L-3 Communications Holdings Management Discusses Q1 2013 Results - Earnings Call Transcript

Apr.25.13 | About: L-3 Communications (LLL)

L-3 Communications Holdings (NYSE:LLL)

Q1 2013 Earnings Call

April 25, 2013 11:00 am ET

Executives

Eric Boyriven - Managing Director

Michael T. Strianese - Chairman, Chief Executive Officer, President and Member of Executive Committee

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

Analysts

Carter Copeland - Barclays Capital, Research Division

George Shapiro

Myles A. Walton - Deutsche Bank AG, Research Division

Cai Von Rumohr - Cowen and Company, LLC, Research Division

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

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

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

Operator

Good day, ladies and gentlemen. Welcome to the Q1 2013 L-3 Communications Holdings, Inc. Earnings Conference Call. My name is Beverly, and I'll be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. At this time, I'd like to hand the presentation over to your host for today, Mr. Eric Boyriven with FTI. Please proceed.

Eric Boyriven

Good morning, and thanks for joining us for L-3 Communications' First Quarter Earnings Conference Call. With me are Michael Strianese, Chairman, President and Chief Executive Officer; and Ralph D'Ambrosio, Senior Vice President and Chief Financial Officer. After their formal remarks, management will be available to take your questions.

Please note that during this call, management will reiterate forward-looking statements that were made in the press release issued this morning. Please refer to this press release as well as the company's SEC filings for a more detailed description of the factors that may cause actual results to differ materially from those anticipated. Please also note that this call is being simultaneously broadcast over the Internet. I would now like to turn the call over to Michael Strianese. Mike, please go ahead.

Michael T. Strianese

Thanks, Eric, and good morning, everyone. Thanks for joining us. We got off to a good start in the first quarter, posting solid sales, cash flow and earnings per share despite what continues to be a challenging environment to the U.S. defense industry. Our employees and leadership team have done an outstanding job staying focused and delivering consistent program execution, and I want to acknowledge and thank everyone at L-3 for rising to the challenge and staying on track.

We've been continuing to execute our strategy to expand our market share and increase our international and commercial business, which is exemplified by our first quarter increase of 18% in commercial and international sales. Taking a look at some key financials, we had net sales of $3.2 billion for the quarter. That was up 1% compared to 2012. Diluted earnings per share from continuing operations was $2.11 compared to $1.86 year-over-year. That's up 13%. During the quarter, we had funded orders of $2.9 billion and a funded backlog of $10.5 billion. The book-to-bill ratio was 0.9.

We continue to concentrate on increasing our operational efficiencies and making strategic investments in research and development that will feed our pipeline for new products and solutions. We've reshaped our businesses to reflect the realities of the marketplace and shifting customer priorities and to capitalize on operational efficiencies and shared service initiatives.

We also renamed our AM&M, or Aircraft Modernization and Maintenance, business segment to Platform & Logistics Solutions, and that reflects our broader addressable market that now includes ground equipment. We had our first win in that space last year, and we're aligning the name of the segment to better fit the marketplace.

In terms of our segment performance, net sales in C3ISR rose slightly by about $2 million compared to last year's first quarter, and that was led by sales of ISR systems. C3ISR continues to be a strong segment for us with growth centered on airborne ISR, network communications and specialized security and encryption products. We're on track to deliver the first of 3 RC-135W Airseeker surveillance aircraft for the U.K. and are focusing on specialized integration capabilities to a new and follow-on business. That program is currently running on budget and ahead of schedule, and, needless to say, we have a very happy customer.

Electronic Systems, our broadest segment, has been a consistent, strong performer. We have the #1 or #2 market positions in many of our businesses in this segment with a diverse balance among defense, commercial and international customers. Net sales for the quarter in this segment increased by $37 million, or about 3%, compared to the first quarter of 2012. This increase was driven by Simulation & Training work from the Link U.K. acquisition and increased deliveries of U.S. Army rotary wing training systems and upgrades to the F/A 18 trainers. KEO also contributed to our results with key international naval contracts.

In the newly renamed Platform & Logistics Services -- Solutions segment, formerly AM&M, net sales increased over 2012 by about $3 million attributable to international head-of-state aircraft modifications, the Australia C-27J program and aircraft maintenance for the Canadian Department of National Defence, all international work.

We'll continue to focus on opportunities for aircraft upgrades and contractor logistics services as cost-conscious customers look to extend the life cycle of both rotary and fixed-wing aircraft as well as ground equipment.

In our NSS, or National Security Solutions segment, first quarter net sales declined by about 5% year-over-year mainly to -- due to lower sales for U.S. SOCOM IT service work. And that's due to going to multiple-award contract vehicles from the previous single-award vehicles, which obviously spreads the work over more contractors and causes a sales reduction for the incumbent.

