Lockheed Martin Corp (LMT) — Q4 2016 Earnings Call Transcript

Thank you, Stephanie, and good morning. I would like to welcome everyone to our fourth quarter 2016 earnings conference call. Joining me today are Marillyn Hewson, our Chairman, President and Chief Executive Officer, and Bruce Tanner, our Executive Vice President and Chief Financial Officer. Statements made during this 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 refer to today's news release, our SEC filings, and chart two on the webcharts for a description of some factors that may cause actual results to vary significantly from anticipated results. We have also posted charts on our website today that we plan to address during the call to supplement our comments. You can access our website at www.lockheedmartin.com and click on the Investor Relations link to view and follow the charts. With that, I would like to turn the call over to Marillyn.

Thanks, Greg. Good morning, everyone. And thank you for joining us on the call today. I hope your New Year is off to a good start. Let me begin by saying that I am extraordinarily proud of our Lockheed Martin team. Their dedication and focus enabled us to achieve outstanding program and financial performance during a dynamic year of transition, and I want to thank them for their efforts. Our performance as a corporation allowed us to exceed all of our full-year goals and has positioned us for future growth and to continue to deliver value to customers and stockholders in 2017. While Bruce will cover the financial results in detail a little later, I want to highlight a few noteworthy 2016 financial accomplishments from my perspective. 2016 was an exceptional year of achievement, with all of our financial metrics exceeding our expectations and in the case of sales, earnings per share, and cash from operations, exceeding our previous historical high watermarks. I was especially pleased with our performance in maintaining our focus on new business wins and building backlog. We received almost $19 billion in order bookings in the fourth quarter, which resulted in our achieving a quarterly book-to-bill ratio of 1.4 and a year-end backlog of over $96 billion. This represents over a $1 billion increase from 2015 year-end level and reflects the broad demand for our products from both domestic and international customers. Significant awards included $7.2 billion for our F-35 LRIP 10 and definitized contract action agreement, a $1.5 billion award for PAC-3 missiles defense capabilities for United States and allied military forces, and $1.2 billion from the Republic of Korea Air Force to upgrade 134 of their F-16 aircraft. Our strong and growing backlog has positioned us to deliver expanding sales level and outstanding financial results as we move forward. Our strong cash generation also enabled us to continue our longstanding cash deployment strategy. In 2016, we returned 100% of our free cash flow to stockholders through our competitive dividend and ongoing share repurchase activity. These achievements reflect our ongoing commitment to perform with excellence for our customers and stockholders. Looking beyond 2016, our 2017 guidance shows that we are expecting solid organic growth and continued strong cash generation, and Bruce will provide a detailed review of the guidance and assumptions in his comments and webcharts. I'd like to turn now to the status of the DOD budget. Currently, the DOD is operating under a continuing resolution through April 28th for fiscal year 2017 with funding constrained to prior FY16 levels. While this will cause funds to be limited for certain DOD programs and likely delay expansion in others, we do not believe our 2017 sales, earnings, or cash flows will be affected by this delay in receiving the full appropriations bill. We forecast that prior year's appropriation levels will support our current plans as our broad portfolio of long-cycle programs remains well-aligned with our customers’ needs. Further support for this conclusion is that the continuing resolution also allows for a limited set of exceptions, which include the ability to additionally fund two of our programs, advanced procurement for new multiyear Black Hawk helicopter contracts, and sufficient funding to maintain the Orion Multi-Purpose Crew Vehicle program launch capability and schedule. While we believe the possibility of a full-year CR still exists and would not be in the nation's best interest, we are hopeful that a resolution can be reached to maintain our country's readiness and strength. Separately, the 2017 National Defense Authorization Act was signed into law last month and reflected bipartisan agreement that defense budgets should not return to amounts defined by the Budget Control Act or sequestration levels. I am personally encouraged by that fact, as there is recognition from both parties that global security threats are not decreasing and that in fact we do need to continue to put resources toward our national security and our interoperability with our allies around the world. We look forward to the upcoming submission of the new administration's budget proposal and continued congressional support for a strong defense and future recapitalization actions both in FY 2017 and beyond. I would like to continue my remarks with a few highlights from the fourth quarter that illustrate the continued upward momentum we have in our operational performance as we delivered daily on the commitments to our customers. Starting with the F-35 Joint Strike Fighter, we delivered 16 aircraft in the fourth quarter, including the first planes for customers beyond our original eight partnered nations, Japan and Israel. These countries represent our ninth and tenth international customers, and along with South Korea show building international interest and the capabilities of this remarkable plane. In November, Luke Air Force Base welcomed the arrival of its first Foreign Military