Lockheed Martin Corp (LMT) — Q3 2018 Earnings Call Transcript

Thank you, John, and good morning. I'd like to welcome everyone to our third quarter 2018 earnings conference call. Joining me today on the call are Marillyn Hewson, our Chairman, President and Chief Executive Officer; and Bruce Tanner, our Executive Vice President and Chief Financial Officer. Statements made in today's call that are not historical fact are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities law. Actual results may differ materially from those projected in the forward-looking statements. Please see today's press release and our SEC filings for a description of some of the factors that may cause actual results to differ materially from those in the forward-looking statements. 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, Greg. Good morning, everyone, and welcome to our call today. As today's release illustrates, we continue to outperform the goals we set at the beginning of 2018, with another quarter of strong operational accomplishments, important new business awards and outstanding financial results. We've seen strong financial performance across the entire corporation. This performance, coupled with our improved outlook for the remainder of the year, has resulted in us updating our guidance again this quarter. I'm especially pleased to see our earnings and cash expectations continue to grow as we remain focused on operational performance and delivering long-term value to shareholders. Our third quarter and year-to-date financial performance and improved full-year projections are the result of the strength provided by our broad portfolio of offerings as each of our 4 business areas contributed to our updated 2018 financial outlook. We will discuss the financials in detail a little later in the call, but I do want to highlight two key actions that our Board of Directors took this quarter in the area of cash deployment. First, we increased the quarterly dividend by 10% to $2.20 per share or $8.80 annually, maintaining our long-standing commitment to a strong dividend. Second, we also increased our share repurchase authority by $1 billion, bringing total repurchase authority to $3.7 billion. This level of authority provides additional flexibility to continue to return cash to shareholders through share repurchases if market conditions and our fiduciary duties permit. Together, these two actions demonstrate our continued strategy of balanced cash deployment and long-term commitment to delivering returns for our stockholders. I'll cover performance highlights in just a moment, but I want to begin by noting several strategic new business awards that we received this quarter, which position us for long-term growth in our existing portfolio, as well as affording us exciting new opportunities. In August, our Lockheed Martin Space team received an initial $2.9 billion reward from the U.S. Air Force for 3 next-generation missile warning satellites. These overhead persistent infrared, or OPIR, satellites build upon our legacy SBIRS spacecraft with a modernized bus and increased survivability, delivering advanced early warning and improved resiliency. We look forward to delivering these next-gen capabilities with this new opportunity. We also received a competitor contract of over $1.3 billion for the first two GPS follow-on satellites, with a total estimated contract value of up to $7.2 billion for 22 new GPS-IIIF spacecraft. These new GPS space vehicles are designed to provide greater accuracy and improved anti-jamming capabilities, providing the technology upgrades to ensure GPS-III remains the gold standard in navigation, positioning and timing. Moving to our Aeronautics business area. We secured approximately $1.7 billion in orders for 22 additional C-130J transport planes, a result of the increases included in the 2017 and 2018 fiscal year omnibus appropriations legislation. These awards bring our C-130J backlog to 70 aircraft, another example of the enduring demand for this legendary platform. In Missiles and Fire Control, we were very excited to be awarded the $480 million Air-launched Rapid Response Weapon, or ARRW program, to provide critical design review and production readiness support for new hypersonic weapon. The ARRW contract marks our third 2018 award in this emerging technological area, and when combined with the previously announced Tactical Boost Glide and Hypersonic Conventional Strike Weapon, or HCSW programs, brings the aggregate value of our 2018 hypersonic awards to over $1.5 billion. We were disappointed, though, at not being selected for 3 large competitive bids this quarter. We believe our proposals represented outstanding technical offerings at our lowest possible pricing. Had we matched the winning prices and been awarded the contracts, we estimate that we would have incurred cumulative losses across all three programs in excess of $5 billion, an outcome that we do not feel would have been in the best interest of our stockholders or our customers. As we conduct our lessons learned process, we will seek to discover any root cause issues which may lead us to alter our future capture strategies. However, our objective will always be to position the corporation to perform with excellence for our customers while delivering outstanding value to our stockholders. Our new business pipeline remains robust and our win rates remain strong. The strategic awards I noted earlier contributed to the corporation recording over $18 billion in awards during the third quarter and allowed our backlog to climb to over $109 billion, a new high watermark. Turning briefly to the Department of Defense budgets. The President signed into law the DoD 2019 fiscal year appropriations act last month, the first time in a decade that an appropriations bill has been enacted prior to the start of the fiscal year. The act provides approximately $670 billion of base budget funding for the nation's security and defense programs. The legislation aligns with the Bipartisan Budget Act of 2018, which provided with an additional $80 billion for national defense