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Lockheed Martin Corporation (NYSE:LMT)

Q4 FY07 Earnings Call

January 24, 2008, 3:00 PM ET

Executives

Jerry Kircher - VP of IR

Robert J. Stevens - Chairman, President, and CEO

Bruce L. Tanner - CFO and EVP

Analysts

Heidi Wood - Morgan Stanley

Steve Binder - Bear Stearns

Troy J. Lahr - Stifel Nicolaus

Robert Spingarn - Credit Suisse Securities

Robert Stallard - Banc of America Securities

Myles Walton - Oppenheimer & Co

Joseph B. Nadol III - JP Morgan

David Gremmels - Thomas Weisel Partners

Douglas Harned - Sanford Bernstein

Cai Von Rumohr - Cowen and Company

Howard Rubel - Jefferies & Co.

George Shapiro - Citigroup

Operator

Good day everyone and welcome to the Lockheed Martin's Fourth Quarter and Year-End Earnings Results Conference Call. Today's call is being recorded. At this time for opening remarks and introductions I would like to turn the call over to Mr. Jerry Kircher, Vice President of Investor Relations. Please go ahead sir.

Jerry Kircher - Vice President of Investor Relations

Thank you Dana and good afternoon everyone. I would like to welcome you to our fourth quarter 2007 earnings conference call. Joining me today on the call are Bob Stevens, our Chairman, President and Chief Executive Officer; and Bruce Tanner, our Executive Vice President and Chief Financial Officer. Statements made in today's call that are not historical facts are considered forward-looking statements and are made pursuant to the Safe Harbor provisions of Federal Securities Law. Actual results may defer. Please see today's press release and our SEC filings for a description of some of the factors that may cause actual results to vary materially from anticipated results. We have posted charts on our website which supplement our comments today. And with that I would like to turn the call over to Bob.

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Thanks Jerry. Good afternoon everyone. I certainly hope 2007 was rewarding for you and your family and that you all were able to enjoy your holidays. And I hope you, like us are looking forward to a prosperous 2008. We were pleased with our performance in 2007 and as I start the call today, I want to give credit where credit is due and begin by thanking our 140,000 employees and their leadership team. It's through their professionalism, their dedication, their talent, and their extraordinary capabilities that we were able to provide mission critical products and services to our customers, while achieving outstanding financial performance. As you would expect, I am very proud to be associated with this team.

And looking at 2007, our overall program execution was solid, we won important new business, and we continue to shape a balanced business portfolio designed to enhance shareholder value while meeting current and future customer needs. Let me spend a moment on each of these areas.

Program execution continues to be a top priority and focus for all of us. It's essential for customer mission success and it's essential to our ability to extend value. Our goal while challenging is to meet every commitment, on every program, for every customer by completing key milestones on time and on budget and providing continuously improving quality.

The professional standards against which we measure ourselves here is perfection. And when we do not meet that standard and sometimes we don't, all energies are devoted to an objective understanding as to why, whatever the source and to addressing the root causes with effective remedial action. We believe we have the experience, the talent, and the commitment to assure continues improvement in meeting expectations. As a result, we had thousands of successful operational achievements across all business areas in 2007, I will highlight just a few.

We made continued progress on the F-35 Joint Strike Fighter development program with completion of 22 test flights of the conventional take off and landing aircrafts. In addition we achieved production roll out in December of the short take off and vertical landing variant with the Stovall airplane, reflecting on time achievements of a key commitment date.

We are confident this 5th generation tactical combat aircraft will serve our country and our allies well for decades to come. Also in aeronautics the U.S. Air Force declared full operational capability for the F-22 Raptor, the world's only fielded 5th generation fighter aircraft. In electronic systems, we had a series of successful tests of THAAD, PAC-3 and the AEGIS missile defense program. I am certain that solid operational performance also acts as an important catalyst in our ability to win new business.

Customers have confidence in our capabilities and that confidence enabled us to achieve the second highest annual level of new order bookings in the history of our company. This booking level resulted in a near record backlog at year-end of almost $77 billion. We believe this new business success is a result of effectively listening to our customers, a continuous drive for innovation and responsiveness, superior program execution, and our ability to leverage our experience and our skills through capabilities alignment and horizontal integration across this corporation. Examples of our new business success included the multi-year contract in the United States Air Force for 60 F-22 fighter aircraft to extend the production line to 2011.

The first F-35 Joint Strike Fighter low rate initial production contract and long lead funding of the second, international C-130J awards from Canada and Norway that extend the production line to 2011, a 10 year $1 billion contract to train U.S. Air Force with special operation command crews on a variety of military and weapon system, international F-16 awards from Turkey and Pakistan that extend the production line to 2012, $1 billion multiyear contract from the United States Navy to integrate the MH-60 Romeo helicopter system, and $850 million contract from the U.S. Navy for production and support on the Trident II D5 fleet Ballistic Missile and civil information outsourcing contracts with the internal revenue service The FBI, The General Services Administration and the Army Corps of Engineers.

In addition to solid performance and key new business awards, we continue to enhance our business portfolio through acquisitions. During 2007, we completed four transactions. These acquisitions have already provided strategic benefits in securing new technologies and providing expansion of our capabilities and new customer access. This brings our total completed transaction since 2001 to 19. We are confident that those that were closed in 2007 will provide the same positive value to shareholders that previous acquisitions provided.

During 2007 we saw significant new opportunities emerge in the international marketplace in our traditional lines of business, such as fighter and transport aircraft and missile defense systems. We also made significant progress into new adjacent business activity such as logistics and sustainment, biometrics, business process solutions, and support for peacekeeping and nation building efforts.

We also remain dedicated to fostering an inclusive workplace environment where opportunity exists for those with talent and commitment. It's very gratifying to receive recognitions, that Lockheed Martin is a desirable and valued place to work. We received more than one million resumes in 2007 and the Company was slated again by Business Week magazine as a great place to launch professional career.

