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Exelis (NYSE:XLS)

Q3 2012 Earnings Call

November 02, 2012 10:00 am ET

Executives

Katy Herr

David F. Melcher - Chief Executive Officer, President and Director

Peter J. Milligan - Chief Financial Officer and Senior Vice President

Analysts

Joseph B. Nadol - JP Morgan Chase & Co, Research Division

Robert Stallard - RBC Capital Markets, LLC, Research Division

Michael S. Lewis - Lazard Capital Markets LLC, Research Division

Howard A. Rubel - Jefferies & Company, Inc., Research Division

Peter J. Skibitski - Drexel Hamilton, LLC, Research Division

Operator

Welcome to the Exelis Third Quarter 2012 Financial Results Conference Call and Webcast. Hosting the call today from Exelis is Ms. Katy Herr, Head of Investor Relations. Today's call is being recorded and will be available for replay beginning at 1:00 p.m. Eastern Standard Time. The dial-in number is (800) 585-8367 and enter pin 36250442. [Operator Instructions] It is now my pleasure to turn the floor over to Ms. Katy Herr. Katy, you may begin.

Katy Herr

Thank you, Jackie, and good morning, everyone. Thank you for joining us today on our third quarter conference call. During today's call, we will reference supplemental information in the form of the presentation that you may access at www.exelisinc.com/investors.

Moving to Slide 2. Before we start, please understand that this call contains forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. Such statements are made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995, and certain factors that could cause results to differ materially from those anticipated are set forth on Slide 2 of today's presentation and in this morning's earnings release. During today's call, we will discuss our financial results for the third quarter of 2012. We may refer to non-GAAP measures, which are defined and reconciled in the appendix of today's presentation and available on our website.

Joining me on the call today are Dave Melcher, Chief Executive Officer and President; and Peter Milligan, our Chief Financial Officer. As always, we encourage questions at the conclusion of our remarks. With that said, please turn to Slide 3, and at this point, I would like to turn the call over to Dave.

David F. Melcher

Thank you, Katy, and good morning, everyone. Before we dig in to the slides, it was 1 year ago that we became Exelis Inc. and started trading on the New York Stock Exchange as a Fortune 500 company with the ticker symbol XLS. Four quarters later, we're proud that we have continued to deliver on our operational and financial commitments, despite an uncertain economic environment, the challenges, our end markets and customers, as well as defense orders and revenue.

In our first year, we have focused our efforts on winning key programs like the enhanced night vision goggle, Next Generation Jammer, commercial space payloads, affordable communication solutions, large-scale networking and service opportunities and critical ISR applications that make data to decisions easier and more secure. We've continued our cost reduction actions to align the cost structure in our C4ISR segment to the market challenges we see ahead in 2013, and we'll continue to evolve these actions into 2013 as we match our cost structure, portfolio and priorities to the current business environment.

We bought 2 small companies that have filled niche capabilities in our portfolio. We've also invested in our ADS-B infrastructure and expanded our Salt Lake City aerostructure composites business and our Panama City mine defense business. And we worked hard to develop our leaders and engage our employees in both work and philanthropic efforts. In that regard, there's another challenge that many on this call and many of our employees face this morning and that's recovery from Hurricane Sandy. Certainly, in New York City and in several of our business locations in New Jersey, New York, Virginia and Massachusetts, our employees and their neighbors and friends have been affected. And we wish them a quick recovery. Our businesses are mostly back up and running or will be shortly. And our leaders are doing all they can to restore a sense of normalcy. I'd also like to mention that Exelis will be establishing an appropriate level of matching contributions for employee donations to organizations helping with this effort as we did several months ago during the Colorado wildfires, which affected our employees in the Colorado Springs area.

