Good day, welcome, everyone, to the Lockheed Martin first quarter 2016 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.
Thank you, Abigail. Good morning, everyone. I'd like to welcome you to our first quarter 2016 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. 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 Marillyn.
Thanks, Jerry. Good morning, everyone. Thank you for joining the call today. We are pleased to have you with us as we review our first quarter results and full year outlook for 2016. As today's release details, we had a very strong quarter, financially and operationally. The corporation continued to perform at a very high level in delivering critical solutions to customers while returning value to stockholders. I want to highlight a few key items in the quarter, including an update on our Sikorsky activities, as well as the current status of the strategic disposition of our Information Systems and Global Solutions business to Leidos. Turning to the quarter, our team continued to deliver broad-based results across the corporation, with achievement of first quarter financials that exceeded all of our internal plans.
This strong year-to-date performance enabled us to increase full year 2016 guidance for sales, segment operating profit, earnings per share, and cash from operations. As a reminder, the guidance continues to assume inclusion of full year 2016 financial results from the Information Systems and Global Solutions business. We will adjust our financial outlook when the disposition of IS&GS is completed, which we continue to anticipate will be in the third or fourth quarter of this year. Bruce will provide a detailed review of the guidance and assumptions in his comments and web charts. One of the standout items in our financial results is the strong performance of cash from operations. Consistent cash generation is a financial hallmark of our corporation and enabled us to return over $1 billion to stockholders this quarter through dividends and share repurchases.
I would also note that share repurchases year-to-date have reduced the outstanding share count to approximately 304 million shares. This lower level illustrates the progress we are achieving on our goal to reduce outstanding shares to below 300 million by the end of 2017. This long-standing goal does not consider the additional share reduction opportunities from the pending disposition of IS&GS. We anticipate further share reductions will be accomplished by a stock exchange contained in the deal transaction. Additionally, the $1.8 billion special cash payment to our corporation at deal closure also provides cash deployment and share reduction opportunities. With a full year of Sikorsky operating as part of our Mission Systems and Training business area, I'd like to offer my high-level perspectives on their activities. Integration actions are progressing well as we work to transition Sikorsky operations into Lockheed Martin.
As we perform the integration, we continue to evaluate the best-in-class processes, procedures, and tools. Our goal remains to identify and apply the best practices across the enterprise throughout the integration process. We continue to see cost reduction and efficiency opportunities emerging as we work as one team with Sikorsky. Areas like supply chain, where multiple business areas procure similar materials, have allowed us to look at where we can realize better buying power and align procurement specifications. By utilizing best-in-class processes from across the corporation, further efficiencies can be achieved, and will help ensure we capture the synergies identified from this acquisition. Moving to an operational perspective, significant progress was achieved on the CH-53K program for the U.S. Marine Corps. The second prototype test helicopter achieved first flight in February, providing additional assets to the flight test program and expanded our ability to achieve future critical milestones.
We look forward to demonstrating the maturity of the aircraft through the current development phase. Since the end of the quarter, we received a contract from the U.S. Navy for long lead items required for the first two CH-53K helicopters on low-rate initial production Lot 1. These initial units are part of the Naval Aviation Procurement Plan to field 200 helicopters on the program in coming years. In the area of commercial helicopters, we are seeing some emerging interest from other customers beyond the oil and gas sector for S-92 platforms, and we are pushing aggressively into the search and rescue, VIP transportation, and international military segments. We also see significant potential to create additional value in these sectors in sustainment. To pursue this area, we recently opened a state-of-the-art customer care center in Connecticut that is designed to enhance platform reliability and ensure 24-hour availability to customers' aircraft needs.
Overall, I remain enthusiastic about the opportunities for long-term creation of the rotary aircraft business to customers around the world. Turning to our Information Systems & Global Solutions business area, key events associated with the pending strategic disposition included successful clearance of the Hart-Scott-Rodino regulatory review in the U.S., satisfying one of the key conditions to deal closure. The only remaining review of competition impact is in process in the U.K. We also filed the required registration statements last week with the Securities and Exchange Commission. This filing, and a comparable filing by Leidos, initiate a review process by the SEC staff. Once the review process is completed, a prospectus describing the terms and conditions of the exchange offer and transaction will be provided to Lockheed Martin stockholders.
Switching to some brief comments on the F-35 Joint Strike Fighter, overall, the program continues to progress on satisfying remaining development activities while also ramping up the production rate. Several noteworthy events were achieved this quarter and included completion of the first transatlantic F-35 flight from the Italian final assembly and checkout facility to the U.S. to enable commencement of training for Italian pilots. Surpassing 50,000 flight hours of the F-35 fleet, demonstrating the increasing level of flight operations. Lastly, we also successfully conducted first flight of the software required to achieve initial operational capability of CTOL aircraft to the U.S. Air Force. Achievement of this milestone enables the program to progress towards IOC, scheduled later this year. I will conclude my remarks by recognizing the difficult but necessary workforce reduction actions implemented this quarter by our Aeronautics and IS&GS business areas.
