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Exelis (NYSE:XLS)

Q3 2013 Earnings Call

November 01, 2013 10:00 am ET

Executives

Katy Herr

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

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

Analysts

Christopher Sands - JP Morgan Chase & Co, Research Division

William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division

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

Howard A. Rubel - Jefferies LLC, Research Division

Operator

Welcome to the Exelis Third Quarter 2013 Financial Results Conference Call and Webcast. Hosting the call today from Exelis is Ms. Katy Herr, Head of Investor Relations. Today's call is being recorded. [Operator Instructions] It is now my pleasure to turn the floor over to Ms. Katy Herr. Katy, you may begin.

Katy Herr

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

Moving to Slide 2. Before we start, please understand that this call contains forward-looking statements that involve risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. Such statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, and certain factors that could cause results to differ materially from those anticipated are set forth on Slide 2 of today's presentation and in this morning's earnings release.

During today's call, we will discuss our financial results for the third quarter of 2013. We may refer to non-GAAP measures, which are defined and reconciled in the appendix of today's presentation and available on our website. Joining me on the call this morning are Dave Melcher, Chief Executive Officer and President; and Peter Milligan, our Chief Financial Officer. As always, we encourage questions at the conclusion of our remarks. With that said, please turn to Slide 3, and at this point, I would like to turn the call over to Dave.

David F. Melcher

Thank you, Katy. Good morning, and thanks for joining us today. As you've seen in our press release this morning, we delivered a third quarter that exceeded margin requirements and was highlighted by a particularly strong quarter of funded orders in the Information & Technical Services segment, resulting in an almost 30% sequential increase in funded backlog. Funded orders for the quarter were $2 billion, an increase of 48% compared to the third quarter of 2012. Our enterprise book-to-bill ratio in the quarter was 1.7x. Year-to-date, our book-to-bill ratio stands at 1.2x. At the beginning of the year, we said that we plan to end the year with a book-to-bill of at least 1:1, and we are well down the path to achieving this goal. I'll discuss a bit more about our orders backlog and new business pipeline in just a minute.

Revenue for the quarter of $1.1 billion reflected contraction in short-cycle logistics and base support contracts and lower volumes in ground electronic warfare and legacy night vision products. As we have discussed on previous calls, sequestration and general budget uncertainty have resulted in a slower contract award environment. Due to the furloughs and delays we have experienced already and a slower business pace anticipated for the rest of the calendar year due to continuing resolution, we now expect that full year revenue will come in slightly lower than previously expected. Operating income of $133 million translated to an operating margin of 11.7% for the quarter. Restructuring actions taken in the quarter accounted for about 50 basis points on the margin. Year-to-date, we have incurred $68 million in restructuring charges. This reflects a 6% headcount reduction and a 600,000 square footage reduction since the beginning of the year. In addition, we have expanded our shared services organization to increase centralization of financial transactions, selected human resource responsibilities and information technology planning and operations. And we have expanded targeted strategic sourcing initiatives to consolidate our supplier base and better manage our purchasing costs. These actions help us to shape our business operations for the realities of the current market environment and aim to improve our competitiveness and ability to reinvest in longer-term growth opportunities.

We have continued to improve our cost structure and our business operations in the fourth quarter, primarily in the C4ISR segment, and expect a full year charge slightly ahead of prior expectations at about $85 million. We are already seeing the benefits of our restructuring. I&TS segment operating income reflects in part the benefits of our efforts earlier in the year. In addition, less restructuring and a lower cost base enabled a 75% quarter-over-quarter improvement in C4ISR segment operating income. Excluding restructuring, the C4ISR segment generated a 14.9% operating margin in the quarter.

Moving to Slide 4. As I mentioned, the I&TS segment delivered a robust quarter of funded orders, as customers used year-end funds to ensure continuity of critical services, particularly those in the Middle East and Afghanistan. Some of these programs now have full year funding in place as we begin the new government fiscal year. As a result, I&TS funded backlog doubled compared to the second quarter. Total company funded backlog increased 28% sequentially. International accounted for 1/3 of C4ISR funded orders in the quarter led by over $140 million in communication systems and night vision equipment awards. Year-to-date, international accounts for 28% of C4ISR orders, reflecting a 50% increase from the same period in 2012.

This morning, it's also my pleasure to announce that we were informed earlier this week that our team has been selected for a multimillion-dollar project to build a climate monitoring satellite for an international customer. Exelis will build the primary instrument which will measure carbon dioxide and methane gas levels. We expect to be on contract in late fourth quarter 2013 or early first quarter 2014. This award supports our broader ISR and analytics strategy to use our past performance and expertise in weather sensors to expand into the broader climate and environmental remote sensing market.

Also during the quarter, we announced over $25 million in aerostructure awards and the completion of Nadcap certification of our new aerostructures facility in Salt Lake City. Nadcap is a worldwide cooperative industry effort administered by the Performance Review Institute for quality assurance throughout the aerospace and defense industries. This accreditation recognizes our robust quality systems and confirms to the aerospace industry that Exelis operates under the highest quality standards.