As you know, Peter and I have spent a good amount time on the road this year, meeting with financial analysts, current and potential shareholders and bondholders, as well as other stakeholders. The question we received most often is, what's going to happen with the U.S. defense budget? And what will sequestration mean? While there's a good amount of rhetoric in the press about the negative implications of sequestration, it remains difficult to predict how this issue will be resolved in 2013. This means that planning for the future is challenging. We are currently operating under a 6-month continuing resolution, which limits both new starts, as well as reprogramming funding. As a result, we anticipate some top line pressure in 2013. Peter will discuss a bit more about our 2013 expectations, but let me say that at Exelis, we remain focused on outstanding program execution, maintaining a tight rein on discretionary cost and aligning our business operations for continued profitability, managing those things that are within our control and maintaining our flexibility to continue to involve with our markets.

Moving on to the financials. As you have seen in our press release this morning, we delivered a solid operational quarter, driven by our continued focus on delivering mission critical, affordable solutions and disciplined cost controls. Let me dwell a bit on orders and our order-producing efforts. Orders in the first quarter totaled $1.3 billion, representing a top year-over-year comparison due to, among other things, the full option year exercise on the K-BOSSS contract in 2011. This was our strongest quarter year-to-date for funded orders, which were sequentially higher, up about 9% over the second quarter of 2012. During this quarter, we announced new airborne electronic warfare awards with the U.S. Navy and the Oman Air Force. We also continue to press forward to bring new innovations in Air Traffic Management to market, with the announcement of a strategic partnership with Metron Aviation to provide airport and airline customers a comprehensive view of their operations in the air and on the ground. And we announced the new agreement with the Greater Orlando Aviation Authority to upgrade its noise and flight tracking systems.

Also, during the quarter, we were pleased to announce new opportunities to provide mission-critical support our customers' most important operations, including a position as a prime contractor for the 5-year $23.5 billion Enhanced Army Global Logistics Enterprise or EAGLE IDIQ program. This contract gives Exelis the opportunity to submit proposals in support of the Army's future logistics requirements. In addition, Eagle will replace the Army's Field and Installations Readiness Support Team or FIRST contract. We have extensive experience in performance in the FIRST program and look forward to continuing to support our customers through the EAGLE contract. One early win on EAGLE is the Fort Rucker, Alabama base operations and support contract announced in October. Also, during the quarter, we announced our partnership with Sierra Nevada Corporation to bring customers an affordable fee-for-service, wide-area, airborne-persistent surveillance system. We call this technology Vigilant Stare. And it has a strong legacy from the very successful Gorgon Stare program that proved its value in theater. As an aside, one other example of our great work in networks and communications is the Exelis-operated Deep Space Network communications system that helped successfully guide NASA's Curiosity rover to the surface of Mars in August. We're proud to support this unprecedented scientific achievement with our leading technical solutions and support for this critical mission.

In terms of revenue, our third quarter revenue of $1.4 billion was in line with our projections, and we were able to expand our adjusted operating margins as compared to the third quarter of 2011. We continue to project that revenue for 2012 will trend towards the upper end of our guidance range of $5.4 billion to $5.5 billion. Adjusted operating margin came in at 10.9% for the quarter, an increase of about 16 basis points from 2011.

As I discussed earlier, we continue to manage our discretionary costs and evaluate opportunities for larger cost-reduction initiatives. Adjusted EPS was $0.45, on track with our projections for 2012. Importantly, we generated $167 million of free cash flow during the quarter, driven by improved collections and lower pension contributions. Year-to-date, free cash flow stands at $26 million and we expect a strong fourth quarter of free cash generation. Most of the difference between the cash position in third quarter 2012 and third quarter 2011 can be attributed to the much larger pension contributions made earlier in the year, which Peter will discuss a bit later.

Moving to Slide 4. We closed the quarter with total backlog of $10.5 billion, unchanged from the second quarter. Our book-to-bill was just under 1.0 for the quarter. About $3.2 billion of our backlog is funded, which includes both product deliveries and funded option years for service contracts. We continue to anticipate some moderation of our funded backlog as production contracts move to sustainment levels and our government customers change their acquisition mode to smaller order quantities and smaller funding increments on service contracts.