As stewards of the enterprise, it is a business imperative that we remain agile and competitive in our cost structure. In response to dynamic business conditions, these businesses implemented voluntary and involuntary headcount reductions. While these reductions resulted in a special severance charge in the quarter, they also significantly improved our competitiveness and ability to win future new business opportunities with a leaner cost structure. I'll now turn the call over to Bruce to review our financial performance in more detail, then we'll open up the line for your questions.
Thanks, Marillyn, good morning, everyone. As I highlight our key financial accomplishments, please follow along with the web charts we included with our earnings release today. Let's begin with Chart three and an overview of our results for the quarter. Sales for the quarter were $11.7 billion, slightly ahead of our expectations. Segment operating profit was also higher than expected at $1.2 billion, resulting in earnings per share of $2.58, which included the impact of about $100 million in severance charges associated with planned headcount reductions. We generated $1.6 billion in cash from operations, a good start to the year. We returned $1 billion of cash to our stockholders in the quarter, about equally split between share repurchases and dividends. Because of our better-than-expected performance, we are increasing our outlook for sales, operating profit, earnings per share, and cash from operations.
We're off to a strong start in 2016. On Chart four, we compare our sales and earnings per share in the first quarter of this year with last year's results. Sales were about $1.6 billion higher this year than last year, driven by the inclusion of Sikorsky into the results of MST for about $1 billion, and more than $600 million in growth at Aeronautics, driven by about $400 million in higher F-35 production volume, along with higher C-130 and C-5 aircraft deliveries. Earnings per share were lower than last year. This year's results include those severance charges for reductions in Aeronautics and IS&GS, as well as the headwind effects of the Sikorsky purchase accounting adjustment and integration costs. On Chart five, we'll discuss the cash returned to our shareholders in the quarter.
With nearly $1.6 billion of cash from operations and slightly more than $150 million of capital expenditures, we had $1.4 billion of free cash flow this quarter. With over $500 million each in share repurchases and dividends, our total cash returned to shareholders was 73% of free cash flow. With our share repurchase level in the first quarter, we are right on track to our plan level of $2 billion in share repurchases for the year. If you'll turn to Chart six, we'll provide our updated outlook for 2016. Because of our strong performance in the quarter, we are increasing our yearly outlook for all key financial metrics. We're increasing our sales outlook by $100 million and our segment operating profit outlook by $125 million due to our performance in the first quarter.
We're increasing our earnings per share range by $0.05 per share. I'll discuss that in greater detail on the next chart. We increased our outlook for cash from operations by $100 million, consistent with our improved profit outlook. Chart seven provides a reconciliation of our current and prior earnings per share outlook. Excuse me. The $125 million increase in segment operating profit results in a $0.26 increase in EPS, while the $100 million special charge associated with our severance actions reduces our EPS outlook by $0.21, netting to the $0.05 increase that I mentioned on the prior chart. On Chart eight, we show our revised sales outlook by business area. The $100 million increase in sales is due to the improved outlook we have for IS&GS after its better than expected results in the first quarter.
We are reaffirming the sales ranges for the other four business areas at this time. Chart nine provides the updated segment operating profit outlook by business area. We increased our operating profit outlook in four of our five business areas, with Aeronautics, Space Systems, and IS&GS increasing $25 million each, while Mission Systems and Training was increased by $50 million. Finally, on Chart 10, we have our summary. Our strong start to the year led us to increase the outlook for sales, operating profit, earnings per share, and cash from operations. We continue to provide significant cash returns to our stockholders. We remain on track to complete the IS&GS RMT transaction later this year. With that, we're ready for questions. Abigail?
Thank you. In the interest of time, we are limiting you to one question. Please return to the queue for any follow-up questions. At this time, we are opening our lines for questions. Please press star one to enter the queue. To exit the queue, please press the pound key. Our first question comes from Carter Copeland of Barclays. Your line is open.
Hey, good morning, Marillyn, Bruce. Good quarter.
Hey, Carter.
Thank you. Good morning.
Just a couple of quick ones on the margin. I noticed that the profit contribution from the C-130 that you called out on the $200 million in higher revenues is only $10 million, and sort of implies a lower margin than we would think is normal for that. I wondered if there was a negative offset there. As a second one in the guide, I noted the sales in MFC have obviously been strong and benefited from, I think, some of the consumable stuff and some of the stuff you highlighted in the release. The guidance didn't increase there, and I wondered if there was, again, an offset to call out for the full year. Thank you.
Thanks, Carter. Thanks for the question. The first one, I think, was your margin contribution question relative to C-130, and you picked up right. I think we had $190 million increase in sales and about a $10 million or so increase in profits, what we called out, I think, on the earnings release. This is somewhat of what I talked about, I think, either in October or January, where we're sort of finishing kind of an older, I'd say multi-year contract, because it's more than a multi-year contract, but an older contract of C-130s that we performed well on. It's at the tail end of that contract, and we're starting off with sort of the new deliveries and new performance on the new multi-year contract that was just negotiated.