Lastly, we currently have over $7 billion of proposals in evaluation for the company. We continue to expect a few sizable international awards during the fourth quarter. Some of this reflects a slip from third quarter as the Foreign Military Sales approval process has slowed a bit during the government budget challenges this year.

Looking ahead at the overall business climate, we continue to see uncertainty and conservatism driving the federal contracting environment as the budget outlines for fiscal year 2014 and beyond are debated. As you know full well, we now operate under a continuing resolution until January 15 with a debt ceiling revisit by February 7. During that time, our representatives in Congress will continue to debate how to balance spending priorities and responsible debt ceiling management. We continue to expect our programs will be well supported, and we are working closely with our customers as they evaluate future funding scenarios. For our planning purposes, we have assumed that full sequestration continues in place during fiscal year 2014.

However, we're not sitting still. Let's move to Slide 5 to discuss how we're taking proactive steps to manage our future business opportunities. At Exelis, we're repositioning. We are already a well-diversified company, and our challenge is to pick the right technologies and market spaces that will position us to advance future opportunities. We are actively managing our R&D funds, our business development resources and our corporate development priorities to support our 4 strategic growth platforms of critical networks, ISR and analytics, electronic warfare and aerostructures. As you can see, these strategic growth platforms use as their foundation the products and services that demonstrate our most differentiated technologies and expertise. They also represent areas that we believe will be well supported in the future, domestically and internationally. We expect these platforms will drive future growth as we continue to expand our core market positions and step into near adjacencies.

Some examples of our current positions are shown on this slide. Simply put, we are focusing on long-term growth drivers that will enable us to remain well positioned in the current and future environments. Today, these strategic growth platforms account for over half of our revenue. I expect that as we mature and invest in these businesses, they will deliver an increasing share of our revenue and our profitability. Not all of our technologies, products and services are reflected here. That is by design. Focus requires choices. The products and services not represented on this page are no less important, but are engines that will feed the investment in these strategic growth platforms. We have made choices about our investments based on market realities and are looking for those that will yield the best return over the long run.

Importantly, the strategic growth platforms also provide a common lexicon and shared vision for our company, both internally and externally. Exelis is diverse. We have over 1,000 contracts, hundreds of products and myriad technologies in development. By focusing on these 4 areas, we can more meaningfully impart the priorities and progress of our company to our external stakeholders. Internally, they enable us to communicate our investment priorities in a clear and decisive manner and drive integration between and among the platforms. Going forward, you'll hear us discuss our business opportunities and choices more often through the lens of the strategic growth platforms. I look forward to keeping you up-to-date on our progress.

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

Peter J. Milligan

Thanks, Dave. Good morning, everyone. Please turn to Slide 6 for a discussion of our segment results. Funded orders in the C4ISR segment were flat compared to the third quarter of 2012. Importantly, the quarter reflects higher year-over-year bookings in the aerostructures business, which has received organic investment over the last few years. In fact, year-to-date funded orders in this investment area have more than doubled compared to 2012, and we see several significant commercial opportunities on the near-term horizon. As an example, this morning, we announced a multiyear contract with Boeing to produce advanced composite vacuum waste tank systems for use in a variety of Boeing commercial aircraft models. In addition, last quarter I mentioned that we expected a few international contracts during the second half of 2013. During the third quarter, we announced a $115 million foreign military sale contract for communication systems and equipment. We still have a couple of sizable international opportunities in the plan for the fourth quarter. And while we're seeing delays in FMS approvals, we feel comfortable that most should come through before the end of the year. Revenue for the segment was down 18%, primarily due to low sales of legacy night vision goggles and ground electronic warfare systems. Sales of the Spiral Enhanced Night Vision Goggle and classified programs somewhat offset the decline. For the year, we expect C4ISR revenues to be down around 11% to 13% compared to 2012 due to volume declines, delays in contract awards driven by sequestration, the government shutdown and the general customer uncertainty regarding the federal budget. Profitability in the segment declined because of lower volumes, offset in part by restructuring-driven cost reductions. We continue to expect that full year C4ISR margin should be between 10% and 11% on a GAAP basis. Excluding restructuring, margins should approach 14%. Longer term, we expect operating margins in the low teens in this segment.

Turning to the I&TS segment on Slide 7. Funded orders in the I&TS segment were up 81% compared to the third quarter of 2012, due to over $700 million in funding across Middle East region programs. We now have 6 to 12 months of funding on a number of key contracts, providing some visibility in their near-term revenue profile. Year-over-year revenue was down 14% in this segment due to lower revenue on Middle East and Afghanistan programs, somewhat offset by higher revenues on FAA programs. We now expect full year revenue in this segment to be down around 10% to 11%. I&TS continues to drive outstanding profitability. Operating income increased 3% over the third quarter of 2012 and operating margin was 10%, 170 basis points higher than the year-ago quarter. Net favorable contract modifications and higher award fees drove most of the strength. We continue to expect full year I&TS segment margins in the 9% range. Next year, we see high-single digits as an appropriate margin profile for this segment.