Sales or FMS aircraft as Japan took ownership of its first F-35, where it will be used to train an elite cadre of Japanese air self-defense pilots and maintainers. In December, I traveled to Israel to attend the delivery ceremony for the first pair of Adir F-35 stealth fighters for the Israeli Air Force. The IAF has embraced the technologies and capabilities of this fifth-generation fighter and believe it will become a powerful accelerator for their entire air force. Also during the fourth quarter, our F-35 backlog grew as we received an undefinitized contract for LRIP 10, which added 90 planes to our flow. This brings our total F-35 orders to date up to 373 planes. Just as significantly, our 2016 deliveries of 46 jets brought our total deliveries to 200 aircraft at the end of 2016. We expect 2017 to be another inflection point in our production cycle as we now anticipate delivering 66 planes, an increase of over 40% from our 2016 level. As many of you know, I have the opportunity to meet with President Trump on two occasions prior to his inauguration to discuss our F-35 Joint Strike Fighter program. We, along with our partners, share his strong interest in producing this unparalleled aircraft at affordable prices for our warfighters and taxpayers. We believe we are on this path and I'd like to take a moment to give you a quick status of the program. At this time, I'll ask you to turn to the third page in the webcharts that we have provided. This chart depicts the F-35A model per unit price, which is the Conventional Takeoff and Landing or CTOL variant. The chart also depicts the F-35 program order quantities. The bar graph portion of the chart shows our historical and projected orders. You will also observe a dark descending line on the graph, which shows the per unit price of our CTOL variant in each LRIP as noted by the axis on the right. You can see from our latest status on our LRIP 9, our current F-35A is now around $100 million apiece and drops below $100 million for LRIP 10. The LRIP 10 price is currently proposed with a represented reduction of over 60% from the first LRIP 1 aircraft, and this demonstrates a learning curve as efficient as any achieved on any modern tactical fighter aircraft. The chart also includes a red dotted line, which represents the government program office's annual budget estimate to Congress of the F-35A unit price. This selected acquisition report or SAR is submitted annually to Congress as part of the yearly budgeting process in advance of our contract negotiations for each lot. As you can see, we have had eight consecutive years of achieving settlement unit prices below the internal government expectations, showing our ongoing commitment to producing this aircraft with increasing affordability. You will also see the rapid ascent in quantities on the chart. It is with this anticipated trajectory and production that we can continue to see the efficiencies in touch labor, manufacturing techniques, and supply chain operations that we project will allow us to meet our stated goal of offering the CTOL version for $85 million by 2019. We believe this will result in the best combination of capability and price of any aircraft ever offered, while at the same time growing valuable job opportunities for our American workforce. Turning to our Space Systems business area, I'd like to highlight another example of one of our innovative products and the benefits that can be derived from our long-term commitment to technology, our customers, and their missions. In November, we successfully delivered the Lockheed Martin built GOES-R satellite to Cape Canaveral Air Force Station in Florida. The spacecraft was launched on a United Launch Alliance Atlas V rocket and placed into geostationary orbit 22,000 miles above the Earth as the first of four in a next-generation weather satellite constellation. We are excited to be leading the GOES-R program, a collaborative mission between NASA and NOVA, which will provide major improvements to quality, quantity, and timeliness of critical weather data. I'm especially pleased that the company's Advanced Technology Center in Palo Alto, California contributed key instrumentation that will fly aboard each spacecraft, including the Geostationary Lightning Mapper or GLM. The GLM will take hundreds of images every second, mapping lightning activity on the Earth's surface and in the atmosphere. Scientists are hoping to use data from the GLM and GOES-R satellites to provide citizens and public safety officials early warning of severe storms and tornado activity. Finally, I'd like to take a moment to congratulate our Sikorsky team for delivering the 1,000th H-60M Black Hawk helicopter this past quarter at a ceremony in our Connecticut facility. This version of the Black Hawk, dating back to 2007, has been consistently enhanced with more powerful engines, improved airframes, and modern avionics, and it is a key element of the Army Aviation Modernization Plan. The Black Hawk has been noted as the workhorse of Army aviation, and including the entire Black Hawk family, Sikorsky has delivered over 4,000 Black Hawk helicopters, which have flown over 9 million flight hours. We are honored to be part of this heritage and look forward to continuing this proud legacy. In closing, as I reflect back on our accomplishments over the past year, we completed our strategic actions to better align the business for operational and financial success and long-term value creation. We increased sales, grew our backlog, and had strong cash generation while continuing to perform with excellence for our customers. Looking to the future, I am enthusiastic about our corporation’s broad portfolio and the growth opportunities that it provides both domestically and internationally. I'll now turn the call over to Bruce to review our financial performance in more detail, outline our 2017 financial guidance, and then we'll open up the line for your questions.