System -- significant awards and milestones. Let me go through some of the bigger awards for the quarter, and then we'll talk a little bit about the budget.

So for C3ISR, we continued to receive funding for the Predator data links and upgrade work for Global Hawk systems. We received an order for ROVER systems from the SOCOM customer and an order for SIR units by an Australian customer. We booked an order for an additional 615 battlefield anti-intrusion systems for the Army. We supplied more than 3,500 of these systems in 2012.

We also won contracts for encryption key management and advanced key processing systems for critical information security processes. We are supplying next-generation key management work under Spiral 2 funding.

In Electronic Systems, Link U.K. received funding for Airbus A400M simulators in Germany, France and the U.K. and an order from Sichuan Airlines in China for the A320 simulator. To accommodate our expanding business base in China, we've recently opened a customer support center there. Additionally, we received an order for 2 full flight simulators in the Boeing 777 family and the B747 configurations. We were selected to build 2 UH-60M Operational Flight Trainers for the Taiwan Army. Those are similar to those used on the U.S. Army's Flight School XXI program. This award represents Link's first export sales of its rotary wing OFT product line. And we've sold F/A 18 simulators to Kuwait as well. We received additional funding for WIN-T modems and continued orders for our VideoScout systems.

For KEO, and that was the Kollmorgen photonic mast business that we acquired last year, we received an order from the Indonesian Navy for submarine Photonic Mast and valve systems. The innovative design approach for this program will be used as a platform for other international opportunities. KEO also received an order from Korea for visual landing aids.

Security & Detection Systems continues to win new contracts for its personnel, baggage and cargo screening systems. Key awards in the quarter included an order from Saudi Arabia for checked baggage and X-ray-based carry-on baggage systems, an order from Heathrow for baggage XLB pike [ph] systems for screening, and an order from the TSA for eXaminer checked baggage screening systems as well.

In Marine & Power Systems, we were selected to supply ship automation systems for Viking cruise ships and were awarded an FAA contract for depot logistics support and standard transfer switches. Continued solid sales from WESCAM for sensor systems from a variety of military, OEM and public safety customers occurred in the quarter, and we're continuing to pursue several near-term foreign military sales opportunities in that area as well.

Platform & Logistics Solutions. In P&LS, we were awarded a 5-year Army field maintenance program in support of U.S. facilities. We also received the Regional Aviation Sustainment Management contract to provide maintenance and sustainment services for Army rotary wing aircraft. We were selected for a 7-year contract to provide aircraft maintenance at Columbus Air Force Base. We also received continued funding for sustainment support for P-3 Special Mission Aircraft. The Crestview business received an order from Boeing to provide cabin panels for the CH47 helicopter.

In NSS, or National Security Solutions, in a competitive win, they were selected to provide systems and software sustainment, engineering services support and end-user training for the U.S. Army Reserve. I'll note that, that particular award is under protest. In addition, we were awarded continued funding for intelligence support services to combat forces in Afghanistan.

We were previously an awardee under the Agile Cyber Technology program for the Army -- for the Air Force Research Lab. While no task orders have been awarded yet, we are optimistic about work under this program in the future.

As you know, we're committed to delivering shareholder value through our disciplined approach to capital allocation through share repurchases and dividends as well as our disciplined M&A strategy. During the first quarter, we repurchased $122 million of our common stock and paid dividends of $52 million. We strongly believe that returning cash to shareholders delivers value and is a prudent strategy in a challenging environment, particularly in our cyclical business.

Looking ahead, we're closely monitoring the industry for acquisition candidates that may become available, but, as always, we're mindful for price. Our decision to add assets in refining our own portfolio is subject to meeting strict criteria of increasing market share, delivering attractive returns on investment, promoting cross-segment collaboration and expanding international and commercial opportunities.

Let me make a few comments on the state of affairs regarding the DoD budget environment. As you know, we're currently under Sequestration and Congress has not yet taken any action to reverse it. We continue to watch this issue closely with the next milestone for a potential resolution in May when the debt ceiling negotiations begin. There is reason to be cautiously optimistic, however, and Congress has approved an appropriations bill that will keep the government operating through the end of '13. While this action and the ongoing complexities of the '14 budget process do not reduce the impact of the cuts from Sequestration, they do provide some funding stability for the government. However, the recent budget submission for fiscal '14 to Congress did not get a very warm reception. One area of interest to industry will be the extent to which programs, if any, will be cut or discontinued. There will be some program reductions, but we anticipate they will not be in the primary areas of L-3's business. In a constrained budget environment, the government looks for extending the life of current platforms via upgrades and service life extension programs, which is a market niche where L-3 excels and has been a solid business base for aircraft, naval vessels and vehicles. We do see potential in DoD priority projects like the addition of a Virginia Class submarine. We're expecting that the DoD and the intel community will undertake in the near term a major reprogramming that will shift resources, and we're staying close to our customers as they develop that list. But that could be in the neighborhood of almost $20 billion, as we're hearing. So notwithstanding Sequestration, which is the line-by-line reduction of a fixed percentage, when the next step is a $20 billion reprogramming, that really becomes the driver of where the winners and the losers are going to be.

