L-3 Communications Holdings, Inc. (LLL) Management Discusses Q2 2013 Results - Earnings Call Transcript

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

L-3 Communications Holdings, Inc. (NYSE:LLL)

Q2 2013 Earnings Call

July 25, 2013 11:00 am ET

Executives

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

Christopher Sands - JP Morgan Chase & Co, Research Division

Noah Poponak - Goldman Sachs Group Inc., Research Division

Brian W. Ruttenbur - CRT Capital Group LLC, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Second Quarter 2013 L-3 Communications Holdings Earnings Conference Call. My name is Carla, and I'll be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Mr. Alex Hamilton from FTI. Please proceed.

Unknown Executive

Good morning, and thanks for joining us for L-3 Communications' Second 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

Thank you, and good morning. Thanks for joining us.

L-3 had a very good second quarter across our business, reflecting strong orders, solid cash flow, and growth in both sales and earnings per share.

Our book-to-bill ratio for the quarter was a robust 1.09. We also continued to expand our international and domestic security businesses with several strategic new contract wins. Our exceptional employees and leadership team continued to meet the challenges of a dynamic and uncertain environment by staying focused on performance, cost competitiveness, operational efficiency and responsiveness to our customer priorities. We also continue to make smart investments and facilitate intercompany collaborations that are producing innovations in next-generation product systems and services. Our performance demonstrates that this focus has paid off, and I extend my sincere thanks to everyone here at L-3 for demonstrating our world-class aerospace and national security company can turn challenges into opportunities. I'd also like to acknowledge all those whose hard work contributed to L-3's receipt of our 15th Cogswell Award for Outstanding Industrial Security practices in safeguarding classified information. Our success begins and ends with great people, and that's what differentiates us and keeps L-3 moving ahead.

For the quarter, we had net sales of $3.2 billion, a 2% increase over the second quarter of 2012. We reported diluted earnings per share from continuing ops of $2.03. That's up 5% over last year's second quarter of $1.94. Net income from continuing operations attributable to L-3 was $185 million. Funded orders for the quarter were $3.5 billion and our funded backlog was $10.8 billion. We're seeing some funding delays and award deferrals and expect to see increased impacts over time due to the sequestration. However, we continue to pursue a strategy for growth that includes investing wisely in R&D, as well as new technologies that align with important customer priorities, expanding our international and commercial businesses, and pursuing M&A opportunities that meet our criteria of growing both market share and our customer base.

We also place a high priority on winning new business. Our focus on increasing efficiencies to drive down cost ensures our operations are sized appropriately to respond to customer demands. L-3's diverse business base and agility are advantages in this uncertain environment. Our flexibility enables us to focus more intently on delivering consistent shareholder value and generating solid prospects for growth.

Turning to the business segments. C3ISR sales for the quarter were up by $20 million or about 2% over the second quarter of 2012. Increases were evenly split between our network communication systems, due to higher volume for small unmanned platforms, and our ISR Systems for logistics support and fleet management services.

Work on the Air Seeker, which is the U.K. Rivet Joint variant, is proceeding well, with reports of a high degree of customer satisfaction. I'll also mention that program is ahead of schedule and on budget. The U.S. Rivet Joint recently flew its 10,000th sortie, which is a testament to the effectiveness of this ISR platform. We're also seeing increased interest in our SPYDR aircraft among international and other DoD customers.

In our largest segment, Electronic Systems, net sales increased by $5 million compared to the second quarter of 2012. This increase reflected Simulation & Training gains from our acquisition of Link U.K. last year and increased deliveries of U.S. Army rotary wing training systems for the Flight School XXI program. We also had deliveries of Precision Engagement ordnance products, as well as lifecycle support services for U.S. Navy towed arrays and the Landing Craft Air Cushion or LCAC vehicle Service Life Extension Program. In addition, our KEO business, which we also acquired last year, continues to expand its base in support of both naval and international customers.

Our Electronic Systems business is consistently a strong contributor to L-3's performance, providing a broad scope of expertise and products, with leading positions in both international and commercial markets.

In our Platform & Logistics Solutions business, net sales increased by $29 million or about 5% compared to the second quarter of 2012. This gain was as a result of increased volume in Platform Solutions for the Australia C-27J program, the EC-130 aircraft for the U.S. Air Force, aircraft maintenance for the Canadian Department of National Defence and international head-of-state aircraft mods. Logistics Solutions also had increased volume for field maintenance and sustainment services for U.S. aircraft training.