Compared to the second quarter, the third quarter reflects additional orders for spares and repairs in support of our installed base of domestic SINCGARS radios, somewhat offset by deliveries of Band C Crew upgrades and airborne electronic warfare upgrades. The Information and Technical Services segment drives our unfunded backlog, where contracts tend to be incrementally funded. I&TS unfunded backlog was $6.6 billion in the third quarter, reflecting strength in our space ground and range program that was offset by lower backlog for a few of our Middle East and communications and information system programs.

Before I turn the call over to Peter, let me take a moment to discuss 2 late breaking pieces of good news. First, yesterday afternoon, Exelis was named as one of the contractors on the Global Tactical Advanced Communication Systems IDIQ contract, or GTACS, which is a $10 billion IDIQ contract representing a key contracting mechanism for the Army to pursue upgrades to its installed base and networks. We view this as a positive development for upgrades to existing systems. In addition, late yesterday afternoon, we announced our exclusive teaming arrangement with Northrop Grumman in pursuit of the United States Navy's Next Generation Jammer program. As many of you know, the Next Generation Jammer will dramatically improve the ability of U.S. Forces to suppress and defeat enemy integrated air defense systems and disrupt and disable the enemy's ground-based command-and-control capability. Exelis and Northrop Grumman have a history of teaming and cooperation dating back to the 1970s, and we bring a tremendous experience in this mission area through our shared experience with the AN/ALQ-99 Jammer pods. Together, Exelis and Northrop Grumman bring over 80 years or more of experience in naval, airborne electronic attack systems. And we believe that our partnership will deliver the best capability at best value for this critical United States Navy mission.

With that, I'll turn the call over to Peter.

Peter J. Milligan

Thanks, Dave. Good morning, everyone. Let's turn to Slide 5 for discussion of our segment results. As projected, we are seeing lower year-over-year orders in sales in the C4ISR segment as we move to anticipated sustainment levels for domestic SINCGARS, night vision goggles and IED Jammers. Orders in the segment were down about 19% from the third quarter of 2011. Partially offsetting the decline were orders in airborne electronic warfare and international integrated structures. Revenue for the segment was down 18% due primarily to lower sales of domestic SINCGARS and night vision goggles. We did have some offset in the quarter with deliveries of Band C systems to upgrade portions of the installed base of CREW jammers, as well as additional sales of ISR solutions and special-purpose ground electronic warfare systems. We continue to anticipate that sales in this segment will be down about 10% for the year. Profitability for the C4ISR segment was down approximately 91 basis points year-over-year, driven by lower volume and the changing sales mix, partially offset by lower discretionary spending and lower pension expense.

Orders -- let's turn to Slide 6. Orders in the I&TS segment were down about 25% compared to the third quarter of 2011, mainly due to fully funded option years received in Q3 2011 that have been incrementally funded this year. Year-over-year revenue was down about 5% in the segment. We benefited from additional work on Afghanistan programs, but as expected, we are seeing some moderation of revenue as several large Middle East programs move to more sustainable run rates compared to 2011. In addition, the segment had a tough comparison in the quarter due to strong 2011 performance on a contract with [indiscernible] that concluded in the fourth quarter of last year. That said, year-to-date contract extensions and options exercised, coupled with the strength of our customer relationships, continue to give us good revenue visibility in this segment. Adjusted operating income increased 19% over Q3 2011 to $62 million, and adjusted operating margin was 8.3%, about 165 basis points higher than the third quarter of 2011, which was driven by improved program performance and lower discretionary spending.

Now let's move to Slide 7. As you heard from Dave, free cash flow for the quarter was strong at $167 million. We generated free cash flow of about $200 million for the full year, which excludes dividend.

Now let's spend a few minutes discussing pension. Since we received the salaried retirement plan from ITT just 12 months ago, we've taken meaningful steps to control pension costs, make the necessary cash contributions and have seen a change in the asset mix within the trust. As you will recall, about this time last year, the company made the choice to proactively manage our pension cost and give employees a choice between existing defined benefit plan and an enhanced defined contribution plan. As a result, we're able to lower service cost, extend the amortization period for prior gains and losses and lower our noncash pension expense in 2012.

