Lockheed Martin - Earnings Call - Q4 2011

Transcript

Speaker 6

Today, I welcome everyone to the Lockheed Martin Fourth Quarter and Year-end 2011 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.

Speaker 5

Thank you, Javon, and good afternoon, everyone. I'd like to welcome you to our Fourth Quarter 2011 Earnings Conference call. Joining me today on the call are Bob Stevens, our Chairman and Chief Executive Officer, and Bruce Tanner, our Executive Vice President and Chief Financial Officer. Let me remind you that 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 website today that we plan to address during the call to supplement our comments. Please access our website at www.lockheedmartin.com and click on the Investor Relations link to view and follow the charts.

With that, I'd like to turn the call over to Bob.

Speaker 3

Thanks, Jerry. Good afternoon, everyone. Thanks for joining us today. All of us here hope that your New Year's off to a very good start. Let me begin with a quick summary of 2011. In the fourth quarter, we booked almost $20 billion in new business awards from domestic and international customers and finished the year with a record backlog of almost $81 billion. Strong program execution, coupled with ongoing cost reduction initiatives, enabled segment operating margins to increase to 11.5% in the quarter and 11.4% for the year, which reflected improvements over prior year levels. Cash generation was exceptional, with $1.1 billion in cash from operations in the quarter after making accelerated pension contributions of $1 billion and over $4.2 billion for the year, surpassing the prior year by more than $450 million.

We paid $325 million in dividends in the quarter and $1.1 billion for the year as we continue to execute our $4 a share annual dividend payout. Share repurchases continued in the quarter and totaled almost 32 million shares for the year, enabling the retirement of 7% of the outstanding shares. With this focus, we generated a 21% total shareholder return, with 16% stock price appreciation and a 5% dividend yield. These results reflect the quality of our workforce, the dedication of our leaders, and the strength of our corporation and the focus we all have on delivering value to our customers and to our shareholders. Thanks to everyone in the company who played a role in driving these results. Since we last spoke in October, we've seen an expansion and, in some cases, an amplification of the uncertainty evident in the global security environment and in world economic conditions.

The events playing out in Afghanistan, Pakistan, Iraq, Iran, Syria, Egypt, North Korea, China, and many other regions of the world underscore the complexity and the volatility embedded in the mission of maintaining global security. Many signs of economic stress remain, and the global recovery appears to be, at best, uneven and slow. On the domestic horizon, we see change as well. Earlier this month, the administration released the new security strategy, highlighting priorities for our 21st-century defense. Citing a strategic turning point after a decade of war that is now concluding, the joint force will be reshaped to be smaller and leaner, but more agile, flexible, ready, and technologically advanced.

Forces are to be rebalanced with more emphasis on the Asia-Pacific region and the Middle East, while assuring additional focus on the critical priorities of space and cyberspace, intelligence, surveillance, reconnaissance, communications, and navigation systems, counterterrorism and irregular warfare, an effective nuclear deterrent, and counter weapons of mass destruction capabilities. There will be an emphasis on air and naval forces, while reducing land forces, and on building more effective security cooperation partnerships with friends and allies. The President's 2013 budget is also set to be delivered to Congress on February 13th. Secretary of Defense Leon Panetta gave an executive summary look at the U.S. Department of Defense portion just an hour ago in a press conference at the Pentagon, which actually may still be ongoing.

The Secretary described a fiscal 2013 budget request of $525 billion in the base budget that compares to a $531 billion defense budget in fiscal 2012, along with a request for $88.4 billion for overseas contingency operations. This new budget reflects the new security strategy and includes the effects of last year's Budget Control Act that triggered the administration's proposal to reduce the defense top line by $487 billion through 2021, with $259 billion of that reduction occurring between 2013 and 2017. This significant and substantial $487 billion reduction, in conjunction with the new security strategy, assures that commitments to deficit and debt reduction are met while maintaining an adequate security posture necessary in the uncertain and volatile world that we see today.

While we'll gain additional details about specific program funding levels in the budget as more information becomes available, the clear contours of the new strategy align exceedingly well with our portfolio and our experience. This alignment is no accident.

Even as our national focus was appropriately on ground operations in Iraq and Afghanistan after having committed forces there, our assessment of the global security environment suggested that the long arc of our national strategic interests would orient toward the Asia-Pacific region and the Middle East, that regional security there would be influenced by China, North Korea, Iran, and others who are investing heavily in advanced technologies, that these technologies would include sophisticated anti-access and area denial capabilities, the advancement of nuclear and other weapons and the missile systems necessary for their delivery, and an increasingly elaborate series of cyber systems and methods, all of which would require response, and further that sustained pressure in world economic conditions would continue to impose constraints on the resources available to governments, leading to more cooperation on shared security objectives. That is why we took action years ago to refine the architecture of our products to assure they would incorporate the most advanced sensor fusion and communications capabilities, such that real-time intelligence, surveillance, and reconnaissance information could be leveraged and that our systems would be flexible and adaptable in meeting emerging challenges.