So additionally, we still continue to successfully grow our commercial and international mix, and there's areas of opportunity that we still see in places like the Middle East and Asia. Let me have Ralph review some of the financials in greater detail and then we'll go to the Q&A. Go ahead, Ralph.

Ralph G. D'Ambrosio

Thank you, Mike. I'll cover a few details about the first quarter and review our 2013 guidance update.

Overall, we had a good first quarter. The results exceeded our expectations driven by higher sales and operating income with margins and free cash flow meeting our expectations.

Diluted earnings per share from continuing operations was $2.11 for the first quarter, and it grew 13%, or $0.25, versus the first quarter of 2012. The retroactive reenactment of the federal R&D tax credit was about half the EPS increase, and the remaining increase was driven primarily by our capital deployment, which drove a 9% reduction in our shares outstanding, which offset a 4% decline in operating income caused by lower margin.

Consolidated sales totaled $3,185,000,000, increasing 1% versus the first quarter of last year, and sales were about $115 million higher than we expected with better sales in all 4 segments, especially in Electronic Systems. We had some sales planned for later in 2013 that happened earlier. And all things considered, our first quarter sales were very strong given the current environment.

We continued to expand our commercial and international sales, which increased $122 million, or 18%, and that offset or more than offset the decline that we had in our U.S. defense sales.

Consolidated operating margin declined 50 basis points to 9.8% for the quarter. Higher pension expense reduced margin by 10 basis points, and sales mix changes, mostly in Electronic Systems, accounted for the remaining change in margin. We had anticipated those sales mix changes in Electronic Systems, and they pertain to the drawdown from Afghanistan, where our higher-margin EO/IR turret sales are declining, and most of those declines for those turrets were happening in the first quarter comparison. Additionally, segment margins for the first quarter are tracking to all of our full year 2013 estimates.

Moving on to the 2013 guidance update. As you know, we made no changes to our guidance. In summary, 2013 guidance is earnings per share in the range of $8.15 to $8.35 with sales between $12,550,000,000 and $12,750,000,000, margin of 10% and free cash flow of $1,030,000,000.

We also made no changes to the segment guidance.

We previously provided our estimated downside risks to our 2013 guidance for Sequestration, and they remain the same. If you recall, we had estimated that Sequester reductions could be up to $0.5 billion of sales, 30 basis points of margin, which translates into about $0.65 of EPS and about $80 million of lower free cash flow. I would like to underscore that we assess these reductions to be the maximum potential Sequester reductions for 2013, and the margin and EPS downsides also include some restructuring provisions.

With the Sequester trigger slipping 2 months to March 1 and the smaller FY '13 Sequester cut, we also predicted that the impact to our 2013 financials would likely be smaller than these estimated downsides, and that continues to be the case.

There has been a lot of discussion recently by OSD and the armed services about the types of cuts that may need to be taken under Sequestration. But to date, the DoD has not provided any details or specifics of how they will apply the Sequester cuts for FY '13.

So as of today, even though we have experienced some minor Sequester impacts, which are all covered in the 2013 guidance that we updated today, we still do not know the full impact that the Sequester cuts will have on our contracts for 2013. And let me explain why.

You may recall that a significant portion of our business is short cycle, meaning that we need to book orders and convert those orders to sales in the same calendar year. We still have to book about $4 billion of orders from April to December of this year and convert those to sales this year to achieve our sales guidance, and that calculates to about 42% of our last 9 months' sales for 2013. And so those are the 2013 sales that are subject to the Sequester risk that I just talked about.

Finally, we expect to learn more about the Sequester downsides to our 2013 results over the next few months. And to the extent that they are incurred, we expect that they mostly would affect the second half of 2013.

On our capital allocation assumptions for 2013, we also made no changes. They continue to include $0.5 billion of share buybacks, about $200 million of cash dividends and a debt replacement placeholder for $250 million. Our guidance assumes that we'll end 2013 with a cash balance of $450 million.

Taking a look, lastly, at the second quarter for 2013, we currently estimate our sales to be between $3 billion and $3.1 billion, margins will be about 10%, EPS we expect to be in the range of $1.90 to $2 per share, and our free cash flow should be somewhere between $100 million and $200 million with a book-to-bill ratio for the second quarter of at least 0.90.

That concludes my review. I'll just add the final comments that the current environment is challenging, but we think it's manageable. We have uncertainties, but those uncertainties are generally understood and range bound, and we're prepared to effectively manage them as the situation changes. The company continues to be strong and healthy. We're generating solid financial performance, and we're allocating capital to improve our results and increase shareholder value. Thank you, and we'll now begin the Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Carter Copeland with Barclays.