In addition, last month, we initiated a voluntary pension payout opportunity for certain deferred vested plan participants. This action gives the option of receiving their total pension benefit now in a lump sum or annuity if they so choose and the flexibility to manage their retirement savings to fit their needs. This also reduces some of the liability and the associated risk currently borne by the company and will place less pressure on administrative costs in the long run. As you know, we made significant cash contributions to the pension this year, about $265 million to qualified plans. These funds and other funds in the trust were used to shift the asset mix slightly. Although it is too early to determine, we could see a lower asset return assumption in 2013. And I want to remind everybody that every 25 basis points change to the expected long-term rate of return affects our FAS or GAAP expense by about $10 million, and that certainly could put some additional headwind into 2013.

Also pressuring '13, we'll see increased amortization tied to the 2008 asset loss, which will be incorporated into our pension expense. Plus, we will likely have to deal with a lower discount rate for 2013. Our current discount rate assumption is 4.75%. If we had to set the discount rate at the end of September, it would have been closer to 4%. Now we know a lot can happen by the end of the year and we're paying close attention to these rates. Obviously, we set our assumptions at the end of the year and with 2 months to go, we may likely see continued volatility given the political U.S. budget and global macroeconomic conditions. However, as I look at the pension picture today, absent any changes to our method of accounting, we estimate that our noncash pension expense or our FASB expense could more than double in 2013 compared with our current view of 2012, which is in the $30 million to $40 million range.

As we look ahead to 2013, it is obvious that there's a lot of uncertainty surrounding the U.S. budget, the fiscal cliff and more broadly, the global economy. At this point, the specific impacts of the potential sequestration are unknown, but we are currently working under an assumption of a 6-month continuing resolution, which limits new program starts. We will give our detailed 2013 guidance early next year, but we are already taking actions to adjust our cost structure to give the company the flexibility to respond to changing market conditions.

You heard from Dave that we are currently engaged in some fourth quarter restructuring actions. These actions are baked into the 2012 guidance. However, I do expect that these actions are the beginning of a larger adjustment to our overall cost structure in 2013. We'll have more details for you on those actions early next year.

In closing, this was a quarter that was in line with our expectations. We did have some tough year-over-year comparisons, but we are operating on plan and expect to meet our guidance metrics. We continue to deliver innovative, affordable and ready-now solutions to our customers, leveraging our extensive installed base and our legacy of excellent program performance.

With that, I'd like to open the call for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Joe Nadol with JPMorgan.

Joseph B. Nadol - JP Morgan Chase & Co, Research Division

My first question is on the radio outlook. There's been a number of things going on with the JTRS office and some of the, I guess, competitive landscape for next year has been firming up and there's a lot of important competitions coming up next year. I was wondering, Dave, if you could walk through how you see the competitions lining up for Exelis and which are the ones that you're really targeting.

David F. Melcher

Okay, no, it's a good question. There has been a lot of change that's occurred in the JTRS program. And the office was shut down and basically, the Army is now managing the program. And you saw a contract not too long ago for the HMS radio, which is, I guess, in the quantity of about 3,000 of those radios, which are still undergoing testing and not completely through the gauntlet for testing yet. Now one of the things that, I guess, an indicator to me of what the future radio market looks like can be taken in part from the amount of interest that we just had at the recent AUSA show where we talked about a lot of the capabilities that we have inside of Exelis to upgrade certainly the installed base of SINCGARS radios, which are now some 500,000 strong in the force through things like the Soldier Radio Waveform applique. I think there's a solicitation coming out for that here shortly that we'll be competing on, along with some other competitors, to try and upgrade that capability and give it more channels, including the SRW waveform which is compatible with the JTRS program. But we've also been trying to make some inroads and have gotten some interest in, for example, Global Network on the Move, which for us, has a Win-T Increment 3 bridging capability. Win-T Increment 3 is off quite a few years, but we have a capability that's ready now, that's been used in theater. It's also been used in Korea. And we think there's going to be some interest in that. We have a Rifleman radio offering that we have put together, which is also, I think, going to the competitively bid going forward. And we're partnered with Northrop Grumman on the MNVR radio, which was the successor for the ground mobile radio that was discontinued or canceled as a part of the JTRS program. So we have a lot of oars in the water, I think, that give us opportunity. And more and more as Army decision-makers and other service decision-makers look at what's going to happen with either near-sequestration or sequestration-type cuts, they're looking for ways to improve the installed base, and so that's a place where I think we can gain a lot of ground.