Additionally, the Hay Group in conjunction with CEO magazine and Hewitt Associates in conjunction with Fortune magazine recognized Lockheed Martin for outstanding leadership development programs. This is important to us because to have a business that builds upon the momentum that we have established raises the bar on performance and meets the expanding challenges our customers are facing, requires the very best in talent, and the very finest in leaders. Sustained long-term success depends upon it and we are committed to developing both as we continue make to progress on our strategy to differentiate Lockheed Martin among competitors, to diversify our business, and to deliver for our customers and for our shareholders.

Looking ahead to 2008 and as outlined in our increased guidance, we anticipate strong growth in our recurring earnings per share, continued growth in revenue and margin, and excellent cash generation. Let me describe for you our general sense of the overall market and our vision for the future as we look at 2008 and beyond. Long-term there are many signs of continuing complexity and uncertainty in the global security environment which will drive future demands for highly capable military power, strengthen home land security, and importantly further initiatives aimed at international outreach, diplomacy, humanitarian relief, and support for emerging democracies.

We see a growing desire in civil government agencies to have more efficient and effective services provided to citizens. We see a growing international interest in security and how our capabilities, products, and services can play a vital role. To reduce uncertainty and gain clarity all our customers are facing the need for increased situational awareness through advanced sensing devices that will be linked to communication systems that enable them to share information and to be always connected. With data everywhere, networks will continue to grow an importance in power and unfortunately in their vulnerability as well as, the corruption of information will be increasingly viewed as a weapon in the 21st century.

We have the experience, skills, and breadth in our portfolio to contribute significantly to the need in this environment. Looking at funding the current fiscal year 2008 defense budget was enacted at $481 billion reflecting a double-digit increase in annual funding. The investment account in this budget were funded at $176 billion also reflecting a double-digit annual increase. Additionally, supplemental appropriations of $189 billion have been requested to primarily fund the operations in Iraq and Afghanistan with budget approval yet to be enacted.

Looking forward the President's proposed 2009 fiscal year budget for defense will be delivered to the Congress in February. It's likely to be at least $513 billion which is consistent with the President's prior projection. Investment accounts here are projected to be about $188 billion also consistent with the earlier request. The FY09 supplemental appropriations request has had an initial place holder value of $50 billion. However, the administration is awaiting the next report from General Petraeus on progress in Iraq before determining the final amount for the FY09 supplemental appropriations.

Based on all that we see, we expect continued growth in both our core and adjacent markets for both domestic and international customers. As, we grow we anticipate an increasingly diversified customer portfolio with increasing levels of international and civil government sale. We'll continue to expand our addressable government market in three ways by focusing on customers we know and utilizing capabilities we now possess, by extending value to our customers in offering new capabilities and by developing new customer relationships.

Looking, specifically at our business areas we want our electronic systems business to grow domestic and international sales in areas such as missile defense with the Patriot and THAAD systems in missile and fire control systems on programs such as HELLFIRE the guided multiple launch rocket system, Sniper and THAAD in maritime systems such as Ejects [ph], and in platforms and training with system integration on helicopters and military vehicles. Growth also will come from continued creative approaches to adjacent markets and our focus here is on the Joint Light Tactical Vehicle program. We want our information systems in global services business to continue their growth in government information technology, related to our traditional areas of defense, intelligence, and civil agencies and new focus areas such as healthcare. In our global services business focus will be placed on homeland security with solutions for port security and cargo tracking coupled with anticipated growth in infrastructure, peace keeping, and nation building activities.

In our space business, we expect future revenues to be driven by the government satellite market in opportunities like GPS III, additional advanced VHF spacecrafts, POES and the GOES-R Environmental Satellite Systems. Our ramp up on the Orion Crew Exploration Vehicle and potential space exploration missions for NASA will also provide additional opportunities for revenue expansion.

Looking at Aeronautics, as we previously indicated we expect sales growth to hit a low point in 2008 reflecting the reduction of F-16 deliveries. However sales growth resumption is expected in 2009, driven by the ramp up on the F-35 Joint Strike Fighter, continued C130J and F-22 production in increasing levels of sustainment and logistics activities.

We will continue to pursue balanced cash deployment, returning at least half of our annual free cash flow to shareholders, while using remaining cash flow to pursue internal technology initiatives, capital projects and acquisitions that will add to productivity and expand our capabilities. In addition, we have a share repurchase authority in excess of $3 billion that will enable us to make opportunistic purchases to eliminate share creed and return cash to shareholders.

Acquisitions will remain an important component of our strategy to built value in our portfolio and our philosophy on acquisitions remains unchanged. We would have an interest in companies with the right expertise, a good fit, and compelling value. As we continue to grow our sales organically and through acquisitions, we are also focused on ways to continue to expand our margin. We are pleased to report that we've already achieved one of the two goals that we outlined for you during our earnings call last January. In 2007, segment operating margins increased to 11.2%, achieving our goal of 100 basis point increase above 2006 level, ahead of our previously projected target date.

We continue to see opportunities for additional margin expansion by successfully transitioning development programs to production, improving program performance, and adding higher margin international business. We are also accelerating our commitment to achieve the second goal. We now project achievement of our $5 billion in segment operating profits objective, one year earlier than previously forecast with a new target date of 2009. In addition through our continued focus on operating profit generation and margin expansion, we remain committed to strong cash generation and industry leading returns on invested capital. Our prior goal to sustain ROIC performance in the 15% to 20% range remains unchanged.

We believe that the keys to our future success are very simple and straight forward, continuous development of critical competencies, attracting and retaining top employee talent, ensuring alignment of management shareholder interest, listening to our customers, driving innovation, leveraging horizontally integration, and deploying cash wisely. Dana, that concludes our brief summary of '07 and our outlook for 2008. So, if you will open the lines please, Bruce and Jerry and myself are ready to take questions.

Question And Answer

Operator

Thank you sir. [Operator Instructions]. We will first go to Heidi Wood with Morgan Stanley.