Net sales of our National Security Solutions business decreased by about 1% compared to last year's second quarter, primarily due to sequestration, creating a lower demand for our maintenance support contract and less demand for USSOCOM IT support services. Now the 1% decline is significantly less, however, than what we've seen elsewhere in the industry. And that's due to improving win rates and market share gains in sensitive intel and cyber security efforts. A lot of the work we do is mission-critical systems that are faring well in this environment. As the demand for cyber expertise to protect massive amounts of sensitive and classified data grows, we continue to work with leading universities and partners in developing technologies and products that are critical to national security.

I'd like to take a moment or 2 to mention some of the more significant awards and milestones during the quarter.

In C3ISR, we received continued funding for our communications work in support of the Gray Eagle, Hawklink and Global Hawk programs. We also received Phase 2 funding to upgrade an additional 8 P-3C aircraft for the Republic of Korea. We had continued orders for ROVER, including ROVER 6 systems for USSOCOM and ROVER 5 eye kits for an allied country. We were recently selected to supply the integrated communications systems for the Royal Canadian Navy Arctic/Offshore Patrol Ship project. This is expected to also be about 6 to 8 vessels.

In Electronic Systems, we received the strategic contract to supply SATCOM terminals to Australia. This program will provide first-ever Ka-band connectivity to Australian forces. We're seeing ongoing strong orders for our WESCAM EO/IR systems, including orders from domestic, as well as international customers and OEMs, including Cassidian and Eurocopter. Along with our integrated communications systems, our integrated platform management system was selected for installation on the 6 to 8 vessels under the Canadian Arctic/Offshore Patrol Ship project. These will be the third class of Canadian naval vessels using this platform management system.

At home, we received an order from the U.S. Navy for our innovative Universal Modular Mast, which will be used on the high-priority Virginia Class submarine, and we won a recompete for our PMATS training system. We received multiple contracts for monocular and night vision equipment for the U.S. Navy, Marines and Army, as well as equipment for international customers in Italy and other locations.

We had orders for our eXaminer baggage inspection and airport screening systems for Brazil, Saudi Arabia and Turkey, as well as service contracts for airports in Beijing, Singapore and Amsterdam. Additionally, we continue to support a variety of proposals for systems worldwide.

In Platform & Logistics Solutions or P&LS, we received a contract to support a fleet of research and support aircraft at NASA. We beat the incumbent to win the $75 million 5-year contract, providing all levels of maintenance and material management for 22 manned and unmanned aircraft. We received a competitively won contract to provide sustainment and maintenance services for the Canadian Department of National Defence's long-range multiuse AC -- I'm sorry, A310 aircraft.

Also in Canada, L-3 was selected to provide sustainment maintenance services and ongoing modernization work on the CC-150 program, their government's long-range multiuse aircraft. This aircraft's mission ranges from refueling to VIP transport of high ranking government officials and foreign dignitaries, including the Prime Minister. This is a 15-year program estimated at about $200 million.

We also won a successful recompete to provide fleet management and support for the Navy's fleet of TH-57 helicopters and a contract for maintenance services for the Navy's maritime helicopter, a strike squadron in Florida.

In National Security Solutions, we received continued funding through a task order in support of the Army's RCA or Reserve Component Automation program. We won this program in the first quarter. We received an ID/IQ program to provide IT consulting and technical services as part of a 15-year contract for the State of Maryland. We also won a contract to provide a full range of professional and IT support services to the Center for Disease Control. We received continued funding for a variety of intelligence and analysis programs. This includes work in Afghanistan and for the Department of State. And we have continued funding to provide space vehicle and system simulation, engineering analysis and training at NASA's Johnson Space Center, as well as for Army medical communications, and received an IT support contract with the Okaloosa County School District.

In terms of capital allocation, we continue to believe that a consistent and balanced approach of returning cash to shareholders, combined with a disciplined M&A strategy, is the best way to deliver value. During the second quarter, we repurchased $126 million of our common stock and paid dividends of $49 million. Year-to-date, our dividends and stock repurchases totaled about $350 million or 118% of our free cash flow.

We anticipate the opportunities in the current budget environment, the inevitable portfolio reshaping in the aerospace and national security area due to the budget may yield favorable M&A candidates, especially for us using a disciplined M&A strategy.

As part of that strategy, we focus on opportunities that help us expand our market share, grow our businesses and promote cross-segment collaboration. As we get more clarity on the budgeting process, we're committed to seeking out similar good fit opportunities and plan to continue returning cash to shareholders in a prudent and responsible manner. And of course, we'll continue to evaluate our portfolio in view of the ever-changing environment.

I'm going to turn it over to Ralph who will cover some of the numbers in more detail, and then we'd be happy to take your questions. So Ralph?

Ralph G. D'Ambrosio

Thanks, Mike. I'll cover a few details about the second quarter results and review our 2013 guidance update. Like Mike said, overall, and considering the current environment, we had a very solid second quarter. The results exceeded our expectations, driven by higher sales and lower income taxes.

