Lockheed Martin Corp. Q4 2008 Earnings Call Transcript

| About: Lockheed Martin (LMT)

Lockheed Martin Corp. (NYSE:LMT)

Q4 2008 Earnings Call

January 22, 2009 3:00 pm ET


Jerry Kircher – Vice President, Investor Relations

Robert Stevens – Chairman, President, CEO

Bruce Tanner – Executive Vice President, CFO


Richard Safran – Goldman Sachs

Troy Lahr – Stifel Nicolaus

Robert Springarn – Credit Suisse

Cai von Rumohr – Cowan & Company

Douglas Harned – Sanford Bernstein

[Peter Arnnet – Broadpoint Amtech]

Heidi Wood – Morgan Stanley

David Strauss – UBS


Good day and welcome everyone to the Lockheed Martin Corporation fourth quarter 2008 earnings conference call. Today's call is being recorded. At this time for opening remarks and introductions, I'd like to turn the call over to Mr. Jerry Kircher, Vice President of Investor Relations.

Jerry Kircher

Good afternoon. I'd like to welcome everyone to our fourth quarter 2008 earnings conference call. Joining me today on the call are Bob Stevens, our Chairman, President, 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. Please see today's press release and our SEC filings for a description of some of the factors that may cause actual results to vary materially from anticipated results.

We have posted charts on our web site which supplement our comments today. With that, I'd like to turn the call over to Bob.

Robert Stevens

Good afternoon everyone. I hope you've all had an opportunity to read today's earnings release and our updated 2009 guidance. As the release outlined, our internal operational performance continued at a very high level and enable the corporation to achieve record 2008 results in virtually every key financial metric. Our focus, operational tempo, quality and overall execution remain very strong.

However, the release also shows the impact external factors have had on our financial outlook. The market decline and the value of securities and the reduction in discount rates used to calculate our pension earnings have negatively impacted our 2009 earnings per share guidance.

The subject of pension accounting as an impact on our financial results is important to you, it's important to us, and a key area of our discussion today, and I've asked Bruce to provide some additional clarity and depth on pensions later on during the call.

In these times of unprecedented market turmoil, economic uncertainty and falling discount rates, at a time when it seems so difficult to make almost any judgments about the future, I want to focus my comments today on the current state of our corporation and our framework for future performance.

Ralph Heath and his aeronautics team have been performing at an exceptional level across their portfolio. On our largest program, the F-35 Joint Strike Fighter, we continue to retire risk on the development effort. The conventional and the short take off and vertical landing aircraft are progressing well through their flight test programs. The Carrier version design and development is moving forward on schedule and integration and verification of the Mission System suite continues to parallel on our cooperative avionics test bed aircraft.

This airplane continues to yield huge risk reduction benefits as we hoped it would. Production activities in Fort Worth are accelerating with all development aircraft and now the first low rate initial production aircraft in assembly. International partner participation remains solid and we're seeing additional interest by non-partner nations.

By all measures this program remains solidly on track to provide fifth generation, multi-role stealth fighter capability to meet the needs of domestic and international customers for decades to come. Each of our large aircraft production programs, the C-130J, the F16 and the F22 secured new domestic or international awards that enabled all three to extend their production lines.

Our C-130J program won new orders from India, Qatar, and the U.S. Government, solidifying production through December 2012. To accommodate new orders, we're working to double our current annual production rate; 12 to 24 aircraft in 2010. With the versatility, value and proven performance of the C-130J we've gained the confidence of our customers and we believe the future market remains bright.

The F16 program again added to the list of international customers with a new contract from Morocco. 24 countries have now chosen the F16 and this contract extended the production line through December 2012.

Our F22 Raptor program continued to demonstrate extraordinary manufacturing performance in 2008. With the fabrication of aircraft that are meeting the very highest standards of quality, delivered on schedule and on budget. We recently received funding for four additional aircraft under Lot 10 that extends the production line through February 2012.

The decision as to whether to extend the program with additional aircraft orders will be made early this year after discussions are completed along with the Department of Defense, the Congress and the Obama administration, and we'll keep you advised.

As I think of our Space Systems business, I'm enormously proud of [Joanne McGuire] and her team, having won both the GPS3 and [Gozar] competitions. These wins are a direct measure of our world class expertise in next generation satellite systems and extend our foundation for years to come. We're honored to be trusted as a partner providing these mission critical navigation and weather solution to the United States Air Force and to NOA.

Operationally, our Space segment also performed flawlessly on the successful Phoenix Mars Lander mission which captured world attention, and the extension of free ballistic missile successes to 125 consecutive launches.

I was particularly pleased with the sales growth rate and the new business win performance in our Information Systems and Global Services business. Linda Gooden's IS&GS team has led the corporation in top line sales growth since the business area was formed in 2007 and they continued that leadership position in 2008.

Their win rate was exceptional on new business awards and enabled them to close the year with a record backlog that is reflective of clear and compelling value delivery to customers. These wins resulted in an organic growth rate of 13% and solidly positions the business for strong sales growth in the future.