Thanks, Marillyn. Good morning, everyone. As I highlight our key financial accomplishments, please follow along with the webchart we included with our earnings release today. My remarks begin on chart four and an overview of our financial results for the year. Before discussing our 2016 financial results, I want to provide an understanding of the material weakness and internal controls that we described in our earnings release. This material weakness relates to a number of deficiencies in internal control over financial reporting that is limited to Sikorsky only. While we have not discovered any material errors in the financial results included in our earnings release today, our reviews of the internal control processes and IT-related controls over financial reporting at Sikorsky indicated a reasonable possibility that a material misstatement could have occurred that would not have been prevented or detected on a timely basis, which is enough to determine that a material weakness in those internal controls exists. That finding in turn triggered a more thorough review of Sikorsky's financial statements to determine whether or not that potential for misstatement led to an actual material misstatement in our consolidated financial statements, and at this time, we have not found that to be the case. We expect to have completed our analysis of Sikorsky's financial statements when we file our Form 10-K in February. Thereafter, the remediation process will continue as we’ll have to correct and then test the remediated controls over several reporting cycles. We will provide updates on our progress as we file our Form 10-Qs in 2017 and we expect that the remediation will be completed prior to the end of fiscal year 2017. Moving on now to our 2016 results. Overall, we finished the year a little stronger than the outlook we provided to you in the October call. We obtained the highest sales, earnings per share, and cash from operations that we've ever achieved. We continued our track record of returning substantial cash to our stockholders and we grew backlog to more than $96 billion, significantly strong sales volume in the year. So, overall, we are very pleased with our results for 2016 and we think this positions us well as we enter 2017. I’ll add this, also nice for me, and perhaps for you as well, to have the many portfolio shaping activities that occurred during the year behind us, hopefully making it easier to both explain and follow the results of the company going forward. Turning to chart five, we compare our sales and earnings per share in 2016 versus 2015. Sales were nearly $7 billion higher this year compared with last year, and most of that growth came from having a full year of Sikorsky performance and results of RMS for 2016 versus less than two months in 2015 and significant organic growth in Aeronautics driven by the F-35 program. Earnings per share grew by 25% over last year's level, driven by higher segment operating profit and FAS/CAS adjustments, the benefit from a lower tax rate, and a lower share count due to share repurchases in the year, and the results of the share reduction associated with the IS&GS divestiture. Within the 2016 results, we also had the benefit of recognizing the booking resulting from obtaining a controlling interest in the U.K.'s Atomic Weapons Establishment that we discussed on the last call. That gain increased EPS by $0.34 for the year. Chart six shows our actual cash from operations generated in 2016 and outlook for 2017. During the October call, we discussed that our cash projection in 2016 had significant variability in it driven by about $700 million in F-35 collections that could have been received in either 2016 or 2017, and we sized our 2016 cash from operations at $5 billion or $5.7 billion. We also said that if the $700 million was not received in 2016, it would simply be added to our outlook for 2017, resulting in a two-year outlook for cash from operations of greater than or equal to $10.7 billion. As it turns out, we did not receive the $700 million in collections in 2016, but we did generate $5.2 billion in cash from operations even without those collections and we are keeping our 2017 outlook at the $5.7 billion level, resulting in a two-year outlook of greater than or equal to $10.9 billion or $200 million more than we said in October. If you will turn to chart seven, we’ll discuss the amount of cash we returned to stockholders in 2016. With our cash from operations of around $5.2 billion and capital expenditures of almost $1.1 billion, our free cash flow in 2016 was a little more than $4.1 billion, and with $2.1 billion of share repurchases and $2 million of dividends paid, we returned 100% of our free cash flow to stockholders last year. On chart eight, you can see how our consistent focus on returning cash to our stockholders has resulted in a significant reduction in the number of shares outstanding. We reduced our shares outstanding by 36% from our peak share count level of 456 million shares in 2002, and we achieved our goal of reducing outstanding shares to below 291 million shares one year earlier than our target date. As a reminder, we anticipate $2 million of share repurchases in 2017. Chart nine provides our 2017 outlook; our sales guidance is between $49.4 billion and $50.6 billion, and our segment operating profit range is between $5.015 billion and $5.135 billion. Our FAS/CAS adjustment is $880 million for 2017, and we will discuss this in more detail on the next chart. Our earnings per share are expected to be between $12.25 and $12.55 and our cash from operations is expected to be equal to or greater than $5.7 billion, as we discussed earlier, and this represents a good start to achieving the goal we established in October of generating $15 billion or more of cash from operations during 2017 to 2019. On chart 10, we compare the FAS/CAS adjustment outlook that we provided in October with what we are providing now. In October, we expected an adjustment of $800 million; since then interest rates increased, prompting our discount rates to increase to the 4.125% level by year-end, 50 basis points higher than we projected in October. The increase in the discount rate increased our FAS/CAS adjustment for 2017 by $240 million, and we lowered our outlook for the long-term return on our pension assets from 8% to 7.5%, recognizing the downward pressure on the equity and fixed-income asset classes in our trust. Lowering the long-term return on assets lowers our FAS/CAS adjustment in 2017 by $160 million, partially offsetting the increase resulting from the higher discount rate, and netting to a FAS/CAS adjustment of $880 million for 2017. Chart 11 provides our sales and segment operating profit outlook ranges by the four business areas. I recall a briefing we gave in New York City at the end of 2006 where we said that the Aeronautics business area would grow from its $11 billion revenue level then to more than $20 billion by 2015. Given all that's happened since that time, reaching $20 billion in 2017 still feels like a nice accomplishment for our Aeronautics team and has enabled us to forecast 2017 revenue of $50 billion at the midpoint of our guidance. And finally, we have our summary on chart 12. We achieved exceptional performance in 2016. We continued our cash deployment practices and generated strong returns for our stockholders, and we completed our portfolio shaping actions, which we believe positions us for continued long-term value creation. With that, we are ready for your questions.

