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L-3 Communication Holdings Inc. (NYSE:LLL)

March 04, 2013 1:55 pm ET

Executives

Ralph G. D'Ambrosio - Chief Financial Officer and Senior Vice President

Analysts

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

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

Okay, next up on the aerospace defense track, we're very happy to have Ralph D'Ambrosio, CFO of L-3 Communications. Ralph is -- I think is developing or has developed a reputation as a -- very worthy of the reputation of being, I think, the straightest shooter in the business, or certainly one of the straightest shooters. And so I always love to hear from Ralph and to speak with him. So Ralph, I'll turn it over to you.

Ralph G. D'Ambrosio

Good afternoon, everyone. I'm very pleased to be here. I'm going to take you through a quick overview and review of L-3, and then I'm sure we'll have lots of questions from Joe or the audience. So L-3 Communications, as you know, or I hope you know, is an aerospace and defense contractor. This year, we're expecting sales of about $12.7 billion, and we're both a prime contractor and a subcontractor. On the prime contracting side, most of our work is an ISR systems, or command, control and communication systems, and then also in sustainment and logistics support solutions. And we supply a variety of electronic systems, both on military and commercial platforms.

Some of the key characteristics of L-3 are that we're not a platform OEM, even though we're a prime contractor. And we have a very broad and diverse portfolio of products, technologies and contracts. And about 2/3 of our sales are direct to the end customer. And we also have a very flexible cost structure. It's a low capital intensity business. And that all translates into L-3 generating significant cash flow, which is approximately $1 billion per year, and that's free cash flow after capital expenditures.

And a couple of the key things that I'd like you to take away from my presentation today is that L-3 is a solid, financially strong company. We've taken actions over the past year to reshape our portfolio to make L-3 more resilient and structurally stronger to weather the defense downturn that we are currently in and to also take advantage of opportunities on the international and commercial side. And the company continues to generate significant cash flow, and we're using that cash flow in a responsible manner to enhance the value of the company, including shareholder value.

Here's our strategies or our strategy and our priorities. It's very simple. We're trying to grow the company, grow our market share and strengthen our market positions. There's a number of ways for us to do that, that are summarized on the chart. I'm not going to repeat them. We always aggressively and proactively manage our cost structure and our business structures. It's one of the reasons why we believe we have a flexible, adaptable cost structure, and we're allocating the robust free cash flow that we generate in a prudent manner to grow the company and to preserve and grow stakeholder value. If we're doing all of the above, it's going to translate into EPS growth and growing our free cash flow per share.

I have one chart summarizing our accomplishments or our performance for last year. Overall, it was a very good year notwithstanding the environment. We continue to have solid program and contract performance. We achieved our financial plan. Actually, we exceeded it modestly. We strengthened our portfolio, as I mentioned earlier. The main action in that regard was spinning off the Engility businesses. And we also made a couple of small, important acquisitions that are -- have increased our exposure to international and commercial customers.

On the competition side, we won our only large recompetition that we had last year, which was the Fort Rucker contractor logistics support contract. It's our largest contract in terms of annual sales, about $450 million per year. And we also had market share gains in several of our business areas in 2012. We grew our orders 7% with the book-to-bill ratio, which is orders over sales of 1.05x. And we increased our commercial and international sales by 15%. And we generated $1,050,000,000 of free cash flow last year, continuing our trend of strong robust cash flow.

We've been using that cash flow, as I said, in a responsible, disciplined manner. And here's a summary of what we've done with our free cash flow for the last 3 years. And as you can see, we've been returning most of it to our shareholders, primarily in the form of share repurchases, and secondarily, in terms of our ordinary dividend, which has been growing at 5% per quarter over the last several -- $0.05 per quarter over the last several years. We're very comfortable with this model. I suspect that we'll continue to do more share repurchases similar to these levels in the future until good opportunities emerge in the M&A marketplace.

So turning to this year, 2013. I'd like to start by showing you our sales mix that we're estimating for 2013 by end customer. And as you can see in the blue part of the pie, which is the base budget, Department of Defense sales or business, that's about $7.8 billion in 2013 or about 61% of our sales. That's contrasted from the DoD Iraq and Afghanistan business, also the OCO business, which is about $850 million of our sales and declining very rapidly in the last few years and over the next couple of years, for that matter, given the drawdowns that have occurred in Iraq by the U.S. military and the in-process drawdown in Afghanistan.