Carter Copeland - Barclays Capital, Research Division

I just wanted to ask a sort of conceptual question, and it may alter, by your comment, Ralph, that you made about the Sequester impacts being a maximum impact that maybe you're not going to realize. But if we look at the overall impact on DoD outlays from these cuts, both on this year and then maybe as we think even more so about next, it doesn't really jive with what I'd call the sort of aggregated Sequester impacts that the industry broadly has sort of laid out this quarter. And obviously, I mean, I don't expect you to comment on the guidance ranges of peers, but I wondered if you might compare and contrast how this issue resembles what we saw with OCO exposures in years past where OCO was sort of 10% of the budget but war-related exposures that were kind of called out by the industry were a lot less than that, and not so much for you guys but definitely across the industry. And so, I'm just trying to get a sense of are there differences in how the various -- you and your peers are thinking about Sequester from a methodology standpoint? Are there fundamental differences in your business versus the others? Or how should we be thinking about squaring the difference between the cut and the outlays and the overall kind of impact that people seem to be outlining for this year and next?

Ralph G. D'Ambrosio

Well, Carter, we really don't have the knowledge to comment on our peers' impacts from Sequestration. What we can tell you is how we assessed the Sequester downside risks or reduction risks that we talked about and included in the earnings release as well today. And essentially, the way we calculated those from a high-level and top-down methodology was to analyze the portion of our sales mix for 2013 that comes from the DoD base budget, excluding the Afghanistan OCO effort. And while we've disclosed that, that's about 61% of our sales for 2013, that information is also included in our Web charts that we posted today for the first quarter results. So we start with that, and then we understand and analyze where our DoD business is funded from. And it's about 60% coming from the operations and maintenance accounts and the balance coming from investment, mostly procurement. And then we use the information that's known about how the Sequester cuts would be applied to operations and maintenance versus investment account, and it's roughly 50-50 between those 2 broad categories. And then we make an additional assumption of how those budget authority cuts would translate into revenues for us because you have that lag dynamic between budget authority and outlays wherein somewhere in between, revenue recognition occurs. So that's how we did it, and we did it using the Sequester across-the-board cuts approach where everything gets cut equally. And that's how we formulated our downsides. Since then, we also have done and looked at bottom-up type analyses from what we're hearing from different DoD customers, and the bottom-up feedback is very close and consistent with the top-down analysis that I just explained to you. So the next step will be the actual details about the Sequester cuts, and we expect that they're going to come to light or become -- be publicized over the next few months, and at that point, we'll adjust our calculations. But like I said, we've outlined what we think the maximum reductions will be to our results for 2013.

Carter Copeland - Barclays Capital, Research Division

That's helpful color. I wonder, just -- is it correct for us to assume that the logic of the portion -- if we roll that analysis forward and say, okay, somewhere between the budget authority and the outlays, revenue recognition will occur, and we'll have the reduction in outlays that we can probably see, and we can apply that to the DoD portions of the various businesses, yours included, I guess what the real heart of my question is, ultimately, are those declines going to make their way into the revenue line? Because it doesn't seem like the commentary is suggesting that, that's going to happen anytime soon. Is it just it's further out in the future than we can see today?

Ralph G. D'Ambrosio

Well, clearly, we think, based upon what we've said, they would make their way into the revenue line. So I guess I'm not sure I understand your question, Carter.

Carter Copeland - Barclays Capital, Research Division

No, I think it's fair. I'm just trying to confirm that to make sure.

Michael T. Strianese

Yes, let me just add a comment to that, Carter. And it's kind of where we are in this whole process, in that there have been reductions within the DoD, but they've been in areas that are not very visible to us unless you're in the Pentagon or in the services. So for example, the travel accounts. We know they've canceled Fleet Week, flying trade shows. And some of the things that happened more in the background -- depot work, readiness, training support and the like -- so it hasn't found its way yet into the accounts that would directly drive our top lines at this point. So while you hear cuts are occurring and things are going on, we're not seeing any impact at this point. And I don't think you probably will until we get not only beyond Sequestration but, again, against this reprogramming, where I'm sure the exercise is going on now as we speak as to what's going forward and what's not. Basically, it's the reaggregation of the cut and the application of it, of course. But no matter what the Sequestration reduction is, the whole thing is going to get respread through a reprogramming, I'm assuming. So that may be pretty far out. So I -- we think, unless Sequestration gets reversed, it happens. It's just going to be kind of beyond our line of sight right now.

Operator

Your next question comes from the line of George Shapiro with Shapiro Research.

George Shapiro

Yes, following up kind of on that, Ralph or Mike, what do you expect your book-to-bill be -- to be for the year, at the end of the year?