Could you basically update us in terms of where you are in your negotiations on LRIP 10 and whether you intend to basically take any legal action in terms of the way the estimation of LRIP 9 was determined?

Thanks for the question, Cai. I will take that on and Bruce do you have anything to add you're certainly welcome. On LRIP 10 we are very close to a deal as some of you may have seen in the media I expressed that after my discussions with President Trump recently. We are very close to a deal that would allow us to close LRIP 10 in the near-term and so I expect that will be very soon. On LRIP 9, basically we are not under any pressure to do anything further on LRIP 9 at this point. We are just going to continue to look at our options on LRIP 9. Anything do you want to add Bruce?

No, no. I think that captures it, Marillyn.

Yeah. Hey. Hey, good morning, guys.

Hi.

When we perhaps think about modeling the program, the F-35 program as we go out over the next several years, I mean, one question I get a lot from investors is, I mean, how should we think about the margin profile? I guess what I am asking is one of the fears is on Lot 10 pricing, I mean, are we going to see a margin step-down or I mean, can you give us a broad way to think about the margin progression of that program?

Hey, Ron, I will take a shot at that. So the way I think of it, Ron, we have given, I think, a very consistent speech for a number of years about our expectation that the F-35 program will have sort of sequential year-over-year margin improvement up to the point that probably we reach full rate production at which point it ought to look a lot like other production programs at that sort of stage of their lifecycle. And at least as I look with the expectation of where I think the agreement on LRIP 10 is going to come out, I don't think we would deviate from that discussion at this point in time, just to put in some perspective, I think, if F-35 from 2016 to 2017 the margins that we are expecting in between those two years is probably growing 90 basis points, not quite 100 basis points year-over-year. I think that’s going to happen with the results that we expect to obtain on the LRIP 10 negotiation. And thereafter, I would expect that we would continue to have some margin improvement maybe not as at higher rate as we experienced from 2016 to 2017, but still have sequential increases in margin after the full-rate production programs, as we have talked about in the past.

Marillyn, Bruce, Greg, good morning. I have a question on Brexit and international, so one fallout, potential fallout from Brexit is the impact on the U.K. defense spending. I was wondering if you have had any discussions with the British Government on this topic, if you expect much of an impact. And on the topic of international, can you give us an update on the discussions you are having with international customers, for example, how they are viewing the change in administration, are you expecting a continued step-up in international demand, is there any change in emphasis on direct versus FMS, that sort of thing?