The program execution and performance of how focused a hall mark of the corporation, our team continually works to redouble our efforts on any programs where we might be falling short of customer expectations for any reason. As we entered 2008, we had some challenging programs that required additional efforts to achieve mission success.

Those programs included Java, the Littoral combat ship and the V871 Presidential helicopter. Great credit to due Chris Kubasik and his electronic systems team who have been working jointly and effectively with our customers by focusing on program execution. Together, we identified and implement actions that have significantly improved each of these programs. I'm proud of their efforts to restore customer satisfaction.

On Java, we implemented reliability improvements that achieved recertification of the program and new production awards. On the Littoral combat ship, we completed sea trials that demonstrated unequaled speed, maneuverability and capabilities on the first ship of this new class of naval vessel.

The maturity and performance of the ship resulted in commissioning by the United States Navy in November. In December, I had the unique opportunity to ride aboard Freedom from the United States Naval Academy in Annapolis, Maryland to its birth in Norfolk, Virginia.

My conversations with the captain and crew reinforced a universal level of enthusiasm for this ship and its capabilities and I couldn't be prouder of the team that produced this transformational vessel. We look forward to providing additional ships to the Navy to satisfy their 55 ship LCS requirement.

We also continue to have meaningful and ongoing discussions with international where expressions of interest in our ship remain high. The V871 Presidential helicopter program continues to make progress on increment one with all aircraft meeting or exceeding key performance parameters. We await a customer decision on increment two and the future production of these important assets for our nation.

Our focus on program execution means meeting our commitments to customers by completing key milestones on time and on budget while continuously improving quality and focusing on affordability. Our improved actions on these programs demonstrate our strong willingness and ability to work with our customers to correct shortfalls in program execution and get the acquisition right.

I'm encouraged with our progress in expanding our footprint in adjacent markets. I'm very pleased with our recent selection as one of the winning teams on the joint flight tactical vehicle technology demonstration competition. We believe our test vehicle experience, customer intimacy and innovative designs will be a tremendous differentiator in the future production competition.

In our ongoing M&A activities, we completed the acquisition of Universal Systems and Technology earlier this month and have included them in our 2009 outlook. Unitek provides interactive training and simulation solutions to DOD and international customers. They'll be managed within our electronic systems business and will extend our capabilities and relationship and support growing customer demand for operational readiness and training solutions.

With our long standing focus on expanding our international presence to new customers, 2008 achieved significant progress towards that goal. We successfully won a long term contract in Canada to modernize the Halifax Class Navy Frigate and its missile defense. We secured the first sale in the Middle East of the Pac 3 Missile defense system with a contract award from the United Arab Emirates.

These diverse awards demonstrate the broad spectrum of our product offerings and our ability to bring value to new international customers.

Moving beyond our operational and new business performance, we've been working hard to attract new hires and develop our work force. We continue to shape a high performance culture at Lockheed Martin by focusing on our values, strengthening diversity and inclusion, insisting on high standards for ethical conduct, and reinforcing our principals of full spectrum leadership.

For the third year in a row, Lockheed Martin was ranked by Business Week Magazine as one of the top 10 places to launch a career. The sustained recognition that Lockheed Martin is a desirable and valuable place to work continues to fuel the inflow of more than one million resumes in 2008 and enabled our company to hire over 13,000 new employees.

If we work to help our customers meet their current and future challenges, it is essential that we build a team that consists of the very best leaders and finest professional talent. World class personnel provides the skills that will enable us to raise the bar. Our operational and financial performance can build upon our momentum in delivering value to our customers and to our shareholders.

Looking into 2009, we anticipate that revenues will rebound strongly above 2008 levels with solid growth of approximately 6%. Segment operating profit is projected to exceed $5 million in 2009 positioning us to achieve that goal that established with you on last January's call. Cash flow generation is expected to remain about $4 billion and provide opportunities for further disciplined cash deployment.

In November of 2005, we discussed with you for the first time, our strategy to become the world's premier global security company. This evolution was based on our assessment of the global security environment which we saw as growing much more complex and dynamic. The very sense and definition of security for us had been changing.

Certainly, including traditional military preparedness, but expanding further into more effective counter-terrorism and intelligence capabilities, international cooperation requiring more inter-operable systems, humanitarian, peacekeeping and stability operations, homeland security and critical infrastructure protection, improved service levels with civil government agencies, more affordable logistics and sustainment and a far more expansive use of information technology and knowledge based solutions while providing vastly improved levels of network and cyber security.

We were confident we had the skills, experience and global presence to make meaningful and valued contributions across this broader horizon. Accordingly, we've been repositioning the company, growing our portfolio, diversifying the business, adding focus on core defense capabilities and electronics, aeronautics and space, while expanding systems integration skills into adjacent markets that allow us to add more value for example in surface navel vessels, rotary wing aviation and land vehicles.