Heidi Wood - Morgan Stanley

Good morning Bob. Thanks very much for your brief. That was great. I'm going to ask though a devils advocate question for you. You continue to take in a number of noteworthy wins the last few years, again in 2007 but we have also been seeing a number problem program surfacing, I'm wondering if you could talk about the corrective actions you're taking within your organization. I know you referred to the personnel but perhaps talk about tease and fees on the contract and are there are any common threads that you see that might link things like cibers [ph] and JAS [ph] and then LCS and VH-76 that could be important lessons learned and which problem programs are you spending the bulk of your time on?

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Thanks Heidi, I appreciate the question. I must tell you, we spend a considerable amount of our time and attention on all of the 3,000 programs. We don't really select them on which programs and which customers are going to get the best professional performance in the company. We pay attention to all program performance but I do know what you're speaking of in your question. There are some high visibility, marked key programs that we are all very familiar with. You might add to that list the VH-71 Presidential Helicopter or the Littoral Combat Ship. You mentioned cibers [ph]; I'm pleased to report than in the company with more than 3,000 programs, we don't have a great number of these high visibility programs. I'm also recognizing that even having even one of those programs is one too many.

It's interesting to me that, when as your question frame, you look at what might be common properties here. Our observation is that most of the difficulties in execution on a program seem to reside in those that fall into the development portfolio as compared to the production portfolio. And development program have characteristics in common, among them is assuring that even in the very early stages of the programs formulation that the requirements are well understood, that customers know what they want to buy, and that industry understands completely what it needs to deliver, not just what the contract terms and conditions are, but what the customer's expectation is, particularly aligning the system that's being delivered to the concept of operations in which it will be employed.

And I think one of the common themes as we look at our portfolio, as to where there have been stress points, is this common notion of the developmental character of the system. I will also tell you a second independent area, but it's entirely unrelated to development is this aspirational goal that many have had, about the use of non-developmental items or commercially available off the shelf items, that would be applied to, let me say, very sophisticated military or intelligence gathering applications. Because it seems to me that there is a desire, a very understandable desire, to want field systems more quickly and want to more economically use scarce capital resources in the acquisition environment. And that makes non-developmental or commercial... commercially available items appear very appealing. But sometimes after the contract is led, a view is taken of the capabilities embedded in these systems with the desire to add some facility to them and we find some stress points associated with having a clear understanding there of what's expected and how to efficiently take non-development items and commercially available products and cater to them appropriately for the demands and the rigors of very demanding military applications. I will tell you, we are strongest, when we go back to basics.

When we follow the processes in our environment, when we have early visibility, when we have complete transparency and when we work in close co-operation and good partnership with our customers. When our programs have those features, even the very demanding ones, we tend to perform in a more superior way and when those features are lacking, we tend to have stress points.

Heidi Wood - Morgan Stanley

Okay. Great and Bob as my follow-up, you've spoken about making Lockheed a global security company, you talked today about expanding international sales. Looking ahead, can you give us a sense where international sales can go in '08 and through the rest of the decade and maybe outline the major competitions internationally that moved the needle and how you are focusing your team to fully capitalize on those international opportunities and maybe Bruce if you have it handy, tell us where international sales were in '07?

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Let me come back to Bruce and I will just give you sort of cap stone, sense of what we see and where we would like to make some advances, and of course our commitment here is to grow our international business along with our entire business, but to grow the proportion of revenue generated from international sales from about 14% or so to about 20% or so and we would like to do that as soon as possible. I think our aeronautics lines of business continue to offer real opportunities here with the Joint Strike Fighter, I know it's in development but we do have eight partner countries and so far there is considerable international interest here and happily, I can report to you that the program is meeting critical milestones, and running pretty well.

We continue to see a broad interest in the C-130J program internationally. I mentioned Norway and Canada as recent customers. But there certainly additional opportunities in our judgment with the increasing number of countries some of whom already have the C-130J and for some the C-130J would be new. So we're looking forward there and I don't think the F-16 story is over yet, although, as you look at aeronautics revenue, you see the number of airplanes in the F-16 delivery line coming down, there's still interest in that system.

We have a full array of missile defense capabilities. As protecting a homeland or protecting troops that are forward deployed, it's a very high priority for governments. I think we have a superb portfolio in Patriot, MEADS, THAAD, the AEGIS system, that add real muscularity to a missile defense environment. I also think in our missiles and fire control segment, we have quite a broad variety of military capabilities, that governments have interest in, including sniper, Lantran [ph] and THAAD. I mentioned the guide of Multiple Launch Rocket System, HELLFIRE, ATACMS [ph]. We have radar programs from our electronics systems business area.

In the United Kingdom, there will be a search and rescue helicopter program, in the United Kingdom there will be a census program, so I do not feel that we have a shortage of opportunities internationally. Actually, I think the domestic opportunity horizon looks very good. But your question was specifically on international business and I'll ask Bruce to comment on the '07 international sale.

Bruce L. Tanner - Chief Financial Officer and Executive Vice President

Heidi we did just over about $6 billion for the year ending in 2007, but roughly 15% of sales.

Operator

And we'll take our next question from Steven Binder with Bear Stearns.

Steve Binder - Bear Stearns

Yeah, Bob. If you can just touch on the F-22, there has been talk in the FY09 budget, given the fact you are hoping to get advance procurement money for another twenty planes, it looks like they might just fund four planes. But they are going to do that as a supplemental. Assuming that's true, what's the prospects for, do you think, extending the line -- from getting money from Congress this year in the core budget, and how important an issue is it to get money out of the core budget as opposed to the supplemental for that plane.

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Well, I'll tell you Steve, our focus has, I think, understandably and properly been on delivering very high quality jets and we are certainly doing that. It's of interest to us that we're starting to see the harder facts of what is generally regarded as an ageing fleet with high operational tempo. And we certainly saw that in the pair of F-15 failures and we don't find that to be entirely unique because it's embedded in the phenomenology of how airplanes age and fail. So, our sense is, the operational tempo is not likely to diminish in the foreseeable future.