over 2 years in fiscal 2018 and fiscal 2019. The final FY '19 appropriations also reflect continued support for our broad portfolio as funding was increased from the Presidential budget request for some of our key programs, including 16 additional F-35 jets; 14 additional THAAD interceptors; 8 additional C-130J aircraft; 8 additional BLACK HAWK helicopters; and 2 additional Littoral Combat Ships. These increases were supported by both House and Senate appropriations committees and reflect strong bipartisan support for these platforms. Moving on, I'd like to highlight several significant milestones we achieved across the corporation during the past quarter, beginning with an update on our F-35 program. We saw 4 significant events take place this quarter. In September, we finalized an $11.5 billion Low-Rate Initial Production, or LRIP, 11 contract with the Department of Defense for the production and delivery of 141 F-35 aircraft. Notably, we came to an agreement on unit prices, which are the lowest in program history, with the F-35A, our conventional takeoff and landing, or CTOL variant, achieving an $89.2 million price, a 5.4% reduction from the LRIP 10 per unit amount. We remain focused on delivering the best value to our U.S. services, international partner nations, and Foreign Military Sales customers as we continue to pursue achieving an $80 million CTOL target price. The F-35 program also continued its maturation process as it was approved to transition into the operational test and evaluation, or OTE phase, in November. The Defense Department had certified the program’s readiness to enter the OTE phase, one of the final steps being approved for full-rate production. Also in September, F-35 aircraft participated in their first U.S. combat mission as the U.S. Marine Corps F-35Bs successfully conducted an air strike in support of Operation Freedom’s Sentinel ground clearance operations in Afghanistan. The Marine Corps was the first service to declare the F-35 ready for initial operational capability in 2017, and the aircraft has been deployed as part of the Essex Amphibious Ready Group, enabling enhanced stability and security from international waters and demonstrating the remarkable capabilities of this fifth-generation fighter. Lastly, on the F-35, we were all extremely proud to see our U.K. Ministry of Defense partner celebrate an F-35B performing its first carrier landing as British pilots touched down on the HMS Queen Elizabeth in the Atlantic Ocean, laying the foundation for the future of fixed-wing aviation aboard the U.K. carrier fleet. The F-35 subsequently took flight using the ship's ski ramp platform and later performed successful night landings on the carrier, both with and without the use of night vision technology. The F-35 and the HMS Queen Elizabeth are at the beginning of the 2-month developmental test process to establish the envelope for the F-35 to operate from the deck of the ship, and we are very happy to be part of these landmark events. Moving to our Missiles and Fire Control business area. We saw strong domestic and international demand for our tactical missile products this quarter, as well as continued international PAC-3 support in our air and missile defense organization. In our tactical missiles organization, we were awarded an FMS contract totaling over $630 million to provide Hellfire missiles to the Netherlands and Japan. Our tactical missiles team also received a pair of awards totaling over $0.5 billion for 42 High Mobility Artillery Rocket Systems, or HIMARS, launchers and associated hardware to be delivered to the U.S. Army and international customers. Earlier this quarter, U.S. and Swedish officials formalized an agreement to provide PAC-3 MSE missiles to the government of Sweden, helping to increase the country's defensive capabilities and support interoperability with U.S. and NATO forces. Sweden will become the sixth international customer to sign an agreement for PAC-3 MSE missiles, and we look forward to providing our leading-edge missile defense products in support of their national security objectives. I'll close with our Rotary and Mission Systems business area and discuss several noteworthy achievements from our Sikorsky team. First, the Sikorsky S-97 Raider prototype helicopter demonstrated the ability to fly at speeds exceeding 200 knots during recent flight testing at our Sikorsky development flight center. The Raider aircraft incorporates our Collier award-winning X2 Technology, a suite of capabilities, which include our innovative counter-rotating blade design, fly-by-wire flight controls, and advanced vehicle management systems to provide a critical speed and handling quality needed by today's warfighter. The X2 technology allows for speeds twice that of conventional helicopters, and we look forward to offering this unique solution to the U.S. Army as it begins to revolutionize its aircraft fleet as part of the upcoming Future Vertical Lift program. I would also like to congratulate the Sikorsky team on an upcoming milestone as October 31 will mark the 40th anniversary of the first BLACK HAWK delivery to the U.S. Army in 1978. The iconic BLACK HAWK helicopter has more than 10 million flight hours, supporting our army customers' brave missions and has played a key role in humanitarian efforts, aerial firefighting, and border patrols as well. Over 4,000 BLACK HAWKS of all types are in service worldwide. And I would like to thank the Sikorsky organization for their dedication in delivering this remarkable aircraft to our customers for the past 40 years. And we look forward to continuing this partnership for years to come. These two significant accomplishments come at a time when we will be recognizing another key milestone. This November, we will mark the third anniversary of Sikorsky aircraft joining the Lockheed Martin family. The Sikorsky organization has expanded and strengthened our corporation's portfolio over the short time, and I would like to thank the entire team for their efforts as we celebrate this important occasion. With that, I'll turn the call over to Bruce.