Some of that is sort of the resetting, in my words, of the initial profit booking rate on the C-130 contract. As I've said all along, I still think the economics between the two contracts are very similar. As is our sort of historical practice, we're starting that program a little lower than we ended the last program for C-130s, if that makes sense. On Missiles and Fire Control sales, you're right. We did not increase for the year. We're watching that closely. I'll just leave it that as we sit here in the first quarter, didn't feel like now is the right time to look at that. I think there is some upside opportunity. We've seen some good signs, particularly, as you said, Carter, in some of the consumables, particularly with some of our Middle East customers.
I'm watching this to see if it perhaps warrants something later on in the year, but not at this time.
Thank you. Our next question comes from Douglas Harned with Bernstein. Your line is open.
Thank you. I'd just like to follow up on the Missiles and Fire Control side, because you also, in the release, talked about, it sounded like more a timing issue with contracts on missile defense. You referred to PAC-3. Can you talk about when you look at international contracts, particularly in the Middle East on missile defense, where you stand today in terms of the maturity of those programs? Because it appears you may be in some that are earlier stage and perhaps lower margin at this point than when they mature.
Yeah. Doug, I'll give that a shot. I think the watch item in terms of the air missile defense programs for the Middle East are more in the orders expectation for this year rather than, I'll say, the margin expectations. You should think of essentially all international orders for both PAC-3 missiles as well as the THAAD program are sort of combined with U.S. orders. They'll perform essentially at parity with U.S. orders over that period of time. There's not, per se, any greater risk associated with the Middle East portion of the order than the U.S. military portion of the order, if you will.
This, again, is somewhat akin to what I talked about just now on the C-130, where we have sort of a shifting from an older contract where we closed out a good performing contract and a newly negotiated contract where we're starting off at our typical pattern, probably a little more conservative than we expect to make. That's exactly what's going on both the PAC-3 and THAAD programs, is we negotiated some new contracts, and they're starting off A slightly lower margin than what we experienced at the end of the previous contracts that finished up. Again, economically, I'm not sure there's a whole lot of difference between the contracts, sort of from a booking perspective, that's the way that's playing out. I wouldn't attribute that necessarily to any greater perception of risk that we have associated with those deliveries.
Thank you. Our next question comes from Richard Safran with Buckingham Research. Your line is open.
Thanks. Good morning.
Morning.
Morning.
I had a bit of a multipart question here on trying to get an update on the F-35 margin profile we should expect. In 2016, I think you're north of about 8%. As you ramp up production, and some of the low-margin development work winds down, I want to know if you could comment on what the margin progression should be. How quickly do you think you could get to F-16 types of margins? And if you would, could you comment on the F-35 sustainment and if that could drive upside to margins?
Yeah, Rich, I'll take that one as well. F-35 margins are going to vary over time. I think from a big picture perspective, we do expect them to increase sequentially year-over-year. We talked about last year being an expectation of a 100-basis point improvement in the overall margins of the F-35 program. We achieved that. I think I talked about, again, either October or January, the fact that we thought margins on F-35 would be higher in 2016 than 2015. We still expect that, although not at the same 100-basis point improvement as we saw in 2015.
We would expect that trend to continue in 2017 and 2018 as we start to sort of progress to what you're describing, Rich, which is our ultimate expectation, which is that by the time we get to full rate production, the margins on the F-35 program ought to look very similar at a similar stage of its life cycle as F-16 margins, F-22 margins, C-130, et cetera. I don't think that we're deviating from that expectation. Interestingly, as I look at some of the numbers in front of me here, we had probably slightly higher pickups on the production program last year in the first quarter than we did this year, although we did have profit step-ups on production contracts this quarter as well.
I look at last year's first quarter results, and I know I didn't talk about this last year, we were actually close to 10% on the production program. It will sort of peak and valley depending on the step-ups and when they occur and how many of them occur on multiple production contracts in the same quarter. Our expectation, again, is we'll get to sort of legacy program margins when we get to full rate production. Your second question was on the F-35 sustainment margin. Those are typically negotiated at pretty comparable margin levels as the production program. It's not at this point sort of either a drag or a benefit at this point in time. It is growing fairly rapidly, and we're going to start seeing some of the sustainment contracts sort of split out of the production contracts as this volume gets bigger.
We may, in the future, end up talking about sustainment separately from production, you shouldn't think of that as being a whole lot different than the production margins at this point.
Thank you. Our next question comes from Joseph DeNardi with Stifel. Your line is open.
Hey, thanks very much. Bruce, I wonder if you could just talk about kind of Sikorsky performance relative to expectations at this point from a revenue and margin standpoint. Just as you look into 2018, I think that's when the required contributions start again for the pension. Just based on current assumptions, can you talk about what the contribution could be in 2018?
Sure, Joe. Thanks for the question. I would say Sikorsky, and look, we're still early into the integration and into the incorporation of Sikorsky into our results. I'm still getting my head around describing Sikorsky and what the expectation should be and shouldn't be. I would characterize the first quarter as pretty much in line, maybe slightly better, than our expectations. That's both from a revenue perspective as well as a margin perspective or an EBIT perspective. We're sort of front-end loaded during the year with these things I talked about in last quarter's call, these customer lien rights that sort of depressed the sales because of sales for products that were recognized prior to our ownership. That plays out sort of for the most part in the first half of this year.