The assets that are fielded are getting older and they are starting to move into the higher regions of their expected service life. And we've worked long and hard in conjunction with our customers to get the F-22 line, to balance and cycle and get the supply chain to run effectively and efficiently and I assure you it is. And a person like me looks at shutting down a line that has taken a good deal of time to bring to this configuration with real reluctance because there will never be a less expensive F-22 than the ones we can buy off an active line that's meeting its learning curve objectives with incredibly high quality, incredibly high performance jet. And I think the convergence of the ageing F-15, the demands in the operational tempo, the evolutional of the trust, and the quality of this line are creating a fairly compelling dialogue that's occurring in the Pentagon and on Capital Hill.

I know you know there is not a perfect uniformity abuse here but we think it's a very healthy dialogue. Whether or not the program is extended is certainly not a decision that we make and whether or not it is funded out of supplemental appropriations or out of core budget appropriations is a decision others will make. Our job is to make sure that, that option remains open and that the jets that would be purchased would be performing to expectation. So, I guess our sense is this prospect is looking more likely rather than less likely for the conditions I outlined.

Steve Binder - Bear Stearns

Thank you. And can you maybe just touch on the F-35 and your confidence level of achieving first flight in the major timeframe.

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Well, that's certainly is the plan we are tracking to. We made the roll out on schedule on the STOVL aircraft in December. That was a long standing commitment, that was actually reinforced very strongly by Deputy Secretary of Defense, Gordon, England with us as an expectations that he had and we took that expectation seriously and we were able through the very good work of our Aeronautics team and our partners, to produce and deliver the airplane on time. So, we are tracking there and of course AA1 is flying and we are gaining a lot of flight information on the first airplane, the conventional take-off version. So, so far that objective looks achievable, Steve.

Operator

And we'll take our next question from Troy Lahr of Stifel Nicolaus.

Troy J. Lahr - Stifel Nicolaus

Thanks. Backlog was up pretty nicely in 2007. Can you just comment a little bit on what you are thinking for 2008 backlog, does it kind of level off or do you think it continues to grow next year?

Bruce L. Tanner - Chief Financial Officer and Executive Vice President

Troy, this is Bruce. I'll take that one. We did have a good close to the end of the year 2007 backlog. I think in the third quarter that I had keyed up the notion that we might end up about $75 billion or so. We actually ended up just under $77 billion. Most of that came with the benefits of getting the Canadian order late in the year. And we also had strong -- every one of the business areas was up in backlog in the fourth quarter, lot of good awards there. As we go forward into 2008, I expect to have a similar level, maybe a little bit higher than where we ended the year 2007. There are some really good, big sized opportunities in 2008, the TSAT contract, GPS III. We have got a DOE Hanford award that's potentially out there, despite a few, a lot space related, quite honestly. So, our CGX radar and the electronics system business area and we are still taking international opportunities of aircrafts, as I said earlier.

Troy J. Lahr - Stifel Nicolaus

Okay. And then just as a follow up, how are you seeing spending right now in the classified market. It seems like some companies are saying it's really slowed down, others are saying they are starting to see recovery. So, it seems kind of all over the map.

Bruce L. Tanner - Chief Financial Officer and Executive Vice President

I'm trying to decide how to answer that, Troy. I am not sure I want to comment on the level of classified business up or down, to be honest with you.

Troy J. Lahr - Stifel Nicolaus

So just directionally though I mean you are not really seeing any change in the level of spending that you guys are seeing?

Bruce L. Tanner - Chief Financial Officer and Executive Vice President

I don't see -- if you are concerned about a large drop up, I don't see that happening now.

Troy J. Lahr - Stifel Nicolaus

Okay. Alright. Thanks guys.

Bruce L. Tanner - Chief Financial Officer and Executive Vice President

Yeah.

Operator

And we will take our next question from Robert Spingarn with Credit Suisse.

.

Robert Spingarn - Credit Suisse Securities

Good afternoon, everyone.

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Hi.

Robert Spingarn - Credit Suisse Securities

Bob, just thinking about your comment on $5 billion in profits as a hurdle in '09 that you will achieve or likely achieve. Yes, when I look at the numbers there is sort of this cross-up between sales growth and margin expansion, seems to me you could do even well better than that, so in that vein, how do you look from a longer term three years and out prospective at sales growth and margin expansion targets?

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Well, I'd say carefully and with good constructs here but generally I think we have been as careful and as transparent as we are able to be let's start with sales growth. By looking at our four principal business areas, their book-to-bill, our backlog, and opportunity horizon, our likely capacity to go out and win in a highly competitive marketplace, we hold that into projections. It is that kind of process that led us to offer you a projections sometime ago that indicated in our judgment after coming off, say mid single-digit annual revenue growth that we would have a deceleration in that growth in 2008.

We are experiencing about that deceleration that we thought we would see with an expectation that we would recover that top-line growth in the 2009 timeframe and that... we would return after about relatively flat spot to about mid single-digit top-line. That's the very best indication we have by looking at our core business and our adjacencies, our backlog, and our opportunities. From that revenue forecast and that opportunity horizon, we then do as comprehensive a level of modeling we can as to what our earnings expectation and cash flow generation ought to be if we are able to continue to improve our operational processes here and cross pollinate the best practices from one part of the company to another to assure continuous improvement which means continuous expansion of margins, additions in absolute dollar value to earnings, expanding our returns on invested capital.

We have been applying that model now for years. So, I would submit to you we got a track record that you can certainly look out and judge for yourself as to whether it is as effective as you think it could be. We certainly look at it that way and ask is it as effective as it can be then how do we approve it and that's sort of the summary level, the composite view of how we approach these goals and objectives.

Robert Spingarn - Credit Suisse Securities

I guess, what I am getting at Bob is it seems your long-term growth could be more driven at least in our model by sales growth than margin expansion but is that incorrect?

Robert J. Stevens - Chairman, President, and Chief Executive Officer

No, I don't think it is incorrect. I am sorry if I conveyed that to you incorrectly. We certainly believe consistently with your view that we have sales growth opportunities that ought to contribute to profitability but that isn't to say we are finding ourselves without good conviction that we can look at further margin expansion and here again that margin expansion is not independent of sales growth, we think international business gives us margin expansion opportunities.