Thanks, Marillyn. Good morning, everyone. As I highlight our key financial accomplishments, please follow along with the web charts that we included with our earnings release today. Let's begin with Chart 3 and an overview of our results for the quarter. Once again, we exceeded our expectations for every financial metric in the quarter as we did through the first half of this year. Sales, segment operating profit, and cash from operations before making our final pension contribution for the year continued to be strong. The $1.5 billion pension contributions we made in the third quarter completes the $5 billion of pension outlays that we've been discussing all year. We continued our cash deployment actions in the quarter, returning around $800 million of cash to our shareholders through a combination of dividends and share repurchases. And we grew our backlog to a record $109 billion in the quarter, with all 4 business areas contributing to that growth. Based on our performance in the quarter, we expect strong results for sales, segment operating profit, earnings per share, and cash from operations for the full year, as we'll show in a few charts. We were pleased with how our financial results are shaping up thus far in 2018, and we'll be discussing how our performance this year is carrying over into next year when we get to our charts showing preliminary trends for 2019 later in the presentation. Turning to Chart 4. We compare our sales and segment operating profit in the third quarter of this year with last year's results. I'll note for comparison purposes that the third quarter of this year has 14 weeks in the accounting period while last year's third quarter had 13 weeks in the accounting period, and this situation will reverse itself in the fourth quarter when we have 13 weeks this year and will compare to 14 weeks in the fourth quarter of last year. Even without the extra week in the quarter, our results exceeded our expectations. With that background, sales grew 16% compared with the same quarter last year to $14.3 billion, continuing the momentum we had in the first two quarters, while segment operating profit increased 23% over last year's level to nearly $1.6 billion. All four business areas contributed to the significant increases in both sales and profit in the quarter, while the margin increases in the quarter were driven primarily by RMS due to improved performance in our Sikorsky and integrated warfare systems and sensors lines of businesses and by Space due to improved performance in our government satellites line of business. On Chart 5, we'll discuss our earnings per share in the quarter. Our EPS of $5.14 was $1.82 or 55% higher than our results last year, driven by higher sales volume, the margin improvements that I just discussed and a lower tax rate in the quarter compared to last year. Moving on to Chart 6. We provide our revised outlook for the year. With only the fourth quarter left in the year, we are providing our best point estimate of results for the entire year rather than the ranges we have provided in previous quarters. We expect sales to be around $53 billion for the year, near the top of the guidance range we provided last quarter and 6% higher than our results in 2017. At $5.8 billion, our forecasted segment operating profit will exceed the top end of our guidance range last quarter, resulting in a 10.9% margin, about 70 basis points higher than last year's results. Our FAS/CAS pension adjustment remains unchanged at a little more than $1 billion. Our earnings per share is expected to be around $17.50, also above the high end of our previous guidance range, recognizing the strong performance in our business segment operating profit as well as a lower tax rate in our lower estimates, which I'll discuss further in a moment. And we're increasing our outlook for cash from operations by $100 million to be equal to or greater than $3.4 