You may recall in 2006 we purchased Pacific Architects and Engineer, a company with capabilities that now align very well with emerging expectations for homeland security and the application of Smart Power. We committed to higher levels of international growth which we're positioned to achieve and we made disciplined acquisitions and investments to reinforce our market presence and skills in the information sciences domain.

Why? Because expanded access to continuous high quality situational awareness will remain essential in assuring clarity and reducing uncertainty in today's environment. The very need for this increased situational awareness will drive the linkage to the increasing robust communications systems, advanced sensing devices and the computers that control them.

This capability will enable the meaningful sharing of information and networks will continue to grow in power and importance to accommodate these new linkages. The criticality of network security will become even more acute, resulting in increased demands for cyber security and encryption security solutions.

We are confident that our strategy and the world's premier global security company is the correct one. We're committed to building upon the leadership position we've established by setting high expectations, reinforcing our culture, building on world class talent and making smart and disciplined investments.

Let me next turn to an outlook for the U.S. Defense spending. The 2009 budget provided mid single digit growth above prior year levels and solid funding for our major programs. The current outlook for the fiscal '10 budget is project to provide a growth of about 2% to 3% over 2009 levels.

Despite this growth rate, we continue to believe that our revenue growth will exceed the overall BOD growth rate driven by strong expansion in our F-35 program and information technology sales. We expect continued growth in our core and adjacent markets for both domestic and international customers as we broaden our portfolio and remain committed to excellence in execution.

Before to turning to your questions, I'd like to turn the call over now to Bruce to provide some additional detail on pension accounting, cash deployment and capital structure.

Bruce Tanner

Before I begin the discussion of pensions, I wanted to briefly reinforce Bob's earlier comment about our 2008 record financial performance. By any measure, 2008 reflects the strongest financial performance in the Lockheed Martin history. Our record backlog of almost $81 billion was achieved by all four business areas growing their backlog throughout the year.

In cash from operations we generated a new all time high of over $4.4 billion. We expanded operating segment margins by 40 basis points to 11.6% and achieved record return on invested capital of 21.7%.

Based on our continuing operational performance, we increased the 2009 sales and operating segment profit guidance at our January outlook. As you've seen, these operational increases were more than offset by the negative pension impact of approximately $0.70 to the 2009 earnings per share guidance we provided in October.

The primary driver for the change was the large and rapid reduction in interest rates, particularly in the later part of December that resulted in a reduction in indices we use to determine the discount rate to value our pension liabilities. These indices declined between 130 and 150 basis points from our prior outlook, leading to reduction in our discount rate from 7.5% to 6.8%.

The return on our pension assets on the other hand, finished the year much closer to the performance at the time of the call with a negative return of just under 28% for the year. While our CAS process for 2009 were unaffected by these changes, our FAS estimates for expected in 2009 grew by $410 million, resulting in a change to our GAP earnings per share.

I think it's important to remember that in accordance with the Federal Acquisition Regulations that govern how we cost and are reimbursed on our contracts, it is our cash cost estimates that drive our cash requirements and note of profitability, not our FAS expense.

Looking forward, future pension funding obligations will be determined by a RINSA level in accordance with the Pension Protection Act. As you know, large defense contractors were exempted from the PPA funding requirements until the planned cash amortization projected to occur in either 2010 or 2011.

The effect of the cash amortization will be to accelerate cash expenses and recovery to better align with the accelerated thresholds required by the PPA. To help demonstrate this significant annual differences that occur in FAS and CAS expenses, we've included a web chart today that outlines the history of these two expense lines since the creation of Lockheed Martin in 1995.

While the chart shows the annual variability that occurred between FAS and CAS values, it also shows that the cumulative variance is relatively insignificant. FAS recognizes expense impact faster than CAS. CAS expense will lag FAS to enable the government funds to be appropriated, contracts to be negotiated and costs to be recovered on government contracts.

This variability in timing of FAS and CAS results in large annual swings, the result of non cash impact to earnings. The same factors that led to the FAS expense increase in 2009 also contributed to the reduction of equity described in our press release. I will point out that the equity change has no impact on our debt covenants and we continue to have less than $250 million of debt repayments required for the year 2012.

In the area of cash management, we ended 2008 with over $2 billion cash on our balance sheet and project continued strong cash generation in 2009 of greater than $4 billion. These strong cash levels will enable us to continue to implement our cash deployment strategy. We remain committed to returning at least half of our annual free cash flow to shareholders.

We have over $2 billion in share repurchase authority outstanding. We continue to make opportunistic purchases to return cash to shareholders and eliminate share creed.

That concludes our prepared remarks. We're now ready for questions.

Question-and-Answer Session


(Operator Instructions) Your first call comes from Richard Safran – Goldman Sachs.

Richard Safran – Goldman Sachs

I had a question on pensions. I understand your remarks Bruce of FAS/CAS impacting the income statement, but I just wanted to ask you about regarding cash contributions. You pre-funded in the fourth quarter but I did want to know if you could us any comment on what you think cash contributions are likely to be in 2009.