We think the transition of programs from their developmental environment which as Heidi's questioned reflected some stress points, some stress points reflect award fees that maybe a little suppressed but when we get to production we are able realize further margins because those programs stand to perform pretty well. So, I think we have both sides of that revenue growth and margin expansion.

Robert Spingarn - Credit Suisse Securities

Thanks Bob. And just quickly Bruce, could you refresh us on the unit numbers for the major aerospace, aeronautics programs in '08.

Bruce L. Tanner - Chief Financial Officer and Executive Vice President

Sure in terms of number of deliveries.

Robert Spingarn - Credit Suisse Securities

Yes F-22, C-130, F-16.

Bruce L. Tanner - Chief Financial Officer and Executive Vice President

Think of F-16 as somewhere and currently above the high 28 range, F-22 is probably a little lower than what we were at the end of 2007 maybe 20 to 21 and C-130 again we are just at about one a month so I think of that as about 12 in 2008.

Robert Spingarn - Credit Suisse Securities

Fantastic. Thanks, guys.

Bruce L. Tanner - Chief Financial Officer and Executive Vice President

Yes.

Robert J. Stevens - Chairman, President, and Chief Executive Officer

You are welcome. Thanks.

Operator

And we will take our next question from Robert Stallard with Banc of America.

Robert Stallard - Banc of America Securities

Good afternoon.

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Hi, good afternoon Robert.

Robert Stallard - Banc of America Securities

Bob I thought I will first tackle the situation of the U.S. economy with the obvious slowdown in economic growth. Do you think there could be any risk to some of your State and local service activity as you move through 2008?

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Robert, not that we see. Believe me, as you would expect given the, I guess there is no shortage of information about speculation as to what the economies are looking like. We've taken that into full consideration and don't envision any Robert.

Robert Stallard - Banc of America Securities

Okay and as a follow-up. You mentioned JLTV is one of the adjacent market programs that you are pursuing, it seems you require a lot of other teams in the hunt as well. What would you say is Lockheed Martin's biggest pitch to the military if they consider these different teams?

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Well, I think we have got an excellent pedigree in systems integration. So, it depends on, if you want to buy a truck or you want to buy a much more refined system that really brings information into each crew vehicle, we have unique and I don't want to describe this anymore fully than this we have some unique approaches we believe to protecting that crew and we look forward to this competition because I think it gives us an opportunity to showcase some really dazzlingly interesting and innovative technology in a full systems configuration and I am confident that we'll put forward a very, very persuasive atmosphere.

Robert Stallard - Banc of America Securities

When you are expecting news on this program in terms of drill downs or things like that?

Bruce L. Tanner - Chief Financial Officer and Executive Vice President

I think, Bob this is Bruce, I think there is planning right now. There is perhaps a tech demo in the second quarter, perhaps a little a later this year.

Robert Stallard - Banc of America Securities

Yes.

Robert J. Stevens - Chairman, President, and Chief Executive Officer

And our judgment here is that, at one time, I guess there was a conceptualization that the program might proceed without technology demonstration segment. And I think there has been a more emerging discussion now, about having technology demonstrators and maybe opening the aperture and bringing in, down selecting, but not down selecting to one but bringing in two or three companies, to bring a more diversified view of the technology. So, the road tests, those concepts in vehicles, and then have a second down select after that.

Operator

And we'll take our next question from Myles Walton with Oppenheimer & Company.

Myles Walton - Oppenheimer & Co

Thanks, good afternoon.

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Good afternoon

Myles Walton - Oppenheimer & Co

Another follow-up on the international sales if I could. Bruce what was the percent or dollar value of the international bookings in '07?

Bruce L. Tanner - Chief Financial Officer and Executive Vice President

I'm not sure, I have got that number off of the top of my head Myles to be honest with you.

Myles Walton - Oppenheimer & Co

Okay. The reason I asked, I am just curious, we've see a lot the interest side through the foreign military sale notifications and I guess Bob maybe this is a question for you, given the rollover in administration, do you think a lot of those negotiations will be somewhat fast track, to ensure that you get it in under the kind of current bodies that are in the policy making seats?

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Well, I guess our view is that the rhythm is just going to continue the pace, I'm not sure we are going to see a wholesale or significant acceleration.

Myles Walton - Oppenheimer & Co

Okay. Then maybe... ask one other, on the adjacent markets that you mentioned healthcare and energy, Bob can you cite kind of how large those are today and maybe in a five year plan, what your penetration rate could be in such markets?

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Well, I give you a sort of a rounded feel of it. Now say for example, in healthcare information technology for our company today, it's a relatively small market segment. But as one of the acquisitions that we highlighted was a company called Management Systems Designers who have not only expertise in developing healthcare information systems but have an installed base so they have introduced us to a new customer set like the National Institutes of Health and what we attempt to do is build that market from there. So I would tell you quite candidly, it will start small and we will be deliberate and careful here. But when we look at areas that are in need of improved performance, particularly improved performance that can be brought about by bringing either systems integration, software development, or business process improvement skills, we have a very compelling portfolio in each of those areas that have been applied to national imperatives and civil government agencies previously and we believe, we can help address the rising cost of healthcare and the general dysfunctionalility of the distribution of healthcare information through superior information technology products. So that's something we are going to have to work on and build from the inside out.

Myles Walton - Oppenheimer & Co

Alright, great. Thanks

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Thank you.

Operator

And we will take our next question from Joe Nadol of JP Morgan.

Joseph B. Nadol III - JP Morgan

Thanks, good afternoon.

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Hi Joe.

Joseph B. Nadol III - JP Morgan

So Bob I would like to get back to the F-35 a little bit, you shared one major milestone with us this coming year, which is the installed first flight [ph] and I am wondering, if you could maybe go into a little more detail on what some of the others are. I think clearly last year, you made some nice progress on the program but you had a 7 month period of time, where you didn't fly the plane, the conventional plane and it seems to me that this year is really important one to make a lot of progress on milestones given the sort of the importance the program has to sales growth in nine and ten.

Robert J. Stevens - Chairman, President, and Chief Executive Officer

You are absolutely right Joe, Bruce has the detailed. I will let Bruce to comment.