Thank you for your question, Rich. I'll begin with the Brexit inquiry. Regarding U.K. defense spending, I haven't received any information from the U.K. MOD indicating they will alter their strategic defense plan. They have a defined strategy and a regular review process, and they will continue to allocate funds to defense. Therefore, we haven't observed any changes, and there is no indication of a shift. Like many countries, their national security remains their top priority, so they will keep focusing on that. As for discussions with international customers regarding the change in administration, I haven't had any feedback on that front either. With the orderly transition of power in the United States, we have new leaders who may propose different policies, but this has not affected the demand for our international products. Much of our growth in the international market is in the F-35 and missile defense sectors, along with opportunities for F-16, C-130J, C4ISR, and space awareness. We continue to see strong demand in these areas, and as we work with international customers, we’re not noticing any pullback at all.

Rich, you asked about the FMS and our direct commercial sale whether there were discussions about potentially changing that or not. My suspicion is that’s not high on anyone's agenda list at this point in time, and I wouldn’t expect to see any sort of policy changes towards that. Just to put it in some perspective as we’ve talked about in the past, we would expect our FMS percentage of our international sales to grow and our direct commercial sale percentage of our international business to shrink over time, primarily simply because of the F-35 program and that program is a long way from ever having the ability to sell any aircraft on a direct commercial basis, and essentially all the international customers and all the growth that you're going to see from international customers and the program going forward is going to be on the FMS side of the house. And the same thing, frankly, is happening with our THAAD program, which is another large international grower. So that sort of squeezing out if you will the actual direct commercial sale business isn’t shrinking in absolute terms all that much, but the percentage is reduced because of what I just described.

Thanks so much. Good morning.

Hi Rob.

Good morning.

Marillyn and Bruce, your comments on the F-35 program essentially seemed to suggest that nothing is really changing. But in the press, we seem to see the DOD and the President taking a more aggressive stance. Is there a chance you are being too optimistic on this and the actual pricing on Lot 10 and beyond, and the margin could be lower than you expect?

Let me address that since I have had numerous discussions with President Trump. I plan to provide some context based on those meetings. Essentially, President Trump understands that the F-35 is a significant undertaking, the largest program within the Department of Defense. He is focused on ensuring that American taxpayers are paying the lowest possible costs for this program, and we share his concerns regarding affordability. Our meetings have been productive with constructive dialogue. He posed insightful questions and is committed to reducing costs associated with the program. Our discussions are not about diminishing our profit margins; rather, they focus on how we can decrease the cost of the aircraft both now and in the future. I appreciate the chance to discuss this with him, as it allows me to outline our efforts to reduce costs, which we highlighted in our presentation today. We are actively working on what we call a blueprint for affordability and pursuing initiatives to lower sustainment costs, which will help to reduce expenses throughout the supply chain, manufacturing processes, and materials used in the program. I also shared with him potential strategies for the Department of Defense to purchase the aircraft differently in the future, which could further lower costs. It’s crucial to discuss the unparalleled capabilities the F-35 offers to our military and allies, effectively making it a game changer. Recognizing that his focus is on aggressively driving down costs aligns with our goals and those of our industry partners. We have numerous strategies to achieve this moving forward. Meanwhile, we will continue our current negotiations to reduce costs, as depicted in the chart we presented.

Thank you. Marillyn, just a follow-up to that last statement you made on the sustainment cost, are you talking about an incremental initiative here to reduce maybe some of the sustainment spending, or is there maybe an opposite way to think about that, that as you manage this program for the next 10 years to 15 years for Lockheed that you can lower the unit cost, but perhaps recoup some of those upfront unit cost savings for DOD with actually higher sustainment revenues for you guys further down the road? How are you thinking about that balance?

Well, first of all, what I was discussing was the sustainment cost reduction initiatives, just like on blueprint for affordability which was focused on production costs, we along with Northrop Grumman and BAE committed some investment up front to help with getting projects underway that will continue to drive the cost down and production. We have similarly invested upfront to support the U.S. Government in driving sustainment costs down in the near-term over the next five years to drive that cost down. So that was what I was referring to. Now your question about sustainment itself, I mean, we do look at these programs in terms of their overall lifecycle costs, which is not just the development and production but it’s also sustainment and our goal is that the overall cost for the program would continue to come down.