That is why the architecture of our business model was structured on promoting sustainable security cooperation partnerships, where interoperability would support more effective coalition action and leverage the global supply chain. While we clearly recognize there would be challenges with this strategic approach, requiring us initially to deal with an additional measure of innovation and the complexity that results from that innovation, our strategy is proving to be durable and well-aligned. The result is a robust and increasingly mature portfolio of relevant global systems that are meeting the needs of our customers in addressing global challenges, systems like the F-35 Joint Strike Fighter, supporting three U.S. services, eight initial partners, and the needs of an increasing number of international customers, most recently Japan, or our missile defense capabilities, including Aegis, PAC-3, and Terminal High Altitude Area Defense, which are setting the standard for U.S.

and allied defenses, as reflected in the recent selection of Terminal High Altitude Area Defense by the United Arab Emirates, or the littoral combat ship that is driving innovation and adaptability through a more affordable solution to meet the expanding array of demands clearly present in the littoral waters around the globe, or our space-based assets, including advanced DHF, MULOs, SIBRs, GPS-3, and other satellite systems that enable unparalleled situational awareness, secure communications, precision navigation, and prompt global response. We're continuing today to apply the very same energy, rigor, talent, and resources to further integrate systems, adding more effective command and control, constructing more resilient networks, and preparing the information technology environment for the hazards of expanding cyber threats while driving greater levels of efficiency and affordability across our company. There is much more work yet to do, which is why we are greatly distressed by the prospect of sequestration.

That element of existing law mandated by the failure of the Supercommittee to find additional spending reductions. The resulting automatic across-the-board budget cuts in sequestration would approximately double the $487 billion top line reduction already reflected in defense funding, with an additional $52 billion reduction in 2013. Secretary of Defense Leon Panetta has spoken in the strongest possible terms against sequestration, which he described as having catastrophic consequences to our defense. We support this view completely. The sequestration process has occurred independent of any correlation with strategy, force structure, technology needs, or operational reality. While the precise detailing of the adverse impacts of sequestration are yet to be determined, the United States would likely have the smallest ground force since 1940, the fewest number of ships since 1915, and the smallest air force in our nation's history.

The impact on industry would be devastating, with a significant disruption of ongoing programs and initiatives, facility closures, and personnel reductions that would severely impact advanced manufacturing operations, erode engineering expertise, and accelerate the loss of skills and knowledge, directly undermining a key provision of the new security strategy, which is to preserve the industrial base. We understand well the physical pressures our nation faces and have not hesitated in realigning the cost basis in our business through expense reductions, rebalancing the workforce, consolidating facilities, and the like, and will continue to do so. We recognize that the U.S. Department of Defense is committed to a half a trillion dollar reduction over the next 10 years, an ambitious initiative that we fully support. Our position on sequestration is very clear.

We must not let an automatic budget trigger, a default position in effect only due to a committee failure, become the dominant force for allocating resources and shaping our nation's security posture. We strongly urge action to stop this process. Before I ask Bruce to give you some color and details on our performance, I want to highlight an organizational change we announced this morning. After 37 years of distinguished service, Ralph Heath advised of his plans to retire from our company. I've worked with Ralph for a very long time now and found him to be an exceptional executive in every respect. He's been dedicated and professional in every assignment, and he's set the standard for ethics and business conduct.

Ralph's decision highlights why we've invested so much time and energy in our talent management, our leadership development, and our succession planning process over the years, subjects we really don't talk a lot about on this call, but subjects vitally important to our future success. Through this process, we now have an outstanding cadre of highly qualified executives ready to assume additional responsibilities and take our business forward. Effective April 1, Larry Lawson will serve as Executive Vice President of our Aeronautics business, replacing Ralph, and the business could not be in better hands. Larry brings a proven track record of success in all that he has done. Orlando Carvalho will succeed Larry as Vice President and General Manager of the F-35 program. You may recall that Orlando joined Aeronautics in August of 2011 after serving as President of our Maritime Systems and Sensors business.

Orlando's 30 years of experience in complex systems and in organizational leadership equipped him well for the demands of the F-35. Lorraine Martin will serve as Orlando's Deputy on the F-35 program, moving from the C-130, and George Schultz will assume responsibilities for C-130 operations. I mention these names because they represent the breadth and depth of talent in this company. Each has decades of experience, worked in diversified assignments, driven higher levels of performance, and have built superb teams. When I tell you that it is a privilege for me to work in this company, I'm talking about the opportunity to work with leaders like Ralph, Larry, Orlando, Lorraine, and George, and I thank them all. I have Bruce now go through some of the details of our performance, and then we'll open up the line for questions. Bruce?

Speaker 2

Thanks, Bob. Good afternoon, everyone. As I highlight our key financial accomplishments, please follow along with the web charts that we've included today. Let's begin with chart three and an overview of the full year for 2011. We grew sales for the company by 2% over our 2010 level, and given the environment we operated in throughout the year, we're pleased with those results. We're even more pleased with the record backlog amount for the full year, driven by almost $20 billion in orders in the fourth quarter, as Bob said. Segment margins were 40 basis points higher than last year, reflecting a strong performance year for us, with much of that improvement stemming from cost reduction actions that we took earlier this year or last year, excuse me.

Our earnings per share from continuing operations were 11% higher than 2010, and we generated $4.3 billion in cash from operations, while accelerating $1 billion in pension contributions previously planned for 2012. Overall, 2011 was a very strong execution year, and our results reflect that performance. On chart four, we'll look at sales by the four business areas. Two of the four business areas grew sales for the year, led by a strong 10% increase in aeronautics sales over 2010 levels. Electronic Systems had 2% growth for the year, better than what we'd premised when the year began. As anticipated, IS and GS declined by 5%, driven mostly by the absence of the U.S. census activity this year. Space ended the year relatively flat compared with 2010, as we expected.