Michael T. Strianese

Right now, we're estimating 1.

George Shapiro

And then, can you tell me how I reconcile that with the fact that the investment accounts in the '13 budget are down about 15%? I mean, I would -- and granted you've got 27% international and commercial, so I can offset that. But why won't you be down, have a book-to-bill much below 1, more like 0.9 or something?

Ralph G. D'Ambrosio

Well, our estimate is based upon our bottom-up plan that we prepared and which is based upon specific orders that we're pursuing, whether they be existing business or new business. So you're never going to be able to have a perfect correlation to what is happening with the investment account, outlays or budget authority because there's timing lags.

Michael T. Strianese

Another way to say it, George, is right now, we're just benefiting from a mix issue with what's in our actual detailed plan, and I don't think the general cut that you're seeing in the investment account is finding its way into the things we have in our plan yet.

George Shapiro

Okay. And then just one other. The commercial and international, which looks like grew organically about 12%, can you just break that between how much was international and how much was the commercial?

Ralph G. D'Ambrosio

Sure, George. Most of the organic growth was on the international side, which was about $75 million. And it's coming from the orders that we booked at the end of last year or during last year, a lot of them in the Platform & Logistics Solutions segment, including the SIGINT aircraft modifications for Korea, the VIP head-of-state aircraft, as well as the C-27J for Australia. And then we booked a couple of big orders as well within Electronic Systems, one of the most notable items there being the force protection job that we booked in the U.K. Did I answer your question, George?

Operator

Your next question comes from the line of Myles Walton with Deutsche Bank.

Myles A. Walton - Deutsche Bank AG, Research Division

Ralph, I think you mentioned that you had experienced some minor Sequestration impacts to date. Can you highlight where those may have occurred to date? And also, can you comment on some of the cash payment strategies with the DoD changing and if we should think about that as another element to watch?

Ralph G. D'Ambrosio

Well, the minor impacts that we've seen, which ultimately translates -- translate or occur because of customers and program officers delaying orders because of the Sequester uncertainties, we've seen some impacts in each of our segments. And when we put together our guidance originally, we had included an appropriate measure of conservatism for what was happening. So there was about $100 million or so that we -- that's more than adequately factored into our existing guidance before the Sequester downsides that I talked about. And it's combination of seeing a slower and lower order -- lower orders. And by that, I mean in ID/IQs, the -- some of the tasking that's occurring, it's for smaller amounts of time as opposed -- as compared to earlier periods. And on the product side, we're seeing some smaller quantities being ordered. We've also seen some delays in contract awards, and that's both a positive and a negative depending on how you look at it because we've had several of the recompetes that we expected to happen this year being deferred into next year with our incumbent contracts being extended anywhere from 6 to 12 months. So as it stands today, we continue to have no major recompete risks for 2013, and it's less than what -- when we talked about it on the earnings conference call in January. So that's what we're seeing in terms of the Sequester inertia if you want to call it that. And then you talked about cash flow from payment terms. The biggest change that happened on February 21 is that the Department of Defense turned off the quick pay practice that they had instituted about a year ago to pay small business amounts through prime contracts. And they were originally planning to end that quick pay practice the middle of this July, but they abruptly turned it off in February and that did have a timing impact for us for the quarter, not for the year, and I'd size it at around $50 million.

Myles A. Walton - Deutsche Bank AG, Research Division

Okay. Okay, that's helpful. And then just a clarification. When you answered -- I think maybe Mike, when you answered George's question about book-to-bill about 1, was that including Sequestration or the current guidance that you have? I'm just trying to make sure I'm comparing apples to apples.

Michael T. Strianese

No, that aligns to the current guidance that we [indiscernible]

Myles A. Walton - Deutsche Bank AG, Research Division

So what would that be with Sequestration?

Ralph G. D'Ambrosio

We still expect that it would be close to 1.0, probably 0.96 or 0.97.

Myles A. Walton - Deutsche Bank AG, Research Division

Okay. And the last one, how much of the $0.65, Ralph, was restructuring related?

Ralph G. D'Ambrosio

About 35% to 40% of it.

Operator

Your next question comes from the line of Cai Von Rumohr with Cowen & Company.

Cai Von Rumohr - Cowen and Company, LLC, Research Division

And good book-to-bill for the environment. So Ralph, you said that organic growth in international was $75 million. I think in the plan you laid out in January, it looked like international foreign government was going to be up about $150 million or 10%. Is that still a realistic number? Or could you be up more than that?

Ralph G. D'Ambrosio

We still -- we believe it's realistic. If all goes well on some pursuits that we're chasing, it could be higher than that. And what's causing the higher organic growth in the first quarter compared to the remaining quarters of the year is that as we get into the succeeding quarters, particularly the second half, we're still having tougher comparisons, because during the second half of last year is when we started to record significant increases in international sales from the new business competitive wins that we had last year, and I talked about those earlier. So we have a tougher comparison as we move throughout the year. But we still expect the international business to grow overall close to 10% in 2013 versus 2012.