Hunter, maybe just to add one thing from my perspective and just to make sure that we are all clear on this. Sustainment is going to grow in the future. It has grown very significantly last few years as the aircraft is being based at various locations around the U.S. and soon to be internationally as well. So there is no doubt that sustainment will grow and the Lockheed Martin contribution towards that sustainment will grow into the future. This is about just doing sustainment smartly and doing it as economically as we can, but even if we do it as economically as we can we are still going to see some pretty significant sustainment growth in the future.

Good morning.

Good morning, Sam.

You just talk a little bit about the backlog being $96 billion. I was wondering if you could talk a little bit about what your expectations are for 2017 year-end backlog and maybe highlight some of the key orders you are looking at. There was some international THAAD that didn't happen in ‘16 and just if you can talk a little bit about some of the key orders to watch?

Thanks, Sam. As we look ahead to 2017, we are likely to see a slight decrease in backlog, possibly around a couple million dollars for the year. This is partly dependent on several sizeable competitive awards that may or may not occur, and whether we secure those proposals. The main factors influencing our orders and maintaining backlog levels are somewhat lower than current levels. Notably, we expect ongoing advanced funding for the F-35 program. In the first half of this year, we anticipate receiving advanced funding for the LRIP 12 aircraft, which represents a significant increase in the number of aircraft over LRIP 11. Additionally, as highlighted earlier, we will see an increase in sustainment and spares funding to support our bases domestically and internationally in the first half of the year. We also expect to see more GPS III satellite orders and likely finalize the Hellfire order that was incomplete last year, which should happen early this year. Major orders for the year include the LRIP 11 definitization for the F-35. We are expecting to negotiate and finalize both LRIP 10 and LRIP 11 contracts in 2017. A substantial part of the LRIP 10 contract has already been recognized through the U.K. deal mentioned, but we haven’t finalized much for LRIP 11, so this definitization will be a significant portion of our 2017 orders. Regarding international missile defense programs, the largest one anticipated in the second half of the year is the THAAD program for Qatar, where we expect to deliver the first five THAAD batteries. Lastly, we are also looking to close on the multiyear nine Black Hawk order in the second half of this year, which is projected to be the second largest order for the corporation in 2017.

Thank you very much. Marillyn, you’ve gone through a number of significant changes in the last 12 months. And you indicated you and Bruce are going to be back to living a little bit more normal. But could you for a moment step back and kind of talk a little bit about where are some of the competitive advantages you see and how you'd like to shape the company going forward? I mean, 25% of the company is F-35, but you do have a lot of other programs and a lot of other technology opportunities?

Thanks for the question, Howard. As I said in my prepared remarks on the front end, I think we're extremely well-positioned for long-term success. Yes, last year was a challenging year in terms of transitioning the divestiture of IS&GS and really moving very far along in our integration with Sikorsky, and that I would say a great tribute to the team is that despite those major efforts that we had going on in the business we exceeded all of our financial commitments, as well as actually hit some new records, I mean, I think that's a true measure and our operational performance was outstanding in terms of how we are performing for our customers, so I'm extremely pleased with that. In terms of strategically as we look forward, having Sikorsky as part of our company now opens up a lot of opportunities for us; we are currently in the development phase for a number of helicopter programs, so we are going to move into production, so as you look at the CH-53K at the Presidential Helicopter, the work we've been doing on the Canadian Maritime Helicopter program, the combat rescue helicopter that we’re working, all of those programs, as well as what Bruce mentioned, we're continuing on with the Black Hawk and getting into the next year multiyear Black Hawk, which is an excellent growth area for us that will continue to bring good cash generation and continued growth for us as the company. And then we do expect at some point the commercial business will come back; we are at a lull right now with the oil and gas prices, but it’s another opportunity for growth for us and one of the elements of the company that we’ll look forward to continuing to grow. And so, Sikorsky has been a great asset that we brought into the company, and I see great growth opportunities. We’ve talked about 35 at length; you can see, certainly it is a growth engine for our company and we continue to see growing international demand for it, so it’s not just a program of record that we have with the U.S. Government on the services that are buying the aircraft, but many other countries are showing interest in the program. And then across the portfolio from our missile defense to the work we are doing in mission systems and training to all the elements of our fire control capability, our space systems and satellite and spacecraft, I think if you look holistically at our portfolio we are very strong in all of those areas and represent a leader in and virtually every one of those markets. So from a competitive advantage standpoint I think our goal is to continue to perform with excellence on the programs that we have today and to continue to look for opportunities to keep our portfolio relevant to continue to invest in research and development and innovation so that we stay on the forefront. I think innovation for us is the lifeline of this company. What we’re doing in our independent research and development, what we’re providing to our current customers and what we’re looking at and providing for long-term investments for the long-term and things like hypersonics and directed energy and other things. And then as you're probably aware we set up a venture fund where we’re also taking positions in companies that we see as another seeding of our innovation into our company. I would lastly say that from a competitive advantage standpoint my view is that it is the talent in this company that is the competitive advantage. We have the best talent in the industry in my view from and that in my view sets us apart. So that coupled with the technology and the outstanding portfolio, I think, sets us up very well for continued success and continued growth.