Turning to chart five and our backlog to end the year, all four business areas grew backlog in the fourth quarter, and the company increased backlog by about $8 billion over the third quarter level. Key orders recognized in the quarter included additional funding for the F-35 LRIP 5 contract, as well as F-16 awards from Oman and Iraq in Aeronautics, additional domestic and international PAC-3 orders, a $1 billion order to upgrade Warrior fighting vehicles in the UK, and our first international order for the Terminal High Altitude Area Defense program in Electronic Systems, the award of the NSF polar contract to IS and GS, and the FY12 installment of the Fleet Ballistic Missile contract in Space Systems, along with an award for the initial launch of an unmanned Orion capsule in 2014.

Chart six highlights that we grew backlog in 2011 by over $2 billion to $80.7 billion, a record for the corporation. This is the second consecutive year we've grown our backlog, and ending backlog is about $2 billion higher than our expectations at the start of the year. Moving to chart seven, you can see the significant improvement in margins for both the fourth quarter and total year compared with 2010, again resulting from strong program execution and our cost reduction actions. These cost reductions are benefiting our customers as we price new business. On chart eight, we'll discuss our earnings per share. Our EPS from continuing operations increased 11% to $7.85 for the year. I'll remind you that last year included charges for our VEST program and the elimination of Medicare Part D subsidies.

However, when adjusting both years for the negative impacts of the THAAD adjustment, our pension-adjusted earnings per share grew 21% over 2010 levels. Turning to chart nine, you can see the effects of our cash deployment actions, returning $2.5 billion back to our shareholders through share repurchases and $1.1 billion in the form of dividends during the year. Combined, we returned 109% of free cash flow to shareholders in 2011 and returned almost $200 million more than the prior year's amount. On chart ten, we show the impacts of our share repurchases over time. 2011 was the second straight year that we've reduced outstanding share count by 7%, and we reduced shares outstanding by more than 100 million shares over the last five years. Chart 11 shows that our total shareholder return last year was significantly outperforming all major benchmarks.

The TSR reflects both the strong execution in the year and the cash deployment actions from the prior chart. Beginning with chart 12, we'll discuss our outlook for the year 2012. Our sales for the year are expected to be about 2% lower than 2011 at the midpoint of our guidance, and segment profit generally follows the sales volume, with our segment margins expected to remain above 11% for the year. I'll discuss both sales and segment operating profit in greater detail on the next chart. Moving down the chart, our THAAD CAD adjustment has improved from the trends we gave in October. I'll also speak more about this change in a couple of charts. Our earnings per share guidance for the year is $7.70 to $7.90 per share, and as a reminder, it does not include any consideration for the R&D tax credit being extended since 2012.

Think of that R&D tax credit being worth about $0.10 per share benefit in 2011. Finally, our cash from operations guidance is $3.8 billion, up slightly from what we described last quarter. I should point out that we expect the phasing of our cash from operations this year to be different from prior years, and that our cash will be significantly higher in the second half of the year versus the first half. We'll be making the planned pension contributions in the first half with around $500 million in the first quarter and the remainder in the second quarter. We also have a tax payment in the first quarter, while we had a tax refund in the first quarter of 2011. Chart 13 provides our guidance ranges for both sales and segment operating profit by the four business areas.

For sales, we now expect both Electronic Systems and Aeronautics to remain relatively flat at the midpoint compared with 2011, while IS&GS and Space Systems are expected to see a reduction in sales. You'll recall that when we discussed our trend data during the third quarter call, we had expected sales to remain relatively flat compared to 2011. Two key events occurred at the end of the year that changed that outlook. First, we were unsuccessful in our bid to win the G&D competition. This results in sales in our Space Systems segment being lower than expected when we spoke in October. Second, we reduced our guidance for IS&GS as a result of recent customer direction to stop activities on the AMF Jitters program by the end of February. Our segment operating profit guidance is driven mostly by the sales volume.

The margins for Aeronautics, Space, and IS&GS are expected to be down slightly, reflecting a lower dollar amount of profit rate adjustments planned for 2012 as compared to 2011, while Electronic Systems is expected to have consistent margins with what we saw in 2011. Chart 14 shows the changes that impacted our FAST CAD adjustment from what we described last quarter. We ended the year with a slightly higher discount rate at 4.75% versus the 4.5% we discussed in the third quarter, and this improved the negative FAST CAD adjustment by $115 million. We also had other updates, which partially offset the impact of the higher discount rate by some $25 million, resulting in the 2012 FAST CAD adjustment of an $835 million headwind on reported earnings. Finally, on chart 15, we have our summary.

2011 was a strong year by any measure and reflects the focus that our team demonstrated throughout the year. 2012 is expected to be a solid year, building on the strategic alignment of our portfolio, our record backlog, and the strong cash generation we've demonstrated for many years. With that, Javon, I think we're ready for your questions.

Speaker 6

Thank you. Ladies and gentlemen, if you have a question at this time, please press star then one on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. In the interest of time, we are limiting you to one question. Please return to the queue for any follow-up question. Our first question comes from Jason Versky with Citi Investment.

Speaker 9

Hello, Jason. Hey, everyone. I'm sorry about that. I had myself on mute. Just to say something on the guidance and the Secretary's comments that he made this afternoon. Does your guidance reflect the things that he had to say this afternoon, or is there potential risk either to the upside or to the downside after you parsed through his comments?