Our top line grew by 2% and strong orders resulted in a book-to-bill ratio of 1.09 for the second quarter and 1.0 for the first half.

Consolidated sales were $3.2 billion, and they were resilient and about $100 million more than we expected, with better sales across all the segments. We continue to grow our commercial and international sales, which increased 17% or $126 million, which more than offset a 3% decline in our U.S. government sales of about $77 million.

Diluted earnings per share from continuing operations were $2.03, and they grew 5% compared to the second quarter of 2012. Our capital deployment drove a 7.5% reduction in shares outstanding, which offset a 7% decline in operating income that was caused by a lower margin.

Consolidated operating margin for the second quarter declined 90 basis points to 9.6%. Severance cost reduced margin by about 30 basis points. And the rest of the decline was primarily due to higher design and production cost in the C3ISR segment, resulting in a 7.8% margin there, which was an anomaly for the second quarter. We expect the C3ISR margin to normalize in the second half, with margin returning to about 10%.

Moving on to our guidance update. We revised the 2013 guidance to include reductions for the U.S. defense budget sequestration cuts. The good news is that those reductions are substantially less than the maximum sequester downside risk that we talked about previously on April 25. If you recall, I explained in April that the sequester reductions to our 2013 guidance could be up to $500 million of sales, 30 basis points of margin, $0.65 of earnings per share, and about $80 million of free cash flow. And our margin and EPS downsides included restructuring and severance cost. Well, we're only already reducing our EPS guidance at the midpoint by $0.15, making the new EPS range $8.05 to $8.15, and that $0.15 reduction is principally for severance costs that we're incurring to resize our business units affected by the sequestration cuts.

For consolidated sales, our new sales guidance range is $12.5 billion to $12.6 billion, which is $100 million lower than midpoint compared to our prior guidance. And that calculates to an expected decline for '13 versus 2012 at the midpoint of about 4.5% or $600 million. The lower sales in our guidance relate to approximately $150 million of sequestration reductions, partially offset by a $50 million increase in our estimated Afghanistan/OCO-related sales for 2013.

Also, during the second quarter, we made significant progress on our remaining 2013 book and ship business. We only have to book about $1.6 billion of orders from July to December. They need to convert to sales in the second half for us to achieve our full year sales guidance, and that calculates to approximately 26% of second half sales.

There are several reasons why the sequester reductions for 2013 are less than we originally estimated and calculated, and I'll leave those for the Q&A.

With respect to consolidated operating margin guidance, we lowered it by 20 basis points to 9.8%. And similar to EPS, it is primarily related to those additional severance costs that we are incurring to resize some of our business units. Excluding those severance cost, we are achieving our objective of consolidated margin of at least 10%.

At the segment level, we lowered C3ISR margin for the year and raised margins in Platform and Logistics Solutions, as well as National Security Solutions. We revised the C3ISR margin downward by 90 basis points. Severance costs will reduce margin by 30 basis points. And since most of that cost takeout happens later in the second half, we'll begin to realize those cost savings next year. And the higher design and production cost on communication systems contracts that I had mentioned a little while ago, which we incurred year-to-date, will reduce the C3ISR margin by another 60 basis points. While we're disappointed by those higher costs, they actually represent investments that will confer long term durable competitive advantages to L-3. And most importantly, they are enabling us to continue to provide affordable cutting-edge solutions to our customers.

We raised the NSS margins by 40 basis points to between 6.8% and 6 -- and 7%, and that is due to higher expected award fees in the second half, as well as some cost takeouts.

Regarding cash flow, we continue to have robust free cash flow even with absorbing the sequester reductions, we're holding our net cash from operating activity guidance for the year unchanged at $1,225,000,000, which demonstrates the company's high-quality earnings.

While we lowered our 2013 free cash flow guidance by $20 million, it's entirely for more capital expenditures in our international and commercial business, where we are making some investments that have very high returns on investment that are going to position us well for the future.

On the capital allocation, our assumptions for 2013 have not changed. They continue to assume $0.5 billion of share buybacks, about $200 million of dividends, and a debt repayment placeholder of $250 million. We expect to end the year, assuming those assumptions, with a cash balance of about $450 million. I will also add that if interest rates remain where they are today, we expect a decline in our unfunded pension liability, as well as lower pension expense for next year. And that will reduce the need for us to repay debt this year. Therefore, we have some cushion or even upside to our guidance because we can repurchase more of our shares.

I have a couple of points in the third and fourth quarters and then I'll wrap up. Our fourth quarter estimates contained in our guidance are very conservative, but we believe that they're well advised and warranted because we expect the DoD to be operating under a continuing resolution authority for FY '14 at sequestered budget levels and FY '14 begins on October 1. And that's coupled with the DoD civilian furloughs, including acquisition staff, which could further slowdown DoD procurement activities later this year.