billion as we expect a large portion of our earnings increase to be billed and collected before year-end. Chart 7 provides a reconciliation of our earnings per share outlook this quarter compared to last quarter. Operational performance is expected to drive a $0.40 increase in EPS, driven by higher segment operating profit as a result of higher sales volume and margins in our business areas. Taxes and other are expected to add another $0.20 in EPS, with most of that increase coming from a lower tax rate as we continue to reflect the latest understanding of the tax legislation passed last year. We now expect our full year effective tax rate to be between 13.5% and 14%. Together, these changes represent an expected $0.60 improvement from the midpoint of the EPS range we provided last quarter to a new outlook of $17.50 per share. Chart 8 shows our new outlook for sales by business area for the year, also with point estimates for each of the business areas rather than the ranges we provided in the prior outlook. We are increasing our sales outlook by $650 million compared to the midpoint of our last guidance. We expect it to be near or slightly above the high end of the guidance range from last quarter, continuing the strong results we've seen so far this year. On Chart 9, we provide a similar view of our new outlook for segment operating profit by business area for the year. We're increasing our segment operating profit outlook by $150 million from the midpoint of the range we provided last quarter, and our point estimate is above the high end of that range. Three of the 4 business areas are expected to exceed the high end of their prior range, showing the broad-based nature of our performance improvements. On Chart 10, we provide our preliminary look at our 2019 trends. We expect our 2019 sales level will grow 5% to our 2018 sales, which equates to approximately a 6% to 7% increase over the midpoint in the 2018 guidance range we provided in July. We expect our segment operating margin will remain strong at between 10.5% and 10.8%. This margin level assumes similar performance in our legacy programs in all business areas with some dilution resulting from the growing number of new start programs, as the increases in our backlog levels would indicate. We also expect to have lower equity earnings associated with the ULA business as a result of the number and mix of launches expected in 2019 compared with 2018. We estimate that our cash from operations will be at least $7 billion, as we've noted in previous calls, and we have no planned pension contributions next year. We also plan to have at least $1 billion in share repurchases, about the same levels we expect to have in 2018, more than offsetting any planned share issuances in the year. And similar to 2018, we have a debt maturity coming due next year worth $900 million. Moving to our FAS/CAS outlook. We expect our 2019 FAS/CAS adjustment will be approximately $1.5 billion or about $500 million higher than the adjustment for 2018. This estimate assumes a discount rate at the end of the year of 4.125% or 50 basis points above the 2018 rate. Based on our performance to-date, we are assuming a 1% return on our assets for the full year. And going forward, we are reducing our long-term asset return assumption by 50 basis points to 7% per year. All told, we expect to see continued strong growth in 2019 based on the mix of follow-on extensions of our legacy programs and a number of quality, new and exciting orders that demonstrate the long-term strength of our portfolio. And finally, on Chart 11, we have our summary. We've seen strong performance from all of our business areas this year, and I'm especially pleased with our year-to-date orders, both in quantity and quality. Our full-year outlook has improved in all financial metrics, and we look forward to continued growth in 2019. With that, we're ready for your questions.