Bruce Tanner

The pre-fund that we did in 2008, at the end of 2008 should take care of our funding requirements for all of 2009. The only thing that could tweak that a little bit is if some of bargain units make some changes in negotiations that would result in a requirement to fund some of those changes. In any event, I wouldn't see that impacting our cash guidance that we provided to you.

Richard Safran – Goldman Sachs

If I look at your guidance, it seems to be implying flat segment operating margins, so my question is you seem to be, in deference to the remarks you were making earlier, you seem to be retiring risk on a number of programs. You seem to be guiding to flat segment margins. This leads me to think there's some other pressures in 2009. I saw where you're coming from space. So if you think I'm correct, I'm wondering if also you could tell me where you think the upside would be to margins.

Bruce Tanner

If we take a look at space, I think part of the biggest change that we see going on there is just a slightly lower level of ULA, the equity earnings associated with that. There's also some growth occurring within the Orion contract on our space transportation, the government portion there. That's growing at a lower level, so that's more of a mix issue than anything else.

I think electronic systems is fairly constant at 13%. We're guiding actually aeronautics up slightly and IS&GS is also up slightly about a tenth of a percent. We see opportunity. The thing that I always like to say at the start of a year is, I think we have the same sorts of planning at the start of 2009 as we had at 2008, and out of those risks and opportunities are relinquished and put to bed but we have some upside potential there, but they have to be done throughout the year, and we'll obviously status you that as we update you every quarter.


Your next question comes from Troy Lahr – Stifel Nicolaus.

Troy Lahr – Stifel Nicolaus

I'm wondering if you could talk a little bit about some of the adjacent markets. You've had a pretty good job of expanding into helicopters, ships, ground combat vehicles, but is there any other adjacent markets that you're trying to target for 2009, 2010, or do you just kind of penetrate deeper into some of these markets that you're already in?

Robert Stevens

I think a little of both. I think we see there can well be some opportunities in those areas where we have starts previously. For example, as a follow on to the technology demonstration segment of JLPV would be a development and production program, so we're going to evolve our design and put forward our best concepts that we're quite excited about, and I think we could see some market expansion there.

I think we've also defined a little broader aperture for what is adjacent. We thing there should be and really needs to be considerable opportunities in operation and maintenance and sustainment. If we look at the overall Defense budget in the areas where that budget has been growing and we frankly look at the relative approach to providing logistics and support, it's not a very modern information based, knowledge determined process.

And we think by adding better systems architectures here and adding better knowledge, we won't push so much inventory as much as selectively pull it and provide it to where it's needed. Think of it in terms as though we were talking about our business of producing work and profits inventory. What we think is there are lots of opportunities to align the supply chain, reduce that end process inventory and have a much more evolved, much more sophisticated, much more affordable and lower cost and highly predictable logistics and sustainment business, and that is a huge market aperture.

So some of the logistics will follow if you will our programs and some of it won't but we've made a decided effort to expand our business in that respect.

I think we define segments of the information technology market as adjacencies, and here again, I believe that to be a fairly broad market segment in which to work. We have not spoken the last words about the need for cyber security, and I alluded to that in my earlier remarks. It will become an increasingly critical aspect of every action the U.S. Government undertakes on inter-agency coordination or data sharing.

It's so very clear to so many that a real strength is in the knowledge that can be gained by sharing information rather than sequestering information and when that happens, you have to be a trusted person who can get access to the network and assure that the networks are not overly vulnerable. We think we will grow substantially there.

I think we may have mentioned in conversations an interest in overall health care, but where they focus on information technology. As we've broken down the cost, particularly in the escalating cost of health care, there is a lot of relatively low value expense because we don't have very sophisticated technology capability that can move information around and provide simply a better catalogue of your medical history and move that to the right position at the right time. We think we can make a contribution there.

Lastly, and may a little more embryonic, we're looking at the overall energy marketplace particularly with a view on how we can use our analytical skills to determine better ways to conserve energy, and we're seeing some real interest there. From the size of our business, it's relatively small today, but we think there will be continued efforts this year and we want to participate in that aspect of the market as well.


Your next question comes from Robert Springarn – Credit Suisse.

Robert Springarn – Credit Suisse

Moving to NASA, with Mike Griffin gone at this point, having stepped down, do you want to see the shuttle program expanded, and there's a part two to that question. How do you feel about the EELV potentially as a substitute for the Aries launch vehicle?

Robert Stevens

On shuttle expansion, I think it depends on what time span anybody wants to apply for a future ride. I think that probably everybody that I have ever spoken with recognizes the shuttle is a design from years ago that has been falling though its design life and it's very near retirement. I don't know if that retirement is going to be in three, five or eight years, but it's very near retirement.