Here is our third quarter outlook. We expect sales to be between $3.0 billion and $3.1 billion, with margins of about 9.8%, and earnings per share in the range of $1.90 to $2. Free cash flow, we expect to be between $200 million and $300 million, and the book-to-bill ratio in the third quarter should be about 0.90, bringing the full year book-to-bill ratio somewhere in the range of 0.95 to 0.97. And given our first half book-to-bill of 1.0, this implies a second half book-to-bill ratio in the range of 0.90 to 0.94.

To conclude my financial review, while the current environment remains challenging, we're effectively managing through it. We have uncertainties, but we believe those uncertainties are understood and range bound. And we're also encouraged by our strong order flow, the strong book-to-bill ratio that we had in the first half. The company continues to be strong, resilient and healthy. We continue to generate robust cash flow, and we're allocating that capital to increase shareholder value, and we continue to have flexibility on our balance sheet to do more share repurchases.

Thank you. And at this point, we'll begin the Q&A.

Question-and-Answer Session

Operator

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

Carter Copeland - Barclays Capital, Research Division

Just a couple of quick ones. The first one on the sequestration impacts and kind of what you saw in Q2 versus what your plan was, and if you could expand on that a little bit. I know the realtime questions are hard, but we're getting pretty close to the end of the government's fiscal year, and I would assume that with some of the shorter-cycle businesses and things like training and simulation funds could run a bit tight as we end the fiscal year. So I wondered if you could kind of compare and contrast, have you seen any difference in behavior as we enter the last quarter of the fiscal year to what you saw in Q2? And just tell us what it was that you saw versus plan in Q2 on those impacts?

Ralph G. D'Ambrosio

Well, generally speaking, we're continuing to see and experience the same impacts that we saw in the -- toward the end of the first quarter and the second quarter. Regarding the sequestration reduction to our guidance, I just mentioned a few moments ago, I'd like to explain a little bit about why we think the impact is less than we originally calculated. And if you recall, when we did our original calculations, number one, we assumed a $50 billion cut to the FY '13 budget. The actual cut to the FY '13 budget only was $31 billion, after you factor out what was applied to prior year unobligated balances. So that was itself a 38% reduction. Additionally, we also assumed that the budget cuts, the sequester would be applied equally pro rata across all the program and project activity accounts as it was supposed to be applied under the law. Well, it didn't work out that way because the DoD was able to apply some discretion, and they made the sequester cuts unevenly. And the good news is that, with respect to those cuts and how they applied them, it looks like L-3 is better positioned than the overall DoD FY '13 sequester budget cuts. And that's because fewer cuts were made to the Army, particularly in the other procurement accounts, where we do a good amount of work. The FY '13 reprogramming action that increases operations and maintenance funding. And if you recall, about 60% of our DoD business is operations and maintenance funded. And as it turns out, most of our services work is in higher priority sustainment and readiness activities, including mission-critical system activities. So that's why it appears that we're doing better than we thought. And on top of that, we picked up some market share gains as well this year, Mike talked about those. And lastly, I would say that we applied a good amount of conservatism in our initial 2013 guidance, and that is always a good thing especially when we're dealing with these uncertainties so.

Carter Copeland - Barclays Capital, Research Division

That's great. And any difference in activity levels that you can see in Q3 versus Q2 or is it more of the same?

Ralph G. D'Ambrosio

It's more of the same. You mentioned whether or not we can have a slowdown in training and simulation, Carter, and we've been experiencing some of that, and I think we've adequately factored it in to our guidance update.

Carter Copeland - Barclays Capital, Research Division

Okay. And just a housekeeping one on the pension that you mentioned. Could you update us on where the returns are year-to-date? And where -- if you -- you drew the line today where the discount rate would fall?

Ralph G. D'Ambrosio

Sure. So on -- our asset return year-to-date is just about 12%, and that compares to our annual assumption of 8.1%. So if that were to hold, that would translate into additional pension assets of about $75 million, which itself would lower next year's expense pretax by about $6 million. But the bigger, more positive changes are happening in the discount rate area. And if we were to set the discount rate for next year today, and we won't do that until December 31. But if we were to do it today, it looks like our pension discount rate, based upon the increase in interest rates that we've seen in the last month or 2, would be somewhere between 50 and 60 basis points higher than it is for the current year. That would translate into a pretax pension expense reduction of somewhere between $30 million and $35 million, with a corresponding reduction in unfunded liability for pension of somewhere between $250 million and $300 million, which is going to count as a debt reduction if that happens. And that's why I made the comment earlier about whether or not we're making debt repayments this year. So if those trends around the pension hold, it's going to be a positive for next year for us.