Thanks, Marillyn. It seems that border taxation was a topic during your meeting yesterday with other business leaders, and I'm interested in how it relates to your business and the defense sector. Do you have a clear understanding of how this might impact your business in the sector? It appears that the President is in favor of eliminating taxes on exports. Could you explain how this would affect Lockheed from your perspective? Thank you.

Thank you for the question, Myles. If I take a step back from what was discussed yesterday, the focus in the campaign has been on preventing work from being produced offshore and brought back to the United States, which would give companies an advantage by producing elsewhere. For Lockheed Martin, we manufacture our products primarily in the U.S., with over 90,000 of our approximately 98,000 employees based here. This is where our products are made, and we distribute them globally. The work we do in other countries, such as the U.K., Canada, or Australia, does not come back into the U.S. market. Therefore, I don't believe this border taxation issue impacts us as a company; it seems to be more relevant to commercial firms that may choose to produce offshore and then sell their products back in the U.S.

From my perspective, discussing the reduction of taxes on exports is relevant for us since we have a substantial amount of exports and do not import significantly. Therefore, we would likely benefit from such a tax change. Looking at the tax proposals currently under discussion, including the recent one and the one the House proposed last year, both suggest a considerable decrease in the statutory rate. For Lockheed Martin, as a U.S.-based company with most of our income generated domestically, we do not face the offshore issues that many other global companies do. Thus, we would likely benefit from either of these tax policies in the future.

Hey. Good morning, everyone.

Good morning.

Hi, Noah.

Marillyn, I wanted to ask if you could maybe provide a little more detail or I guess thought around the total U.S. defense budget commentary you touched on briefly in your prepared remarks. I mean, I guess, where would the actual likelihood that sequestration is removed from DOD versus the need to have some kind of compromise where they, I guess, still, I guess, I'm not as sure, but still seemingly still deficit focused Congress and if this is happening will we see it in the ‘18 request or does the administration need another year and a half to have it be fully their own and be prepared to do that?

Thanks for the question, Noah. I'll share my perspective, as that's what I can offer at this moment. It's quite unpredictable moving forward, but I believe there seems to be bipartisan support for eliminating sequestration. In past discussions with various members of Congress, I've found that they all agree it's not good policy and want to eliminate it. With the current Congress and the new administration, I feel there is a real opportunity to achieve this, and I'm encouraged by the ongoing discussions about removing the defense sequester entirely. There's also strong conversation around increasing defense spending, as we haven't been investing adequately in recapitalization and readiness due to budget caps. Our services have communicated to Congress and the new administration about the needs of our defense customers, and we believe it's crucial to eliminate the sequester and the associated budget caps to support national security strategies and provide essential capabilities for our military. Regarding when this might happen, I'm optimistic about discussions surrounding supplemental funding for the FY17 budget and tackling the sequestration issue and budget caps. It's difficult to predict whether this will appear in the '18 request or in early '17, but I think it is a near-term and longer-term possibility, as everyone I've spoken with, including President Trump, acknowledges that it needs to be addressed, and we must ensure appropriate funding for our national security.

Good morning, everyone. Bruce, Marillyn, I was wondering if you wouldn't do us a favor and walk through each of the segments and maybe provide a little bit of color on the risks and opportunities this year relative to your official outlook?

Thanks, Jason. Bruce, why don’t you go ahead and then I’ll add anything if needed.

