Ladies and gentlemen, thank you for standing by, and welcome to the Lockheed Martin second quarter 2017 earnings results conference call. For the conference, all the participant lines are in a listen-only mode. There will be an opportunity for your questions. Instructions will be given at that time. If you need any assistance during the call, please press star then zero, and an operator will assist you offline. As a reminder, today's call is being recorded. I'll turn the conference now to Mr. Greg Gardner, Vice President of Investor Relations. Please go ahead, sir.
Thank you, John, and good morning. I'd like to welcome everyone to our second quarter 2017 earnings conference call. Joining me today on the call are Marillyn Hewson, our Chairman, President, and Chief Executive Officer, and Bruce Tanner, our Executive Vice President and Chief Financial Officer. Statements made in today's call that are not historical fact are considered forward-looking statements and are made pursuant to the safe harbor provisions of federal securities law. Actual results may differ materially from those projected in the forward-looking statements. Please see today's press release and our SEC filings for a description of some of the factors that may cause actual results to differ materially from those in the forward-looking statements. We have posted charts on our website today that we plan to address during the call to supplement our comments.
Please access our website at www.lockheedmartin.com and click on the Investor Relations link to view and follow the charts. With that, I'd like to turn the call over to Marillyn.
Thanks, Greg. Good morning, everyone, and thank you for joining us on the call today as we review our second quarter results and our increased outlook for 2017. As today's release illustrates, we had strong results this quarter, operationally and financially. Our strong year-to-date financial performance also enabled us to increase our full year's 2017 guidance for sales, operating profit, and earnings per share. These results reflect the high level of execution being achieved across our businesses in providing critical products and services to our customers while returning outstanding value to stockholders. It was particularly noteworthy that our quarterly cash flows exceeded last year's second quarter by nearly $200 million when we adjust for the $125 million of IS and GS cash that was included in the 2016 results. Our team continues to progress toward our full-year objectives in growth in sales, EPS, and cash from operations.
I thank our team for their dedication to our mission. Bruce will cover the financial results in detail a little later. However, I want to touch on two events, which occurred after our accounting quarter closed that point to the strength of our portfolio and the significant growth opportunities they provide. First, in our Rotary and Mission Systems business area, our Sikorsky line of business secured a $3.8 billion five-year contract for 257 Black Hawk helicopters to be delivered to the U.S. Army, as well as to the Saudi Arabian National Guard. This award marks Sikorsky's ninth multiple-year contract with the U.S. government and includes options for an additional 103 aircraft, bringing the potential value to over $5 billion. We are honored to have the opportunity to continue providing rotary aircraft in support of the important missions of the U.S. Army and our international customer.
Second, our Aeronautics business area received an F-35 award on LRIP 11, which includes funding for 74 U.S. jets and totaling nearly $5.6 billion. This brings the total quantity of U.S. aircraft authorized for LRIP 11 to 91 planes, a growth of 36 fighter jets from the LRIP 10 U.S. government order and represents a 65% increase from the prior lot. We anticipate a separate award later this quarter, which will add additional aircraft for our international F-35 partners and foreign military sales customers. The recent U.S. award demonstrates continued evidence of the strong support the F-35 has earned, and we look forward to finalizing these contracts as we progress to full-rate production. Turning briefly to defense budgets.
The FY 2017 DoD budget appropriations have been enacted and were consistent with the Bipartisan Budget Act of 2015, bringing Department of Defense base budget funding to approximately $524 billion, as well as overseas contingency operations funding to about $83 billion. We were pleased to see that our programs continue to be well supported, as seen by the legislation increasing F-35 aircraft and Black Hawk helicopter quantities. The higher levels for both the base and OCO budgets reflect a growing level of bipartisan recognition of rising global security threats and the need for additional budget resources. The additional funding for FY 2017 will help begin to address some of the acute budget needs to recapitalize our defense assets and respond to the global security environment. Also, the President released his request for the FY 2018 DoD budget.
This included $574 billion for the base budget, an increase of nearly 10% from the FY 2017 appropriations and 3% from the prior presidential base budget submission. Additionally, both the House Armed Services Committee and Senate Armed Services Committee have released their fiscal year 2018 National Defense Authorization Act markups, both of which greatly exceeded the President's request. The House has since passed their version by a wide margin. While we realize that these proposals exceed the current budget caps, we are encouraged to see the recognition that our defense budgets require increased levels of funding. We are hopeful that bipartisan agreement can be reached to rescind or modify the budget caps and fund our military at the levels needed to address the current set of world threats.
Moving on, I'd like to highlight several operational successes we achieved on our F-35 program, then briefly comment on the recent historic announcements from the U.S. and Kingdom of Saudi Arabia governments to bolster global security. The program featured two milestones that highlight the growing international nature of the joint strike fighter. The first Japanese assembled F-35A conventional takeoff and landing variant was unveiled at the final assembly and checkout or FACO facility in Nagoya, Japan. This aircraft marks the first of nearly 40 jets that will be produced for the Japan Ministry of Defense at this location. Similarly, the first F-35B variant to be assembled outside the United States was rolled out in Italy from the Cameri FACO facility. Cameri has already delivered multiple F-35A versions and is slated to produce over 100 aircraft in total.