Operator

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

George Shapiro

Ralph, could you give us a little more detail on the drop in the margin in C3? I mean, you said it was 100 basis points due to some mix. But that's...

Ralph G. D'Ambrosio

Sure. I was figuring you would ask that question, so I made sure I had an answer, George. All joking aside, so as I said, we incurred some higher design and production cost on several -- for a few communication systems contracts. What's happening there is that we're doing some nonrecurring effort or a development effort on those contracts, which pertain to some new antenna designs, as well as new applications for ISR and network communications technologies. And as it turns out, those design engineering efforts are proving more difficult than we thought to complete, but we're completing them. And there's also some related manufacturing effort that goes with those changes. But the good news is that those are very important investments for L-3, and they're going to provide us a strong position not only today, but more importantly, in the future. And they fit squarely into what the DoD and other agencies are doing now, and what they intend to do in the future with respect to ISR and communication requirements. So it's a little more than we intended to spend. But like I said, it's a very good investment that we're undertaking in that segment. So we feel pretty good about it going forward. And I said that we expect the margins to normalize in the second half to around 10%, George.

George Shapiro

So you're figuring it's just kind of a one-quarter event?

Ralph G. D'Ambrosio

Well, there was some of it in the first quarter as well, so a first half event.

George Shapiro

Okay. And then you said the international commercial sales are up 17% or 14% if you took out the acquired. Can you just break that out between international and commercial?

Ralph G. D'Ambrosio

Sure. Most of the growth is in the international...

Michael T. Strianese

Mil side.

Ralph G. D'Ambrosio

Foreign military side. So to give you the specifics, because I know you like to have those specific details, George, and we're happy to give them to you. So almost all of the increase was in international or foreign military. The commercial was only up around 1% in the second quarter. And what's happening on the international side, we've had a lot of recent new business wins, not only this year but last year, which is driving that growth. And on the commercial side, we've seen some slowdown in a couple of business areas, which we anticipated. The 2 large ones are the satellite comms, power devices or traveling wave tubes, and that's slowing down because of what's going on in the commercial satellite space. And we're also seeing a slowdown, which we anticipated, in our commercial shipbuilding products, which is based out of Europe, which we also anticipated. So that's what's happening there, George. I'll add, and I talked about this in the first quarter conference call, that we expect to have tougher comparisons on the commercial international sales growth in the second half of the year. And that's going to certainly be the case. We do have some meaningful upside orders that we're pursuing internationally, and it looks like most of them are going to slide into early next year right now. But there's a possibility that if they happen early in the fourth quarter, we can have a nice upside to sales from them, and it could be as much as $50 million to $100 million of sales in the fourth quarter. But like I said, we think they're going to stay in the 2014 timeframe at the present time.

George Shapiro

Okay. And then one for you, Mike. When you spun off Engility, you talked about keeping NSS because you thought that would kind of give you a lot of growth and improvement. So far, is it performing to your expectations? Can you give us an update on your thinking there?

Michael T. Strianese

Yes, George. Well, it is, considering the environment for that segment of our business, which has been affected both by the drawdown in Afghanistan and even in NSS, we've been supplying intel support, as well as restructuring, if you will, resulting from Better Buying Power that took a lot of the sole source work we were doing and split it into multiple award contract vehicles. And that's behind us now. And so, while we shrunk 1% in the quarter, I think if you look around the rest of industry, at those types of business segments that we -- from what I've seen, we've done better. And I can point to some market share gains, as well as additional contracts in both the cyber and the data protection area. So it's -- yes, it's meeting our expectations. We'd always love to see the numbers be more positive, but given where we are at this point in the cycle, we are satisfied with it. And we think that there is opportunity for further growth. The funding for cyber has been slow, extraordinarily slow to show up anywhere. I think there's some difficulty even getting agreement on the government side as to what there is to do. If you recall, it's almost a year now that -- well, certainly, it will be a year in the fall that the Pentagon had consolidated the cyber acquisition activity under Frank Kendall and -- but because everybody was going in a different direction, so I think that in of itself has slowed things down as they in the Pentagon figure out which direction they're going. Having said that, we have existing contract vehicles with most all of the intel community, different agencies and additional funding for the most part seems to come through those vehicles versus seeing new activity just because of the nature of the business being very classified. So all in all, we are happy and we are optimistic that there'll be some growth in the future. As you can see, the margins did bottom last year and have improved this year, and we hope to see the same with the top line as well now going out.