Bruce L. Tanner - Chief Financial Officer and Executive Vice President

Joe as we look at '08 being the significant event or significant milestones, that I'm watching at least. But again Bob mentioned the rollout of the version in December of last year. We talked about first flight of that particular vehicle in the second quarter of this year. We've actually got the roll out of the carrier variant, that's the navy aircraft to the Joint Strike Fighter program and the fourth quarter of 2008. And we're going to be conducting throughout the year a number of flights on the two aircrafts that'll be flying, both the, the current one the AA1 as we call it, which is the conventional takeoff aircraft, as well as the STOVL once its up and flying.

And we'll also be doing, risk reduction with the so called CATBird or avionics test bed and that's where we have the systems integration capability, kind of packed into a commercial airliner and modified to simulate that which is flying on the F-35 aircraft itself. So there is some early risk reduction associated with that, there are a lot of flights in '08 there as well and the last piece of this, we'll continue to build the other 16 aircrafts in the STD program.

Joseph B. Nadol III - JP Morgan

Okay, I'm wondering if you could share... that's great, thanks for all that information, I'm wondering, if you could share more qualitatively, that where may Bob, where you think you are? If the problems that you encountered last year are fully resolved, did you still have some questions in your mind on any particular aspects of why the aircraft was grounded, and weight issues, what is foremost on your mind with regard to the development program right now?

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Well, I think the development program is getting much more mature. We're learning more as we go... the aircraft was down for while due to some engine performance issues. We have understood those engine issues, our partners have gotten on that problem right away. Every time you ring the problem, I like that out of the system, you gain a huge amount of information. Its very gratifying Joe in the 22 flight tests that we have conducted on the conventional take offs, airplane its performance, its characteristics, its handling is up and away. The basic fundamental engineering flight dynamics, overall performance are meeting or exceeding those targets, if you were internal to an airplane company, you would learn part of the vocabulary called Code-1 and Code-1 is a statement indicating when an airplane lands, it just needs gas and it's ready to go again. It is exceedingly rare to have the first flying article to land anywhere near Code-1 and the AA-1C aircraft lands Code-1 with some frequency.

We are confident in, while our airplane is undergoing test. The engine builders are also testing their configurations. So we have confidence that the lift span is going to perform, that all the mechanics there are going to provide the appropriate and associated amount of thrust. So I would tell you the way we look at it is, how much risk reduction are we experiencing, versus risk that we had forecast as a function of time and as a function of dollars. And I think that we are on or even a little ahead of the overall risk reduction. You can't really predict if the engine is going to eat a blade, you just can't have that knowledge. But you lay into your programs schedule and you lay into your concepts of development, the prospect that something is going to happen, we call them unknown, unknowns which is such an inelegant phrase but that's what it is.

We are making performance milestones on this jet burning off points on the fly test cards in a fashion that we had expected and the repository of knowledge, we've about the flight characteristics of the airplane is superb. And I would also go back and just underscore the comment Bruce offered about this CATBird, almost always on airplane programs, you develop these pieces in sequence and it makes perfect sense because you don't have an airplane against which you tested flying characteristics. So obviously you don't have an airplane into which to install avionics, to test them when it flies, you have to wait till you get there.

The CATBird enabled us to run parallel pads and those parallel pads really do reduce the schedule risk, because as we are gaining flight dynamic information on AA-1 airplane we are gaining a lot of system integration knowledge, about putting all the avionics together. So we will have at that main point a much more robust avionics suite to put into a much more robust flying article.

Operator: And we will take our next question from David Gremmels of Thomas Weisel Partners.

David Gremmels - Thomas Weisel Partners

Thanks. Good morning... good afternoon.

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Hi, David how are you?

David Gremmels - Thomas Weisel Partners

Good thanks. Bob you touched on margin expansion opportunities, in your prepared remarks. And I would like to ask about, aeronautics profitability. The guidance implies high 11% operating margin in aero, which of course would be down from '07 and I guess we are getting used to only thing that numbers go up. So have you hit a feeling in aero or if not what could happen to move the margin higher from here?

Bruce L. Tanner - Chief Financial Officer and Executive Vice President

David, if I could jump in, this is Bruce. Let me try and address that for you. We experienced within aeronautics particularly second half of '07 continuing what Bob talked about the JASF program and risk retirement. So, we got the same sort of characteristics in our production programs, risk retirements for things such as offset obligations, I mean within the F-16 line, we actually moved that line at the end of 2006, there was clearly some risk associated with doing that. As those sorts of risks were retired and we start to see some production efficiencies again particularly, in the second half of '07 we released some of the reserve, we did some pick up associated with that, and that's why you saw the strong performance in '07 for both of those events. That has the effect of the inception to-date pick-up and that's why we had margins in excess of 12% in both those quarters. That good performance, that good momentum is carrying over into 2007, we did actually increase if you take the mid-point margins from '07 to '08, we actually did increase that. That's a direct reflection of that kind of performance that we had in 2007 carrying over into 2008. We just don't get that inception to date benefit. As we go through 2008, we got the same sorts of risk retirement profiles and hopefully some prediction -- some production efficiencies that we'll see if we can do better on.

Robert J. Stevens - Chairman, President, and Chief Executive Officer

And David, I'll add, a couple of degrees are free to remove from the immediate fee of margin expansion. We have talked among ourselves in conversations like this quite a bit about what environmental conditions or circumstances have to exists, for the customer to get good value for the money that he spent and for us to be able to return good value to shareholders. You are seeing the manifestation of some of those issues actually converge in our aeronautics business right now. Because we talked about, do we have good command of the requirements on the airplane. Well, that's true on the F-16, that's true on the C-130, that's true on the F-22. Is there funding stability for the program. While we have a multi-year now on the F-22 and we have a multi-year on the C-130J.