So when you think of a long term national interest and commitment to space programs, particularly human space flight, I think we're all compelled to think about what's next. I'm sure that the incoming administration will be very wise and careful in their evaluation of the allocation of resources.

How much of a scare resource should be put in to sustaining the system that exists versus how much in developing the new system? Of course I think we're making very good progress on the Orion program and I think that will certainly be taken into consideration when we think about the future long term strategy toward U.S. and human space flight.

This notion of the use of an EELV launch vehicle instead of the Aries launch vehicle has been evaluated very thoroughly by NASA, and in my participation in those evaluations, the leadership of NASA has felt strongly and compellingly that the Aries launch vehicle provided the most flexibility and the most performance and that the human rate and EELV was not an inexpensive or easy thing to do.

So we've seen that data. We understand that data, and we support that overall program approach to designing, building and flying out the Aries launch vehicle. But I must say, I applaud the incoming administration for a desire to look broadly, to examine programs, to examine resources that are available and how to best allocate those resources and whether priorities ought to change.

What we want to do is participate fully, openly and transparently in talking about exactly where the programs of interest to us are, how well we're doing on them and certainly be available to answer any questions they have.

Robert Springarn – Credit Suisse

Just a clarification, or really a question for Bruce on capital spending, our understanding is that a majority of the growth in the Air Force in the fiscal '10 budget is an acceleration of R&D for F-35 plus possibly that OSD may accelerate annual production by that 27 units per year of F-35 focusing on the C-call variant probably staring fiscal '11? And I wanted to ask Bruce, what kind of capital spending does your current plan anticipate? Would you have to fund some of that acceleration yourself, and when would that start?

Bruce Tanner

I think the short answer to your question is at the funding levels that we have planned today for the next few years of F-35 productionization or facilitization at our Fort Worth facility, it has enough capacity within the funding levels that we are talking about to make those stepped up production levels that you're talking about.

Incrementally, I would not expect to see any substantive increase to the capital expenditures than we already have planned in our current outlook.


Your next question comes from Cai von Rumohr – Cowan & Company.

Cai von Rumohr – Cowan & Company

Could you give us a firm backlog at year end in units for the C-130J and the F16's and comment a little bit on your highest probability of international order potentials over the next year?

Bruce Tanner

You said F16's and C-130?

Cai von Rumohr – Cowan & Company


Bruce Tanner

F16's at the end of the year, we had a backlog of 103 aircraft. On the C-130J line we had a backlog of 86 aircraft. I'll throw our my conjecture as to what the likely candidates are for growing that and I'll let Bob fill in any details that I've missed.

The F16, I think we've talked in the past, near term events there's a Romanian buy potentially. There is a Taiwan buy and I think the Romanian buy is 12 to 24 aircraft, Taiwan more in the 66 aircraft number. But the longer objective down the road of course is the India competition for the MMRCA which is 126 aircraft.

And we still believe there is an opportunity to sell some within the Middle East. Maybe somewhat surprisingly to you, we think there's some additional sales potential, not additional but new sales to Iraq, and there's potential for additional sales to the government of Egypt. So those are probably again in the 12 to 24 aircraft, the later two I would say.

Relative to the C-130's, really we've got large numbers of domestic C-130's that are still yet to be placed on order with us. Internationally there is still a number of I'll say Middle Eastern countries that are looking to replace not huge quantities, but a few here or there. Israel is particularly one that could buy between four and six I believe. Australia is probably in the four's or so of their consideration.

But the biggest opportunity that we face that we have the opportunity to achieve in C-130 sales is actually the U.S. government going forward.

Robert Stevens

Just a sort of simple thought, on the F16 program, let me say it this way, I think demand is obviously narrow, but there are 24 countries that fly the airplane. Bruce highlighted this specific area.

It is possible because 24 countries and air forces buy the airplane there could be some replenishment or replacement aircraft that would unfold over the next few years. But as I said, it's a contained universe we think on the F16 other than those campaigns that Bruce highlighted.

That world is very different on the C-130. It is a very broad global market where overall for priority on airlifts is huge, and there is no better proven tactical air lifter on the planet than the C-130J. It's met all its performance parameters. The customers who have it are hugely pleased with its overall performance, and I would cite, you know it's hard to develop these kinds of airplanes and insert them into tactical operations.

We're probably seeing part of that story unfold with the A400M which was intended to compete for part of the market segment that a C-130 would have. So given just the high performance nature of the airplane, the great interest in assuring that each country can contribute to the mission, the difficulties that other potential competitors are having in the market segment, I think we're going to see broad and even a resurgent strength in C-130 interest.

Cai von Rumohr – Cowan & Company

On the Rabbi Trust, you had a large loss last year. Could you tell us the size of the trust, the asset allocation and whether losses and gains are tax deductible or not?

Bruce Tanner

I think for Rabbi Trust you add all the pieces and somewhere in there, it's a little bit north of $.5 billion, in the $500 million to $600 million range. Asset allocation I would say is very similar to what we have in our defined benefit Master Retirement Trust, not a whole lot different than what we experienced there.