We would expect to see sort of sequential growth in sales at Sikorsky quarter over quarter, with the fourth quarter obviously being the highest quarter of the year. Similarly, we expect to have the margin profile for Sikorsky increase quarter over quarter. Again, obviously having the fourth quarter being the highest margin quarter as well, and this is, again, some of the timing of the customer lien rights in the first half of the year as well. I'd say just big picture, that's pretty much in line with what we expected to happen in the first quarter, and we're going to watch it throughout the year, and we'll give you updates as we go and progress through the rest of the year. Secondly, Joe, you asked a question about 2018 pension funding.
We had described several years ago our expectation that we were going to have a three-year pension holiday, cash funding holiday, as I called it, I think, and that was 2015, 2016, and 2017. Unfortunately, that holiday does stop at the end of 2017. In 2018, we would expect to have to start making cash contributions to the pension plan as well going forward. I think as we sit here today, Joe, that's probably somewhere north of probably a billion and a half dollars or so. Importantly, I think you shouldn't think of that as necessarily being sort of taking the current run rate of cash and subtracting, say $5 billion and subtracting a billion and a half dollars, and we're down to three and a half billion dollars.
We expect by 2018 to have much greater cash from the Sikorsky acquisition, as well as cash from the other business areas that's going to offset most, but not all of that pension contribution. We also get a tax benefit of that as well. We get a cash tax benefit associated with that. It's somewhat mitigated, in 2018. You shouldn't think of it sort of as falling off the cliff from 2017.
Thank you. Our next question comes from Ronald Epstein with Bank of America. Your line is open.
Yeah. Hey, good morning.
Good morning.
Can you kind of just walk through the laundry list of upcoming competitions that we should keep an eye on? I mean, we all kind of know Trainer's happening, and maybe you can make some commentary on that, what's on that list of stuff we should keep our eyes out for?
Hey, Ron, this is Bruce. Did you say competitions or just big awards coming up, or do you care?
No, competitions. Yeah, competitions. Right. We've got Trainer, what else do we have on the horizon?
There's not a whole lot of, I'll say, large dollar, strategic competitions coming up. Even Trainer, the decision is likely going to happen in 2017 as opposed to 2016. Another large one that we're watching is JSTARS. That's probably not a 2016 decision either. Frankly, most of the, I'll say, the strategic competitions that I think is at the heart of your questions would probably not be in 2016. I mean, these are things like, the LRSO competition, the GBSD, Ground Based Strategic Deterrent, or Ballistic Deterrent. Those are probably 2017 and even beyond as far as the real big-ticket strategic items. Beyond that, the one we're watching obviously closely, which I wouldn't characterize as a competition, MEADS in Germany is one that we're hoping to close, perhaps at the latter part of the year. I'll let Marillyn add some color to what I just said.
The only other ones I would say that we're watching are some of our international partners making their decision on F-35 buys. Denmark's coming. They're going through their process, Canada will ultimately, but we think the best choice for them is F-35. They'll go through their process for that.
Okay. Okay, great. Thank you.
Thank you. Our next question comes from line of Robert Spingarn with Credit Suisse. Your line is open.
Good morning. I wanted to ask really a two-part question on IS&GS, if I could. First, I think as you both stated, the business is doing a little better than perhaps you guided for. You've tweaked up the guidance there. I wanted to talk about whether that is just timing on some of these program closeouts or pricing environment, which I think you cited pressure in, maybe it's a little better than expected. Separately, Marillyn, the deal was contemplated, I think, on what the business will look like at the time of transaction. Of course, that's a nine-month period. From the time of announcement, how do we think about some of the puts and takes and strategic things that you're doing with regard to headcount vis-a-vis the new management team? Are these things that were negotiated? How do we think about that?
Thank you.
Robert, let me take the first part of that question, sort of the IS&GS performance. I'll say, obviously we increased the outlook for both sales and profits, it's exceeded our expectations. I think there's a couple of things going on, and some of them are a little subtle. Sales is just, this is a tough business to sort of predict which competitions are you going to win, which ones are you going to not win. You get scenarios where things get protested, even if you lose, and therefore you can actually get the sales stretch out of those. We're sort of seeing all of those happen at the same time.
The one thing I'm really pleased with, probably more than anything, even higher than sort of the sales volume, because again, that's a little bit hard to call, is the better than expected earnings performance and the margin performance. This was a quarter where we had a pretty significant write-off on an international contract. Even with that write-off, we still exceeded our expectations, we still, as obviously we said earlier, increased our guidance for the year. I think that's sort of due to three reasons that, at least as I look at it sort of big picture-wise. One, we had expected a number of recompete activities to occur on some of our larger contracts in the year. We bid those probably more aggressive than the previous contract where we were the incumbent.