Speaker 2

Yeah, Jason, I'll take that one on. Obviously, we're still sorting through what the Secretary is saying, but I think in any event, I don't think there's a change to the 2012 guidance. Essentially, anything that would happen, at least that I'm aware of in the conversations that he had today, would affect 2013 and beyond. We've still got some sorting out to do to see exactly what that impact would be. Bob, I'll offer any other comment.

Speaker 3

If you need to inject another thought, I think the Secretary gave some executive summary views, and so we and others could get a sense of the shape and overall feel. I think our experience has been it's highly valuable to get into the details, the time phasing, and other facets of the budget proper, and I don't think that's going to be available to us until February 13. I think we'll be able to give you much better insight as to our overall reaction to what is just really breaking news today when we next speak with you. As Bruce said, it doesn't feel likely that we're overly sensitive in our current fiscal year.

Speaker 6

Our next question comes from the line of Douglas Harned with Bernstein.

Speaker 0

Hi, I wanted to get an update on your views on the F-35 right now. I know, Bob, when you talked after Q3, there were issues when you looked at LRIP-5 in terms of the structure of that program, the risks involved in potentially having to pay for work on prior airplanes. If you could update both on LRIP-5, where that stands today, and also when you're looking at some of the technical challenges on the airplane, such as the arresting hook, helmet-mounted display, could you give us an idea of how some of that progress is going and when you expect a resolution of some of those issues?

Speaker 3

Sure. I'll do my best, and you'll let us know if it's thorough enough, Doug. When we last spoke, we had a very unique issue on LRIP-5, and it had to do with risks associated with concurrency costs. At the time of our discussion, the formulation that we were reviewing from the government had a substantial risk transfer to industry, our company and our partners and our suppliers. Through negotiation and discussion that unfolded subsequent to the call, we negotiated the parameters associated with concurrency, and I would tell you, put it into a formulation that both we and the government felt was appropriate with regard to risk and execution, where we are accountable and they are accountable, and that's what partners do. I think that matter is resolved. We are in the process of negotiating Lot 5 now.

I don't have a time horizon where I can give you some assurance that negotiation will be complete, but we are leaning forward in an attempt to negotiate the final terms, conditions, pricing, and provisions of Lot 5. Relative to some of the technical issues that you described, Doug, and I think a number of those over time were associated with the STOVL variant of the F-35 Joint Strike Fighter, I'd tell you we're making progress along each of the items that are identified. I think that progress was reflected in the 2011 performance of the program overall, certainly the flight test program that ran a little bit ahead of schedule. I think most people would have noted that the STOVL variant was removed from probation after personal involvement by Secretary of Defense Leon Panetta. The Secretary visited the PAX River Naval Air Station.

He spoke directly with the pilots and the maintainers and others familiar with the airplane. These are folks in the government as well as folks in industry. I believe he went through a careful and detailed review, item by item and issue by issue. I must tell you, I admire very much the personal level of due diligence from a person as busy as Secretary Panetta, to get personally involved, to understand the details. With that understanding, he removed the jet from probation. We know there are challenges. This is a development program. I've spoken to you as honestly and straightforwardly as I possibly can about our assessment of a development program. I would tell you, this feels ordinary and traditional for complex airplanes of this type.

It doesn't mean we're pleased when we have to modify an arresting hook or adapt the helmet-mounted display or work some thermal issues in the propulsion system. These are observations that are the types that are relatively familiar with complex aeronautical systems like this. We've aligned our resources well. We've got great cooperation from the Naval Air Systems Command, from the Joint Program Office, from others in the government. Everyone is leaning forward. When I tell you we had a better year on the Joint Strike Fighter, I don't mean we, Lockheed Martin. I mean we, our partners, our suppliers, as well as all those in the government who support this effort, who understand the need. What you will consistently hear is the underscoring of the criticality of having fifth-generation capabilities in this complex security environment. You heard that from Secretary Panetta today.

You heard that from the President of the United States and Secretary Panetta when the new strategy was rolled out. We take that responsibility seriously. We have international partners who expect us to deliver on this program, and we will. We have an increasing number of foreign military sales participants, most recently Japan, who can look at any airplane around the globe and pick the best airplane in which they have the most confidence that will meet their security demands. They selected the F-35. That's a huge honor and responsibility for the F-35 team. Larry Lawson's leadership on this program has simply been exceptional. He is a very seasoned and skilled executive. He's built a lot of sophisticated airplanes, including the F-22. The team that he assembles has assembled is first rate, and we're ready for the challenges that we face.

I will tell you, the momentum is in the program. Yes, there will be some quantity reductions. We've talked to you before about the new reality. This is part of the new reality where there are complex global security challenges and scarce resources available to governments to meet those security challenges. We'll make the adaptations. We'll incorporate the new quantities once we understand their time phasing. We will drive hard to have a successful, effective, affordable program.

Speaker 6

Next online, we have Richard Safran with Buckingham Research.

Speaker 2

I wanted to ask a question on your backlog. Taking a look here, book to bill was pretty hefty, 1.6 times this quarter. You finished the year greater than one times, as you said, last year. Following last year is greater than one times book to bill. Not meaning to sound like someone who's saying, "What have you done for me lately?" Just wanted to know if you could comment on the opportunity set for 2012. What's your view on 2012 book to bill? What I'd really like to get a sense of is, do you feel, do you kind of feel that book to bill has peaked in 2011, or do you see an ability to repeat that this year? Hey.