As far as the tax deductible, in particular for the Rabbi that occurred in 2008, those are primarily unrealized losses and at this stage they are not deductible.


Your next question comes from Douglas Harned – Sanford Bernstein.

Douglas Harned – Sanford Bernstein

You've painted a very positive picture in terms of the outlook for the company. If you look out the next three years, what would be the three things you would see as the largest risk to performance, and how are you spending your time? How are you focusing you time these days when you consider that?

Robert Stevens

That is where I focus most of my time and most of my attention. We have got to execute against the commitments that we make to our customers and we have to do that every day on every program. That's a commitment that we make and we take that commitment very seriously.

There are programs that we are engaged in now that to us either have operational or strategic significance in addition to having very considerable customer significance. Obviously the F-35 program falls into that category. Because it is a program that will be used by three services in the United States, eight partner countries today and we think the long term potential of that program is about to exceed the potential that we've seen in the F16 program. So very obviously getting that right is important.

But we also have sufficient resources in the corporation to make sure that we get other programs right. I personally am excited about the Littoral Combat Ship. I have ridden on this ship. I've stood on the deck at 47.2 knots and seen this ship do things ships don't do. And it is a game changer strategically and tactically for the United States Navy, and I believe that demand for this ship will be superior.

So our job here is to focus on execution. Probably think in expanding the definition of execution or re-emphasizing the affordability part of that, because very clearly what we see in the global capital markets is a desire to have sufficient stimulus and fiscal policy to reinvigorate the economy.

It also means that there will be pressure on funding, and we're very aware of that. And yet we can't take a step to the side or back on assuring the nation's security and reinforcing the relationships we have with allies. So that means a considered effort on our part to think about affordability to help our customers be strategic buyers and deliver for them value where they rightfully expect that.

I think as we watch markets unfold, we want to make sure our missile defense capabilities are right particularly in the terminal phase with a bad program PAC3 and I think we have three excellent programs there. When we look at risks around the world we see those threat proliferating faster.

You probably don't have to do more than pick up a newspaper today and read about the proliferation of those threats so we want to get that right. It's sort of a separate category of strategic things to think about.

We need talent in this business and I'm hugely pleased with the position that the company has today of being a highly desired place with the best and brightest people who want to come to work. So the confluence now of years and years of careful attention is building a leadership model that all of us aspire to, to assuring that we have a company that is open and inclusive such that when you bring your A game here, you get playing time, and if you do well you can do more, and you can reach personal aspirations and professional aspirations.

That is a very contagious part of the culture here and we are really surrounded and actually quite blessed to have colleagues who are very excited, very focused on the mission, understand their connectivity to our customers and want to do a good job. And quite candidly, they understand that doing a good job means returning value to shareholders and they intend to do that as well.

Douglas Harned – Sanford Bernstein

One of the areas that you mentioned at the outset was also cyber security. Can you dimension how large that could be for the company in terms of revenue say within the next three years? What order of magnitude are we looking at?

Robert Stevens

Actually it's very difficult for me to do that and let me tell you why. Already in much of our information technology work, you get an element of cyber security. It might be an intrusion protection capability or a prophylactic that allows a network to remain secure and less easy to penetrate.

Or, redundancies such that if there were a denial of service attack that the network could repopulate itself. The system would sail over easily. So we already have I think a significant portfolio of those capabilities.

What I think will happen is the tempo and the criticality of assuring that all new systems that go into place have these capabilities and all rated system be brought up to this standard is an absolute imperative. And the reason for that is, networks fail at their most vulnerable linkage and it's all the nodes and all the productivity. It's a very different model and some overall models for security have.

Networks behave the way they do, and I think to have any assurance that we're providing sound security solutions in these networks means that you've got to in and invest yourself and build the new networks outright, and I think there will more business. It's very hard for me to have it segregated out of revenue today.


Your next question comes from [Peter Arnnet – Broadpoint Amtak]

[Peter Arnnet – Broadpoint Amtak]

Congratulations on a nice 2009. The Department of Defense is getting ready for their QDR next month and there's been a lot of calls of rebalancing the DOD's long term budget plan. How should we think about that in affecting Lockheed Martin?

Robert Stevens

We look forward to QDR. We think it's a very healthy examination. It's very difficult for you and frankly for us to get any visibility about what makes sense if you don't follow a strategy, you don't have some sense of in the case of the QDR, what the global threats look like. If there's anything that we've learned it's that the velocity and dynamic range of threats is simply increasing.

It used to be months or years, and then it was weeks, and then its days, and now it's even less. And so it's healthy to pause and take an examination of exactly what threats are out there. And then we'll have to collectively determine how technology can play a role in meeting those threats.

How much core structure will we need? What will the assumptions be about Iraq, about Afghanistan, about other critical and sensitive places around the world. Do we want to prepare for two theaters, one theater? How broadly, how deeply? Those are the most healthy discussions that I think that we can engage in.