Together, these two events underscore the benefits of the multinational partnerships that have been forged as we work to provide fifth-generation capabilities to both U.S. and coalition forces. Keeping with the F-35 program, we were also proud to spotlight our F-35A at the Paris Air Show last month. The CTOL variant performed its inaugural aerial demonstration, showcasing its aerobatic maneuvering and the jet's raw power to climb and run. I watched along with the rest of the amazed crowd at the Le Bourget Airport as the aircraft flawlessly executed 90-degree climbs, remarkable angle of attack displays, and several unique moves that only a fifth-generation fighter could accomplish, all of which shined a bright light on the impressive capabilities this unrivaled stealth fighter provides.
As the crowd erupted into applause, I could not have been more proud of what our Lockheed Martin team, together with the U.S. government, the JPO organization, international partners, industry teammates, and hundreds of suppliers have been able to accomplish. Before I conclude, I'd like to take a moment to say a few words about the unprecedented announcements that President Trump and His Majesty King Salman of the Kingdom of Saudi Arabia made in Riyadh in May. As part of those announcements, the kingdom expressed its intent to procure more than $28 billion worth of Lockheed Martin products and services, including air and missile defense products such as THAAD batteries and PAC-3 missiles, multi-mission surface combatant ships, variants of our Littoral Combat Ship, C-130J aircraft, and various other defense-related capabilities and solutions.
These announcements reflect the strength of the relationship that our corporation has built with the kingdom over the past 50 years. In addition, the requests touch each of our four business areas, demonstrating the breadth and depth of our offerings and the growth potential that our portfolio brings. Finally, I would like to acknowledge our space systems team as they mark the one-year anniversary of the Juno spacecraft orbiting the planet Jupiter. Images from the Juno orbiter graced the cover of the May issue of Science magazine, delivering breathtaking views of the giant planet's polar region. The mission also included measurements of the magnetic and gravitational fields and unique perspectives on the atmospheric and weather environments of Jupiter's surface. Scientists are excited at the initial in-depth results being provided, as well as with the potential new discoveries that may be made in the upcoming experiments.
We believe our continuous commitment to innovation and our long-term partnership with NASA have contributed to these remarkable achievements. We are proud to be a part of this ambitious undertaking. I'll now turn the call over to Bruce to review our second quarter financial performance in more detail. Then we'll open up the line for your questions.
Thanks, Marillyn. Good morning, everyone. I'll be making remarks based on the web charts that we included with our earnings release today. Let's begin with chart three and an overview of our results. We're pleased with our performance in the quarter. Sales of $12.7 billion were slightly ahead of our expectations and showed solid growth over last year's results. Our operating profit and earnings per share results were also ahead of our expectations, while cash from operations was in line with what we were expecting. We continued our strong cash deployment actions. We increased our full-year outlook for sales, operating profit, and earnings per share. We had a very solid second quarter and a nice rebound from some of the performance issues we had, excuse me, in the first quarter.
On Chart four, we compare our sales and segment operating profit in the second quarter of this year with last year's results. Sales were $1.1 billion higher this quarter compared with last year, with most of that growth coming from the Aeronautics and Space Systems business areas. Aeronautics growth was driven by higher volume from the F-35 and C-130 programs and an additional C-5 delivery this quarter compared with last year. Space Systems growth was driven by the inclusion of the Atomic Weapons Establishment sales in the quarter, compared with none in the second quarter of last year. Segment operating profit was $55 million higher this quarter compared to last year.
This was driven by higher volume and improved performance for the F-35 program in Aeronautics, improved performance across multiple lines of business within RMS. These were partially offset by lower equity earnings from United Launch Alliance in Space Systems. Turning to Chart five, we'll discuss our earnings per share in the quarter. EPS from continuing operations of $3.23 was about 10% higher than the results from a year ago, reflecting both higher operating earnings and lower share count this year compared with last year. On Chart six, we'll compare our cash from operations this quarter versus our results from 2016. We generated more than $1.5 billion of cash in the quarter, over $70 million more than we did in the second quarter of last year.
As Marillyn said in her remarks, that understates our relative performance as last year's results included around $125 million of cash generated by IS and GS, which was not divested until August of last year. On a year-to-date basis, our $3.2 billion of cash generated is also about $70 million higher than our results from the first half of 2016, but last year's amount included nearly $300 million of cash generated by IS and GS. Chart 7 shows the cash returned to stockholders in the quarter. Subtracting capital expenditures in the quarter from our cash from operations, our free cash flow was just under $1.3 billion. We returned slightly more than $1 billion to stockholders, about equally split between share repurchases and dividends. This cash deployment represents 81% of our free cash flow in the quarter.
On Chart 8, we want to make you aware of two large awards that took place shortly after the end of the quarter that are not reflected in our reported backlog level. The largest award was for the F-35 LRIP 11 UCA for domestic aircraft that Marillyn mentioned and was worth $5.6 billion. The second award was for the Multi-Year IX buy of Black Hawk helicopters and was worth $3.8 billion. Both of these awards occurred within two weeks after the quarter close, and their combined values would have pushed our backlog above $100 billion for the quarter had they occurred just a few days earlier. Chart 9 provides our updated outlook for the year. We increased sales by $300 million, with all of that increase coming from the Space Systems business due to the higher volume we're seeing this year.