Speaker 0

Rich, I'll take that one on also. I was looking at this. Actually, recently, we kind of did a review of the plan for 2012 and the out-year look as well. The thing that struck me as I was looking at that is there's not just a large number of, I'll say, high-dollar awards in the first quarter or practically, for that matter, in the first half of 2012. What I think we're going to see, at least in the first half of the year, is some reduction in that backlog. Our book to bill will be lower than 1.0. I'm trying to think off the top of my head of some of the larger orders we have in the first quarter, but things like the fiscal year 2012 F-22 sustainment contract is one example.

The authorization under AEUKA, in all likelihood, of the F-35 El-Rib-6 contract and some international sales within aerial, perhaps for some C-130s, might be the highest-dollar items in the first half of the year. I think we will likely have greater than 1.0, at least as we sit here today, we'll likely have greater than 1.0 book to bill in the second half of the year. In the third quarter, a little bit different maybe than years past, which has always historically been our lowest quarter of the year from an orders perspective, and we'd always try to backlog more in the third quarter than any other quarter. I think that might change somewhat, at least as we look at it today, that the third quarter will actually see some backlog growth.

I'm hoping, Rich, that by the end of the year, I think we might see some slight reduction, but I'd like to think we can be around the $80 billion mark for the year. I don't think that's, I guess that's a stretch goal I'd like to have for ourselves is to kind of keep the backlog starting in the $80 billion range. That's not a slam dunk by any stretch, but that's, again, as we sit here today, that's the way I think about it, Rich.

Speaker 6

Next on line, we have Heidi Wood with Morgan Stanley.

Speaker 7

Yes, good afternoon. Bob, two questions for you, one simple and the other more big picture. First, when do you get to rate on the F-35? The second question is, can you talk about the state of IR&D? The DOD doesn't seem to be clear about where their R&D priorities are going to be beyond bomber. Where does your IR&D future look like since DOD may be a less reliable source of R&D going forward?

Speaker 3

Yeah, thanks, Heidi. You know, on both of these fronts, the answer is going to be a little bit, we're going to have to wait and see. For example, rate on the F-35 is going to be a function of, we think, of new quantity adjustments that will phase out, I'll give you our best understanding today, phase out of the nearer term loss, some of the build cycle, probably more or less leveling the quantities at around 30. Again, we'll look for the detail. In conjunction with that, Heidi, our understanding today is that the total quantity to be procured domestically remains at 2,443. We're looking at a phasing. The phasing will have dual advantages of lowering the budget demands, aligning the fiscal pressures, as well as creating some time for the maturation of the airplane that might minimize some of the revisions to the configuration.

Both of those things, we think, make sense. The other aspect of rate or volume, at least in the near term, we will, in the very short term, get some clarity and insight as to the U.S. government's buy plan, and we'd like to anchor that as the foundation. Then revisit with each of our international partners and each of our potential foreign military sales customers, not just those who are already on board the program like Israel or Japan, but maybe future purchasers like South Korea, where there's a tender and others, and begin to then build this revised acceleration plan that will lead to rate so that we can do that in the most efficient and effective way possible.

I think that's about the best summary of F-35 volume over time to rate that we have today, and we'll get you some more details when they're available to us. We continue to make investments internally in the areas that we think will be most relevant to the forces described in the strategy that was released. I'll say to you again, I think that our portfolio, as defined in products and services, but also our portfolio of research and investigative initiatives, aligns pretty well with the strategy that was described to the extent that we have those broad contours. For example, a number of years ago, we established through this research and development facility a cyber laboratory so that we could begin to much more thoroughly exercise the resilience in systems and the resilience in networks. I think some of our actions there have aligned very well.

I think the future of the overall portfolio, and I very much resonate to the spirit of your question, in an era of more fiscal austerity, how will the apportionment of a top line budget reduction flow between and among expense accounts like operations and maintenance and personnel and the investment accounts of procurement and research and development, and how will resources available for research be thrifted? That is sort of an open watch item for us because we don't want to see an attrition in our engineering facility. We don't want to lose some of the innovative expertise that is fueled by access to this type of funding. I think the best we can do is look for the details over time that we're not in possession of today and maybe be sure to follow on with you in that regard.

Speaker 6

Next on the line, we have Cai von Rumohr with TD Cowen.

Speaker 2

Yes, thank you very much. On the F-35, looking through your commentary, it looks like revenues last year were up about $700 million on both parts of the program, and profits may be off $35, so the margins off may be, you know, one point. Could you give us any sense now that you seem to have the concurrency issues resolved? Do we have any opportunity on margins this year, or, excuse me, or moving into the future?

Speaker 0

Hey, guys, to Bruce, I'll take that one on. Without commenting on your math, your math is usually pretty accurate, but without commenting on it, the way I look at 2012, let's start with revenue on the F-35 program. I think the F-35 LRIP contracts are growing somewhere in the 9% to 10% range year over year. We're still seeing some good growth there. That's being offset because the development contract, the SDD contract, is going down compared to 2011, as you might expect. I think net-net, the F-35 is up, you know, some mid-single-digits growth year over year. As to your question on margins, I would expect us to see some margin improvement on the F-35 in 2012, primarily because if you just sit back and think about what we're going to accomplish in the year, we're going to deliver a lot more aircraft this year.