When we get to talking about sequester -- and I know we'll talk about that today, that's going to impact our base budget DoD business, which again is 60% of our sales, approximately, in 2013. It's not all of L-3. And then, I'll also point that our commercial and our international businesses, which have been growing at a nice pace the last couple of years, they're going to approximate about 27% of our sales in 2013, and we expect that those sales will continue to grow as a percentage of our total sales mix.

Here's a quick overview of what's happening in the U.S. government markets. Most of our business there is the DoD. The country continues to deal with geopolitical threats, national security threats on one side, and on the other side, we're dealing with physical (sic) [fiscal] constraints, deficits, et cetera. The DoD budget actually began to decline a couple of years ago in 2011, and I'll show you that in more detail in the next chart. So we're in the middle of a down cycle.

As I mentioned, the OCO budget has declined rapidly with the drawdowns. About 2.5 years ago, the Department of Defense embarked upon efficiency initiatives, or Better Buying Power initiatives, and that was to stretch their budget dollar and to get more value for the taxholder, which is a noble and a great thing to be doing. That's impacted the industry and our sales, more so in some areas, including the Engility business that we spun off last year.

We've been through the first round of the Budget Control Act cuts, which happened toward the end of 2011. And now, last Friday, the sequester cuts took effect and they're scheduled to reduce budgets by about $490 billion over the next 9 years, unless they're somehow altered or changed.

On top of that, we have a continuing resolution for the government fiscal year 2013 that expires on March 27. It's going to be an interesting month. We expect that the CR will be extended. And we also expect that there will be more clarity, resolution and perhaps sanity brought to the whole sequester process where ultimately, there will be discretion afforded to the DoD as to how they apportion whatever budget cuts they're dealt with in FY '13 and in future years.

The non-DoD business, which is about 5% of our sales, is actually growing in 2013 due to a couple of contracts that we won last year. And generally speaking, we expect the non-DoD government business to be a smaller bill-payer than the DoD when it comes to sequester. And we believe that we -- despite all that's happening, we have market share opportunities again in 2013, and we're working to capitalize on those opportunities.

Here's a look at the defense budget for the last several years and for the next 4 or 5 years. We've segregated it here into 3 components. On the left-hand side is the base budget per the FY '13 request or plan that was submitted by the administration to Congress about a year ago. That's pre-sequester and that incorporates the first phase of the Budget Control Act budget reductions. And as you can see, despite those cuts from the BCA, the base budget is about nearly flat right now, declining by about 1% next year and then expected to grow nominally at about 2% per year. Again that's pre-sequester, unlikely to happen. In fact in the middle column right now, which is the base budget plus the sequester cuts, which are approximately $50 billion per year starting in FY '13, and you can see the impact that those sequester cuts have, particularly to the FY '13 budget, where instead of declining by 1%, it declines by 10%.

Now one thing that I think is very important that you need to consider when you look at budget trends, particular on the base budget, is that these are budgets in terms of budget authority. They're not actual in-year spending or outlays. And there's generally a lag dynamic between budget authority and outlays where the outlays can happen over a 1- to 5-year period. So I think when you analyze the base budget, you almost have to look at it in terms of a 3-year moving average to get a better sense of how the budget is going to impact industry revenues. So that's what I would suggest you do when you analyze the base budget, including with the sequester case. And that 3-year averaging, as you know, tends to smooth out ups and downs in terms of year-over-year budget changes.

And then lastly, in the right-hand column, is the overseas contingency operations budget, or OCO. That is where the Iraq and now mostly Afghanistan war effort is funded from. And as you can see, those budgets are declining rapidly and expected to continue to do so through 2014 to 2015 as the drawdown from Iraq -- or rather Afghanistan is completed by the end of 2014.

Here's a look at what's happening in our commercial and international markets. All right, generally speaking, we're gaining market share, both on the foreign military side and the commercial side. And we made an acquisition last year that expanded our simulation business, taking it from the military side to the commercial civil aircraft side, and also giving us a full-motion simulated capability. We'd like to do more acquisitions like that. That said, our end markets here look pretty strong internationally and commercially. And we expect that we're going to continue to have modest growth the next several years, and the growth for 2013 is about mid-single digits between the 2.