Cai Von Rumohr - Cowen and Company, LLC, Research Division

Well, it looks like you've done half of that in the first quarter, so -- okay. And then commercial, your last plan had commercial growing about 6%. Is that still what you...

Ralph G. D'Ambrosio

That is still our estimate or forecast.

Cai Von Rumohr - Cowen and Company, LLC, Research Division

Okay. And then DoD x OCO was going to be off 4%. I mean, I would think it's like all the children can't be equal. Which of these guys are looking better or worse? I mean, so looking at the numbers, it seems as if foreign government and commercial may be a little bit better. I would think DoD x OCO might be worse and other government might be a little bit worse. Is there any color you can give us on those?

Ralph G. D'Ambrosio

Well, clearly, the -- that's where the $0.5 billion of Sequester downside versus sales comes from, see? The DoD, other or base business and then plus some other U.S. government non-DoD work.

Cai Von Rumohr - Cowen and Company, LLC, Research Division

And do you feel that your OCO estimate of 8 50 down from 12 50 is still a reasonable estimate?

Ralph G. D'Ambrosio

Yes, yes, very reasonable. If anything, what we've learned is that the OCO funding is actually going to experience an increase. In the FY '14 defense budget request, as you may know, the placeholder for the OCO funding is about $88 billion, which is twice what it was in the FY '13 plan for 2014 and about flat with the currently appropriated OCO budget for FY '13. So it looks like there's going to be stronger OCO funding for certainly the next year. We don't know how much of it will go to the industry because there's a lot of nonindustry expenditures in there. But it's clearly a positive for OCO funding over the next 12 months.

Cai Von Rumohr - Cowen and Company, LLC, Research Division

Okay. And then a last one and I'll move on. Can you give us maybe a little bit of color in terms of your book-to-bill in the first quarter and what you see in the second and the full year in terms of by the end markets we've just talked about? Just the major trends.

Ralph G. D'Ambrosio

Well, we see -- if you look at our segments, compared to the first quarter book-to-bill, we expect to have the most improvement in C3ISR with the book-to-bill ratios staying about constant with what they are in the first quarter in Electronic Systems and Platform & Logistics Solutions, and we expect some improvement in NSS when we get to the back end of the year or second half of the year. In C3ISR, we have some large international ISR pursuits that we're competing on, and we think we'll have some good news on those beginning in the second quarter.

Operator

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

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

First, I wanted to talk about Link for a second. And Mike, maybe you could discuss how the integration has gone? And has it proceeded the way you've expected? It looks like some of the orders would say so.

Michael T. Strianese

Yes, exactly, Howard. The growth in the international business for full flight simulators and other training systems is actually slightly ahead of where we had forecast, and there's just a -- it's going to follow the delivery of the commercial aircraft because you need so many simulators per delivered aircraft. And on top of that, they're operating with a new product line, which is more modular in design, that provides an interesting upgrade for customers as well on some of the installed base. In terms of the integration, this is -- this business is in the U.K. and ours is in Texas. So of course, it's not physical integration in terms of more leveraging the research and development spend as well as we now have an in-house source for the full-motion platforms, where in the past that would be something we would be going outside for. So it gives us tighter quality control over our products as well as control over design and costs. So from that perspective, it's going very, very well.

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

And they do speak a different language, I guess?

Michael T. Strianese

Yes, but it's really been very -- a rewarding experience having something working so well from out-of-the-box. So we're happy.

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

That's good. On the other side of the international front, can you -- or maybe it's domestically, can you sort of give some color on the C-27? I mean, there doesn't seem to be a -- on some hands, a bunch of people like the airplane, and then on other cases, it's getting treated as an orphan.

Michael T. Strianese

Yes, it's -- confusing is an understatement. Where -- there has been some desire domestically to put those aircraft, I guess, in the hands of the National Guard units perhaps for disaster relief and other national needs. And to that end, there has been some direction from Congress to potentially order more airplanes. Now our teaming agreement is essentially over at this point, so it could not be under those same terms. The options have expired to go on to that vehicle. So I don't know that it really means much to L-3's future business at this point, but that could change depending on what direction we decide to go in domestically on these programs -- on these platforms. Unfortunately, that decision would have been better made before the options expired and -- since a large part of that -- the lion's share of the bill of materials on that system is the airplane itself, which is made, as you know, by Alenia. That is the primary cost driver. And that pricing has expired as well, so it's not going to be under the same terms or even close to the same terms, from what I can see.

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

Okay. And then last, Marine has not -- Marine sometimes is up and sometimes it doesn't seem to be where maybe you've expected. How are you thinking about that business going forward? It's still a couple hundred million dollars, if I'm not mistaken?