Because these contracts are actually being protested, we are continuing the performance on the older contracts, which are at the, if you will, the higher margin on the incumbent contracts. It's good for us from both the sales perspective and more importantly on the margin side because of that. I think we also had better performance on sort of the closeout or transition of some of the programs that we lost. You should think that most of these contracts tend to have transition periods that extend for some period of time, we're actually performing very well on those transition periods, then taking some cost out as we end the program higher than our expectations, which are resulting in higher margins. The third thing I would just say is really just across the portfolio, strong performance by the IS&GS team.
I think credit goes to that team. I think it's indicative of the fact that they haven't taken their eyes off the ball. It's a well-run organization, and the entire team understands that the mission that they perform for their customers is important, no matter who they work for. I think we're seeing that play out live in person in front of us here. I'll ask Marillyn to answer the other question you asked, Rob.
I'll pick up on the second part where you ask about at the time of transaction, how to think about some of the gives and takes in the headcount and how we think about it. I first just want to build on what Bruce said. This is a management team that's running a business. They've outlined some commitments for the year, and they're performing those commitments, and the whole entire team in IS&GS is making sure that their cost structure is in line with the business base that they have. As they look at what they need to do to be competitive in a very competitive environment that they operate in, it's ultra-competitive, and it's an area that you've got to constantly be watching your cost, and you have to manage that. There's close coordination with Leidos as they make headcount reductions.
Certainly, we have an agreement as we're going through this process to closing the transaction. Actions that we take on the Lockheed Martin side, they're aware that we're going to take those kinds of actions. It is our job to continue to run the business, to perform well on the business. It's in all of our best interest, and we will continue to do that with an excellent team that's working that every day.
Thank you. Our next question comes from David Strauss with UBS. Your line is open.
Thank you. A couple questions within one, I guess. Bruce, can you talk about the only six F-35s that were delivered in the quarter. Was that your plan, or was that actually below your plan? On Sikorsky, can you talk about, it looks like MST that you're guiding for fairly flat EBIT from here through the rest of the year, but I would think as you've commented, Sikorsky is expected to get better, and whether you're still tracking a plan for Sikorsky as a neutral to earnings in 2017. Thanks.
Thanks, David. Good question. The six F-35s, probably a little lighter than we expected. There's probably three or four different reasons for that, but none of them that will play out, I think, by the time we get to the end of the second quarter. I think we'll be back on track at the end of the second quarter. We're very much on track to have the 53 aircraft that we talked about in the first quarter, or the last call in January, excuse me, delivered for the year. No issue there. Some of it was just the sort of the transition between lots, and getting new acceptance for new software and the like that delayed some of the deliveries, but sort of from a production or manufacturing side, there is no issue there.
It's more of a, I'll say, not quite administrative, but not a production issue there. You talked about Sikorsky within MST, guidance looks like sort of flat earnings for the rest of the year. That's what we're showing, David, in the outlook there. Even with the $50 million increase in guidance from an earnings perspective with MST, that's one that we're still watching closely. It's a little early in the year to go more than that, but I think there is some potential upside in the numbers that we've got on the table right now. If you just do the math the way you did it, David, with including the Sikorsky uptick for the rest of the three quarters of the year, you'd kind of come to that conclusion, I think, as well.
Lastly, I think the Sikorsky, you asked about Sikorsky being neutral in EPS. All this has to do with the share reduction from the Reverse Morris Trust transaction and expectation of some of the bleed off of the transition costs or transaction costs, including the integration. That's still our expectation, David, is that'll be neutral going into 2017 with all the pluses and minuses going into that.
Thank you. Our next question comes from Peter Arment with Sterne Agee. Your line is open.
Yeah. Thanks. Good morning, Marillyn and Bruce. Bruce, a question on kind of just big picture on the backlog. You closed in 2015 at a record level, and then we had a little bit of a downtick here this quarter, I guess timing related. On IS&GS, you're going to lose that. Is there a number that we kind of should be looking for where you think backlog ends up at the end of the year? Then just Marillyn, if I could relate it to that, how are you looking at kind of the international front? We've seen a healthy drop in oil over the last 18 months. We haven't seen a big impact on your awards, but just seeing if you're seeing any behavior changes. Thanks.
Yeah. Peter, I'll answer the backlog question. We were down in the quarter after the record backlog at the end of last year. Actually, we were ahead of plan in the first quarter, I think a couple of billion dollars worth or so. That may not be apparent. Even though it was down, it was not down as much as what our plan had suggested it might be. An interesting thing we're going to have probably a little bit of an opposite or unusual pattern to backlog this year, at least as we see it, or the orders this year. We're probably not going to have as large a fourth quarter from an orders perspective as we ordinarily would.
The largest quarter is actually third quarter this year. That's sort of the planning and the biggest single ticket item there is the definitization or award of the LRIP 10 contract on F-35, and it's worth a significant amount of money. Depending on when that happens and when IS&GS is dispositioned, we could actually see potentially $100 billion worth of backlog that will quickly dissipate with IS&GS's disposition. If I was to pick a number, it's probably going to be somewhere between low $90s to $95 billion by year-end is the expectation. We were sort of expecting about almost four and a half or so, $5 billion drop, steady run rate with IS&GS in the mix. When you take out IS&GS, it gets down to that 90-ish billion dollar level.