I'll take a quick look at our segments right now. We have 4 reportable segments. The largest one is Electronic Systems. It's also our most diverse segment. This year, we expect sales to be about $5.5 billion. It's declining 4% versus 2012. Almost all of that decline is due to the Afghanistan drawdown that's happening. This segment is also mostly short cycle in nature. And we also have our highest exposure to commercial and international sales in this segment, with those sales comprising about 43% of Electronic Systems sales for 2013.

So it's only about half of the DoD story in this segment. We're leveraging technologies across our diverse business areas in Electronic Systems. And we're using those collaborating across our business units to grow our market share and move up the value chain, by acquiring high-level assemblies and systems on different platforms, both on the military side and the commercial side.

I talked about the Afghanistan drawdown and its impact to the top line this year versus 2012, and we also have our highest segment margins in this segment. Those margins have been impacted in the last couple of years by pensions and changes in sales mix, but the margins here continue to be very robust, and I expect they're going to continue to our highest margins in the company. And this year, we expect them to be 10.8%.

C3ISR is our next segment. This year, we expect sales to be between $3.5 billion and $3.6 billion, that's down 1% or about flat versus 2012. The Afghanistan drawdown is causing about a $116 million sales decline here. So if you strip that away, the base non-OCO business in C3ISR is actually growing at a nice pace in 2013 in the mid-single-digit area, and that growth is coming both from DoD business as well as select international business, mostly on the ISR system side. Generally speaking, we have very strong long-term contract and program positions in this segment. There's also significant opportunities for pull-through out of this segment for Electronic Systems products and our sustainment solutions in the Aircraft Modernization and Maintenance segment. And the margins here are also very solid, despite higher pension expense, and the margins are actually expected to grow by 40 basis points in 2013, up to 10.5%.

Within the Aircraft Modernization and Maintenance segment, we expect sales to be about $2.4 billion this year. It's down about 4%. Again, most of it is due to the Afghanistan drawdown. I know that sounds like a broken record, but that is the main trend in our top line for 2013. Despite that, we do have very good opportunities here. We've been growing our international business, particularly on the platform systems side. We've been expanding our logistics support work into ground equipment. And the margins here continue to be stable and solid, above 9%.

Lastly is our National Securities Solution segment, or NSS. This is our smallest segment. It's about 10% of our sales. The midpoint of our sales guidance this year is $1,250,000,000. The sales are down 10% in this segment. It's due to a variety of market pressures affecting the whole federal services space between the OSD efficiency initiatives, Better Buying Power initiatives, tighter budgets and the drawdowns; they're all contributing to cause that reduction in sales. We believe we have technology elsewhere in the company, particularly out of the C3ISR segment, that will give us opportunities in this segment, including in the cybersecurity space. But the competition in this segment has been significant, I would call it intense. But our business here has stabilized, and we're actually maintaining and sustaining our market share. And I think that's obvious if you look at our fourth quarter '12 performance in the segment compared to all of its peers across the industry. And lastly, our margins, while they are the lowest in the company in the segment, they're actually improving, and we're expecting over 50 basis points of margin expansion in NSS to 6.5% in 2013. I'd also add that we think our margins bottomed in this segment in 2012.

Take those 4 segments and add them together, here's our consolidated financial guidance for 2013. Sales of $12,650,000,000 at the midpoint. It's down 4% versus last year. 80% of that decline is coming from the Afghanistan drawdown, which is about $400 million of a sales reduction in 2013. The margins are expected to be 10%, which is very solid, and that is our objective for operating margins prospectively. We want them to be at least 10%. We have some reductions in interest expense, a significant reduction in our share count from us buying back our stock, and that's all resulting in a modest increase to EPS of about 3% at the midpoint. And most importantly, our free cash flow is going to exceed $1 billion, again, in 2013 at $1,030,000,000. If you look at that cash flow, that free cash flow on a free cash flow per share basis, which you can do by dividing it into our estimate for diluted shares, you'll see that we expect to generate over $11 of -- per share of free cash flow in 2013, which is going to be up about 6% versus 2012. And we're all about growing our EPS and more importantly, growing our free cash flow at L-3.