Joseph B. Nadol - JP Morgan Chase & Co, Research Division

It seems like the applique is probably most in your wheel house. When do you expect that decision?

David F. Melcher

Well, I think there's a solicitation that's been out and there's some precursors to that, that have been cycled around to industry. We're preparing our offering for that. I think they're going to pick 3 companies to be a part of that, and they're going to probably do -- have a fielding schedule that aligns with their rotational model for how they're getting brigades ready for training or deployment. So yes, that certainly is the most immediate of the things that are out there. But we continue to be involved in this thing that's been called the Network Integration Evaluation that the Army has hosted, which is a way to go test capabilities that are off the shelf, that are high technology readiness levels and that can be employed quickly in the next 2-year cycle of equipage. And this GTACS contract that I mentioned, the reason that that's important is that is the vehicle that I think that they're going to use to bring in some of these non-program of record capabilities and introduce them to the Force.

Joseph B. Nadol - JP Morgan Chase & Co, Research Division

Okay. Second question is on the cash front. Have you guys settled on -- have you settled on what you're targeting for a contribution next year? And the add-on to that is, if you're going to contribute less than you had previously planned, say 6 months ago, have you thought about what else you're going to do with that savings?

Peter J. Milligan

Sure, Joe, this is Peter. High-level -- our expectation for next year is probably in the low $200 million range as sort of the required contributions, which is probably anywhere between $75 million and $100 million less than we were thinking before the interest rate stabilization took hold.

Joseph B. Nadol - JP Morgan Chase & Co, Research Division

Okay, okay. And then finally, just looking at the I&TS margins, this is the second straight quarter you've been on an adjusted basis around 8%, and you go back in the first quarter and then going back into last year, it was more like kind of 6%, 7%. And I was wondering, maybe Peter, if you could -- wouldn't mind laying out from a profile standpoint, if there are EAC changes that have boosted the last 2 quarters that you don't think are sustainable or if there's been maybe a more sustainable mix shift.

Peter J. Milligan

Sure. Certainly, there has been some program performance and that really is in the way of an EAC update. If you think about our I&TS business, there is about 20% or so that's actually fixed price. So even though we largely view that as a cost-plus business, I think, many do, there is still a fixed price component. And some of those programs, most notably, the work we do with the FAA, plus some others we do on the operations and maintenance side, are fixed price, and we have seen some improvements in that. So that has certainly driven some of the margin improvements. This quarter, I probably would put 1 percentage point of the margin that sort of was driven by that. The sustainability of that, of course, depends on how much risk you can take out of programs. I do think, however, that we would likely see that trend back down. I don't think that 8.3% that we've seen this quarter is the sort of normalized margin run rate that you would expect. I do expect it to go down somewhat in the fourth quarter and probably for next year as well, to be more in that 6% to 7% range.

Operator

Your next question comes from the line of Robert Stallard with RBC.

Robert Stallard - RBC Capital Markets, LLC, Research Division

First of all, Pete, I was wondering if you can start on the separation costs, what your expectations might be for the rest of this year and if you expect any next year.

Peter J. Milligan

Sure. So for next year, there might be a couple of million dollars, but we're certainly not going to sort of normalize for it. I think the commitment that we made earlier this year is that, for 2012, since it was the year post-separation, post-spin, that we were going to sort of normalize those costs. There might be a couple of small trailing costs next year, but we're not going to sort of call those out specifically, so a couple of millions dollars. For the rest of this year, you would expect somewhere in the $5 million to $8 million range in 4Q, which would put us, year-to-date, at around $27 million or so and then I think we're pretty much done.