Peter, I'll pick up on your question relative to impact of oil prices and what we're seeing on our awards. We often talk about this because we're trying to watch. We're not seeing a pullback on essential national security assets and what these countries need. What we are seeing is that there's a couple of them that we're watching, and particularly one that's in our numbers and that we're watching very closely is the Qatar THAAD order, because that's something that we're hoping to have in this year, and it is in our plan. It could potentially delay. I think it's not an indication they're not going to buy it. To me, it's just a matter of them balancing with pressure on their budgets, with oil prices, balancing what they can buy. I think that we'll see probably some of that.
Maybe it'll impact some volumes or delays in some orders. The bottom line is, you know the conflict in that region, you know the challenges they have from a global security standpoint. Because they have increased security responsibility since the U.S. is not so prevalent there, they're having to step up and buy the things that they need in order to protect their citizens. We anticipate continued demand. It's just a matter of maybe some things will slip. That's not unusual in the international marketplace, even on a good day. We don't always see things come right online with what we anticipate anyway, because as they're dealing with multiple procurements, they may have to do it more serially sometimes and get one out of the way before they move on to the next. We have to wait through that process.
Thank you. Our next question comes from Sam Pearlstein with Wells Fargo. Your line is open.
Good morning.
Hi, Sam.
Can you talk a little bit about ULA? You had said you thought it would be flattish this year. It looks like it was down a little in the first quarter, and at least the press talked about a further headcount reduction this year and then again next year. Trying to just think about how severance would flow through. If I could follow up with a second one, just in your proxy, you removed the orders category from some of the incentive comp and just want to talk through why you would have made that change at this point.
Yeah. Sam, I'll take the ULA question. Yeah, ULA was down in the first quarter. In terms of the equity earnings, it's purely timing. We actually expect ULA's earnings will be higher in 2016 than 2015. That's actually the primary reason behind the guidance increase in Space Systems is, in fact, because we do have a higher expectation of ULA. The severance charges that were taken on ULA, I don't think you'll see much impact of that in the numbers, and that's just a little bit of, you've got the severance costs offset by the lower cost once the people are removed. That'll, I think at least in 2016, be somewhat neutral for the year. It's a little too early for me to call 2017, but that's the expectation for 2016. Orders in the proxy.
We had a lot of discussion about that, Sam, and Marillyn can comment on this as well, obviously, but we actually had a lot of discussions with the board and our compensation committee. The concern was that because orders are so variable, a perfect example perhaps is you can imagine a scenario where we had won the bomber program in 2015, but it had been protested and pushed out in 2016. Do you give actually someone credit for having won it, or do you say you missed it because you didn't bring it home? These are some of the real-life conversations that we had, we ultimately decided that sales, earnings, and cash flow were better measures of the actual performance without the customer vagary going on there. In terms of awards, I'll remind you also that we do have an incentive compensation metric associated with focus programs.
The thought was, as long as we win the right programs, I'll make this up, whether or not the fiscal year LRIP 12 on F-35 happens in December or January is probably not as important as winning some of our critical competitions. We decided to sort of focus more on the critical competitions as opposed to some of the timing vagaries associated with orders that really don't influence the economics or financials of the company, whether they happen again end of this year or beginning of next year.
Let me just add to that. I think Bruce has covered it well, if you look at how we've outlined our incentive compensation, we have very clearly on the financials, sales orders and cash, I mean, sales even cash as you see. Then where the orders come into play is in the strategic and operational area, and that is still an element of compensation. We look at it more in terms of focus programs, as Bruce said, or programs that we need to continue on contract growth with and keep sold to keep them forward. As we flow down those metrics throughout the organization, the individuals in the organization are still going to be tracking their orders, they're still going to be driving to achieve levels of financial performance on the orders front.
It's not something that we've taken out, it's just that we've looked at it more realistically on what we should be compensating for in terms of incentive compensation. It's still an element. It's just not outlined as a digital requirement.
Thank you. Our next question comes from George Shapiro with Shapiro Research. Your line is open.
Yes. Bruce, I wanted to pursue on the F-35 margin, you said last year was 10%, obviously including the one-time catch-ups. Given that this year the profit was only up $30 million on $400 million sales increase, obviously that relates to having lower pickups. Could you tell us, though, what the F-35 margin actually was this year, and maybe kind of what the run rate has been going at?
Yeah. George, it's a little lower. The reason I highlighted the first quarter of last year, that's probably the high point of any quarter in the history of the F-35 program. That's to say that that's what we expect eventually to become sort of standard practice, is that will be a double-digit program going forward, just as F-16s, F-22s, C-130s, and you name the program, are. First quarter of 2016 is a little less than 2015, but not much less. We still had good performance, and you should think of that as, even though the step-ups were lower, sort of the run rate of the programs is higher. Therefore, it's almost comparable, but not quite to what we performed in 2016, or excuse me, in 2015 in the first quarter compared to 2016.