So a quick question for you, first on the margin side. So the implied mix that you're talking about, can you give us maybe quantification of how much the growth in cost versus fixed price and also maybe by segments, a bit more color on where the 10 to 50 basis points of headwind is coming from?

Thank you, Myles. I'll address that. The simplest way to put it is that we are observing new starts across all our business areas, some of which you've already noticed in prior orders, while others have occurred under classified contracts in multiple areas. I can't provide too much detail, but this is contributing to some margin pressure we expect moving forward. The most significant factor affecting margin reduction next year is our equity earnings from ULA, which we anticipate will decrease by nearly $150 million compared to this year's estimates. This drop is due to a reduced launch quantity and a notable change in the mix of launch vehicles. For example, we expect fewer Delta IV launches next year, which are the most profitable in ULA's range. Without diving into every detail, I can share some insights about specific business areas for the coming year, with more details to follow in January. In aeronautics, we expect margins to remain quite similar to this year, bolstered by improvements in legacy programs. Start-up activities, including the F-16 production program, which we consider a restart after three years, will contribute to maintaining these margins. In the classified sectors, contract activities will also keep margins relatively flat. For Missiles and Fire Control, margins might be slightly lower or comparable to this year. Again, legacy programs are expected to improve margins. We're seeing good growth in our SOF GLSS contracts, which are lower margin relative to the overall portfolio. However, the primary factor affecting Missiles and Fire Control is a series of new starts, including hypersonic programs and classified efforts previously discussed. For RMS, we anticipate margins will remain comparable moving forward. So, in summary, for the three business areas I've mentioned—ARRW, Missiles and Fire Control, and RMS—margins will likely be stable, with Missiles and Fire Control being slightly lower. The main driver of the changes will be the ULA equity earnings, while the rest of the portfolio is performing as expected compared to this year.

I wanted to ask a multiple-part question on F-35. It looks like F-35 in the quarter grew fairly significantly well above kind of the delivery rate growth. Can you talk about kind of how far in terms of the revenue growth we're seeing, how that breaks out between production and sustainment? Kind of how far ahead we are based on going from 91 deliveries this year to 130? And then last one, on your cost curve, obviously, the price per LRIP is coming down like 5%, 6%. Can you talk about your cost curve? What kind of learning you're seeing from a cost perspective?

David, I'll address that question as well. You had several components in your inquiry, so I will do my best to cover them all. Regarding revenue growth for the F-35, your assessment seems largely correct. We experienced notable growth this quarter, with an increase in the double-digit range, actually slightly above that for the F-35. As we contemplate what next year will look like, particularly with the ramp-up from 91 to approximately 130 aircraft, we anticipate F-35 revenue to also grow at a double-digit rate, possibly even a bit higher. This growth applies to both production and sustainment activities. Additionally, I want to mention an unexpected development: the development activities for the F-35 are also projected to grow at a double-digit rate next year. This is partly due to a sizable reduction in the older Systems Development and Demonstration (SDD) contract from 2017 to 2018, but we're increasingly seeing new noncore SDD development initiatives being incorporated into the contract, which is contributing to this growth. The development portfolio is expected to grow at a rate higher than double-digits from 2018 to 2019, which is a pleasant surprise for us. Regarding the cost curve, I don't have the exact learning numbers at hand; perhaps Marillyn does. However, I believe we’ve been operating at a mid-80s learning curve percentage for the F-35 for some time, since around LRIP 1. We are maintaining this trend, but eventually, it will plateau as we've maximized the potential from our learning curve. Future investments will be needed to achieve any significant improvements. For now, we are still observing that trend, sustaining a mid- to higher-80% learning curve, which aligns closely with what we've seen in other legacy production programs, if not slightly better.

Marillyn, I just wanted to follow up on your comments regarding those programs you've lost in the quarter and the potential $5 billion hit. Are you concerned that this is changing the landscape for defense contracting, and the sort of low ball bids could make your future profitability less attractive?

No, that’s not applicable to us. That’s not the expectation for Lockheed Martin. My initial remarks highlighted that we will focus on securing quality business for the company and delivering on our commitments to our customers. That is our priority. I cannot comment on how our competitors are operating in this environment; you would need to reach out to them for that information.

Bruce, some of the commentary you provided on the margin, I was wondering if you can give us some perspective on sales growth, including on some of the single aisles, which impacted 2018. How what the prospect is for growth to accelerate in '19?