Operator

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

Myles A. Walton - Deutsche Bank AG, Research Division

Mike, L-3 sits in this unique position in the defense complex, the smallest prime or the largest mezzanine. I'm curious of your perspective, not how the customer is behaving under the sequestration umbrella that's over the industry, but more how industry is behaving within itself. I think if I have the numbers right, you still have about $2 billion, $3 billion sales to the primes, in addition to the $6 billion-plus that you're selling direct to the DoD. Can you comment more on the -- what you're seeing as a customer to the primes and also what you're seeing below you in the rest of the supply chain?

Michael T. Strianese

Well, as you know, we are a prime working in just the percentages, both U.S. and internationally, about 70% of our total revenue is as a prime. And that business is under firm fixed price or fixed-price incentive contracts, which is somewhat atypical to the room, compared to the rest of the community and shows our commitment-based culture, which limits cost growth exposure. And it's also consistent with Better Buying Power. Now when you get to the other players in the industry side, everybody has got cost-reduction initiatives in place, which includes cost-reduction initiatives as it relates to the supply chain. We have been active in taking costs out for the better part of the last 2 years. And I can't really point to an effect coming from our role as a supplier in terms of margin, if that's what you're getting at.

Myles A. Walton - Deutsche Bank AG, Research Division

Yes. I'm just curious if they're changing behaviors of in-sourcing or if you're seeing more margin pressure or incremental margin pressure from your subcontracts versus prime contracts?

Michael T. Strianese

Yes. Well, the prime contracts are affected by Better Buying Power. But I think, again, we have been aligned and have been structuring in a way that met most of those Better Buying Power objectives. And again, as a supplier, all companies now are facing the same cost issues and are looking for more bang for the buck on everything that they buy, but again, we are very cost competitive. In fact, unless we're a sole sourced position, we can get competed in any time typically, and the reason why we're in a good position is our prices are very competitive, especially when you take into account the fact that we're in many areas 1 or 2 in terms of the technology and products that we supply and the performance of our systems. So there's increased emphasis now on lifecycle costs, our unique skills and weapon systems sustainment, logistics, et cetera, even the systems that are built by other firms have put us in a very nice position because we are very cost effective. The technologies are still focused on communications, electronics. ISR domains are still enjoying robust upgrade programs. The things that must be done at the expense of new programs starts. So from that perspective, we're feeling pretty good as well. You also mentioned in-sourcing or vertical integration. That's always a risk when you get into this environment where everybody wants to keep as much as they can of their sales dollar, and we do see that. But however, many of the things that we do are not easily duplicated elsewhere, and we enjoy some pretty good market positions in many of the things we do. So I'd like to tell you that when it comes to a make versus buy decision, many times, we get selected anyway as a buy versus a make because we could outperform even the internal capability of some of the larger primes. Fortunately, we haven't been hit very hard in those areas.

Myles A. Walton - Deutsche Bank AG, Research Division

That make sense. That's helpful. And then, Ralph, just into '14. I know you're not going to give me guidance. But on the cash flow side, anything moving of noteworthiness in the '14 cash flow versus '13 on the working capital accounts? And is pension probably still around the same contribution year-on-year?

Ralph G. D'Ambrosio

Well, if the pension discount rates stay where they are, I expect that we probably will be able to fund less into the pension in 2014 than this year because it won't be required. And I also expect to have less CapEx next year compared to this year. I'm not expecting any dramatic changes in the working capital accounts though right now.

Operator

Our next question comes from the line of Cai Von Rumohr with Cowen and Company.

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

So what's the current assumption in terms of book-to-bill for the year?

Ralph G. D'Ambrosio

I said it was in the range of 0.95 to 0.97, Cai.

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

Okay. So really, you're assuming you're going to go at about 0.92 in the second half because...

Ralph G. D'Ambrosio

We'll be right down the middle.

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

You did 109% here versus...

Ralph G. D'Ambrosio

I agree with your calculations, Cai.

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

Okay. But I guess. So the question is, you -- I think you were looking for what? 0.9, 0.93, so was the better-than-expected performance in the second quarter a function of pull forwards? Or what was it?

Ralph G. D'Ambrosio

Well, it was some pull forwards. But frankly, compared to 3 months ago, we're that much closer to FY '14 right now. Looks like there's been no progress made at all on sequester. We're anticipating a CR, so accordingly, we're playing a little more conservatism.

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

Got it. Got it. And then, so your severance was $21 million or $0.15, $9 million of it occurred in the second quarter. How much of that is new versus your prior guidance?

Ralph G. D'Ambrosio

Well, we footnoted that in the earnings release. About $21 million is new.

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

Okay. So the total severance is how much?

Ralph G. D'Ambrosio

$25 million, and the increase compared to the prior guidance is $21 million.

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

Okay. And how much of the $21 million? I know that it happens in the second half. How much of the 20 -- on a full forward basis, is that $21 million of cost savings on an annual basis?

Ralph G. D'Ambrosio

Not including [ph] $21 million because it's going to offset some lower volume and absorption.