Robert Stallard - RBC Capital Markets, LLC, Research Division

And then secondly, you called out the goggles, the jammers and the radio, so there was revenue pressure there. I was wondering how much of the percentage of revenues they make up and what sort of clarity you've got that this is now at a stable state.

Peter J. Milligan

Yes. So this year, if you're looking at the high end of the range for the top line, which will put us at $5.5 billion, we're sort of almost exactly where we thought we would be on those 3 programs at about $300 million this year, which puts it a little over 5% of revenue. As we move into next year and again, without talking specifics about what the top line looks like next year, I would expect that to sort of be the high end of the range. We could certainly see that sustainability level be in that sort of $250 million range or so. It certainly depends on a lot of things that, in many ways, are out of our control. We've seen a couple of good awards just last quarter for SINCGARS on the spare and repair tail. So there certainly is opportunities as we expected there to be, $300 million is probably on a high end though.

Robert Stallard - RBC Capital Markets, LLC, Research Division

And then maybe, finally, Dave, I was wondering if you could give us an update on some of the big competitions that are coming up in the re-competes for some of your service contracts perhaps?

Peter J. Milligan

Okay. Well, we have a number of competitions coming up that are important to us. On the service side of the house, certainly, what's called the OMDAC-SWACA contract, which is the replacement for what was called TAC-SWACAA, the major communications networks over in theater, that's a re-compete that comes up here in the next year. Also, we're competing with a team on a contract called Lisk, which is the space ground range contract that's being let, in which we have combination of several contracts into one. And that replaces what we have presently, which is called the space ground range contract. Those are 2 things on the service side. On the product side, obviously, I mentioned NextGen Jammer, we're competing for that. We're going to be competing for task orders for aviation goggles, as well as the enhanced night vision goggles, that are out there. We're 1 of 2 competitors. And those are going to come as a series of task orders, I think. We have other offerings out there that we're going after. Certainly, in terms of EAGLE, with the contract, which is a major conveyance for the service side of the house in order to do these base operation support businesses at all the different post camps and installations around the United States. And then a lot of the things that I mentioned in the comms arena, ISR offerings, we have some large-scale networking things that we continue to work on. So there's plenty to keep us busy here in the next year.

Operator

Your next question comes from the line of Michael Lewis with Lazard Capital Markets.

Michael S. Lewis - Lazard Capital Markets LLC, Research Division

Dave, I just wanted to circle back on the Next Generation Jammer and your new -- the fact that you'll be working with Northrop Grumman. Will you be -- will this be almost like a 50-50 JV or you're subbing to NRC on the work? Could you give us a little more detail around that arrangement?

David F. Melcher

Yes, sure. We've began working on this a little while back. And the genesis for making a decision to partner in this fashion with Northrop really stem from a decision on the part of the customer to take a different approach to this program. Unlike many programs where they want to have 2 providers of capability across the DoD, this was one where the government explicitly said, "Hey, we're going to go from 4 competitors to down to 1." And so I think then that presents certainly a different picture than if they were going to 2 and then eventually down select to 1. And the fact is, with Northrop Grumman, we've had a long-standing relationship doing this kind of work. There are some things that we certainly do better. There are some things that Northrop does better. But in this relationship, they are the prime and we're a sub to them. And I won't talk about the different shares of work. They actually vary a little bit between phases, but at the end of the day, all I'll say is that we're very satisfied with the share of the work that we're getting out of this arrangement. And we are very, very pleased with the partnering arrangement and how it's proceeded so far. So we think this is going to be a gangbuster offering for the United States government with best value and best capability out there.

Michael S. Lewis - Lazard Capital Markets LLC, Research Division

That's fair. And -- so I'm assuming that you'll be able to take the number of pods down materially and have a wider bandwidth on the output.

