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Exelis (NYSE:XLS)

JPMorgan Aviation, Transportation and Defense Conference

March 05, 2013 9:30 am ET

Executives

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

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

Okay. Next up on our Aerospace Defense track, we're pleased to welcome Exelis, which, as most of you, I'm sure, know, was spun out a year and changed ago out of ITT. Dave Melcher, who's President and CEO, is here, and I'll introduce him to introduce the rest of the team and give you a presentation and we'll have some time for Q&A. Dave?

David F. Melcher

Thanks, Joe. Good morning, everybody. With me here today are Peter Milligan our CFO. Raise your hand there, Peter. And Bob Durbin, who's our Vice President of Government Relations and Business Development. Normally, Bob wouldn't be with us, but we were visiting customers yesterday down in Huntsville, our Army Materiel Command customer and our Space and Missile Defense Command customer, and Bob was on the plane. So he ended up here in New York, and I figure we'll put him up front.

So look forward to having a chance to interact with you and have a dialogue about Exelis and some of the things we're working on. I think it's always good to start with a statement about what we believe about the company. We believe Exelis is a company that has agility in this marketplace, that we're a premier C4ISR technology and networking provider for the government. And one of the things we're working on pretty hard these days is customer intimacy, bringing forth great technologies and affordable solutions. Affordable solutions is something that we'll probably spend a little bit of time talking about in the Q&A because it is something that, I would just say over and over, we're hearing as being very important in this time of sequestration enactment and we'll see if there's resolution.

In terms of the company itself, just to give you a little snapshot of what the company looks like, we report in 2 segments. On the left, 4 businesses comprise our C4ISR Electronics and Systems segment. And on the right, 2 other businesses constitute Information & Technical Services.

A little bit about C4ISR on the left. This is pretty much a product-related business for the most part. It contains Electronic Systems, things like jammers on aircraft and vehicles, mine defense equipment, radars are a part of Electronic System, night vision and tactical communications. We stood up as a new separate division. We pulled some parts from other pieces of the company and put them together, mainly because they are very similar in terms of both relatively later cycle businesses. Both have very large installed bases out in the marketplace, 1 million night vision goggles, nearly 500,000 tactical radios. Both have the same kind of international customers. And so we have a leader named Nick Bobay leading that, who knows very well both of those pieces of business.

Geospatial Systems is everything space and airborne lair-related for sensors. We do payloads for imagery, we do payloads for GPS and weather. When you turn on the device in your car, that signal comes from a payload that was made by Exelis or its successor, ITT Defense. And we also do payloads on UAVs, but most importantly, a lot of the work in Geospatial is related to data analytics and taking the volumes of information that come off of those different conveyances and make it into usable intelligence.

And then of course, aerostructures. We have a business out in Salt Lake City, less than $100 million in size, but one that we've invested in and expanded with some capital expenditures, the plant and the automated capabilities that we have there to service both commercial and military customers.

And then on the right side, Information Systems. You know probably best for the work that we do for Federal Aviation Administration as the managers of their next-generation Air Traffic Management network, and the ADS-B program. And we also run about 60% of NASA's communications networks out of Information Systems with another great mix of cyber-related capability and other things like we were talking about yesterday with Space and Missile Defense Command.

And then lastly, Mission Systems is our Technical Services business, Logistics business. A lot of exposure certainly in theater, contracts in places like Kuwait, Camp Arifjan, Qatar, and Afghanistan, and to a lesser extent, contracts here in the United States at places like Fort Benning, Fort Rucker, Vandenberg Air Force Base, Maxwell Air Force Base, et cetera. The left side is about 45% of the company's revenues. It's about 80% fixed price contracts and about 20% cost plus. The right side is about 55% of the company's revenues and the opposite, about 80% cost-plus contracts and 20% fixed price.

This is really where we focus most of our effort and interest in terms of growth platforms for the company. Critical networks, sensors to decisions, electronic warfare and aerostructures. I mean, these really are the places that I think have the most promise for the company going forward. Some of them military-related promise in the fact that they align very well with the strategy that's been articulated by the Department of Defense, and emphasis on electronic warfare and intelligence, surveillance and reconnaissance and so forth. And then of course, aerostructures is in support of a secular trend going forward that says we're going to be building more aircraft and the composite parts that go on it are going to be in greater demand as that has been proven.