So let me spend 2 minutes on our free cash flow and then I'll summarize. Here's our guidance for 2013, as well as our actual for 2012, reconciling essentially net income from continuing operations to free cash flow per share. As you can see, our conversion rate exceeded 130%. Why is the conversion rate so high? There's a few reasons. One, L-3 is a low capital intensity business. Our CapEx is only about 1.5% of our sales at about $200 million, and probably only 40% to 45% of that is maintenance CapEx. The rest of it is growth and capability oriented, and that's a lever that we could use if we need to use, depending on what happens with sequester.

We also have a lot of noncash expenses that largely stem from our prior acquisitions, mostly in the form of lower cash payments, which here manifest themselves as deferred income taxes. And we've been able to structure a lot of our acquisitions in a tax-friendly manner that generates real economic benefit for L-3 in the form of lower tax cash payments. We also have intangible amortization expense from the acquisitions and, as you know, that's noncash. And then lastly, we match our 401(k) in common stock, which most companies do not do. We think it makes sense for a variety of reasons. But in any event, it's $110 million expected for 2013 that we disclose it. Even if you take that away, our conversion exceeds 120% per year. So we're very proud of the robust cash flow we have, and our objective is to continue to deliver consistently high quality earnings to cash flow conversion.

With that, I'll summarize. I didn't talk much about sequester. I'm sure Joe will have a lot of questions on that. We don't like the fact that it's happened, we're not -- happening. We're not pleased by it. But we believe that we can effectively manage through it despite those cuts, and that's ultimately our jobs as management and leaders of L-3. The company has significant diverse technologies and using those technologies and capabilities to provide affordable, innovative solutions for our customers, and we have very strong market positions in most of our business areas. We're growing our international and commercial sales in 2013, and we're also growing select areas of our DoD business this year, as well. We have a flexible cost structure, which I talked about, and also mentioned the proactive cost structure management. Notwithstanding the fact that we're in defense down cycle, the cycle is going to turn at some point. All cycles turn, and we're confident that when the cycle turns, L-3 is going to emerge even stronger than we were going into it. And all along, we expect to continue to generate robust cash flow, growing our free cash flow per share and using that cash flow in a discipline, balanced manner to increase the value of our company and our shareholder value in particular.

That concludes my comments. Thank you very much.

Question-and-Answer Session

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

Ralph, thanks so much. And I'll open it up to the floor in a few, but I want to start you off with a couple of questions. Not surprisingly, let's start with -- as you alluded, let's start with the sequester. The first question on it is what are you seeing? What's the update on what you're seeing day to day right now versus, say, your conference call a few weeks ago?

Ralph G. D'Ambrosio

We're not seeing a whole lot new compared to what we were seeing the beginning of February. We've seen some slowdown in order flow. Last time we talked about it, we said that it was mostly in our NSS segment and the sustainment or logistics support businesses. That's still generally the case. We're seeing our customers do a lot of planning exercises as to how they would implement the sequester cuts. And we've also seen delays in the awards of contracts. And if anything, that's probably benefiting us because a lot of the contract recompetitions that we're anticipating to happen in 2013, we're seeing several of those being extended for 6 to 12 months. So that's, I would suggest, is a positive. And that's the gist of what we're seeing right now. I'm sure as we get -- as we continue to go through sequester, the situation may change. And I'll point out that when I covered the financial guidance for this year, one of the key assumptions in that guidance was that sequester would be somehow avoided and that the continuing resolution for FY '13 would not be extended beyond March 27. If you'll recall, I also framed what we thought the downside would be to 2013 from a full-blown sequester if sequester began on January 2. As you know, it began 2 months later because of the American Taxpayer Relief Act. And what I said then is, the same assessment today, is that a full-blown sequester, we expect would reduce our 2013 sales by about 4% or $500 million. It would put some pressure on our margins, which we sized at about 30 basis points. And that's due to the fact that it's not possible to cut overhead cost as quickly as sales decline because overheads go in step functions. And we also would probably recur -- incur some resizing or structuring charges. That sales decline and the margin reduction would translate into about an $85 million reduction to operating income, which is roughly $0.65 EPS. And I expect that our free cash flow would continue to be close to the $1 billion range for 2013. So in that context, I think the situation is very manageable in terms of sequester. And we hope that it's a better outcome, and that we don't have a full-blown $50 billion per year cut.

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

And just to be clear, that's the impact from both sequester and a full year CR?