If you have funding stability and requirement stability then it's the contractor's responsibility to get a line of balance that works to drive that through the supply chain, to optimize, to make the right investments, to put the right labor on, to get the right training, to put the right process in place. So, if some of the parts model, it's real easy to say and it's very difficult in reality to accomplish. And in our aeronautics business we think that sum of all of these parts and the convergence of all of these prior initiatives on the part of our customer, on the part of our own workforce, on the part of our suppliers and our partners have lead to an environment where we're really optimizing the performance here. The result is that customers getting very high quality airplanes that have no defects upon their delivery, all the parts work, all the systems work, that degree of customer satisfaction clearly goes up. And as their interests are satisfied, our ability to return to investors as you would expect goes up. And it's that virtual cycle that we've all work so hard to achieve. And that's why when there is a question about the F-22 or any other question about, do you want to discontinue the production line, I think a lot of careful consideration ought to be given about such discontinuity because it's real hard to get and it's real easy to give up, and you don't get it back.

David Gremmels - Thomas Weisel Partners

That's great. And if I could just ask a quick one on cash flow, you had a great year even after the $0.5 billion pension contribution. Just wondering how much pension contribution, if any is contemplated in your '08 cash flow guidance?

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Well not, not any now. I mean we'll always take a look at it, there is no contemplation there.

David Gremmels - Thomas Weisel Partners

Thanks very much.

Robert J. Stevens - Chairman, President, and Chief Executive Officer

You bet. Thank you.

Operator

And we'll take our next question from Doug Harned of Sanford Bernstein.

Douglas Harned - Sanford Bernstein

Good afternoon.

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Hi Doug.

Douglas Harned - Sanford Bernstein

On space, when we look out to next year, your guidance is, I would say flat at best in terms of revenues and I know you commented in the earnings release that satellites were down some in Q4. How do you see, first, could you comment on what brought this satellites down in Q4 and then how do you see that mix between the three businesses going into 2008?

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Let me make sure I'm clear on the three businesses?

Douglas Harned - Sanford Bernstein

I am thinking of S&DMS, Space Transportation, Satellites.

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Well, we are looking forward to opportunities in government satellites this year of a pretty significant number and dollar value, particularly when you think of the global positioning three contract, here you should probably think above $1 billion class award, perhaps awarded in the second quarter. I think we have a competitive offering there. There will be an environmental satellite called GOES or here the customer is NASA that will likely be awarded later in the year. Perhaps in the third to fourth quarter and I think may be think about it in hundreds of millions of dollar, class of opportunity and then there is a transformational communication system, TSAT. There is some discussion as to whether TSAT will be reformulated or not but as of now we are competing with an offering for that satellite system.

Bruce L. Tanner - Chief Financial Officer and Executive Vice President

Doug, if I could jump in. Let me talk a little about the variability, you are talking the satellite changes. We are seeing -- we are going from four commercial sats in 2007 down to two commercial sats in 2008. So, as you would expect our satellite line of business is going to be down somewhat because of those reductions. On the other hand within space transportation, we actually are going to see some good side stroke there that potentially is going to mitigate being down the two commercial satellites. That's really coming from the CEB or Orion program and then we have got on the straight defensive missile, the fleet lines, a little bit of growth but still fairly flat up. Also, the three of those, sats is down a little bit, space transportation offsetting that and strategic and defensive missile is really flat as well.

Douglas Harned - Sanford Bernstein

Okay then separately on aeronautics, do you talk about what you are seeing in terms percentage of sustainment revenues today and if you see that moving higher as you go into '08 and '09 and would that have a positive impact on margin potentially?

Bruce L. Tanner - Chief Financial Officer and Executive Vice President

I'll try to address that as well. I think sustainment revenue, and one of the reasons... we keyed up for quite some time the fact that we thought aeronautics was going to be down about $1 billion year-over-year from 2007 to 2008. I tweaked the guidance just a tad on aero going into 2008. So, its somewhat less than $1 billion. That's almost entirely because of additional sustainment prospects within the combat airplane F-16 and F-22 as we start to position more and more F-22s at their various bases where they're going to be located within the country of United States. We are seeing the sustainment business there growing higher than what we'd anticipated when I gave you the October guidance. As far as margin is concerned, I'm not sure, that line of business for us within aeronautics is probably equal to the overall margins of the business. So, it will probably bring with it a similar level of margin going forward.

Operator

And we will take our next question from Cai Von Rumohr with Cowen and Company.

Cai Von Rumohr - Cowen and Company

Could you tell us what are you assuming for tax rate for the year and what is the impact since your now not assuming the R&D tax credit. If it's enacted, what impact that will have on your tax rate?

Bruce L. Tanner - Chief Financial Officer and Executive Vice President

Hey Cai, thanks. I think I'm tax guy today, so, I will try to answer that. I would think for a guidance purposes, our tax rates in 2008 is just a little below 33% and we did have the... back in the October guidance, we did have the assumption that the R&D tax credit would be passed and its been passed every year for a number of years. That was actually linked with the alternative minimum tax build end of the year in December, those got separated, the AMT, they get passed, the R&D tax credit did not. The effects of that on our overall tax rate was about 70 basis points.

Cai Von Rumohr - Cowen and Company

Okay. Excellent. That's all I had. Thanks.

Bruce L. Tanner - Chief Financial Officer and Executive Vice President

Thanks, Cai.

Operator

And we will go next to Howard Rubel of Jefferies & Co.

Howard Rubel - Jefferies & Co.

Well, thank you. I have one question for Bob and -- we all expect for the out of the rockets at some point but you talked to a lot of people that operate in that world and one of your predecessors had a charge to show that overtime the product should produce should be just one missile, one airplane and so on. And, so one of the risks you always have Bob is, how do you make things more affordable and what have you seen that Lockheed can bring to bear to solve this, this new war that we seem to be fighting?