We increased segment operating profit by $35 million, with $20 million of the increase coming from our Aeronautics business and $15 million from Space Systems. The Aeronautics increase recognizes better-than-planned performance so far this year, while the Space Systems increase is primarily volume driven. We had an improvement in our unallocated costs worth $25 million, driven mostly by a reduction to a previously established reserve. With these improvements in our operating profit, we increased our earnings per share by $0.15. Lastly, we're maintaining our cash from operations outlook at equal to or greater than $6 billion. Charts 10 and 11 show our revised outlooks by business area for both sales and segment operating profit. I covered the revisions in the outlook in the prior discussion. Chart 12 provides a reconciliation of our prior EPS outlook to our current outlook.
The $35 million increase in segment operating profit increases our expected EPS by about $0.10, while the $25 million decrease in unallocated expense improves EPS by around $0.05, resulting in a revised outlook for the year of $12.30 to $12.60. This new range is higher than the guidance we provided when we began this year, more than offsetting the setbacks we experienced in the first quarter. We have our summary on Chart 13. Our quarterly results for sales, profit, EPS, and cash from operations were all either in line or ahead of our expectations. That resulted in the increased outlook that we just discussed. We are well positioned to achieve our full-year goals. As we look ahead to the third quarter earnings call, we'll provide our initial trend information for 2018.
As a reminder, the new Revenue Recognition rule will be effective for us starting in January and will be incorporated into our trend information. With that, we're ready for your questions. John?
Thank you. Ladies and gentlemen, if you would like to ask a question on the call, please press star, then one. You'll hear a tone indicating you've been placed in the queue. If your question gets answered, you wish to remove yourself from the queue, please press the pound key. Again, star one for questions. We do ask if you please limit yourself to one question, then feel free to re-queue for additional question as time permits. First we have the line of Samuel Pearlstein with Wells Fargo. Please go ahead.
Good morning.
Hey, Sam. Good morning.
Bruce, always a lot of focus on the cash flow. There's been a lot of discussion about capital spending at various defense contracts. Your CapEx is certainly up over the last few years and up year-over-year. How should we think about that in future years, and what's going to dictate that? Is this F-35 volume? Are there contract wins or losses like T-X? What's going to dictate kind of the levels of CapEx we see over the next few years?
Sam, thanks for the question. It's a good question. As we looked at our long-range planning from last year, that covers basically 2017, 2018, and 2019. 2017 is sort of a peak in terms of the capital expenditures for the corporation. That reflects a number of things, some restructuring that we're doing within our Space Systems business, moving some of the work around within locations within Space Systems. It also reflects the sort of the last tranche of investments required to get the F-35 sort of fully capitalized. It increased in, I'll say, between 2015 and maybe years prior to going forward because we added Sikorsky into the portfolio, which obviously has higher capital expenditure requirements than did the IS&GS business, which really had practically immaterial capital expenditure requirements.
If you start to sort of think of 2017 as sort of being the high point, at least as we look at it today, going forward, we would expect that number to slightly decrease going forward. Within that slight decrease going forward, there are some requirements for additional new capital for some of the wins, one of which you described in your question. That's sort of more than offset by the reductions in the other capital expenditures required, including F-35.
Our next question's from Noah Poponak with Goldman Sachs. Please go ahead.
Hey, good morning, everyone.
Good morning.
Bruce, how should we think about Aeronautics organic revenue growth in 2018? Because now you're going to have a pretty tough sort of just growth comparison. You'll have more F-35 growth, but you had mentioned before other aircraft in the segment being headwinds. Not sure if those have moved around. If you could just perhaps tie that into a few quarters ago, you talked about kind of staying in the 3%-5% total company growth range, but 2018 maybe being at the low end of that. Just wanted to check back in if that was still sort of the case. Thanks.
Yeah. Thanks, Noah. Aero's organic growth, I think what I said previously, or what you said that I said previously in earlier quarters still is true today. I'll probably answer your second question first. We're still looking at the total company about the 3%-5% growth going forward. 2018 is a little less than that, actually in 2019, as we sit here today, it probably picks back up. A lot of that is because, as to your first question, in 2018, we're actually seeing a drop-off because we have the end of the F-16 production line, at least based on current orders at close to the end of 2017. We have no new production F-16s planned for 2018 as we sit here today. That's not in the numbers that we've talked about previously.
We also have the end of the C-5 program, in the early part of 2018. Those two events are kind of bringing down Aeronautics organic growth. You're still seeing tremendous growth potential in both the production and sustainment programs for Aeronautics for the F-35 program. The other two are slightly, as I said, dissipating some of that growth. That's one of the reasons why in 2019, we kind of bounce back as we're operating off of a lower compare, if you will, in 2018.
Our next question's from Howard Rubel with Jefferies. Please go ahead.
Thank you very much. I want to change a little bit from operations, talk strategy for a moment. There's two things related. One, Marillyn, you've started to make some investments outside of your core that look like they're complementary. Maybe you could address that and talk about how significant a commitment it could be. Then related to that is from a longer-term point of view, you have to think about people and what are going on there, and how do you think about succession planning?
Excellent questions, Howard. Both of which I've spent a lot of time on a regular basis. Thank you for the question. From the strategy standpoint, our focus is on growth. We've been very clear about that. We think we've got a lot of opportunity to continue to grow. We see our international growth increasing from what today in 2016 was about 27% of our sales, 30%, we'll continue to see that growth. The demand around the world is high for not only F-35, but missile defense, a lot of our F-16, C-130, other defensive systems that we have, as well as our opportunities in space-based situational awareness, et cetera. That growth.