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

Well, I'm just saying on the cost side, I mean, obviously, maybe it doesn't all flow to the P&L.

Ralph G. D'Ambrosio

Well, I mean, at a minimum, to the extent we don't have to do more resizing next year, I expect to have a considerable pickup on that comparison.

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

Got it. And then, of the $21 million, because it's happening, you did a lot of it in the second quarter, like $9 million. So -- and the $9 million is of the $21 million new, so how much is the cost savings this year of the incremental $21 million?

Ralph G. D'Ambrosio

It's a small fraction of it, less than -- probably 30% to 40%.

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

Got it. Okay, okay, okay, great. And I know that next year is pretty murky, a lot of uncertainties, but can you give us -- you gave us some very useful comments in terms of the cash flow. Just in terms of the operations, where you see the things look better or worse or any kind of just general color, you or Mike could give would be really terrific.

Michael T. Strianese

Well, let me give you, I would say, Cai, a 20,000-foot view. This may be a 60,000-foot view of things. Like in the ISR space that are kind of related to current geopolitical risks, and threats and the like, they're going to get more prioritized. New starts are going to suffer. Some of the quantities on some of the obvious programs that haven't been worked out, which kind of has a ripple effect through everything else. A lot of the work that we do is in the O&M side, O&M side of things, and I think that should hold up pretty well in the 3400th area as they call it. It's clearly showing some prioritization in both the '13 obligations, as well as the '14 planning. What else could I derive from this for you. Kind of very cryptic right now.

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

I think what I was -- any sense about -- NSS has had pressure this year, do you expect that -- as you look at your 4 business units, any of them should do better or worse or...

Ralph G. D'Ambrosio

Well, it's difficult to predict what will happen if the FY '14 cuts are made. But if you look at our recent book-to-bill trends into the segments, whether they be the last 6 months or the last 12 months, we've had the highest book-to-bill ratios in C3ISR and Electronic Systems, and comparatively lower ones in Platform & Logistics Solutions and NSS. So that's one data point. And it suggests that C3ISR and Electronic Systems looks stronger heading into next year.

Operator

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

Christopher Sands - JP Morgan Chase & Co, Research Division

It's actually Chris Sands on for Joe. Ralph, I just wanted to confirm that there's no more costs expected with the design and production in C3, is that right?

Ralph G. D'Ambrosio

I didn't say that there's no more cost expected. I said that we expect the margins to go back to a more normal level in the second half, all things considered. Yes, there are a lot of variables that go into our guidance assumptions.

Christopher Sands - JP Morgan Chase & Co, Research Division

Okay. Fair enough.

Ralph G. D'Ambrosio

So obviously, the bulk of it is behind us.

Christopher Sands - JP Morgan Chase & Co, Research Division

Right. And then one for Mike. You had mentioned that you continue to expect the budget to create some M&A opportunities. Are you seeing anything now or how has the pipeline changed over the last 12 months or so?

Michael T. Strianese

No. Actually, we have not seen a lot of activity. In fact, there's been virtually no activity year-to-date. And I think that's a function of not having the clarity that would be required to make the decisions for many companies on the portfolio shaping. It's deciding who the winners and losers are going to be. What areas to then consolidate. What areas might be better rationalized at another -- through a sales process with another company. So I think I was more -- being more forward-looking in saying, once things resolve, I think it will break the logjam we're seeing in the M&A. You'll see some -- finally, see some portfolio shaping. The deals that we are seeing go by -- it's not like there's no books circulating -- but they are generally standalone companies where you have a owner that's exiting and things like that, not portfolio shaping up the primes at all. And we've probably seen 50 books or so this year, and we haven't really seen anything that we thought was a good fit or a good deal or brought something to the table for us, so we're more than happy to return the cash to shareholders while we wait. But we are going to be opportunistic when the time comes, I can assure you that.

Operator

Our next question comes from the line of Noah Poponak with Goldman Sachs.

Noah Poponak - Goldman Sachs Group Inc., Research Division

A question on the market share gains that you talked about, Ralph. Could you maybe -- I don't know if you'd be willing to quantify how much that added to the offset to what you previously thought for sequestration in the full year revenue outlook.

Ralph G. D'Ambrosio

Sure.

Noah Poponak - Goldman Sachs Group Inc., Research Division

And then, I was also curious, related to it, if you could maybe elaborate on why that's happening? Are you experiencing a hot streak, and you'll revert to the mean on win rates? Or is there something sort of materially different that you're doing when you're going to compete?