In terms of 2012, we finished up the year with, I think, solid results. We were at the high-end of our guidance range and I'll show you that in just a minute. We have a very strong financial position heading into 2013. Cash up from operations over 15%. Net debt addressed to the tune of about 33% from 2011. And we still have a $600 million undrawn credit facility that is available to us.

We won a few things that I think are very important to this company going forward in 2012 to include some compelling contracts for both electronic warfare and countermeasure activities at home for U.S.-based capability, as well as internationally with the AIDEWS pod that goes on aircraft in International Sales. Both of those are enhancements to existing capability that we've been doing for 20, 25 years, and there continues to be a very strong demand for that as opposed to some of the exquisite new things that are out there. But we're also going after the exquisite new as well in the form of the next-generation jammer, and we have invested in that and are partnered with Northrop Grumman for that competition, which should be decided here in the spring, summer of this year.

We won a position on a contract called APAS. It was an interesting one because it is for, basically, the networking of security for infrastructure and installations. This was a Navy contract but I think it opens up some new pathways for us as we go forward. And we continue to be involved in the next-generation of night vision. We are the only company fully certified producing the fused night vision goggles called SENVG, Enhanced Night Vision Goggles. We have our foot in the door for connection of night vision goggles into the network, which is something that always was an aspiration, has not been done. We've been working on that. And so we intend to keep a lead in the night vision world.

We won 2 other contracts that are mainly IDIQ indefinite delivery/indefinite quantity contracts, EAGLE, which, as you now, is a over $20 billion contract. It's going to be the prime vehicle for the kind of logistics, maintenance, base support work that we have going forward. And GTACS was a contract led by the Army to allow procurement of nonprogram of record kinds of capabilities, of which we have many, which I'll be ready to talk about if you like.

We did some investment this year in those growth platforms that I showed to you, both in terms of IRAD and capital expenditures. We bought 2 companies in 2012, 1 of them was a company called Applied Kilovolts. In the U.K, it is a power solutions business that nested well with a like business that we have. The difference being most of their customers were medical and scientific and commercial customers, most of our customers were military power solutions. The combination of the 2, I think, makes us stronger, both domestically and internationally.

We also bought another company called Space Computer. Now, these are relatively small. These are $20 million, $25 million companies. But Space Computer was very important to us because in the data analytics world, this is a company, a software development company, that has proven itself very adept at taking -- creating the right algorithms to take these vast quantities of multispectral imagery that are part of the picture now and distilling them down into usable information.

We also finished the acquisition, just in January of this year, of C4i, which is a company located in Australia that does work related to Air Traffic Management and switching. It was a good acquisition for us as we're pursuing a large competition in Australia called oneSKY, which would be an extension of the kind of work that we've been doing here for the FAA with the ADS-B program. So we made some niche acquisitions, and we'll continue to look at things like this as we go forward.

Looking at the whole picture of the company, the revenues in 2012 were about $5.5 billion. The customer set, you can see on the left, fairly diversified. A little bit larger composition of Army customer, but some of that is related really to the Mission Systems work that flows in theater, where the Army is the executive agent for many of these contracts, whether they support the Army, the Marine Corps, the Navy or the Air Force. So Army is about 38%. DoD is about 70% of our company revenues, 30% is other. And that other consists of the FAA and the NASA work, 10% international and about 3%, 4% commercial. Commercial is aerostructure composites, payloads, night vision, which is sold, in some cases, through commercial distributors and so forth.

And then the contract types, you see on the right, they roughly align with what I told you earlier about the amount of business in C4ISR versus our Technical Services and Information segment. And then we tend to be a prime on about 80% of the work we do. We're a sub on about 20% of what we do.

For 2012 results, you can see the results here. In all cases, the elements, the guidance that we had put out, we had exceeded, had good cash flow of $285 million free cash flow in 2012 after contributing $266 million to our pension plan. Pension, as you may know, if you've covered the company, is one of the things that we deal with. We have a very large pension liability of about $1.9 billion, which was part of the spin-off from ITT Corporation. We've been working on that and we can talk more about the ways we've been working on it, but it is at about $1.9 billion.