And from that, I think will unfold the prioritization across the portfolio. But I say that with some confidence because I do believe we've been as careful as we can be working internal with our company and with the prior administration about understanding threats and securities.

And I think that's not a political dimension. I don't think it's a party affiliation. I think threats tend to have persistence and I think we've got most of the analysis right. And while some of the priorities will change most of investments that we've made, most of the lines of business that we've crafted, all of our acquisitions have led to focusing on what are the most enduring national imperative critical missionaries because that's what fuels our business. That's what gets our folks excited.

So I actually think that there will be pretty strong core relations between what we've been doing up to now and what we will have to do next. There will very obviously be specific program discussions like, will there be for F22's? That's a healthy conversation to have. We have our views about that program. Others have their views.

We ought to have that discussion in the open. We ought to weight the strength and the weaknesses, make decisions and move forward. I'm very confident we'll be able to do that.

[Peter Arnnet – Broadpoint Amtak]

You mentioned F-35 as retiring a lot of risk, how should we think about that margin progression throughout this year and maybe heading into 2010?

Bruce Tanner

We do see some margin. We are planning for some margin improvement on the F-35 program. We've really got kind of a two pronged approach that's benefiting there. One is we do have some expectations that the FCD program itself will retire enough risk to justify some level of step up there, and those will justify that include obviously the first flight of the STOVL aircraft in the STOVL mode probably later in the first half of this year.

Then completion of the aircraft, and also the first flight of the Navy there, the CD as well call it. I think that will allow that.

The other prong that's attributing to that margin improvement is just the introduction of greater lower initial production volume which is bringing with it slightly higher margins than the FCD contract.


Your next question comes from Heidi Wood – Morgan Stanley.

Heidi Wood – Morgan Stanley

I have a split question between Bob and Bruce. I wanted to ask about international. Can you talk to us about the international sales in 2008 by division? Remind us what percentage of your backlog is in international right now and what you expect sales growth to look like international in 2009?

Bruce Tanner

Let me start of first with the backlog percent of international business. What we have as you might expect given the level of sales, we have slightly higher than 15% of backlog is made up of international contracts. It actually grew at a faster clip in 2008 than did the sales, and we're happy about that.

As far as by business area, I think you well know the biggest two areas where we have international activity is the electronic systems business area which is probably approaching 30% of the volume within electronic systems. And in the aeronautics business which is somewhere in the 22% to 23% range or so there.

And then as far as growth going forward, I think you're going to see growth in international business in electronic systems. It's probably going to be at a higher clip than I'll say the mid single digit level that electronic systems is growing at as a business area in total.

And in aeronautics, near term probably some slight reduction just because that 35 will be growing at a much faster clip, obviously a huge step up from the U.S. Government portion of the business. With some of the orders I talked about previously with the F16 and C-130, that will contribute to higher international dollars but much of the percentage will go up simply because it will be kind of overwhelmed by the F-35.

Heidi Wood – Morgan Stanley

I can't do the math on the moving parts fast enough, but what does that put international sales content in '08 and where does it go in '09?

Bruce Tanner

I think international sales in '08 were greater than $6 billion. I think it was in the 14%, 15% range and I think at least for 2009, it's probably going to be a similar percentage. So whatever that works out to be on our sales guidance, it's pretty close to that.

Heidi Wood – Morgan Stanley

And you're not talking about lift in margins at ES even though now you've secured the UEA tax treaty and it looks like you're going to get that in a quarter or two from now. I know those will be small, but won't those provide some amount of lift over the next two years.

Bruce Tanner

Think of both FAS and PAC 3 as being delivery based contracts, not too different from delivery based contracts that we have in aeronautics, but they're a little shorter duration, but typically think of them as about an 18 month cycle from the award to actually deliver the product. The awards that we were awarded last year will actually not have a sales value in 2009.

Heidi Wood – Morgan Stanley

Bob, on international from your perspective when you think about the skyline over the next couple of years, how much of your forecast for sales growth includes Middle East and how does it change in oil price kind of alter your plans with respect to Middle East demand the next couple of years?

Robert Stevens

Actually not very much, and I'll tell you why. It's one of those environments where if you've got oil and the price is low now, you got oil, and you also have a vulnerability, and you will protect that vulnerability. And the need to protect those vulnerabilities really drives the desire for security systems.

I'm looking at about five or six areas of where in the near, intermediate, maybe longer term, we're probably going to see lots of interest across our portfolio. First in airplanes. I think the F-35 will continue to have real appeal for international customers because it gives them a leveraged advantage from being connected. There's so much more information technology that that airplane lets you connect to.

So you're inter-operable. You're already inter-connected and you're getting a fifth generation superior performance aircraft. I also think the C-130J falls into that category as we've already discussed.

Separately, missile defense systems. Those are one of the highest proliferating threats out there. You see it every day and almost anyone who has anything to protect is going to want to invest in some version of PAC 3 FAD Egis, or a command and control systems that allow you to link that with your air traffic management system or other things as we have superior expertise along those lines.