In terms of your comment about outside our core, but complementary, I would say that our commercial satellites, our commercial helicopters, work that we're doing with the LM-100J, which is the commercial version of the C-130, those are absolutely areas to move in commercial, but very closely aligned. The hybrid airship is another opportunity for us. Those all are in line with our core competencies and our capabilities. Pardon me. Moving more into the commercial space and aligning with that. Long term, we're always focused on our talent management, on our talent development. It is an ongoing part of our business.
In terms of succession planning, as you look at the leadership team that we have at Lockheed Martin, very seasoned, very strong, a talented team that I'm really proud to be a part of the team and working collectively with them on how we are executing our strategy for the corporation. At all times, we're looking at building that pipeline of talent into the business. We also look at that talent from the standpoint of its diversity. I'm proud to say that 21% of our leaders are women, and we continue to bring more talent in from that regard. Succession planning is something that we continue to look at as a company, and it's an ongoing effort for us. Thanks for the question.
Next we'll go to Robert Spingarn with Credit Suisse. Please go ahead.
Good morning.
Hey, Rob. Good morning.
I wanted to ask, as you go into next year and we think about going back to the cash flow, Sam asked about the CapEx, and you talked, I think, at the tail end of last quarter about trying to ex pension contribution, perhaps operating cash flow could be flattish with this year. Bruce, does that still work with the multi-year on the Black Hawk and the quantity adjustments that are happening there, and any other new incremental information that we have since last time?
I think the answer is no. It doesn't change, Rob, as far as our thinking is concerned relative to the way you've described 2018 sans pension contribution. I would expect operating cash flow for the corporation to look pretty similar to this year. Again, we've talked about after those pension contributions, both in 2018 and 2019, that if you add the cash from those years along with 2017, we expect to be in excess of $15 billion. We're off to a great start, obviously this year, in 2017, and we'll give you more insight into what we're looking for 2018 and maybe a little beyond as we talk to you on the next quarter call.
Our next question's from Ronald Epstein with Bank of America Merrill Lynch. Please go ahead.
Good morning, guys.
Good morning.
Just want to maybe talk about some business opportunities. The first of which would be the T-X and JSTARS. How's that going, when would you expect a decision made on those?
Sure. I'll take those. We're looking at where the Air Force is on T-X and JSTARS. They've said an award in the fourth quarter of this year. Obviously, we never know until they actually do it, so it could slip, that's what they've outlined is the fourth quarter of 2017 for JSTARS and T-X. Then, we see some other nearer-term awards that we're hoping to see in September, October timeframe. Ones like the Special Operations Forces Global Logistics Support Services that we're an incumbent on that today, it's in competition, we hope to see that awarded. It's got a total program value with options of up to $8 billion. Our Ground-based Strategic Deterrent is another one that we would look to see an award coming here in the fourth quarter.
We're hoping as we look at the Saudi operations, the opportunity that we have there, that potentially we could see a FAAD award sometime late in the year or early next year. Then another would be LRSO, long-range standoff missile. That is also looking at September timeframe. Let's see, another would be the Saudis are looking at getting a search and rescue and S-70i helicopter award that we expect in the September timeframe as well. Several awards in the near term. I think I rattled off six or seven of them just there, we're excited. Bruce, you have some other thoughts?
Hey, just maybe one to address the question at the start, or the start of your question, Ron. You should think of most of these as we've already submitted the proposals. You sort of asked what's the status. The status is, I think we're all sort of waiting and for the most part, the government is evaluating ours along with everyone else's proposal, and we sit anxiously waiting to see the results of that. There's not much we can do at this point, as I said, because almost every one of the ones that Marillyn, if not all of them, that Marillyn just rattled off, we've already submitted the proposals for those.
Our next question's from Douglas Harned with Bernstein. Please go ahead.
Hi, it's Finbar Sheehy for Doug. In your press release, you talked about higher sustainment activities in the quarter for the F-35. Can you talk to us about how big those are now relative to total F-35 revenues and how you expect that's going to evolve over the next few years? Maybe how big a percentage of F-35 revenues will sustainment be, say by the end of the decade? How do the margins on sustainment compare to the incremental margins you're getting now on new aircraft?
Yeah. I'll try that one, Finbar. The sustainment is growing fairly rapidly. I want to say it's not quite growing this year at the same pace as is production, but it's growing dramatically over last year's numbers. Maybe you should think of this as in the sort of high teen sorts of numbers. It's growing incrementally, and it'll continue to do that for a number of years as we set up more and more bases, both around the U.S., but as well internationally as international customers start bedding down the aircraft in their home location. That growth's going to continue. I don't have the exact split, but I want to say, if you look at sustainment out of the total F-35 production, I want to say it's probably 20%-25% as large as the production volume on an annual basis, something like that.
It stays at those sorts of levels for the next few years. As production grows over the next couple of years to its peak when we hit full rate production, I would expect that the sustainment will sort of follow suit there. Your last question, Finbar, was relative to the margins and how we do on sustainment contracts. I'll tell you, we do about the same on the F-35 sustainment as we do on production. That might change somewhat in the future going forward, but at least as historically and where we sit today, they're pretty comparable without a whole lot of difference between them.
Next we'll go to Seth Seifman with JPMorgan. Please go ahead.