We're going to deliver, and I'm quoting this from memory here, we're going to deliver all the LRIP-2 aircraft, all the LRIP-3 aircraft, and a good portion of the LRIP-4 aircraft, all in 2012. As you might expect, we have a historical practice of not booking from a booking rate perspective at the at-completion position or as we expect the programs to run at their end or at their completion until we've retired the risk on those contracts. As you might expect, we've got some risk retirements that we're expecting to become finalized with the final delivery of those aircraft. Again, because a good chunk of those three LRIPs are all finishing in 2012, we would expect to see some margin improvement compared to 2011 for the F-35.

Speaker 6

Next on the line, we have Peter Arment with Baird.

Speaker 4

Good afternoon, Bob. Just a question on capital deployment. You guys have been setting the standard amongst your peers in terms of dividends and buybacks. How are you approaching it going forward now that we kind of have a pretty good feel directionally where the budgets are going to be and potentially a lot of moving parts amongst your peers when you weigh that against a selective M&A? How are you looking at that in terms of going forward in the strategy?

Speaker 3

In today's environment, we're looking at cash deployment pretty much the same way we have been. We're not communicating with you any change in strategy or philosophy. Peter, I think you know that the first thing we do is start by getting the cash. I don't say that lightly, but we have a very rigorous focus and disciplined process here that is institutionalized around the company. Cash management matters a great deal relative to our ability to both make appropriate internal investments and then return appropriate value to shareholders. We're rigorously focused on that, and we like the balanced cash deployment approach we have that you highlighted with a component for share repurchases and a component for dividends.

We spent a lot of time talking with the investors in the company to make sure that we understand your sense about how we ought to be thinking about cash deployment, but I don't think you should expect a change in our approach.

Speaker 2

Peter, this is Bruce. I don't think I said in my remarks, but I'll say it here because it relates to your question, obviously. The guidance that we provided for 2012 assumes that we're going to have at least $1 billion of share repurchases contained within the earnings per share number that we gave you. I think that's at least some indication that we're going to continue the practices that we've done and demonstrated the last few years.

Speaker 6

Next on the line, we have Carter Copeland with Barclays Capital.

Speaker 4

Hi, good afternoon.

Speaker 3

Hi, Carter.

Speaker 4

Just for Bruce, a quick clarification on your comments around the aeronautics margin and then a question about long-term pension funding. On the margin, back to what you were talking about on the F-35 and your sort of historical behavior pattern on EACs and risk retirement around the end of a contract, as you look to the end of the F-22, should we be expecting anything in the kind of intra-year quarterly patterns of margin in aeronautics that's worth noting in one quarter versus some of the others? Secondly, you provided some commentary around pension funding, obviously, that's in the guidance in 2012. I just wondered if you might give us some color on how that stands where we are today for 2013 and beyond.

Speaker 0

Yeah, thanks, Carter. Let's see, I'll start with the F-22 question. Would you see the same thing that we described? I think that was your question, as we saw or as I commented on the F-35. I think there's eight aircraft left to deliver on the F-22 production program. All of them have literally left the factory, and they're sitting in what we call our flight line operations, going through, as you might expect, flight testing, both with our pilots and with the government pilots. There's not a lot of, frankly, there's not a lot of cost left to do on those aircraft. Again, they're all built at this point in time. They were finished up last year. Most of the risk retirements that you would associate with the end of the program occurred in the 2011 timeframe, not the 2012 timeframe.

While there may be some opportunities for improvement, I wouldn't expect it to be as substantial, for instance, as what we saw in 2011. Longer-term pension funding, you know, we accelerated $1 billion of the required payments from 2012 into 2011. As we look for, I think you're probably aware, the cash harmonization rules were recently passed or implemented. I think they're actually effective not until next month, but I think the notification came out at the end of December of last year. We should see cash recovery rise in the next few years, but the actual payments from an ERISA perspective, looking from 2012 into 2013, I think we're paying now about $1.1 billion in 2012. That number grows to about $2.1 billion in 2013. The flip side of that is the cash recovery is about $1.1 billion. Think of that as being sort of a break-even position.

ERISA payments out and cash recoveries in for 2012. The cash recovery in 2013 is more like $1.4 billion. We're getting some of the benefit of the cash harmonization, but not much. ERISA payments are probably a similar level in the year after, and the cash recovery grows some beyond that. Slow recovery, I'll say back to sort of getting back to a break-even position, primarily because the cash harmonization got pushed out further than we had expected when we started first talking about cash harmonization, but still expecting in the not-too-distant future for that to get close to break-even and then start to flip the other way around where we're getting more collections than payouts.

Speaker 6

Next on the line, we have Joe Nadol with JPMorgan.

Speaker 8

Thanks. Good afternoon, everyone. Bob, on the capital deployment front, you have made maybe a subtle shift in the strategy, or maybe it's just the timing, but you've done a couple of acquisitions here in the fourth quarter that were, they weren't huge, but they were bigger certainly than you've been doing. You've also, over the last year or so, divested a couple of the deals that you had done a few years ago. I think all four of these acquisitions, I'm including the, or all four of these deals, I'm talking about the two acquisitions you made in the fourth quarter, as well as Savvy and PAE. They're in adjacencies.

I was wondering if you could maybe characterize big picture how you're viewing acquisitions in adjacencies and then maybe a little bit on each of the deals and why you decided to divest Savvy and then acquire these other two.