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Well, I will certainly say, Howard if there is one missile and one airplane, I hope we are the people who are making it. We work very aggressively at trying to reduce cost. I think there is a part of the overall cost value equation, that gets a little hard to measure and you are probably seeing it exemplified, let me just say, in fighter airplanes. We are not replacing today the existing fleet of fighter airplanes on a one-for-one basis. You see it in the F-22, the current buys of 183, I don't know if there will be more F-22s ordered. The air force talks about 381 but that's to retire probably two to three times in the number of F-15s because the systems while we enjoy talking a great deal about their dollar cost, it's very difficult at times to talk about their value and how you are retiring two or three assets when you are replacing one. So, our goal here is to focus on cost, try to get the most economical possible environment in which to produce these systems. And I'll just refer you, Howard to my prior answer where when you get the conditions right, when the line balances, when there is funding stability, when there is requirement stability that is the time when systems are produced at their most economical basis and then when we look at the cost of the system, I don't think that it's always taken into consideration that this, if I pick on the F-22 that it's likely to be in-service for 25 or 30 or 35 more years. So, we are really buying a capital asset that has a very, very long life.

So, the short answer is we do all we know how to do to suggest economic order quantities, multi-year contracts. The purpose in doing it is we know we give greater value to the customer and we know the customer always has more things to do than there is money available to do it. On a policy front there is a very active discussion about what threats exist today and what are the likely challenges that we will face tomorrow, will every future confrontation appear as an insurgency appears. And that is the kind of spirit that today we all have to be involved in. Our answer is that you need a mix and appropriate balance because our judgment about the global security context as it affects America is these trucks have got much more complicated. And it isn't that you get to pick among them one or the other one, you must be prepared now for threats that act a lot like individual non-State sponsored actors, terrorists, who can do an enormous amount of harm with the right technology, all the way through near peers who may have the propensity to express some muscularity to meet their individual interest for which the United States have to prepared. So, we are working with our customers on the broader front of preparedness. And trying to bring to bare all of our skills to help answer some of these very vesting problems and meet some of these demanding challenges.

Douglas Harned - Sanford Bernstein

Thank you.

Robert J. Stevens - Chairman, President, and Chief Executive Officer

You're welcome.

Jerry Kircher - Vice President of Investor Relations

Dana, this is Jerry. I think we are getting right up against the hour. Maybe, one more question.

Operator

Thank you sir. We will take our final question today from George Shapiro with Citi.

George Shapiro - Citigroup

Yeah. Good morning, good afternoon Bob.

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Hi, George.

George Shapiro - Citigroup

A question, if you look at information services, I mean that's been the one area that's probably disappointed a little bit this year, the fourth quarter was only 5% organic growth which isn't bad but its less than what you had thought. You lowered the guidance for sales growth in that particular area for this year. Can you just go through what you think is going on in that business and what can be done about it?

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Yeah, Bruce will give you some detail and color. I'll tell you, when you use the word disappointing, I watched this business during the year, undertake some important demands that I personally placed on them. and one is to take what was our disaggregated information technology businesses even in our organizational structure having two significant business areas and consolidating them into one business area, which as you know is no small task. So, I was very pleased with the operational efficiency that was undertaken in putting together our information technology capabilities, because now I think it gives us the kind of muscularity to move the market with a portfolio that no one else can match. And by that I mean very high end, system architecture, system engineering, highly complex, even classified programs throughout the value chain down the desktop applications. I don't know that there is a competitor in the field that can offer the breadths, the depth, the level of experience that we have and the kind of muscularity that's in that portfolio. If I look at their overall revenue expansion, if I compare '06 to '07, they were up 14% across that portfolio. That may have not met everybody's expectation, but I would say to you, George that is nothing. And I think there is more opportunity here as we continue to refine the integration of the business and we look for opportunities, both domestically and internationally.

Bruce L. Tanner - Chief Financial Officer and Executive Vice President

George, if I could just take you back a little bit. Bob said we did 14% year-over-year growth within IS and GS, think of that as about half of that coming on the organic side. So, that was not a bad year by any stretch. This particular business area, by virtue of the contracts within that organization has the highest level of services contract accounting which creates itself some variability between the quarters. I kind of teed up in the third quarter call, that we were seeing some transitions from our recorded backlog to sales a little slower pace than we expect to have happen. But quite honestly, the backlog grew by over $1 billion, in fact, there was a record level of backlog within IS and GS, I think that's the best indicator of future sales potential, if you take kind of a just the mid-point guidance that we provided you, we are still showing 10% year-over-year from '07 to '08, that is the expectation, in excess of $1 billion of revenue growth.

All well, we expect the margins for the business area to grow somewhat, probably 10 to 20 basis year-over-year. So as Bob said, this organization has just been combined for just a little less than a year and I think we are starting to see the synergies that come from that organizational combination. And we are pretty excited about was going to happen in 2008.

George Shapiro - Citigroup

Can you highlight Bruce or Bob some of the bigger opportunities in that business this year?

Bruce L. Tanner - Chief Financial Officer and Executive Vice President

Well, the first one we looking for is actually. Let me say probably going to be awarded in the first quarter and could actually be awarded in say weeks to a month and that is a mission support contract for the BOE facility of Hanford, Washington. This is not nuclear waste remediation or environmental remediation. This is an information technology system management job. If you look over the lifecycle of the contract, you might even see $1 billion kind of class award here. So that will be good first test, we think, as to... we have able to put forward a very compelling value offering for an important customer information technology domain.

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Just to piggyback back again George, the other big award we are looking at out of IS and GS, the AMF jitters is coming up also likely in the first quarter. That is a fairly good sized order. We have got a large, a fairly large IDIQ contract, which is kind of second round for the rapid response for the army coming up in the second quarter. In fact this gives you a little bit of the idea what's popping out.

Operator

And that does conclude our question and answer session. Gentlemen I will turn the call back over to you for any additional or closing remarks.

Robert J. Stevens - Chairman, President, and Chief Executive Officer

Dana, thanks very much. Let me thank you all for your participation on the call today and your interest in Lockheed Martin. All of us here focused on delivering operational results for our customers and industry leading financial results of our shareholders. We are committed to maximizing shareholder value by building a balanced portfolio of businesses that will allow us to continue to expand margin as we grow our revenues organically and through acquisitions. We thank you for your support and we do look forward to speaking with you throughout 2008. Thanks again.

Operator

And that does conclude today's conference call. Thank you for your participation and you may disconnect at this time.

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Source: Lockheed Martin Corp. Q4 2007 Earnings Call Transcript
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