We experienced growth throughout 2018, previously estimating about 2% but achieving 6% growth compared to 2017. I believe this was largely due to substantial increases in awards, particularly in the first half of the year, which came in earlier than historically expected. This aligns with the concept of delivering results faster to the warfighter. For 2019, I anticipate continued growth, particularly in the Missiles and Fire Control sector, which may see growth slightly above double digits. Aeronautics is expected to grow in the high single digits. Both RMS and Space are projected to perform similarly to their 2018 results, though there may be opportunities for additional growth, particularly from the Canadian Surface Combatant competition. Overall, I foresee Aeronautics and Missiles and Fire Control driving sales growth, while Space and RMS are expected to maintain comparable performance to this year, with some potential for improvement.

Bruce, I think this is going to be for you. And I'm going to ask you a bit of a forward-looking question here. And if you feel you can't answer it, just tell me and I'll ask something else. The long-term 2018 to 2020 cash from ops guide was not in the slides. So I thought I'd ask you about that. Would you comment on your 2018 to 2020 cash from operations trends? And would you care to comment on 2021? And if you can't answer it, would you include in your answer just a general discussion of major programs, about what's baked into your guidance and what's not?

Thank you, Rich. Let me try to address your question. We have provided three-year numbers in the past and will discuss this in more detail during the January call, but I'll share some insights now. Previously, we anticipated around $3 billion in 2018, and we ended up approximately at $3.4 billion, which is a positive outcome relative to our expectations. For 2019, we're projecting at least $7 billion, which aligns with what we presented in earlier charts for 2020. This is due to significant working capital growth in both 2019 and 2020 from our new start programs. Fortunately, this coincides with two years without pension contributions, allowing us to maintain strong cash levels while increasing working capital. Looking at 2021, we expect working capital to start reversing, leading to recovery of the growth seen in previous years. While I’m not providing a specific three-year guidance number, I believe that the 2021 cash should be comparable to our cash from operations in 2019 and 2020, even with expected pension contributions exceeding $1.5 billion in 2021. We'll be recovering working capital during that time, alongside higher depreciation recovery and profit growth from increased sales. Consequently, we have a reasonable expectation to maintain the $7 billion level as we look ahead over the next three years.

I just want to follow up on that comment you just made about capital spending. And I guess I'm trying to just think about that as we project forward, how much does it increase and when does that increase stop? And is this new facility, that go with a lot of the wins that you've seen to-date? I mean, can you just characterize where that money is going?

So Sam, I'll address that. It seems like I get this question every year, and each time I indicate that next year is expected to be the peak for capital expenditures. Unfortunately, that isn't the situation now. However, I would argue that this is positive news. Next year, capital expenditures will likely be around $1.5 billion or slightly more, marking a significant increase from this year. In our 3-year planning, the capital expenditures for 2020 are actually higher than those for 2019, but they will drop relatively sharply in 2021. As a result, our free cash flow is expected to improve in 2021. You’ve pointed out correctly, Sam, that this involves the ongoing ramp-up of both buildings and tooling at Missiles and Fire Control to accommodate capacity increases for weapons and air missile defense programs. I have discussed in prior calls that we are experiencing substantial demand to boost production rates for various programs, especially in weapons but also in air missile defense. For instance, with Hellfire, we anticipate capacity requests to rise to around 11,000 per year or more. For PAC-3, we could see a request for up to 500 missiles per year. Thus, we are facing significant requests for additional capacity, which is encouraging. Furthermore, it requires capital to meet these demands, ensuring we have the capacity that will lead to growth in the future once it becomes operational. This captures what is happening at Missiles and Fire Control. At Space, we are finalizing a major infrastructure project for a new manufacturing facility for larger satellites, which will enhance efficiency in building those satellites. This should be completed in 2019. Lastly, we are also increasing both buildings and tooling at Aeronautics to support our Skunk Works or ADP programs on the West Coast. This is where much of the confidential work is being undertaken, and it requires additional infrastructure going forward. These three key areas are the reasons for the capital increases in the upcoming years. Marillyn, is there anything else I may have missed?

A question that needs to be asked right now is regarding the political situation with Saudi Arabia. Can you provide insight into what your backlog exposure is to Saudi Arabia and the UAE? Additionally, how are you assessing the current political environment and your relationship with Saudi Arabia? How do you manage that in relation to your portfolio?