Thanks very much, and good morning. I wanted to ask about the SAR that came out last week and the change in the peak quantity of the Air Force buy in the out years. It came down from 80 to 60, but we're talking about numbers that are pretty far out there in the 2022, 2023 timeframe. I'm wondering how you're looking at that. What implications you think it might have, whether it's a change that you expect to kind of stick around?
I'll take that, Seth. Thanks for the question. I would just say, first off, we haven't really seen the SAR. We know that it's been submitted to Congress. We know there's been sort of a top-level readout from the JPO of a fact sheet that came out on it. I think in that, the Joint Program Office highlighted the fact that the reason that the numbers were changing were predominantly due to a change in the procurement profile of the Air Force jets, which is the largest volume buyer for the Air Force. Frankly, I know that in my discussions with the Air Force, there's a desire to buy as many as they can, as quickly as they can. I haven't got an official position from them that they've reduced their procurement profile. That just happens to be what's in that select acquisition report that came out.
Certainly, lots of opportunity to change the quantities, as you can see just with what's in the budget and deliberations right now with the ads that are coming forward on the F-35 for the various services. We think we'll still see potentially some upside on it. That would be my take. Bruce, anything you want to add?
The only thing I might offer, just for a little bit of perspective, I think you had it right, Seth, in that the planned peak volumes for the USAF are sort of far out there right now. Just to give you some perspective on that, we're still in discussions with the Joint Program Office relative to potential block buy. The numbers that have been thrown out for that block buy, and this is just again, to put this in some perspective, over three LRIPs, is about between 440 and think of it as 450 or so aircraft over that three-year LRIP period. Nearly 150 aircraft per year. That's what we're talking about for LRIPs 12, 13, and 14. These are literally right around the corner. That's 150 aircraft with the USAF buying 48 aircraft in each of those three fiscal years.
The cut to 80 to 60, we're not even approaching the 60 yet. We're building aircraft of quantities of 150 per fiscal year. As Marillyn said, a lot of opportunities to change quantities between now and then. It'll be interesting once we do see the full SAR report, how much of that was sort of budgetarily driven, with the potential to change that budget that far out versus, I'll say, a quantity difference. If I read the fact sheet right, actually from the JPO, I think the actual total quantity of U.S. government buys for F-35s went up, coincidentally enough, by about 13 aircraft for additional Marine Corps buys. Pushing out to the right, but again, as Marillyn said, lots of opportunity to change those values between now and then.
Our next question's from George Shapiro with Shapiro Research. Please go ahead.
Yes, good morning.
Good morning, George.
Can you hear me?
Barely, George. Try it again.
Okay. On the F-35, the incremental margin was 17%. Did you increase the margin on the LRIP 9 or 10, or both? Also, the deliveries were flat with last year and down from Q1. I would think that we'd be starting to see increases here given the deliveries are going to be higher. What's happening there? Thanks.
Yeah. George, I'll try those. Incremental margins, I didn't do the calculation that you just cited, but you're probably right. Your math's always good, George. We did have a couple of pick-ups. I think you asked which specific LRIP we had some risk retirements or step-ups. We actually had, I want to say, three separate LRIPs, and you should think of these as somewhat older LRIP contracts or LRIP numbers. I believe two of the three were LRIPs five and seven. This is sort of reflecting the fact that we're closing out or getting ready to sort of close out some of those lots.
The ones you talked about, the more current ones, lot nine and so forth, and lot 10, we're getting good performance on those, but that's probably step-ups that we'll look forward to in the coming years or coming quarters as opposed to this quarter here. As far as deliveries, George, the way I look at that, I think we're planning 66 aircraft to be delivered for the year. What may not be clear in that number is only the biggest lion's share of that, 61 of those are being delivered out of Fort Worth. The other five are going to be delivered out of the international locations that Marillyn talked about, the FACO in Nagoya, Japan, and the other FACO in Italy. None of those five aircrafts have yet to deliver, although they've rolled out, as Marillyn said.
All of those are out in front of us. As you look at where we ended the first half of the year, we'd actually delivered 29 aircraft. That number's a little deceptive because we closed the quarter actually on June 25th as opposed to the end of the month, and we actually had some deliveries between then and the end of the month. As we sit here today, George, I want to say we've delivered 34 aircraft so far, and I think we're on track to deliver 36 by the end of this month. We're actually progressing essentially right on track on the domestic deliveries. We do expect those five international deliveries to all take place in the second half. Short said, I think we're tracking to our expectations relative to 66 aircraft for the year.
Our next question's from Peter Skibitski with Drexel Hamilton. Please go ahead.
Good morning, guys. I had a further kind of F-35 and aeronautics margin question. Because, Bruce, it seems like the F-35 has kind of been less of a headwind maybe than you expected going into this year. I know some of it's on better performance at the international facilities and whatnot. As you kind of look out into 2018, it'll be a bigger part of the mix, F-35 aeronautics. Do you have any confidence level yet to say that this year is kind of the trough for aeronautics margin, and we'll start to expand as we go out on higher F-35? Or is there still some uncertainty in some of the latest LRIP lots?
To be clear, Pete, you're talking about a trough for aeronautics or a trough for F-35? You're talking about aeronautics, I presume, right?
Correct.