And the one area that I would say on this chart that was not up to what we wanted was orders. Orders were a little light in 2012. Some of that you could relate to the customer behaviors as more and more reality of a continuing resolution followed by a potential sequester followed by a sequester all became part of the picture in the DOD environment. I do think, for example, that we're going to be able to make up some ground here in 2013 and I want to go back to a 1.0 or better book-to-bill going forward and I think we have a lot of opportunities. One such opportunity presented itself in January after the end of the fiscal year where we had a very large contract of, I'll just scale it at less than $100 million, but a very large contract and a meaningful one for a meteorological payload that we're selling to an international customer. So just the kind of thing that we're trying to move forward on to give us some additional outlets for our capability.

One of the other things we're doing, as you might expect, is working hard on controlling our costs and our cost structure. This actually isn't a new effort. We've been working on this for a couple of years. I'd say up to the end of 2012, we had reduced our footprint in the company of about 10% from what it used to be in the past couple of years. And we have taken our headcount down well over 1,000 to 1,500 people in relation to the reduced volume of products that were flowing through after the postwar surge. In 2013, we're continuing that trend. We're reducing our workforce about 6%, which equates to about 1,150 people, and 600 of those were -- have already departed via an early retirement program that we offered in the November time frame, and has finished by here, February, March timeframe.

We also are reducing our footprint another 10% in 2013, and I will tell you now, as likely to do another 10% after that in 2014.

So the first phase is really what I've talked about, which we've programmed in and made a part of our budgets for 2013. The second phase, we're working on very hard now. And it's not just footprint and headcount, it's also looking at supply chain, it's looking at shared services, it's looking at global sourcing, and all the other things that we have to do more effectively in order to be competitive in this environment that we know is going to be around for defense businesses for a few years. So we're working very hard on repositioning our cost structure as well as finding new business.

In 2013, we just put out our guidance on March 1. We had an earnings call and talked through the guidance for 2013. You see it on the right. It is a bit of a step down, if you will, from 2012, in terms of expectations. But I honestly think that, that is appropriate given the context that we're in. We have had a continuing resolution. I do expect that will be resolved in some way, shape or form, between now and the 27th of March. There could be some leaning towards trying to address some of the sequestration hits that the department is trying to deal with now. But I don't, by any means, expect that a full sequestration restoral is going to happen in this year. I think that's probably beyond the arc of the possible given everything that's transpired to this point. So we made it clear when we gave the guidance that we weren't giving, as Clay Jones just told you if you were in here, full sequestration guidance for the year. I just don't know how that's going to turn out yet. And I think we need to really see what happens.

I've spent a lot of time with customers lately, I just have to tell you. In the Pentagon, in places like Huntsville and in other places where we interact with those who make the decisions, they do not have certainty either. They have not come to terms with the kind of programs that are going to remain funded and the programs that are not. They do not know whether they're going to have any flexibility in how the sequestration or near sequestration-type cuts will be enacted. And so I think there are decisions yet to be made by customers about how they're going to do that. And one of the things we are seeing a little bit is that the one lever that all the folks in the DoD can pull quickly is the lever on their O&M funding and of course, their civilian employees. And so thus, everybody's dealing right now with this notion of furloughing civilian employees for 1 day a week going forward effective soon. And everybody is doing testing of what would happen if we cut back on certain operations and maintenance spending at our installations, camps, posts and stations around the United States. Not so much internationally because ironically, well, everyone always talks about OCOs coming down and it's the thing we all worry about, but in this year and perhaps next year, OCO is the thing that's going to probably have more stability than most because it's supporting the war effort, which the administration has said, is going to be a priority. And so in a strange sort of way, the OCO-funded things might have a little more resiliency in this year than the domestic things.

So that's it for presentation. I would be happy to answer any questions that Joe or you all have.

Question-and-Answer Session

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

Great, thanks, Dave. I'll just start you out with pushing a little more on the sequester, and please, if there's any out in the audience, please raise your hand. But in terms of the -- let's just start with what you've seen the last 2 months. Even before sequestration kicked in, there was a lot of planning, a lot of memos flying around. What have you seen in terms of your day-to-day activity, particularly in the booking side?

David F. Melcher

Well, I do think that customer behaviors certainly have changed in that regard. For some of the large service contracts that we have, there was a day when those would be funded a full year in advance upfront and there you go, you're off executing. That has gone down to about, at best, 2 months at a time, and more likely, 1 month at a time. So in terms of getting funded orders and funded backlog in the service world, that's a more difficult thing. And on the product side, I think others would tell you the same phenomenon. Those things that can be slipped to the right have been slipped to the right. Those things that did not require a decision immediately are not getting a decision immediately. Although I do sense that for things like the next-generation jammer and other things that are priorities for the strategy and with a sense of urgency for the need, those things I think, will stay on schedule as we go forward. But clearly, customer behaviors are changing.