Ralph G. D'Ambrosio

I would say, generally, yes. I think -- although we do think, ultimately, if the CR is extended, if that's the most we get that discretion will be afforded to DoD to allow them to make some new starts and to also to reallocate budget dollars between title accounts, which you typically can't do in a CR situation. That seems like it makes a lot of sense to us, and that's what we hope happens.

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

And then in terms of the $500 million, your NSS is your shorter-cycle business, but it's only a bit over $1 billion of sales. I imagine AM&M has probably some impact as well. Can you -- are you comfortable yet, at least, roughly penciling that out by segment?

Ralph G. D'Ambrosio

All I'd like to add to how we think things will play out, Joe, is that in all likelihood, we'd have more sales downside in NSS and the sustainment solutions or CLS part of the Aircraft Modernization and Maintenance segment, as you suggested, which makes sense given that those are the shorter-cycle businesses that we have, mostly O&M, in fact all O&M funded. But I also would add that those are our lowest margin sales, together about 7%. So -- and I didn't necessarily factor that into my top-down look at what the impact of sequester will be. So maybe that gives us a little margin of -- a little margin for error on the downside. And then followed by that, we probably would have the next most significant downside happening in Electronic Systems with very little impact in the Aircraft Modernization and Maintenance platform system side of the business and C3ISR, because that's where most of our longer-cycle business resides.

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

I think you guys had spoken about moving that 27% of commercial/international up into the mid-30s?

Ralph G. D'Ambrosio

Yes.

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

And so that's been a growing area for you, nice opportunities there. Can you speak a bit more to what's driving that? And do we get there in mid-30s by a combination of M&A and organic, or is that all organic?

Ralph G. D'Ambrosio

Well, that -- the commercial/international business, which used to be only low 20% of our total sales, is now 27% for this year. And we've increased those sales, as you said, through a combination of organic growth in the commercial and international business, some acquisition and also attrition or decline in the noncommercial and international business. And I suspect, as we get closer to our objective of being in the mid-30% range, it's going to come again from a combination of those 3 items, although we want to grow our business in every end-customer market that we have. But for the time being, for this year and next year, we see better growth opportunities there than we do in the defense business because of what we've been talking about, most importantly, sequester.

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

I would imagine that the M&A market right now is pretty frozen. How do you value a business when you don't understand the revenue next year? But what can you tell us about that? And since it's a really an allocation between M&A and share repurchase that you really -- that's primarily the lever that you pull right now at L-3, I could ask you the same question about your own stock. How do you know how to value your own stock if you don't know what the revenue is? And are you waiting to see how things play out in the coming weeks before you act either way?

Ralph G. D'Ambrosio

Okay. So you asked a few questions there, Joe. Let me try to take all of them. So you asked about the M&A marketplace. So I wouldn't characterize it as frozen, but there is very little activity. And we're still looking at a few opportunities, they're very -- they're small in nature. And I -- it's a function of what's been happening the last couple of years, as you've said, with the overall defense outlook. I think it's also a fact of the significant amount of M&A activity that's occurred over the last 2 decades, if you think about it. So we do expect that there will be more activity once there's some more clarity around our future budgets. You also asked about how we value L-3 given the uncertainties. And you mentioned that we, without knowing what's going to happen to revenue, and we don't know exactly what's going to happen to revenue, but we think it's pretty much well very range bound given the scenarios that could happen on sequester. So I think we have a pretty good handle on what happens to our revenue base even in a sequester scenario, and that gives us confidence in how we value the company, specifically when it comes to buying back our own stock. And despite all that's occurring right now, we think our stock has a very good value and that's why we're buying it back in significant amounts. When the time comes that we think our stock's overvalued, you'll see us do less share repurchases and probably more special dividends. That will be when you know what we think about our stock price. So I'll leave that question at that, that answer that way, Joe.

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

That's great. That's interesting. Looking at across your segments, one of the more interesting ones from a number of different angles is even though it's the smallest, I believe, is NSS. A double-digit down year is what you're projecting for your revenue and that was even pre-sequester. But you noted your margins bottomed last year, and you're projecting up this year. And so as we think about the risks and opportunities to that business, is this a business that ultimately you expect some margin recovery beyond the 6% to 7% range? And let's assume that we have a full sequester and CR, is next year another double-digit year on the downside?