Ralph G. D'Ambrosio

Well, Mike already talked about the win rates, and they already have reverted to the mean. So we've seen a meaningful improvement in the win rates, particularly at NSS for the last 6 to 9 months compared to earlier periods. But to give you some more details, and these are rough estimates. I talked about our OCO sales being $50 million better than we anticipated. And if you recall, the original guidance assumed that we'd have a $400 million reduction coming from Iraq, Afghanistan/OCO sales. Well, we think that's going to be $350 million now. And half of that improvement or $25 million is coming out of NSS on intel support work. Where frankly, we took task orders away from other competitors. So that's a clear market share improvement in that respect. The other half of it has come from higher EO/IR turret sales that we anticipated earlier this year. Additionally, you saw that we made no reduction to our Platform & Logistics Solutions sales guidance for the year, and that's where also we've had some market share gains, particularly on the ground equipment, logistics support areas that Mike talked about. And so that's been helping to offset some of the sequester reductions that we've been seeing. So we were fortunate to offset some of it with market share gains, as well as the comments I made earlier about our O&M business seeming to be in the right higher priority grayness areas that looked like they're going to be better funded in this environment.

Noah Poponak - Goldman Sachs Group Inc., Research Division

Got it. And then just one other one for me. Can you update us on how much share repurchase is now embedded in the new outlook?

Ralph G. D'Ambrosio

Okay. Well, like I said, the new outlook continues to assume $0.5 billion for the full year, and we're just about halfway there...

Noah Poponak - Goldman Sachs Group Inc., Research Division

Oh, you did say that. Okay.

Ralph G. D'Ambrosio

For the first half. The guidance also assumes a $250 million debt repayment. And I called out a placeholder and explained that it may not be necessary given what's happening in the pension area, so that could free up $250 million, plus the $450 million of cash balance that we expect to end the year before that. So that gives us a good amount of flexibility whether to make some M&A as those opportunities arise or to return more of that cash to our shareholders in the form of buybacks.

Operator

Our next question comes from the line of Brian Ruttenbur with CRT Capital.

Brian W. Ruttenbur - CRT Capital Group LLC, Research Division

The second half, it appears in terms of total revenue, it be falling off kind of a year-over-year basis, about 10% to 12%. Is that all due to sequestration? And it appears the margins x pension are down, but you're going to make up a lot of that in 2014. So it's basically a 2-part question. So first of all, am I right on my calculation on the falloff year-over-year? And is it all due to sequestration?

Ralph G. D'Ambrosio

Okay. So your math is correct. Secondly, it's not all sequestration. I talked about us having tougher comparisons on the international sales growth in the second half, so that's part of it as well.

Brian W. Ruttenbur - CRT Capital Group LLC, Research Division

Okay. So I'm trying to model going forward as is I'm sure everybody else out there and trying to figure out if sequestration hit...

Ralph G. D'Ambrosio

And we're trying to do the same thing, Brian.

Brian W. Ruttenbur - CRT Capital Group LLC, Research Division

Yes. Why don't you have crystal ball for us? But is half of that then the falloff because of sequestration, so you'd be impacted maybe on a going forward basis by 5%, 6% or half of it international? I'm trying to figure that out. And then it sounds like on the margin side, any falloff that you'd have because of sequestration cuts and other things that you're going to make that up because of pension?

Ralph G. D'Ambrosio

All right. So on the revenue side, I think the expectation that we talked about the full year book-to-bill ratio of 0.95 to 0.97 in that range is probably a good indicator of what could be happening to sales next year, which means, we could be down 3% to 5%. And maybe we'll do better if this positioning that we experienced in the FY '13 sequester cuts continues. But we want to wait and see what the details are before we make an opinion about that. On the margin side, we expect to have a pension tailwind, if the discount rates stay where they are, and we talked about that in a good amount of detail. And these cost-reduction actions that we're taking should help next year. We don't expect higher -- have these higher design and production costs in C3ISR either next year, which should be a positive. And then we also expect that we're going to make a meaningful reduction in our diluted share count next year versus this year as well, like we've been doing. And that will also be a positive earnings indicator for next year.

Michael T. Strianese

Okay. To wrap up, we're executing our business strategy by focusing on customer priorities and continuing to deliver shareholder value. We've positioned our business to deal with the emerging impacts of sequestration and the uncertainty of the current environment. We continue to develop and offer competitive solutions to our customer base that is focused on performance, as well as cost. We are likewise building long term customer relationships by anticipating our customers' needs and helping them achieve their goals. Our business is growing both internationally and commercially. We have a committed leadership team and an exceptional workforce who understand the challenges of this environment. We'll continue to respond with excellent program performance and an appreciation of our customers' national security responsibilities. Thanks once again. We look forward to speaking with you in October.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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L-3 Communication (LLL): Q2 EPS of $2.03 beats by $0.10. Revenue of $3.2B (+2% Y/Y) beats by $0.15B. (PR)