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

And on the competition side, since you are going there, so you do believe the jammer will remain in -- on schedule but how about -- you're going after a variety of communications-type contracts, are those sliding or are those staying intact?

David F. Melcher

Well, what Joe is referring to is we do a lot of Army communications business and have done so in the past through the SINCGARS radios and so forth. The Army sponsored this thing called the Network Integration Evaluation out at White Sands Missile Range, which was designed to be a more rapid-fire, a more rapid acquisition channel to bring high technology readiness items forward, have them tested, and if found to be worthy, procured. That's gone very slow, just to be honest. And I've talked with the Army Secretariat and uniformed leadership about the fact that it's very difficult to maintain the same level of interest iteration after iteration when you're investing in a chance to show your products but it's not translating into production. Now, they all swear that it will, that they do have an interest in bringing forth these capabilities and in procuring them, and so for us, that would be a Soldier Radio Waveform appliqué, which is an adjunct to the SINCGARS radio and gives us a JTRS-like, Joint Tactical Radio System-like capability, another thing called Global Network on the Move which is a, really, a bridging capability for the Win-T, wideband network, that is pursued for communications on the move. I think both of those things are going to get traction and here's why. As the realities of sequestration or near sequestration cuts sink in and particularly for the Army, and we're holding manpower levels at higher than we should, we should more rapidly reduce manpower levels to get to a state where you can afford to invest in the business, the Army business. I think what you're going to see is you're going to see cuts to the investment accounts. And the Army will not be able to afford exquisite new capabilities, even those that now, supposedly, have been proven in some sort, like the Joint Tactical Radio System. The amount -- the cost of those radios is just too much. The cost of Win-T is just too much. So I think our affordable solutions are going to have a place and we've just got to let this play out.

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

In some cases, in the short term, if there are delays to procurements, if you are the incumbent, it can actually help. And I think maybe in your Services business, that may have been a positive factor for you.

David F. Melcher

Absolutely. Our Services business held up better than most in 2012. One thing we're sort of proud of is we put out guidance in 2012 with the same uncertainties that everybody else did. And we held that guidance for the whole year. We did not change our forecast at any point throughout the year. And we performed pretty much, quarter by quarter, as we expected. One helping fact there was that we have several large contracts like our communications contract in theater, like our space/ground range contracts and others that kept getting pushed to the right because of the same phenomenon that we were describing. Decision-makers couldn't get themselves to put the new contract out on the street and so, those delays benefited us as an incumbent. And so, we've been on both sides of that equation.

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

And so since we're now getting to the point where maybe not throwing the towel in on sequestration, but getting close, what -- how can you help us bracket the impact to your top line, the $5.0 billion to $5.1 billion?

David F. Melcher

I think we've thought long and hard about it and of course, we gave guidance a little bit later than most did, right? We gave guidance on the 1st of March. We might have had a different view of it if we had given guidance at the end of January as some others did. So I think what we tried to do is take stock as best we could of the situation that was out there. With, keeping some sense of potential, which our customers are keeping as well, some sense of potential that they might be able to get a little bit of easing of what this is. Ultimately, I think, there's no doubt it's going lower. I would like to be able to tell you today that the guidance that we put out, we intend to meet and make and hold. But I think I have to see what really happens yet in terms of congressional action, administration action or customer decisions. I like where we're at, electronic warfare is good, critical networking is good, aerostructure composites is probably not going to be affected by it that much and data decisions, these are good places to be. But I have to see what happens in the larger picture.

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

It feels like this month, we'll probably get some level of, I don't want to say certainty, there's never certainty, but some level of confidence in the big picture. And then maybe in the month or 2 after that, we'll start to get a little bit more granularity on decisions that the services make on individual programs. And so when May rolls around, which is probably early May, I imagine, is when you're doing your first quarter call, do you think you'll have more granularity?

David F. Melcher

Well, I think we'll have a better sense than we do today, for sure. And one of the things we tried very hard to do in our first year as a public company is to be as transparent as we can about what we believe vis-à-vis what you all believe and what our customers believe, and we're going to continue to do that. So Joe, we'll have, I'm sure, a good conversation in the May timeframe about that.