Run rate, as I said to the earlier question, I've lost track now who asked it, but our expectation is we still do expect to have margin improvement on the entire program, including the development contract. The total F-35 program this year in total is probably 50 basis points margins higher than it was in 2015. Again, nice progression. Not quite as high as the 100 basis points we talked last year, but still progressing nicely and sort of in line with what I've said all along, which is that double digit by the time we get to full rate production.
Thank you. Our next question comes from Seth Seifman with JPMorgan. Your line is open.
Thanks very much. Good morning, everyone.
Good morning.
Morning. On F-35, I think we all understand that there's a lot of good progress that's been made, but that there's also still challenges ahead. When you think about those challenges, which we read about fairly often, if the development portion of the program was to become extended, let's say into 2018, in terms of financial implications, I'm guessing there's fairly little exposure to you. Are there concurrency implications to that? For example, if there are issues that delay the program further, is the exposure for you sort of in going back into and making upgrades to aircraft, and could you talk about how much we should be concerned about that, if at all?
Yes, let me take a shot. It's a really good question, Seth, and let me just give you, hopefully, a thoughtful answer to your question there. The challenges that we have on the development program are surely winding down as we're progressing through a lot of the changes. A lot of the, I'll say, the impacts that might result, your question sort of tallied what's going on with concurrency changes if, in fact, the development program is stretched out. Most of the structural types of testing that could result in, I'll say, large concurrency changes, we should have a really good idea of where those are probably by the end of this year or in the middle of next year as we complete sort of the fatigue testing and the multiple useful life testing of all three variants.
I've lost track off the top of my head where we are in progressing on that, but all three variants are well past a single useful life in terms of their durability, and we're in 150% of useful life and beyond, I believe, for where we are on the testing of that. Most of the structural items, I would say, I wouldn't expect to see huge concurrency impacts. There may be some relative to some software changes that come out of it, relative to some testing, and particularly some of the armament testing later in the developmental program that might result in some software changes. I don't particularly view those as sort of concurrency issues. We're still on track for the IOC of the USAF later this year. We're making really good progress on the software to accomplish that.
The ALIS program is probably the other thing that we all have our eyes on in terms of this is the sustainment vehicle that sort of is your one-stop shop for sustainment on the F-35 program. The huge amount of software that we're doing there is high on our list of things to be mindful of, but I think that's still going to support the IOC and whenever that's scheduled, the fourth quarter or so of this year. I'll remind you that the development contract is still cost reimbursable. I know your question was more on the concurrency, but we really do think most of the concurrency risk starts to fade pretty measurably once we get past these testings the latter part of this year and into early 2017.
Thank you. Our next question comes from Myles Walton with Deutsche Bank. Your line is open.
Thanks. Good morning. Bruce and Marillyn, I think you've talked about top-line organic growth targets of the company going forward in the 3%-5% range with the outside contributor at Aeronautics, but that's also where you did the headcount reduction actions. Two kind of sub-part questions. One, is that growth rate still the right growth rate to think about? Two, is this more of a reactionary headcount to some of the ongoing negotiations as it relates to F-35 and/or other internal DoD competitive pressures?
Let me try that to begin with. I'll let Marillyn chime in, Myles. I think I've said publicly, once you sort of strip out IS&GS and you sort of re-baseline Lockheed Martin without IS&GS in the portfolio, I think organically going forward, you should expect us to have about 3%-5% growth, heavily driven, obviously, by the F-35 program and aeronautics in general. Also contributing to that is, across all the business areas, it may not be self-evident because we've actually got some DoD contraction in some of the business areas there, but our international growth is probably going to grow from 21% or so this year to somewhere in the 25% in the not too distant future. That's helping fuel that growth as well.
As far as the reductions, I would say that's not because of pressure that's being put on us from a DoD perspective. If you just think of sort of the life cycle, and it goes back a little bit to Seth Seifman's question there, the development program is winding down. The production program is going leaps and bounds year-over-year. The workforce is sort of transitioning more from sort of an engineering dominant workforce to more of a manufacturing base workforce, and we're starting to see that transition occur. That's what some of these reductions are for, is simply the lower level of sort of the development program going down and the higher production program increasing without the same number of heads required to support the manufacturing growth as what we saw in the development programs, if that makes sense.
Yeah, I think you've got that right on the mark, Bruce. To add to that, it's also changing the nature of the work that the indirect personnel support to that, you don't need the same number of people that are in certain roles as you move into the production phase and you ramp up that production.
It may not be perfectly evident, Myles, but recall, we, Lockheed Martin, were responsible for the large bulk of the development program there, whereas the production program, obviously, is a lot more of the supply chain, including two large partners there. They're doing pretty good chunks of the aircraft from a production perspective, whereas we were doing, I'll say, more of the development program as pure Lockheed Martin.
Thank you. Our next question comes from Howard Rubel with Jefferies. Your line is open.