David F. Melcher

Yes, I'm not sure if I understand the question exactly. But regardless of what the projected production levels are going to be, we're going to be fully engaged in this, and we think that it does represent certainly billions of dollars worth of opportunity going forward over the next couple of years.

Michael S. Lewis - Lazard Capital Markets LLC, Research Division

Got you. And then just a quick question for Peter. On your adjusted EBIT margin guidance for the full year, it is a little bit better than I had expected. As we look out into fiscal year '13, and let's just assume a normalized environment x sequestration, where are some of the puts and takes for the margin as we progress -- the core margin as we progress into next year? And what's the biggest headwind that you will face as we move into the next calendar year?

Peter J. Milligan

Sure. The biggest headwind, undoubtedly, is pension expense, and I did mention, absent changes in our sort of accounting approach. And all that really means is whether or not you certainly have seen other companies look at a mark-to-market approach. So that's something that we'll take a look at and will determine if it's the right to go, then we'll make that move. But we certainly have not made any decisions on that yet. But so absent that, Mike, absent that, it would be -- pension expense, no doubt, would be a big headwind as we move into next year. Offsetting that, would have to be exactly what we started in the fourth quarter and we'll certainly continue in a significant way next year and that's cost-cutting actions. The costs are -- have largely been adjusted over these last number of years as you've seen a big mix shift between products and services. Our headcount has remained roughly flat, but within the divisions, it's changed dramatically. And we do expect that as we move into 2013, we're going to have to adjust our inputs to really reflect where the environment is headed. So we certainly think that we'll take some aggressive cost actions in 2013 and that will create some benefit to the margins. So again, high-level mix shift. Even if you look at mix shift for next year, and this year we're at 55% or so on the services side, I don't expect it to be vastly different next year. We'll probably be in that 55%, maybe a little bit higher on the services side. So I think that the mix shift that's changed the margin over these last few years is sort of largely behind us. And then it's just really working the cost structure because as we leave some of the higher margins sort of longer-term programs, the bigger programs that you well know, as we move into smaller sort of a -- higher number of smaller production programs, that's where we're going to have to get aggressive on cost.

Operator

Our next question comes from the line of Howard Rubel with Jefferies.

Howard A. Rubel - Jefferies & Company, Inc., Research Division

Peter, you talked about all the bad things about pension. How's the return for the year? And where are you in terms of funding? I'm sure those aren't all bad.

Peter J. Milligan

No, no, not at all. And so for the year, our asset return, as we looked at the end of September, was in the sort of 8% range, north of 8%, and our projections for the year were 9%. So we're sort of pretty close to where we expect it to be. Now October has been a little bit tricky in the equity market so I'm not exactly sure how that's moved, and you also may know that our trust has a fair amount of investments that are considered Level 3 investments. So the mark on those things are a little bit tricky and they trail a little bit. So it's not that we can get sort of a daily really good look on it, but we do expect that our asset return assumptions this year are going to be pretty close, at least that's what we're hoping as we sit here right now. So that's a positive. And then, as you know, we have made some significant contributions. I think, as Joe mentioned before, we will make fewer next year. And I briefly talked about another action that we're taking and there's a number of former employees that have that choice right now, and that is whether they take a lump sum. So we have 55,000 claimants on the pension plan, 40% of them are what we would call term vested. So they have -- they are no longer working at the company, but they're not collecting benefits yet. So that's about 22,000 folks. We've sent offers to about 2/3 of those and they have the option of taking a lump sum. So too early to get to the expected returns on that yet, but I think that's another, what I would call, pretty strong positive with respect to starting to take some risks out of the plan.

Howard A. Rubel - Jefferies & Company, Inc., Research Division

And then you've sort of talked about this restructuring that you're indicating. And while it generates some cost, how close would you be to doing this prior to year end so that 2013 numbers are relatively clean?