Peter J. Milligan

The other thing, Joe, if I could add is, I think if we see a full impact of sequestration, whatever that might look like, that's going to be more of an impact to the backlog. When you look at 2013, you'll probably have over 80 -- we do have over 80% in either backlog or sort of closely -- close follow-on type work. So our view would be, there certainly could be some pressure on the top line if the impacts were greater than what we thought because we said there's no major impact in the numbers but there's certainly some in the guidance that we gave, but it would be more so -- it would be more impactful to the backlog.

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

To the backlog that's in place or the bookings that you expect?

Peter J. Milligan

The bookings that we anticipate over the year.

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

Okay. But you do have, x sequestration, you, and I guess that's a little less relevant, is under-viewed, but not irrelevant. You did have or you had have a pretty good outlook -- more confident outlook, I think, in C4 in particular coming into the year. You mentioned the big satellite. What we talked a little bit about some of the things that are slipping out in the Army communications side. What else -- are there any other chunky items we should...

David F. Melcher

We're working on another big international payload that we hope that will come to fruition in this year. Certainly, next-generation jammer is important to us, although it will still be mostly developmental effort in its first year, once announced. We're still actively pursuing everything that we mentioned with respect to the communications gear and so forth. We've seen increased demand for mine defense equipment, so much so that we expanded our facility down in Panama City, Florida. And as you might imagine, when you announce a shift to the Pacific, that's one of the things that's going to get resonance as well as the shipboard ESM and so forth. And then of course, internationally, that's pretty much mostly all a product market for us. And so we're working very hard to sell internationally those things that we can, which include radios, includes night vision, includes radars, includes, potentially, things like aerostructure composites that we can sell to Airbus and we're working on something with them right now. So those are the kind of things that I think give us opportunity and promise and it's the C4ISR segment and aerostructures.

Peter J. Milligan

The other thing, if I could just add on that piece, we have about 10% or so of our revenue is international, but none of it on the Services side is. So that just, mathematically, it's over 20% sort of in the 23%, 24% range I think, it would be, on the C4ISR side would be international. So less domestic exposure than you may think.

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

And then it sounds like you can't -- aren't able to speak in too much in depth about the payload that you won or the one that you think you have coming. But maybe could you specify whether those are the same payloads or the same customer? And then is there anything you can say about that business which -- it seems like it might be -- it certainly is a big opportunity for this year. What's the opportunity looking forward?.

David F. Melcher

There's actually quite a bit of activity in Geospatial and with payloads. First of all, this -- we have sold a meteorological payload to Japan, 2 of them. And we're also producing similar payloads for NOAA. So there's a logical extension of that capability, both domestically and internationally. The one that I just referred to that we got is a new customer, not an existing customer. So opening the market up a little bit. But we're also involved with GPS III payloads, right? We're working those with Lockheed. We're working on the first delivery order of that GPS III payload this year. But the potential for that extends all the way up to 20 payloads. I mean, both on a cost-plus and, eventually, a fixed-price basis. So if the government decides to pursue these various increments, and they've already agreed to pursue several of these, there are tranches beyond that, that I think we're trying to get locked in place which would represent pretty much a great pipeline and a factory for these things to flow-through. So I do think there's a lot of promise in the Geospatial area.

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

Peter, on the pension side, MAP-21 has effectively cut your contribution in half from what you had previously expected for 2013. And last year came in a little below where you had previously expected. The way that the law works though is that this quarter that opens up over time, and so can you give a little bit of your sense of the profile looking forward? What you think your contributions will be? You're talking $150 million this year. And then the second part, I'll just ask it all at once, is as you think about that contribution, I imagine getting larger in future years, but at a low -- relatively low level right now, how do you think about the balance sheet flexibility, what -- how do you put into context what you can and can't do?

Peter J. Milligan

Sure. So at a high level, you're 100% right. I mean, our contributions for -- the mandatory contributions in 2013 are about 1/2 what we thought they would be before the legislation was enacted. That corridor does widen and as a result, the impact of that look back on interest rates is decreased. So if you look out now in 2014, you're probably up maybe $100 million, so in the $250 million range. And it gets a little higher in 2015, and then I guess it's a race against whether or not interest rates are going to go up and we'll see how that plays out. So that's sort of what we're looking out in the next couple of years. The high point is probably in that $300 million range. And then if assets return as expected, and of course, we lowered our asset return assumptions, then you start to see the funding increase effectively, right? So this is not a $300 million contribution forever, far from it, right, because our resource [ph] are going to require you to get there to 100% funding in a defined period of time. So that, I think, is sort of the way we think about the pension in the short term...