Michael T. Strianese

Marine?

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

Yes.

Michael T. Strianese

Marine is well over $1 billion.

Ralph G. D'Ambrosio

You mean the commercial version of it?

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

Yes, commercial. Yes, thank you. Yes, that's what I was referring to.

Michael T. Strianese

[Indiscernible].

Ralph G. D'Ambrosio

Our commercial shipbuilding products last year were about $460 million in sales. And this year, we anticipate about a 5% or 6% decline there because of a slowdown that's occurring in commercial shipbuilding. But still, we'll put those sales at about $430 million.

Operator

Your next question comes from the line of Joe Nadol with JPMorgan.

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

On the sales profile, Ralph, I heard you say $115 million was the number that was above your expectations. I was wondering if you could break that out a little bit? How much of that was pull-forward and otherwise? And frankly, even if I pull out the $115 million and I look at your typical sales profile through the year, usually you have a ramp-up through the year of $400 million, $600 million between Q1 and Q4, and your guidance definitely doesn't imply that. So -- but what was different about this year coming in even before the $115 million? And what's in the $115 million?

Ralph G. D'Ambrosio

Well, so the observations that you made are correct. The pull-in, or what I'd characterize as sales happening earlier than planned, was probably about half of that $115 million. And what's different this year is given all the uncertainties that we have to contend with in the environment, we applied a appropriate measure of conservatism. I know that sounds cliché, but that's what we have, Joe.

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

That's what I'm driving at because, Ralph, usually your guidance is pretty spot on, and you have to, in this job, be able to gauge what people say. And your book-to-bill last year was very good. So I'm just really trying to gauge how much of this is you're changing the way you're giving guidance versus something else going on in the business? What you're saying is your guidance this year was in fact different than in the past couple of years?

Ralph G. D'Ambrosio

Well, I mean, it was also more conservative in 2012 and, in fact, ended up doing about $100 million better than we guided to ultimately in 2012. So I really wouldn't say that we're changing our guidance methodology. But clearly, there's more uncertainties and variables to contend with given Sequester and all the moving budgets this year and next year with -- for the defense budget.

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

Okay. On the balance sheet, just secondly, you have a little bit -- you have a reasonable amount of debt but more than some of the other defense companies, a couple of turns on -- of net debt relative to EBITDA. And if a Sequester does hang in and sales and earnings do decline the next couple of years for the overall industry and for you guys as well, Ralph, how do you anticipate -- what level of leverage do you anticipate you'll be comfortable with? Do you want to bring down debt to keep that leverage ratio flat? Could you bring that up a little bit and use that cash to buy back stock? How are you approaching that issue?

Ralph G. D'Ambrosio

Okay. So you asked a few questions there, Joe. So our objective with the -- with our balance sheet and leverage is to maintain our investment-grade credit ratings, which are the first tier. And that's what -- that's how we're managing our balance sheet. I also explained that when we perceive there to be a turn in the cycle which will translate into growth in operating income, we would like to increase our leverage and stay within those credit ratings. And then when you compare us to the other large defense peers when it comes to leverage, you really have to also factor in the unfunded pension obligations. And ours, compared to the other companies, our unfunded pension obligations are clearly smaller, both in relative and absolute terms, for the most part. So -- and just to complete the discussion on how we modeled the Sequester downside risks, going back to the methodology that we used and I explained a little earlier, it would follow that there's going to be second and third derivatives to Sequester downsides if Sequester's cuts stand for this year, next year and the years after. The good news for L-3, given the way we think our cycles play out, is that if Sequester stay -- remains in full effect, there will be another revenue reduction in 2014 incremental to the $0.5 billion that I talked about for 2013, but it would be less, probably somewhere around $400 million, and then when you get to '15, the reduction would be substantially less, probably in the $50 million to $100 million incremental range. So I think that's a positive for L-3. And it all boils down to the cycle. Since we're shorter cycle, we see things sooner whenever they change. So that kind of explains as well as how we're thinking about our leverage and the credit ratings and what we would have to do in terms of debt repayment.

Operator

Your next question comes from the line of Peter Skibitski with Drexel Hamilton.

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

Yes, Ralph, in a lot of your comments, you're talking about Sequester in the context of your short-cycle businesses. Should we conclude that you expect NSS and P&LS, your 2 lowest-margin businesses, to be the most impacted by the Sequester? Is that fair or not necessarily so?

Ralph G. D'Ambrosio

Marginally more. But we have a good amount of book-and-ship type orders in all the segments, mostly [indiscernible].

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

Okay. Got it. Okay, okay. And then maybe one for Mike. Mike, with the '14 budget not including the Sequester, I'm just wondering what your sense is, maybe what you're hearing from your people on the Hill in terms of how the '14 budget may work out at the end of the day, if we could have some sort of grand bargain that maybe splits it down the middle, or if the '14 budget does largely go through as it is or -- any thoughts there as to how things might end up at the end of the day?