Peter J. Milligan

Sure. So we will have some restructuring in the fourth quarter, that is within the guidance, and then I expect that there would be a sort of more significant action, which will be early in the year. Our hope would be that things that we do in 2013 are done early enough in the year so that any restructuring action essentially is "paid for" within the same year. That would be our objective.

Howard A. Rubel - Jefferies & Company, Inc., Research Division

And then, Dave, there's been a lot of F-16 sales and other things of late that would indicate that Lockheed's trying to do something with the Viper and so on. Could you maybe address what you're seeing in the pod market on that opportunity?

David F. Melcher

Yes, well, in terms of the ADOS and other capabilities that we market internationally, we have had some sales of that. With each successive F-16 sale, we're trying to make sure that our offering is trailing close behind. And of course, it means other workforce, too, in terms of things like weapons release and other things for any kind of aircraft that's being marketed internationally. So yes, we're looking to try and capitalize upon those opportunities as they're developing.

Operator

[Operator Instructions] Your next question comes from the line of Peter Skibitski with Drexel Hamilton.

Peter J. Skibitski - Drexel Hamilton, LLC, Research Division

I guess, one for Peter, and I might have missed this, but Peter I expected, I guess, C4 margins a bit higher this quarter. I think you guys are tracking some FMS radar deliveries this quarter. Did those slide into the fourth quarter? And so are we going to get a bump in margin in C4 in the fourth quarter?

Peter J. Milligan

Yes, so there is definitely a little bit of mix shift that we had seen in the third quarter. I do expect the fourth quarter margin within the C4ISR business to be higher than the third quarter. We had a 15.2% margin in Q1, then we're in low 14s for 2 and 3. I think that the fourth quarter probably looks more like the first quarter.

Peter J. Skibitski - Drexel Hamilton, LLC, Research Division

Okay, got it, got it, okay. And then, I guess, one for Dave. Dave, it looks like you guys have really controlled your SG&A really well. And I'm just wondering, is this kind of a level we should expect going forward, kind of a low to mid-8% type of range?

David F. Melcher

We're really trying to take a good look at it. We began to net down on some discretionary spending in this year, which was really sort of appropriate. Even, for example, things like trade shows, right? AUSA, the Army had less participation. We scaled back and had less participation. And looking forward, I think we're going to do smart things there. But we're trying very hard to control SG&A. And as we've developed our operating plans and potentially budget here soon for next year, we're going to be taking a very hard look at that, and each President's going to be accountable to come on and tell us how they're saving cost.

Peter J. Skibitski - Drexel Hamilton, LLC, Research Division

Got you, okay. And I guess just last one. I was just wondering if you could elaborate a little bit more on this GTACS contract. Is this the vehicle that you think maybe you'll GNOMAD through? Or is this kind of another opportunity to do SINCGARS upgrades apart from SRW applique? I'm just wondering how you guys are thinking about that vehicle.

David F. Melcher

Yes, we really are sort of looking at it as an umbrella contract for the Army to basically buy communications capabilities that it needs that are outside of programs of record. So GNOMAD would apply. The SRW applique could apply. I don't know whether it'll extend to other SINCGARS enhancements, geopositioning, locating. There's a lot things you can do to improve SINCGARS going forward to give it greater capability. I suspect this contract could be the vehicle for any or all of those things.

Operator

At this time, we have no further questions. I'd now like to turn the floor back over to David Melcher for any closing remarks.

David F. Melcher

I think I've sort of said what was important upfront, and I really appreciate the questions. We always get great questions from our analyst community and our investors, and we very much appreciate that. Makes us better. We look forward to these opportunities every quarter to talk with you. We're pretty proud of what the company has been able to accomplish. We'll all see what the future holds here in January and with next year related to sequestration or other decisions. But we're working hard for our part to make sure that we let our elected officials know about the importance of certainty. It's important, certainly, to our investors. It's important to the business. And we're doing what we can to try and find certainty going forward. But thanks for all your support and your questions.

Operator

Thank you. This does conclude today's conference call and webcast. Please disconnect your lines and close your webcast browser at this time, and have a wonderful day.

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