we projected when we acquired Sikorsky, aiming for around $150 million in steady-state savings starting in 2018. I believe there's a good chance that will be the figure we see then. We have a lot of work ahead of us, but I think we are moving nicely towards our expectations for Sikorsky.

Abigail, this is Jerry. I think we will have time for one more question.

So, if we can go back to the severance charge, Bruce, $99 million, can you provide some details on how that is divided between Aero and IS&G? What type of employees did you let go? Do you anticipate recovering all of it this year? If so, why didn't the guidance for Aero and IS&G increase by more than $25 million each?

I think you should consider the severance charge to be approximately three-quarters attributed to Aero, around $70 million, while the remainder is in IS&GS. I don't have the exact figures in mind, but it's approximately three-quarters to one-quarter. Most of the headcount reductions at Aeronautics are salary positions, and the indirect support required for the production ramp associated with previous developmental work is no longer necessary. A significant portion of the reductions in Aeronautics was actually voluntary and aligned with our expectations. Fortunately, this resulted in very few involuntary layoffs, which is a positive outcome. Regarding this year's recovery, it's still developing. In broad terms, you should anticipate a largely neutral response in 2016. Depending on the timing of the reductions or the severance costs, there may be benefits extending into 2017. We'll closely monitor this over the next three quarters to determine any impact in 2016 and will keep you informed if it occurs, including any insights for 2017.

So let me conclude the call for today and I just want to end by reiterating that the Corporation completed a very strong first quarter. Our robust backlog coupled with an increasing DOD budget has the Corporation positioned for top-line growth and increasing cash flows into the future. So, thank you again for joining us on the call today. We look forward to speaking with you on our next earnings call in July. Abigail, that concludes the call today.