Thank you very much. Marillyn, not to kind of show off a little bit, you didn't mention Pakistan and F-16s, I suspect you probably have some other opportunities there. Then in addition to addressing that, would you also talk about a number of the items that are in the HASC that sure seem to play into your wheelhouse, whether it's the F-22 restart or some new air defense system opportunities?
Thanks, Howard. Appreciate the question. Back to your question about F-16, we continue to look for opportunities for F-16. Certainly, Pakistan, as it got through its congressional notification, we'll look forward to the opportunity on that. Bahrain, we hopefully, ultimately at some point in the future, will have an opportunity. In India, we're continuing with our upgrades of the F-16, a lot of the modification work, like in Taiwan.
The potential line start-up in India that we talked about.
That's right. Yeah, we've talked about that India is looking at their tactical fighter competition, and we are in there with an offer to move a production line to India. In terms of the mark, the most recent mark that came out of the HASC for the defense bill, they have, as you have seen, have added 11 aircraft for the F-35. We saw an increase last year in the FY 2016 omnibus, seeing that coming forward is important. There are also a lot of our programs that are well supported just in the budget itself, then with potential adds as they look at additional opportunities. On the F-22, I know there's been some discussion about a restart in the F-22, we just stand ready to support with whatever information we're asked to provide.
You're probably aware that the tooling does still exist, as most programs, you start one from a cold start. I'm sure they'll really want to understand the cost associated with a cold start, but at the same time, you wouldn't want to build the same aircraft, you'll do some upgrades to that aircraft to modernize it, and some of the design incorporate some of the things that we've learned through F-35 and other programs that you could incorporate into that. We'll stand ready to support that. Bottom line is, I think our programs are well supported in the president's budget submission, then I think the mark that's going through would potentially add some additional ones for us. We know there's a long way to go on the budget process. It's early days in getting through that.
We'll remain hopeful that with our programs that really line up with the department's strategic priorities, that they'll continue to be well supported.
Thank you. Our next question comes from Pete Skibitski with Drexel Hamilton. Your line is open.
Yeah, thanks. Nice quarter, guys.
Thank you.
I appreciate the color on Sikorsky earlier. I was just wonder if you could go farther and update us on your updated expectations for intangibles amortization this year and integration costs, and how fast or what magnitude do you expect that to kind of drop off in 2017 and 2018?
Yeah. Thanks, Pete. I'll take that on. Intangibles, we'd said in the January call that those might move around. I think we have a year's time to sort of set the numbers there. I think we're real close. It's a slight improvement in the intangible amortization. When I say slight improvement, it's a little bit slower or smaller intangible amortization in 2016 than we'd originally talked about, but not enough to get too excited about, to be honest with you. The integration cost, I still think that the bulk of that will be completed in 2017. Still some of that might carry over into 2018, or excuse me, 2017, as we look forward there.
I still think as we sit here today that we're tracking towards what we talked about when we did the acquisition, which was about $150 million or so per year of steady state savings beginning in 2018. I still think that's a good possibility that that will be the number that we're seeing then. We've got a lot of work to do between now and then. As I said earlier, I think we're actually tracking very nicely to what our expectations were on Sikorsky.
Abigail, this is Jerry. I think we have time for one more question.
Our last question comes from the line of Cai von Rumohr with Cowen. Your line is open.
Yes. Thanks so much. If we can go back to the severance charge, Bruce, $99 million, can you give us some color? How does that split between Aero and IS&GS? What sort of folks did you lay off? Do you expect to recover all of it this year? If so, how come the guide for Aero and IS&GS didn't go up by more than $25 million each?
I think the way you should think about the severance charge, Cai, is somewhere in the range of roughly three quarters is Aero, somewhere in the $70 million, and the difference, $75 maybe, and the difference is in IS&GS. I don't have the numbers exactly to memory, Cai, but somewhere in that range, three quarters, one quarter or so. As I said earlier, I think I was talking to Myles on the question on the headcount reductions in Aeronautics. Most of these are salaried folks. As Marillyn said, some of the indirect support is no longer required to support sort of the production ramp rate that was required to support some of the developmental work that we were doing.
Importantly, I think a big piece of the Aeronautics reduction was actually a voluntary reduction, I think we actually got about what we were expecting as a result of that voluntary reduction. We were pleased with that it came with very few, I'll say, involuntary reductions. I think that's a good thing as well. As far as the recovery of this year or not, that's still playing out, Cai. I think in big picture terms, you should expect to see a somewhat neutral reaction in 2016, there may be some benefit depending on what the timing is of the reductions or the severance charges as they play out that may carry over into 2017. We'll watch that closely and monitor that as we go through the next three quarters to see if there is an impact in 2016.
If there is, we'll surely tell you about it, if it happens in 2017, we'll try to give you insight into that quickly as well.
Let me conclude the call for today, I just want to end by reiterating that the corporation completed a very strong first quarter. Our robust backlog, coupled with an increasing DoD budget, has the corporation positioned for top-line growth and increasing cash flows into the future. Thank you again for joining us on the call today. We look forward to speaking with you on our next earnings call in July. Abigail, that concludes the call today.
Thank you. Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect. Everyone, have a great day.