Thank you for the question, Doug. I want to remind you and everyone on the call that most of our agreements are government-to-government purchases, so everything we do adheres strictly to U.S. government regulations. This applies to sales to Saudi Arabia as well. We operate in over 70 countries, and our general business model relies on government-to-government procurement. This includes the weapons sales we've discussed regarding Saudi Arabia. We continue to advance the programs we mentioned in the May 2017 announcement. For instance, we reported this quarter that our Multi-Mission Surface Combatant program with Saudi Arabia has made progress with an additional $450 million contract for detailed planning and design for their multi-mission combatant, which was already part of the contract. Moving forward, we will collaborate with the U.S. government as they continue their relationship with Saudi Arabia. Bruce, would you like to address the outlook?

Yes, I'll address that, Doug. We anticipated a question on this during the call. So far, we have had just one significant order, which was for the Multi-Mission Surface Combatant. Think of it as a more capable next-generation Littoral Combat Ship. The major order we are still waiting for is THAAD, and we are unsure of when that will occur. An interesting aspect of the THAAD order is that while it would significantly increase our backlog, the subsequent sales, profit, and cash flow from it will be delayed. This is due to a dependency on the radar, which requires a technology refresh that is years away. Therefore, even with large orders, we won't see significant sales in the near term because the missiles will arrive too soon to be supported by the radar that still needs to be updated. I believe the initial operating capability in Saudi Arabia is expected around 2023. Regarding the backlog, I don't have the exact figures, but I checked the sales projections for KSA, and we plan for about less than $0.5 billion in sales for 2019 and just under $900 million for 2020. So, there isn't a significant dependency on this activity, even though the opportunities we've outlined are much larger.

Maybe, Bruce, just following on to that. Maybe you could just update us on some of the outstanding international contracts that you're expecting maybe before the end of the year and just any levels of backlog, where you sit, that you're finishing up?

Yes. In the fourth quarter, we typically see a significant amount of domestic orders from the U.S. government, which is the first quarter of our fiscal year and often involves new funding. The largest order is the F-35 economic order quantity or block buy, which includes around 219 aircraft from lots 12, 13, and 14, for U.S. aircraft in all three variants, as well as a substantial number of international aircraft. This order alone is approaching $30.5 billion. Additionally, we expect to receive 20 aircraft from the FY '18 appropriations, contributing to our normal orders in the first quarter, including items like PAC-3 for FY '19 and likely another block buy of THAAD missiles. Overall, we anticipate growth in our backlog, which we expect will exceed $120 billion by year-end, mainly due to the F-35 block buy but not limited to that. Looking ahead to 2019, we anticipate potential orders like an F-16 for Slovakia, and out of the 24 C-130s expected, approximately 11 will be international, with 6 potentially for Germany. For now, the majority of our orders will be coming from domestic sources, including some Orion orders.

Marillyn, I wanted to come back to you, I guess ask you another political question. There's been some discussion recently about lower defense budgets for fiscal '20. I think it's like 5% or so of the decline. How do you interpret that? And do you have any insight as to what the base that may be using to step down from? And if it is some sort of contraction, how do you think Lockheed is positioned? What are the risks and opportunities we should be thinking about?

Thanks for the question, Rajeev. As we look at fiscal year 2020, the President's defense program input released earlier this year indicates a modest increase in funding levels for that year. However, we will have to wait for the presidential budget submission, which will come early next year. Historically, fiscal years 2018 and 2019 saw healthy funding, providing us and our industry counterparts with better visibility. Given our long-cycle business, we have many initiatives underway as we consider 2020. We remain aware of the Budget Control Act caps that will take effect in 2020 and 2021, and we are actively urging lawmakers to address that. They have already worked on bipartisan budget cap agreements for the past two years. We hope this trend continues, as Secretary Mattis and the Trump administration emphasized the importance of modernizing our military. I understand that the President has asked all government departments to consider a 5% reduction in spending to emphasize affordability and cost reduction. We will see how this affects the Department of Defense, which has also been vocal about the necessity of focusing on defense spending and military modernization. Currently, we anticipate a modest increase for fiscal year 2020, and it may potentially be higher due to the required modernization efforts.