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

But before we get to the big picture? Yes, sorry to interrupt, as I asked you 2 questions, now I'm interrupting. But just on the same point, your CAS [ph] recoveries are about $100 million this year relative to the $150 million. So net, you're only out $50 million. As you scale up from the $150 million to the $300 million contribution, you have harmonization kicking in, it's pretty complicated but very important for you guys, where do you expect that CAS to be when you get back up...

Peter J. Milligan

Yes, CAS really starts to go up in '14 and '15. I don't know if it gets to as high as the pension contributions. Actually, I know it doesn't. But the biggest issue, I think, for CAS for us, and I'm sure, for others, is you have to find a home for it, right? So it's recoverable. But you have to find a contract to put it on. And of course, it is an expense like all other expenses if you had pure elasticity in your pricing, you can put every allowable cost in. But it's a competitive market, and even on the service jobs whereas it could be cost-plus as we all know, that the competition there is not easing so our cost structure, as we go into a bid, is going to reflect those CAS cost. So we have decisions to make as to whether or not do you take a lower margin and put all your CAS cost in, or a lower CAS cost and higher margin. It's the same economically to the customer. There might be different strategies behind. But so it's a long way of saying that although the CAS costs are going up, and they are, theoretically, recoverable, we still have to make sure that we're in a competitive position so that we can recover them. So there's sort of another aspect to that. Does that help?

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

Yes, that's a great help [ph], thank you.

Peter J. Milligan

Okay. The other piece on the balance sheet. We made a point, I think Dave made it again this morning, last year's cash flow was significant and it was better than we thought. So at $285 million of free cash, we find ourselves in a position to have our net debt go down by 33% last year. So not aggressive, as you could see, on acquisitions. We spent $40-something million on acquisitions in a little bit early in this year. So we are in a much better position than we were a year ago. The reality though is that unfortunately, the liability in the pension stayed at $1.9 billion, and it really, it was just -- notwithstanding significant contributions that we made and a higher-than-expected asset return, we predicted 9, we did 11. The liability went up by $400 million because the interest rates went from 4.75 to 4.09. So it was just -- we didn't get anywhere, unfortunately. Now, again, I'm sure many times, folks have heard that interest rates can't go any lower. So are we there yet? Who knows? I guess anecdotally, I did read the other day that January was the best month for -- second best month for pensions ever, so maybe we should have closed the books, extended our fiscal year. But at any rate,, I think the reality for us in the short term is certainly, we feel the dividend is highly secure and it's -- the payout ratio is not enormous. We have done a number of things operationally to try to deal with the pension expense, right? We've frozen the plan, we've done some lump sums. But that's still a big liability that I spent a lot of time thinking about. So while the MAP-21 legislation has given us optionality, question is what option are we going to choose with that cash flow. And I have to think about sort of accelerating, potentially, contributions to the pension vis-à-vis other things. And I think the choice that we'd sort of start with, if there's opportunities on the M&A side, we would certainly look there. I'm not talking anything significant, but it's certainly something that could be important for us if we find the right fit. And then obviously, you have dividends and then you have pension. Buybacks in the short term is not something that we've focused on in any meaningful way other than just to offset option dilution.

David F. Melcher

Joe, if I could just make a comment, I mean, I think there may be the right context to go in for another run at MAP extension. And I say that because I mean, Peter and I spent lot of time on the Hill talking with ways and means and others about how we, as a company, were a great example of how we were not able to adequately invest in the business absent some smoothing of interest rates. Given that interest rates have continued to be held down and it is a revenue enhancer like it or not, what was done, I think that, that's worth another run. And so we're trying to look congressionally to see, with business roundtable and others, can we take another run at that.

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

And are you -- the reception to that, since it's a revenue enhancer is...

David F. Melcher

Well, yes. The revenue -- because it's a revenue enhancer, the receptions is always more positive, right? Because this one last time got tied to the highway bill as a revenue enhancer, and it would be so again, going forward. So to the extent people are looking for revenue, there's a place to find it.