I'm not sure I want to call that in this quarter, Pete. I'll feel a whole lot better. We do our planning between now and the third quarter, and when we give you the trend information in 2018, I will surely address that then. I don't think your question is that far off the mark. If the answer is not, yeah, that's probably where we'd expect the trough, the answer is it's probably pretty close to that. Maybe 2018, we'll take a look at that when we give you the trend information in October.
Great. Fair enough. Thank you.
I should say, in any event, we would still expect Aeronautics, even if it was a trough, I don't see it dropping below 10%. The only question is we've had, to your point, some pickups earlier this year. Can we match that next year going forward? Again, I'll give you a little more insight on that in the October call.
Thanks.
Next, we'll go to David Strauss with UBS. Please go ahead.
Thanks. Good morning. Thanks for taking my question.
Bruce, I guess first a clarification. The 3%-5% revenue growth and talking about maybe being at the lower end of that in 2018, does that include the change in Revenue Recognition? That's the clarification. Then thinking about cash conversion, free cash flow conversion over the next couple of years, you've obviously got pension cash moving down, then as we look out towards the end of the decade, you have FAS expense that's going to come down. Could you just talk about the progression of how you're seeing free cash flow conversion over the next maybe towards the end of the decade? Thanks.
Yeah. David, I'm actually glad you asked that clarification on the 3%-5%. Well, sort of based on current Revenue Recognition methodology. Although we'll get more information on this when we have the results or when we give the trend information in October. At least preliminarily together in anticipation of that Revenue Recognition change, we're kind of, I'll say, running Revenue Recognition in addition to the normal methodology for the first quarter and second quarter. I haven't seen the second quarter results yet, but so far everything's indicating that you would think we shouldn't see a whole lot of difference. Part of the reason for that is a lot of the units of delivery are what we call POT, passage on title transfer, where we essentially record sales upon delivery.
As long as you're sort of delivering at a constant rate, and the program is not at the end of its life, if you will, then you wouldn't expect to see a large swing even when you convert it over to a percentage of cost or cost to cost methodology. That's sort of our expectation. We don't see a large drop off or a large increase or decrease in our POT deliveries there. Most importantly on our Revenue Recognition, F-35 does not change one bit, and that's obviously the biggest driver of Aeronautics, and for that matter, sales for the corporation. I'm hopeful, having said that, Dave, that the 3%-5% sort of works under either methodology, the current methodology or the new Revenue Recognition methodology is what I'm trying to say.
We'll see what that looks like when we provide the trend information in 2018, as I keep saying. Relative to the free cash flow conversion, we've teed this up in the past, Dave, and you and I have had a couple of conversations on this. We talked about FAS income. You sort of brought that up in 2020. The 2020 timeframe is the end of the accruals relative to our pension trust going forward. Essentially, the trust becomes completely frozen at that point in time. Because you lose the service cost, we actually end up getting FAS income in that point in time. As far as cash is concerned, we will expect to see cash contributions, the ERISA contributions, continue to increase through that period of time.
We would also expect to see CAS recoveries in our price that our government contracts increase by about a similar amount. We still expect to have a tailwind associated with pension, cash, and free cash flow literally going out. I think, it's still consistent what we showed maybe as much as a year ago that all the way out through 2025, at least as we sit here today, we expect to have some tailwind from pension dynamics relative to our cash flow going forward. That's still what we see today.
Our next question's from Cai von Rumohr with Cowen and Company. Please go ahead.
Yes. Thank you very much. Since your first quarter, it looks like your foreign sales prospects have improved. Can you update us in terms of what you're looking for book-to-bill this year and any color on next year? Secondly, you mentioned a lot of the foreign potentials. You didn't mention some of the NATO missile defense potentials such as Romania, Sweden, for the Patriot system and MEADS. Thank you very much.
Cai, I'll take a shot at that, and Marillyn can add some color to it if she wants to. Relative to the first question and how we're doing, we're actually tracking, I'll say, at or better than planned relative to international orders to date. I don't have necessarily the book-to-bill for the year, but I've been trying to do this math in my head. I think we're slightly ahead of book-to-bill as we sit here today, meaning international orders are higher than the international sales to date. I would expect that to be the case at the end of the year. A lot of that obviously is predicated on whether or not we get sort of the first tranche of the KSA, the Kingdom of Saudi Arabia orders that Marillyn talked about, those $28 billion worth of orders.
There's the potential that some of those can come in between now and the end of the year. It's not obviously clear that they will. There's obviously some congressional notifications and the like that has to take place, and getting the funding in place to do that. There is that possibility. Even without that, I still think we'll probably be in a positive situation book-to-bill because we won't have the sales for that either, for international business there. Having said that, as we look out in the future, and you didn't ask this question, Cai, but we still think we've got a chance to end the year potentially at around $100 billion of backlog if some of these, especially the Kingdom of Saudi Arabia orders, come in this year as opposed to next year. But even without that, 95 to 100 is probably what we're expecting.
Again, more on the international side than the sales for the year, so positive book-to-bill. You asked about the air missile defense. We're still in conversations with Germany right now on the MEADS opportunity there. There's a stated objective to get that negotiation complete by the end of this year. We'll see if that actually closes then. But if not then, I would hope that that closes at least in the early part of 2018. Obviously, there's Poland with the Patriot sale, and we'll do all the PAC-3 missiles associated with that sale. You mentioned some other NATO countries. I'll let Marillyn maybe jump in and give you a little more insight than I can provide to you.