Sure. Let me address that, and Jason, if I don't fully capture what you're asking for, please let me know. Starting with Aeronautics, which is our largest business segment, we anticipate sequential growth quarter-over-quarter, making the fourth quarter the peak of the year. The first quarter, as is customary in Aeronautics, will be the lowest. In comparison to 2016, I expect the growth rate over that year to diminish slightly as we progress, even though the overall numbers will increase. This is partly because the F-16 program is set to conclude in the late second or early third quarter, marking the final eight aircraft deliveries currently in our backlog. Until we secure another F-16 contract, production levels will decrease in the latter half of the year, but we still expect substantial quarter-over-quarter growth for Aeronautics, predominantly driven by the F-35 program. I believe EBIT will align with sales volume throughout the year, maintaining stable margins quarter-over-quarter; this will depend, of course, on the timing of planned risk retirements, but we anticipate consistent margins based on our outlook. Moving on to missiles and fire control, we expect the first quarter to come in a bit lower than anticipated. It will be significantly lower compared to the subsequent three quarters due to the timing of deliveries. This drop will be evident particularly when comparing it to the fourth quarter of 2016, which saw far more deliveries in the second half compared to what we expect in the first quarter of 2017. The following three quarters should exceed the fourth quarter and remain relatively consistent. Similar to Aeronautics, EBIT will follow sales volume, with consistent margins expected between quarters in 2017. For Rotary and Mission Systems, we also anticipate sequential growth quarter-over-quarter in 2017. EBIT should align with sales, and we expect to see margins increase throughout the year. This increase is partially attributed to the winding down of certain purchase accounting and integration costs related to Sikorsky, as well as the timing of planned risk retirements in 2017. Finally, regarding Space in 2017, we expect consistent revenue of around $2.2 billion each quarter. Unlike 2016, we don't have any commercial launches or satellite deliveries planned that would contribute to revenue recognition upon delivery. Last year, we had two commercial launches, but none are scheduled this year, leading to a steadier revenue stream. EBIT will generally follow sales volume, though there may be some variation linked to the timing of equity earnings throughout the year. I hope this provides a clear overview of our expectations. As we reflect on the year, it's essential to note that the opportunities embedded in our plan for 2017 are similar to those we encountered in 2016 or even 2015. The key will be making those opportunities a reality this year, which is not entirely reflected in the numbers or planning we've discussed.

Stephanie, I believe we have time for one more question.

Good morning. Thanks for squeezing me in. Just a couple of cleanup things on F-35. Marillyn, if we go back to the sustainment discussion, in your discussions in your negotiations with DOD on LRIP 10 and on anything else, has there been any consideration to defer future competition for either F-35 sustainment or for the Block 4 subsystem upgrade work? And Bruce, how is this potential competition contemplated in your long-term outlook for the aircraft? And then the last thing I wanted to ask you is how important is the 450 unit international block buy to the margin growth cadence that you described to Ron earlier?

Thanks for the question, Rob. I guess, the first question on sustainment, sustainment is a separate contract from the LRIP 10, so it isn’t part of the discussion at all in LRIP 10 negotiations nor would it be the upgrade work for Block 4 going forward.

But might they factor into any horse trading or anything that you all are talking about?

Actually, no, we treat them separately as separate contracts; we look at what the sustainment contract is versus the LRIP 10. I mean, there are just, the separate LRIP 10 is pretty straightforward, as we look at our assessment of the costs associated with LRIP 10 and the offer we put forward based on the cost of the aircraft and the terms and conditions associated with that contract. It doesn't include sustainment.

Rob, let me address your questions. I hope I've captured them accurately. Regarding future competition for the sustainment block, competition is a hot topic these days, but we are not concerned about it. We believe our legacy of performance in software development and our accomplishments in sustainment, along with the cost reduction initiatives Marillyn mentioned, position us very well if there is competition. We anticipate winning those competitions, and this is factored into our planning. You also inquired about the block buy and the significance of the 450 aircraft in relation to margins. While we don't expect significant margin benefits from this block buy, it will help us secure long-term commitments from suppliers and enable better planning in our factory. This approach could lead to cost reductions for the aircraft, as discussed in Marillyn’s conversations with the President regarding cost reduction efforts. Any multiyear or block buy typically comes with associated savings; the key question is the extent of those savings. We believe we have a solid plan to lower costs with the block buy moving forward, but I wouldn't anticipate an immediate margin spike from it.

With our last question, I would like to conclude the call today. I want to finish by emphasizing that 2016 was an extraordinary year of transition and success, with our team performing exceptionally well in all areas: strategically, operationally, and financially. As we look forward to 2017, our strong backlog and solid portfolio have positioned the corporation for a promising future of top-line growth and increasing cash flows. Thank you for joining us today. We look forward to connecting with you at our next earnings call in April. That concludes our call today.