Bruce, I wanted to follow up on some of your comments regarding cash and working capital. If we consider around $3.5 billion in operating cash flow this year, and not including pension contributions could bring that close to $7 billion. Additionally, your underlying operating profit growth after tax might add another $200 million or so. However, working capital will take a bit out of that. For your initial guidance, which I assume you want to be somewhat conservative, are these the main components that explain how we move from this year to next year?

Yes, I think you've summarized it well, Seth. I would just add that we will see slightly reduced cash taxes paid due to the future pension contributions we will be making during that period.

So, Bruce, I have a couple of questions for you. Regarding the F-35, you've mentioned the learning curve, and Marillyn has too, but you also achieved a significant incremental margin this quarter, the best in three years. Could you discuss how that margin might change as the learning curve flattens? I believe you mentioned it was around 24%. There may have been some unusual factors, but could you elaborate on the margin trends and what we might expect going forward? Additionally, with the volatility in equity markets, is there a specific return on assets level or underperformance that could lead to a return to ERISA contributions in 2019 and 2020?

Yes, let me address your first question. We experienced some significant step-ups or risk retirements on the F-35 in the quarter. This mainly pertains to an annual review of older production contracts that occurred in the third quarter. The largest step-ups came from LRIP 8 and LRIP 9. This involved adjusting the profit estimates from where we had previously booked them to where we expect to land at contract completion, which came to fruition this quarter. Given the size of these contracts and the difference between our previous bookings and completion estimates, this resulted in a substantial risk requirement. Looking ahead, we believe there is potential for some margin improvement in this legacy program. We achieved over the 10% ROS level for the entire program in 2018, a milestone we had targeted for a long time, and we reached it this year. There may be room for incremental improvement moving forward, but overall, the F-35 story will likely focus on volume and possibly slightly improving margins over time. Regarding pension funding and the returns it may yield, at the 1% level, this might generate a couple of hundred million dollars in funding for 2020. We previously indicated zero contributions for both 2019 and 2020, but it seems there will be a necessary contribution for 2020, which we did not anticipate when we projected the $7 billion for those years. However, we believe we can more than offset this requirement and still maintain the $7 billion figure, even with the anticipated $200 million contribution.

Marillyn, just a question from a corporate risk standpoint. I think if we were to go back several years, the expectation was that F-35 would maybe get to 20%, 25% of total sales. It seems like it's marching higher than that. I'm just wondering at what point in terms of its contribution to revenue or earnings it would become unacceptably big just in terms of contribution to the total company?

First of all, I don't believe that growth in sales is excessively large for the corporation, but we want to see it continue to sell globally as we have mentioned. We hope it develops similarly to the F-16, which we have successfully sold over 4,500 units worldwide. Currently, the F-35 program has a target of about 3,200 units, and we expect it to continue to grow at that pace. I understand your concern regarding its significant role in the corporation. However, this program has diverse support and isn't reliant on a single customer. It's a global offering, with domestic customers as well as 9 international partners and 3 foreign military sales customers. They are evaluating their fighter aircraft needs, and we believe the F-35 will emerge as the best option. It will keep selling and has a broad reach. Although it is a major program, the diverse customer base should help reduce the associated risks. Moreover, as I mentioned earlier, we are witnessing growth across all areas of our business. Every segment contributed to this quarter’s growth and will support our positive outlook for the year, helping to further mitigate reliance on any single program. Therefore, I am quite confident and look forward to seeing continued growth in F-35 sales.

Well, John, thank you very much. We're actually a little bit past the hour. With that, I'll turn it over to Marillyn for some final thoughts.

Sure. I'll conclude the call today. And I want to conclude just by reiterating that the corporation had another strong quarter, and we consider ourselves very well-positioned to deliver growth and substantial value to our customers and our stockholders as we progress towards the successful closure of 2018 and as we look ahead into 2019. So I want to thank you all again for joining us on the call today, and we look forward to speaking with you on our next earnings call in January. John, that concludes the call for today.