Speaker 3

Sure, I'll be happy to, Joe. I think that we are, you know, you mentioned timing here. I think that's maybe a little bit of timing. We've had a string of pearls approach. We like that approach. We look for companies that give us access to markets, unique technology. They provide a good fit. They have some ease of integration, and they meet our overall tests for valuations. I think the acquisitions you're referring to are SIM Industries and QTC. They are part of an adjacent market strategy that we've had in place for a number of years now. We are certainly interested in moving this business forward into technology areas that we think customers will increasingly value and in areas where we can back up some synergies. If you think of SIM Industries in the market for simulators, we've been in the simulator business for a long time.

This extends our portfolio. We're not unwilling to take that portfolio beyond our traditional customer sets to bring in some of those business practices into our core business. We think there's real synergy there. We'll continue to explore for businesses that fit our portfolio, fit our business model, and that will now align with the contours of this new national security strategy in the portfolio we put in place. To the extent that there would be a business that would provide for us international opportunities, we will certainly look at that. With regard to the cyber domain, I think there'll be a continuing and even growing demand for capabilities in that regard. Our systems integration business is always one that we'd like to reinforce and support.

Certainly, the emerging fields in energy, and here we're going to be selective because one size isn't going to fit all, but we do have some interests in the energy domain as well as others. I think there'll be some opportunities unfolding as we see the details in the budget domestically and maybe get a better feel for how our global customers respond, perhaps in logistics and sustainability and support. If long-term budgets are going to be under pressure, yet operational tempos are going to remain high, if we're going to have deployments to Asia-Pacific and the Middle East, if we're going to find innovative ways to move forces around, we think there'll be roles in our logistics business, our support, and our supply businesses there. If there were acquisition opportunities there, we would look.

We've been prudent, I think, as good stewards of the hard-earned cash position that we have. We want to maintain good credit quality. We have firepower. That financial flexibility, I think, is a discriminator of our company along with our portfolio and our selectivity about what we buy and what we do with it. In the case of the divestitures, if there are changes in the market, changes in the customer's behavior, we are not going to keep businesses that don't align with the overall strategic arc and trajectory of these businesses and will be decisive. I think on the acquisition side, we want to be selective so that we're not talking in the future about a lot of divestitures. In a case where circumstances change, we're going to face the reality, deal with those changes, and move the business forward.

In doing so, we'll try to generate as much value as we can and share that value with investors to the best of our ability.

Speaker 6

Next on the line, we have George Shapiro with Access 342.

Speaker 1

Good afternoon. This is for Bruce. If you take a look at Aeronautics, you disclosed this quarter that you had risk retirement of $70 million on the F-16 and another $35 million on the C-130 and C-5. You know, together, that's maybe 270 basis points in addition to the margin. Can you just describe what they were actually related to and what the opportunity is for getting more of those next year? Is there any way we can kind of anticipate some of those coming? One other one in that area. The F-35 profit margin is clearly implied to be down in this quarter based on your commentary. I just want to validate that that's probably LRIP 4 being booked in higher revenues and a lower margin that's kind of swamping the overall numbers, and there wasn't any change in any of the other program margins.

Speaker 0

Okay. Let me start, George, with the first question. The F-16 step-ups and the C-130, what drove them and what's out there for next year and what should you be looking for? The F-16, we've, I'll say, a lot of that was sort of ordinary run-of-the-mill program execution, clicking off performance milestones and retiring risk accordingly. There was, on one of our international contracts, a particular item that we were tracking towards that we actually reached closure on in the fourth quarter that we felt justified the step-ups. That particular item, which was, I'm trying to think off the top of my head, George, that was a pretty good chunk, probably half or so of that F-16 pickup that will likely not repeat next year on the F-16 program. The C-130 program is, again, just sort of the clicking off the normal manufacturing activities.

The only thing that was a little bit unusual on the C-130 is we had really, really good performance on the sustainment contracts on the C-130 activities in the quarter. I'd like to think that we had the opportunity to do that in 2012 as well. I think we've really hit a stride where, you know, customers are seeing great value in the sustainment support that we are providing those, particularly, obviously, the international customers is where most of that happens. I'd like to think that that will be something that you'll continue to see in 2012 as well. As far as the F-35 profit margins are concerned, I mean, there was no, and I'm doing this again from the top of my head, there was no profit adjustments upwardly or downwardly in the quarter. Any margin change that happened was purely volume-related.

We are starting to get some heavier activity in the LRIP-4 contract, as you described in your question. That's, again, because, as I said earlier, LRIP-2, 3, and in part of 4 will start delivering this year. That volume is starting to come in, and some of that margin improvement that we're looking for in 2012 will be on contracts such as LRIP-4. As we start to see production aircraft roll off the line, as we anticipate, that will be the triggering mechanism, if you will, for the risk retirements that we plan.

Speaker 6

Next on the line, we have Myles Walton with Deutsche Bank.

Speaker 4

Thanks. Good afternoon. Just going back to the cash flow outlook for next year, $3.8 billion on the out cash line. Bruce, a couple of things. One, the pension expense after tax looks like it's a $750 million tailwind or so, maybe a little bit less than that. Is there anything outside of maybe advances or cash taxes? Are those the two major downers to the cash in 2012? It just seems like even your usual 10%, 15% conservatism, this would be a little bit lighter than you might otherwise have given the tailwind on lower pension contributions.