Ralph G. D'Ambrosio

Well, on the margins, we do expect that we'll continue to have some modest improvement there, above 6.5%. And if you look at NSS' peers, whether they be pure-play service companies or segments of larger integrated defense companies, their margins are right in the middle of the pack right now. So we should have some improvement there, but not significant improvement. It's just endemic of that whole space. If the sequester cuts go into effect, it's going to have a negative impact on all businesses, including the NSS business. But I don't expect that we're going to -- I expect that we're going to, at least, continue to hold our market share in that segment, as we've been doing the last several -- last year or so. And if we succeed on some new business pursuits if they ever happen, and if they were awarded, we could actually pick up some market share in that segment, and that's what we're trying to do. Which is what we're trying to do, frankly, in all of our business segments, grow our market share.

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

Any questions in the floor here? So if there is one, just pop your hand up, and I'll ask another one now. Ralph, the C3 segment has been such a horse for you guys for a few years. And initially, it really looked like a lot of that was, at least to me and I think I was wrong, war driven, because we're still seeing it maintain some pretty decent -- very decent fundamentals despite the real drawdown we're seeing. Is that -- and we think about the next few years and we think about, again, the downside scenario you outlined, which is sequester, CR this year and the OCO funding doing what it's supposed to do, how do you think about that segment and the top line outlook?

Ralph G. D'Ambrosio

Well, you're correct. C3ISR has been our best performing segment in terms of sales for the last several years. It is again the same for the case in '13, and I expect that it's going to be similar in the future. And that segment was not only benefiting from war spend, because what we do there is really -- is very critical for the warfighter in the war zone, and not in the war zone, for that matter. But also, we've been very successful in continuing to expand into adjacent markets, particularly on the -- really in both the communications and the ISR side. We've also been growing internationally on the ISR side. And we think we'll have more opportunities in the future there, particularly with our small ISR aircraft, SPYDR, which we didn't talk about today. So despite the drawdowns and the sequester cuts if they happen we still think we're going to have very good opportunities here. And a year ago, when the U.S. military announced its revision to its roles in missions, ISR continues to be one of the key tenets of the military strategy and we expect that that's going to continue to be the case, really, in any scenario. And what we do in C3ISR enables, as the name suggests, ISR capability and functions. So we like the underlying long-term fundamentals in that business. And international is only going to be about 12% of those sales in 2013. And we think we have opportunity to increase the international sales in that segment next year and even after next year.

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

Okay. Question in the back.

Unknown Analyst

When you say the impacts are range bound, does that mean your customer mix chart, that you showed up earlier, is also pretty static?

Ralph G. D'Ambrosio

Well, the cost of that was pre-sequester, and I outlined what we thought sequester would do to our 2013 guidance. So it's not static in that it can't change, it's static in that I don't expect there to be any meaningful changes, given the underlying diversity that we have across our businesses and our contract base. So for example, there is no swing -- single swing factors in recompetitions. So this year, we're not going to repeat -- recompete any contract that generates more than $100 million of sales at L-3. There was one that we were recompeting in NSS, which was $200 million a year in sales, and it looks like that is being extended for a year, and we'll be recompeting it a year from now. So we don't have a lot of recompete risk. And that's probably where you'd have to have -- we'd have to have a lot of recompete risk to meaningfully change that pie chart.

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

Is pricing on that -- when you get these extensions because of the situation, is your pricing intact?

Ralph G. D'Ambrosio

Usually the pricing is the -- based upon the existing incumbent contract.

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

So it's good news?

Ralph G. D'Ambrosio

Generally good news.

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

There's a question over here.

Unknown Analyst

Yes. I believe you mentioned on the last earnings call that you have a $250 million placeholder for a potential debt reduction, if needed, to protect your rating. So can you kind of talk through where you are on the balance sheet right now? Do you feel good about it? Do you think you need that reduction? And what you're hearing from the agencies?

Ralph G. D'Ambrosio

We're really -- not really hearing anything new from the agencies. We're very explicit about our capital structure and our desire to maintain our investment-grade credit ratings. And as of today, the $250 million debt replacement -- debt repayment placeholder is still correct, still where we think it is in 2013.

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

I think we're in the red here, Ralph. Thanks so much for your time and your comments.

Ralph G. D'Ambrosio

You're welcome. Have a good afternoon. Thank you.

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