A little long out, but not that far out, I think protection of the Littoral and the Littoral combat ship is going to be of huge interest. Think pilots in the Gulf of Aidan, and I guarantee you haven't ridden on this ship, there won't be any more pirates in the Gulf of Aidan because it's a 377 foot cigar boat that will run down anything else on the sea.

On land vehicles, we're probably a couple of steps away here, but I really like our concepts for the joint life tactical vehicle, and I think that vehicle has legs not just for the U.S. forces but opens up an international aperture for the company, as does our logistics and supply chain management and services businesses because talent is a constraint strategically not just for the company, but for governments around the world.

We can start doing work freeing up levels of talent for our partner governments internationally. That's a very appealing construct and of course we can now provide a much full array of turn-key solutions for logistics, and I think you'll see the same thing in services and technologies.

So there are multiple apertures in our company in the intermediate and longer term for us to look for expansion and growth.

Heidi Wood – Morgan Stanley

You touched on opportunities within Linda Gooden's world, but does the focus of the Obama administration on both smart stealth and diplomacy and working with allies portend that maybe in the quest for heightened global security, give more opportunities overseas?

Robert Stevens

I'm sorry I didn't do a better job on that in the remarks that we offered. I highlighted PA&E because I think they fit right in the sweet part on smart power. That was a judgment you know we made in 2006. In this strategic assessment that we did in the changing definition of global security and our changed strategy to be that global security company, we saw very clearly that there was a huge appetite in global demand for the United States to take this prodigious power and influence that we have and express it in ways other than militarily.

And I think that absolutely now unfolding in the policy discussion that we're hearing, and I think Linda's business is supremely well positioned to contribute right now to this evolving missionary.


Your next question comes from David Strauss – UBS.

David Strauss – UBS

The FY10 budget, when do you think we'll see that? When do you expect the 10 process to play out here?

Robert Stevens

Well I know the Obama administration has been in place now a day, maybe two whole days so I think all of us ought to give them enough time. Probably what we will see is somewhere around February 13 might be a day you'd keep in mind. We'll see what actually is quite a traditional view of sending up top line agency numbers.

Now, I'll go backwards a little bit and see if we can put flesh on this. The '09 base budget was about $512 billion and the former administration was looking at about a 1% to 2% growth in that to about $524 billion, and then in discussions, that $524 billion actually went up to about $581 billion.

I think it's just fair game to ask and permit the incoming administration to look at that and see what they want to do in sculpting that top line. It may not be $581 billion. It may well be something less than that. They will also need to look at the op tempo in Iraq and make some critical judgments about supplementals which I know they will want to do.

So I think the preliminary top line sort of organizing principals will go up in February and the probably in the April/May time, we'll start seeing more flesh about priorities, judgments and funding, and I know all that will unfold against the backdrop of this discussion that we're all feeling about what's the appropriate stimulus package.

So this sending up the budget in February with the top line is very typical in a transitional environment. What's atypical is the desire to focus on the economic stimulus. I'm certain there will be some discussions about how much of the Fed's budget will in fact have the core and additional benefit of having the stimulus effect. All of that will be good and welcome and we'll keep you posted as we learn more about it as it unfolds in real time.

David Strauss – UBS

Directionally, the pension as we think about it beyond 2009 into 2010 assuming that the discount rate doesn't really move and you hit your assumed rate of return, is it fair to think about the FAS adjustment in 2010 would actually be higher than 2009?

Bruce Tanner

Let me start by saying that the one thing I'm glad about our FAS/CAS is that for all the variability that we've had getting to this point, at least I know it's locked down in 2009, and for that I'm extremely happy.

As we take a look at 2010, as you well know, and I heard your questions, but as you well know the rates can change dramatically between now and the end of the year. FAS returns have yet to be played out. The piece that gives me a little pause to answer your question, I don't know what's going to happen. That kind of affects FAS more so than CAS.

The wild card today that could affect 2010 is the CAS amortization that I mentioned. Those discussions will take place throughout 2009 and they could have a substantial impact whether they close and therefore are affected in the year 2010 or affected in the year 2011. And because of that variability, I'm just hesitant at this time to even guess what that's going to look like in 2010.

We're going to provide as soon as we know it updated evaluation of what is happening with the cash amortization process going forward.

Robert Stevens

Let me end by reiterating the corporation has been performing at a very high operational level and we intend to continue to do so. We have a record portfolio of long term work, solid balance sheet, excellent cash flows and sound credit rating. All of these provide a solid foundation that has us well positioned to weather the unprecedented financial turmoil in the marketplace.

Our financial strength and market position has provided the stability to remain on the operational and financial course we believe will generate solid returns for our shareholders in this challenging period.

I want to end by thanking our 146,000 employees. This world class team has enabled Lockheed Martin to achieve [audio ends].

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