Sure. You mentioned Poland, Romania, and others. Of course, we have Aegis Ashore, which is a U.S. system that's been placed in Europe, but that's an opportunity. Missile defense, there's a strong demand in Europe as well as in other parts of the world, Asia-Pacific and Middle East, where we continue to see opportunity MEADS. JASSM was an opportunity from the standpoint of Poland. You're exactly right. There continues to be in the NATO environment, missile defense opportunities for us to continue to meet as well as for other parts of the world. I think as we have recently done the THAAD test out of Alaska, that was a very successful test. In fact, 14 out of 14 on THAAD, one that I'm sure that
Many countries took a look at it, at the successful capability of that to take out a ballistic missile. That being an opportunity that we've talked about that currently in South Korea, protecting that area, and Guam. Certainly, Japan and other countries will continue to look at THAAD as a capability in the European market as well.
Our next question's from Myles Walton with Deutsche Bank. Please go ahead.
Thanks. Good morning. On space, you raised the sales guidance there, just curious your outlook for space in general, going here in 2017, where the uptick was coming from, then if 2018, this gives you any indication that it's actually got some growth in it. Conversely, the incremental margins looked a little light, 5% incremental margins. Is that just to absorb the commercial satellite charges or something else? Thanks.
Yeah. I'll try those, Myles. Yeah, we're pleased with where space is heading this year in terms of sales. As I said in the prepared remarks, it's a little higher than our expectations. Obviously, we increased the guidance for the year. It was a little higher than what we expected when we started the year. I do think that portends well for 2018 growth. There's some of that coming from our special programs business, there's some opportunities there that we have to see how they play out that will drive that either higher or not as high, depending on the outcome of those opportunities. Then relative to the incremental margin, you have that right, Myles, that is reflective of the fact that some of that volume was offset by the commercial satellite charge that we did take in the quarter.
That's probably worth talking maybe a little bit about, only because that sounds like a bad item to have a charge on the commercial satellite. This is really taking our old legacy A2100 satellite bus, which we've had for a number of decades, and really providing a technology refresh of that legacy satellite. It's sort of updating it to the current state of the art. We're putting a whole lot of new technologies and capabilities into it, everything from power capabilities and increases to the propulsion on the satellite, the electronics. We've got a new solar array, new power regulator. A lot of different items all being sort of put together. Unfortunately, the satellite where this happened to be the first article for production was the largest commercial satellite we ever built, or will have ever built. Well, that's the bad news.
The good news is this new configuration satellite has already resulted in new orders from the U.S. government. I look at it as this is something that we had to do. We had to refresh that product line. While I'd prefer it not to be on a fixed price commercial international contract to have to sort of cut your teeth on, we're glad that we're doing this now because this will position us to have a foundation for new satellite offerings, hopefully for years to come.
Next, we'll go to Joseph DeNardi with Stifel. Please go ahead.
Yeah, thanks very much. Bruce, wondering if you could just talk about capital deployment. From a leverage standpoint, are you comfortable with where you are now, and we should just assume that all of the free cash flow gets split up between the buyback and dividend, or do you see some de-leveraging over the next year or two?
Yeah. Good question, Joe. That's something we obviously talk every September with our board relative to future deployment actions relative to dividends. Before that session, before we have those discussions, and we discuss that sort of strategic view with our board of directors, I'll say the expectation is it's sort of more of the same in terms of our deployment actions. We do have some nearer-term debt retirements coming up, starting in 2018. That's something that we'll guide you towards relative to the trend information in 2018 as far as our thinking relative to refinancing that or paying that off. Our expectation is we'd probably do some de-leveraging, as I said here today, going forward in the near term. Those aren't huge chunks of debt, but some of these, frankly, are the very short-term financing that we did actually to finance the Sikorsky transaction.
Next, we'll go to Peter Arment with Baird. Please go ahead.
Yeah. Good morning, Marillyn, Bruce.
Hey, Peter.
Bruce, just sticking on Sikorsky, which you just mentioned. Total military helicopter deliveries were down about 18% year-to-date. How are you thinking about that for the balance of the year, and then in the context of obviously the new multi-year with U.S. Army and Saudi, how should we think about the kind of government deliveries going forward?
Yeah. Good question, Peter. That's actually something I looked at as I was prepping for the call also, is the first half deliveries of Black Hawks are down. At least as I pulsed that with our team at RMS, that really is just because of the timing of the contract deliveries in the current Multi-Year VIII Black Hawk order profile. Even though we're down, as you pointed out, relative to last year, the expectation is that we still expect to actually deliver more Black Hawks this year than we did last year. Just not a huge number, just a handful there. We would expect to catch up and actually have sort of sequential growth in Black Hawk deliveries with the fourth quarter obviously being the highest by quite a bit relative to the first quarter.
A little bit of a different pattern than what we saw in 2016, but that is the contractual pattern. I didn't look close enough to see if that's because of the types of aircraft. We have some medevac helos versus utility helicopters, and that might be part of it as well, but all sort of expected, and that is the plan going forward, again, is to sort of finish the year higher than we did this year. You also asked about what was another part of your question, Peter? I think you asked about 2018 and relative to the Multi-Year IX. The Multi-Year IX, I think, I haven't got my head exactly around the deliveries next year, but I think they're fairly comparable. Maybe a little less than this year, but not hugely less. Alternatively, as we look forward, the bigger drop-off, frankly, is in the Romeo helicopters.