Michael T. Strianese

Well, given the reception of the '14 budget out of the gate, it was not really well received. So I -- we believe there will be some kind of a grand bargain. One of the wild cards here is what happens with this OCO budget, which is already looking like about $88 billion, which is up significantly from where this was originally thought to be, which, I think, is up from around $50 million. It could have been as low as in the mid-40s, if I recall correctly. So one of the likely scenarios is even if you have some downward pressure on '14, I think you'll see the potential for offsetting increases in the OCO to make up for certain of the must-have things that need to happen anyway. So as I said in the prepared comments, the next inflection point, I guess, for a grand bargain, if you will, will be May with the debt ceiling expiration, and perhaps everything gets done in one fell swoop with this budget. But there seems to be some willingness, on the one hand, in the White House to do something with the spending side, the entitlement side of spending as well as some taxes and new revenue through loopholes and the like. And I -- the assumption there is that takes the pressure off Sequestration, and it kind of washes and it goes away. So if that were to happen, that would be great. But as we've seen lately, it's very difficult to get anything done on a negotiated basis in the short term. But eventually, I'm hopeful that, that's where this ends up. I hope that answers it, Pete.

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

Yes. No, very helpful. If I could sneak in one last one, Mike. Can you update us on the outlook for SPYDR in terms of timing and size of awards? And kind of parallel, on the U.S. side, it sounds like maybe we'll have another EMARSS buy, potentially helping the competition. I wonder if you can comment on that.

Michael T. Strianese

Yes. Well, yes. And hopefully, that will be competitive in terms of what happens with EMARSS. But as you know, we've been working on the development for several years of an export version of the Liberty, it's different in some ways, known as SPYDR. We have -- we do now have it qualified for export. So we have gotten the licenses and everything that we've needed. It's undergoing some final system checkout and everything. We have a lot of interest, in particular internationally. It's hard to predict what the initial orders will be exactly, but we have maybe $35 million of sales, about $100 million of orders in the plan in the second half right now as our mark as to where we think it's likely to land for the year with accelerating prospects going out further. I would also say that we are in development of a second platform that will be the same model, where we will actually have a -- remember, what's unique here, for the most part, is that we've actually developed a system -- we'll have a fly-before-you-buy type program where we can bring this in-country and have customers use it, see how it operates, and then have the ability to order systems or modifications that they may want for their particular situation as add-ons. And we're following that same model in another -- so they're not ready to talk in specifics on the platform. But we're going down that path as well. This is furtherance to our goal to drive our international and commercial business. Another good news story, by the way, on Liberty itself with, again, in this small aircraft ISR space is that in the last couple of weeks, a Liberty was used here in the States in a situation where there needed to be a search and rescue. It was able to locate the people that needed to be rescued and actually vector in the emergency responders and things. So it got some attention, at least some interest, here for possible civilian uses as well, and we're going to pursue that path as well, with either Liberty or SPYDR. So it is a very, very cost-effective solution when you look at what else is out there. And it's disruptive performance -- or a disruptive price. There's no better way to say it. So I'm very optimistic that this is going to fill some of the gaps that we're going to see going forward.

Operator

At this time, we have exhausted all questions in queue. I would like to hand the conference back over to management for closing remarks.

Michael T. Strianese

Okay, well, overall, we feel good about the results for the first quarter. We're a little bit ahead of where we thought we would be. We still have that big overhang out there that I know is giving everybody fits in terms of being able to do any type of meaningful out-year forecasting for this industry. One thing we didn't talk much about is the tension between our geopolitical environment versus military readiness. A lot of what you're not seeing is kind of the effects on readiness that are going on by some of the Sequestration. So in contrast, where this week we heard about the furlough of some air traffic controllers, something very visible in the face of the traveling public, a lot of the things on the DoD side is the exact opposite, things that are not very visible that are going on. But I -- but again, there are things that are affecting readiness. Now eventually, there's got to be some recognition, I believe, at Congress, in conjunction with the Pentagon, in some of the testimonies that there is an impact that's going to have to be addressed. So with a little luck, we'll get a solution later on this year.

In terms of L-3, we have a pretty clear vision of what we need to do to execute. As we've been saying, we've been -- not abandoning the U.S. market by any stretch, but we have been placing significant amount of focus internationally with good results, I'll add, and we are continuing to build lasting customer relationships. So we'll stay connected, and we'll give you another update when we speak in July after the second quarter. And thanks for joining us this morning.

Operator

Ladies and gentlemen, this concludes today's conference. Please disconnect your lines and have a great day.

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L-3 Communication (LLL): Q1 EPS of $2.11. Revenue of $3.2B (+1% Y/Y) beats by $0.16B. (PR)