Speaker 0

Yeah. Miles, let me just clarify what I think I heard. I think you said $2.8 billion in operating cash in 2012 is $3.8 billion for the year. Your question is a good one. There was a lot of receipts that got pulled into 2011 from 2012, including some fairly good-sized international receipts. That is one of the things that enabled us to do the billion-dollar acceleration of the pension plan. We are actually ahead of the game. In fact, for the first time in the corporation's history, at least as I have looked back in the records, we actually have negative working capital at the corporation level. That is hard to replicate.

One of the reasons that you will see that your calculation from a balance sheet perspective, that is the heart of your question, is because you are seeing some of the work-off, if you will, of that negative working capital come back next year. I would like to think, even having said that, there are still opportunities. I can tell you, if you talk to any of my folks in the finance organization who work in any of the four business areas, they will tell you that I am pushing hard to do better on cash flow than what we have committed to here.

I think there are opportunities to do that, but we are just not there at this point in time to change the guidance accordingly. We will obviously give you updates throughout the year as we progress, and we will come back to you and tell you how we are doing on that challenge.

Speaker 6

Our next question comes from Howard Rubell with Jefferies and Company.

Speaker 4

Thank you very much. Bob, you were very successful in placing that in UAE. Are there a couple more opportunities for this, and might you also address some international potential things?

Speaker 3

Yeah, thanks, Howard. I'll tell you that relative to the F-35 in the UAE program, you note that Chris Kubasik hadn't been on the calls because he went out and got a real job as our Chief Operating Officer and he's been doing an excellent job in focusing on the execution of programs like that, as well as assuring that we're listening carefully to the needs of customers. When we look at the Middle East and you start with an assessment of the security climate there, I think many people look at the Iranians with respect to their actions and their intentions, even in the most recent discussions about the prospect of closing the Straits of Hormuz, that it creates a very high level of tension.

People recognize that they have invested in the kind of technologies that include ballistic missile threats, and therefore many in the region who have population centers, who have oil production centers, who have strategic areas of interest view missile defense as a very critical system. As we look at the national security strategy that was outlined by the President and the Secretary when they talk about increasing security cooperation partnerships, the movement, as you highlighted by the United Arab Emirates here with that, I think if you look across generally the Gulf Coordinating Council regions, you would see, I think, a similar level of threat and risk and a similar desire on the part of our administration to lean forward. You know we follow a very discrete process here that starts with government-to-government discussions first, and nothing that we would say or do would subvert that process.

In the longer term, I suspect there'll be heightened and continued interest. I think that those interests will be viewed favorably by our government, and I think we'll have a maturing portfolio in the Middle East with regard to missile defense. I think there'll be a similar version of that experience throughout the Asia-Pacific theater because we're watching the same or similar type of overall security risk, the proliferation of technologies, the desire to get missiles of greater performance, longer range, more precision, and the desire for governments to have some protection against that ballistic missile threat. I think this segment of our portfolio is one that will likely grow internationally. Our focus is on making sure that we're executing the requirements under the contract, that the technology stays robust. There was a question earlier about research and development or how are you investing?

We want to make sure that we have resources available to think in terms of next-generation technology and how can we adapt, how can we provide adjuncts to this system. Maybe it's greater range, maybe it's greater payload, but to continue to evolve these systems. We think that's a very smart way to address the demands in the global security environment. Of course, you need a mature portfolio to start with before you can evolve that portfolio as the dynamics in the global security environment unfold themselves and we can address them.

I'm very pleased that we have the kind of portfolio you mentioned, that we have it in Aegis, we have it in PAC-3 in our missile defense portfolio that forms a really good basis where some incremental investment can not only satisfy customer needs today, but satisfy them tomorrow and can enable us to adapt the system for regional demands around the globe.

Speaker 2

I think we're coming up on the hour. We'll take one more question.

Speaker 6

Yes, sir. Our next question comes from David Stouts with UBS.

Speaker 1

Good afternoon, guys.

Speaker 3

Hi, David.

Speaker 1

Just a couple of little things. Bruce, I don't think you specifically said the tax rate you're looking for for 2012. Back on F-35 in terms of the mix, could you maybe break out %‑wise on the production side how much of the revenue base you think in 2012 will be LRIP 2 aircraft versus 3 versus 4?

Speaker 0

Okay, I'll answer the easy one first, David. The tax rate for 2012 is right now we're looking at about 30%. That excludes, obviously, the effects of the R&D tax credit, but for planning purposes, think about 30%. Relative to your question on the split of the El-Rib, I'll remind you this is a contract that we're, the El-Rib contracts themselves are contracts that we're booking on a percentage of completion basis. There's very little cost, I'll say, for the El-Rib-2 aircraft relative to, and it's not proportional to taking simply El-Rib-2 aircraft divided by the total because the cost to build those aircraft, similar to what I was describing on the F-22 program, are kind of behind us. They're out of the factory. They're going through flight testing and the like. It's difficult to parse that out.

Off the top of my head, I'll say for the total El-Rib activity, that's heavily, heavily dominated by El-Rib-3 and El-Rib-4 activity, which you would probably expect in 2011. That'll shift over in 2012 to be El-Rib-4 and El-Rib-5 and a similar pattern all the way through future years.

Speaker 3

Shaban, let me say thank you for your help today. We're going to take our increasingly mature portfolio of relevant global systems, focus on the needs of our customers in addressing global challenges, and we look forward to updating you with our progress next quarter. Thank you all very much for tuning in on the call today. Again, Shaban, thank you.

Speaker 6

Thank you, ladies and gentlemen. This does conclude your conference today. Please have a great evening.