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

And then Dave, when we look at the big picture here and the budget and the way you think about the company, pretty important from the standpoint of making acquisitions at some point or making acquisitions of your own stock at some point, that you come to a decision on where we are in the Defense cycle. There are -- I've heard varied views. There's a lot of variety out there. Some people think that this sequester, if the bottom is in, you can also make the argument, they think, very clearly that taxes went up on January 1 and there was, 2 weeks later, talk of raising taxes again, you live in a democracy. And if they come after Defense 1, 2, 3 times already, it could happen again. So when you think about allocating the capital of the company, where do you think we are in this process, how much more -- is there downside beyond the sequester?

David F. Melcher

I mean, and I think we're about 3 years into a classic Defense downturn, which tend to last upwards of 8 to 10 years. So I think that there's a chance that this will continue for a while. What does that mean for us? It means that as we look at those things that we call growth platforms and we look at the trends that are out there, you'll see us more likely to invest in things that are supportive of, for example, our Air Traffic Management aims and our aerostructure composites and other things, while keeping the right amount of IRAD in those programs that are important for us to get hooks in the future to allow the same kind of explosive growth that we work -- that we had in night vision jammers and radios in the middle of this last decade. So you got to keep your hooks in the right things. But I think in terms of where we would invest our acquisitions that we'd be oriented on, it would be more in that arena.

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

Are there questions out there on the floor? I don't want to hog everything here. Let's talk about -- maybe because everyone's happy with me asking questions, so I'll ask you another one. Let's talk about the Services side of things. You guys have looked at the portfolio there, and thought through that pretty carefully I think in the -- since you were spun off. It's held in better than maybe one what might have thought for a couple of different reasons, but you still do have a pretty big OCO overhang in a pretty tough environment here in the next couple of years. So how do you think about, strategically, that portfolio?

David F. Melcher

I think clearly, the couple of contracts that we have in Afghanistan, I would not expect them to go on a whole lot beyond 2014, right? Because it will be tied, in some sense, to the troop drawdowns. The interesting thing about those contracts is that they are for support of the Afghan military, not the U.S. military. So the counterpoint to that is to the extent that the U.S. will continue to provide aid to Afghanistan much as was done in some cases for Iraq until they could stand up their oil revenues, Afghanistan does not have that kind of a growth engine other than poppy, and I don't think that's going to be it. And so U.S. aid to Afghanistan is likely to continue for many years, perhaps through the State Department. I think there's a reasonable possibility that some of that aid would be used to support the kind of contracts that we have there now. Our LOGCAP work, we're a sub to floor, in Afghanistan, I think clearly that comes down. But that's not the greatest preponderance to the work that we do there. In places like Kuwait, Camp Arifjan, which is the power projection platform for the combatant commander in the Middle East, that is going to be funded and maintained whether it is OCO-funded or whether it's base-funded. In fact, a good chunk of that support for that installation comes from the Kuwaitis because they like having the U.S. presence there. So I think that's relatively stable. What is in Qatar is stable. And the next frontier, I think, if it's not going to be more work in the Middle East, and clearly, Asia Pacific is a focus, it's going to be Africa. And so I think we need to be looking at what are the opportunities in Africa, and I'm also asking our Services team to look at opportunities outside of the Defense context with three other agencies, Department of State, maybe even educational institutions, oil and gas industry. It's not a leap to think that the kind of things that we've done in austere environments could be done in other contexts as well.

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

We're pretty much out of time, but maybe I'll stick the other side of the equation here for a moment. If it doesn't make sense to divest any of these businesses that are in decline because, frankly, you probably can't get for what it's worth, what you're going to receive in cash flow the next few years, maybe does it make sense to ever to think about picking the other side of that? And there are other companies out there that are -- have some businesses that are in similar positions. Does it ever make sense, in this type of a real tough business but with very, very low asset valuations, to make investments?

David F. Melcher

We look at that. And in fact, I've told our leader of that business he should think creatively and strategically and he should come to us with things that make sense and give him an opportunity to get into the other markets. And so we certainly will look at that. I haven't written that off as a possibility. But we're looking across the spectrum. And as you know, I mean, we have a limited amount of firepower. We hope to apply it in the best way as possible.

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

Very good. Guys, thank you very much.

Peter J. Milligan

Thank you.

David F. Melcher

Thank you.

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