These are the Naval Hawk helicopters, if you will. That's sort of coming to a much lower number of production aircraft delivery, maybe by a third or so of a more reduction next year. The one thing that we're watching to see if we can get some rebound on that is from the Kingdom of Saudi Arabia. One of the items that was in that, actually two of the items that was in that $28 billion that Marillyn referenced before was for additional Black Hawks on top of what's in the Multi-Year IX Black Hawk deal today, and additional Romeos or the Naval Hawk helicopters as well.
Those have got to sort out, again, the timing of that, Peter, is what we're watching very closely, seeing whether or not those orders come in this year, the early part of next year, we're hopeful they can sort of butt up against the Multi-Year IX deliveries we're talking about.
John, this is Greg. I think we have time for one more question.
That will be from Jason Gursky with Citi. Please go ahead.
Hey, good morning.
Hey, Jason.
Hey, guys. Marillyn, I wanted to ask you about the company's supply chain, your strategy there. You've spoken in the past about the need for Lockheed and its suppliers to focus on two things, affordability and cyber security, essentially to assure continuity. Can you provide us a bit of an update on the company's effort to drive affordability out of the supply chain? Is your strategy continuing to evolve there? Are you looking to maybe vertically integrate a little bit more than where you've been in the past? As you look out at things, how far along do you think you are in accomplishing your near to medium-term goals on affordability?
On the cyber security front, how do you view the health of the industry overall at this point, and what's Lockheed and the rest of the industry currently doing to improve the cyber security health of the supply chain? Thanks.
Thanks, Jason. Those are great questions. If you look at our supply chain, it represents 60%, sometimes 70% of the revenue on many of our programs. It's a very important element of our business in terms of our execution on programs, performance on programs, as well as what we're able to financially accomplish with those programs. That's a great question. On the affordability front, I will just start with our largest program, which is the F-35 and representing last year, about 23% of our sales, we put a lot of effort into that piece of it.
Collectively, with our major teammates with Northrop Grumman and BAE Systems, we work together on something that the government calls a blueprint for affordability, where we actually put funding up front, working not just with the three teammates, Lockheed Martin, BAE, and Northrop Grumman, but all the way through our supply chain on identifying areas where we could invest to continue to drive the cost down on the F-35, beyond what you would normally get through a ramp-up of production and the volume. We'll continue to do that. We're also doing that on the sustainment side as to look at where are there cost reduction initiatives that we can put in place there that would continue to drive the cost down. We work with supply chain affordability every day on all of our programs. I feel really good about our affordability initiatives in that regard.
Our teams that work directly with our subcontractors, with our suppliers, that is one of their primary efforts and ones that, working alongside them, they're constantly focused on. The other thing I would say is where we have a big opportunity on F-35 is through the block buy, because that's where we can get the volume reductions. That's where we can get suppliers. If they know they're going to get 3 lots worth of work, 450 airplanes or plus, then they can invest in driving the cost down. They can commit to a lower price to us on their element of the system. Bottom line is, we look all the way across our supply chain on an ongoing basis and are constantly driving. In terms of vertical integration, I think it really just is driven on a case-by-case basis where it makes sense.
If we're seeing that we think we have the capability inside Lockheed Martin that we could do at less cost and better technology, then we might look at some vertical integration there or through an acquisition that gives us the opportunity to do that. Generally speaking, we're mainly focused on the affordability and the performance of our supply chain on an ongoing basis. You asked a question about cybersecurity and sort of the health of the industry and what are we doing on that front. I would just speak from a Lockheed Martin standpoint. We recognize that the supply chain, it's critically important that they have in place the appropriate cyber defenses in their business.
We have worked with the Department of Commerce and the National Institute of Standards to help put in place voluntary initiatives and frameworks that work with supply chain on how they can get in place the appropriate defenses. We then audit and monitor what our supply chain, our suppliers have in the way of cybersecurity defenses on an ongoing basis. We actually work with our customer. Our customer often looks to us for the depth and capability we have in cybersecurity. It is a line of business for us. We do it for many customers and supporting them, and we likewise take that same capability and try to work it back through the supply chain as well. In terms of the health of the industry, I think it's an ongoing effort that we've got to constantly stay focused on as a nation.
The threats are constantly changing or there's always an unpredictability in that sense. We have been a thought leader and an industry leader in cybersecurity for many years. In fact, we have the National Cyber Range where we developed that and where our government customers and others can bring their solutions and test them on this National Cyber Range to determine whether it brings the kind of defenses that they're looking for, that they expect. I would say across the board, cyber has been an area for us that is in everything that we do across the system. It runs through all of our programs. We have a robust capability that we provide to customers, and we work hard with our supply chain to make sure that they get the right defenses in their own networks on an ongoing basis. Thank you.
I think that that was the last question, Greg. Let me just wrap up and conclude the call today. I want to conclude by restating that our second quarter results and our increased 2017 outlook reflect that we have an ongoing commitment to our strategy for growth, strong cash generation, and we continue to deliver innovative solutions for our customers and long-term value creation for our stockholders. We're very pleased with the solid results that we had for the quarter. I want to thank you all for joining us on the call today, and we look forward to speaking with you on the next earnings call in October. John, that concludes our call today.
Thank you. Ladies and gentlemen, that does conclude your conference. Thank you for your participation. You may now disconnect.