Moving to Slide 8. Year-to-date orders and a stable backlog provide a good amount of near-term visibility. However, due to the current contracting environment, the recent government shutdown and contract award delays, we expect full year revenue 1% to 2% below our previous guidance. However, we expect operating margins to now trend towards the high end of the range previously given, close to 9.8%, driven by year-to-date performance in the I&TS segment and benefits from restructuring. And we continue to expect full year EPS in the $1.45 to $1.55 range.

Our cash flow trajectory appears similar to 2012, and we are reaffirming our expectation for at least $220 million -- $225 million in free cash flow for the year. For the full year, we continue to anticipate a tax rate in the 36% to 37% range and a share count of approximately 192 million shares. And with that, I'll turn the call to the operator for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll go to our first question from Joe Nadol with JPMorgan.

Christopher Sands - JP Morgan Chase & Co, Research Division

It's actually Chris, on for Joe this morning. Quick question on C4ISR. Can you give us an idea of when and at what level that might stabilize from a top line perspective?

Peter J. Milligan

I'm sorry, Chris. Can you say that again?

Christopher Sands - JP Morgan Chase & Co, Research Division

The C4ISR top line, when might that stabilize and at what level?

Peter J. Milligan

Okay. So if you think about where we are now and where we expect to be for the full year, we're certainly implying pretty significant change in 4Q. That business has declined in the sort of the teens. We expect that certainly to stop in the fourth quarter. And that's supported by some of the backlog now that we booked, most recently in the last month, couple of months or so. So we do expect to see a pretty strong fourth quarter from that unit. And certainly a large majority of that is already in backlog, and of course, a great part of it has already been shipped. So -- but that's sort of on the quarter basis. As we go into next year, certainly we would expect, across the entire company but probably more so on the C4ISR side, for that revenue decline -- the rate of that revenue decline to slow significantly.

Christopher Sands - JP Morgan Chase & Co, Research Division

Right. And just given that the majority of the orders have been in I&TS, are there significant orders in Q4 that you're looking for that would help kind of solidify next year's revenue outlook?

Peter J. Milligan

Sure. We certainly have that every quarter. But I think as we exit this year, there's opportunities in a couple of the key areas, and they really all fit into where we call our strategic growth platforms. There's a couple of international EW opportunities. There's some international radar opportunities. There's actually also some international night vision and communications opportunities and something as well in the payload -- in the satellite payload area.

Christopher Sands - JP Morgan Chase & Co, Research Division

Okay. And then just one more on I&TS margin. You previously said that 7% to 8% was your long-term outlook. You just said high-single digits. So does that represent, by high-single digits do you mean higher than 7% to 8%? And does that have to do with the mix change in the backlog, given all the orders this quarter, cost takeout, or any commentary there?

Peter J. Milligan

Sure, and that's a good catch, and what I said previously was right, 6% to 8% longer term, and I still believe that. I think as you go out over the next number of years, I think as we look -- as we sort of close out on 2013 and as we're pulling the plans together for 2014, I think we're certainly at the higher end of that range. And then we'll see how the mix, of course, develops over the next number of -- next year or so and see where we fall in that 6% to 8% range. But I think in the near term, as we move into '14, we're certainly in the higher end of that range.

Christopher Sands - JP Morgan Chase & Co, Research Division

Okay. And then can you just quantify the amount of the favorable EACs that helped the I&TS margin this quarter?

Peter J. Milligan

Sure. We had 6 million of EAC adjustments in the third quarter for I&TS, and we had 10 million or 11 million on the other segment, which just for comparative purposes in both cases are down, certainly in the I&TS side it's down dramatically from last year. And a little bit -- it's actually up a little bit a couple of million dollars on the C4ISR side. But in total, our EAC adjustments have trended down, as we expected.

Operator

We'll take our next question from Bill Loomis with Stifel.

William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division

Can you just update us first on kind of the Middle East programs? I know -- just remind us how much are more war support-related. And then somewhat related to that, on some of your major programs that are more enduring, like K-BOSSS, where do they stand in terms of level over the next year? Any changes there?

David F. Melcher

Yes, Bill. This is Dave. A good question. I mean, we noticed a little bit of a drawdown in the total volume of the international programs, which I think is in line with what you would expect with drawing down presence in Afghanistan and all of the things that we dealt with here in this year that our customers were dealing with as well. We've got several programs that really have some good durability. K-BOSSS program is one where we're performing extremely well, located in Kuwait, getting high marks from our customers and performing well, albeit at a slightly less level than it was last year. The OMDAC-SWACA program or the big communications contract, also out of Kuwait but reaching into Horn of Africa and Afghanistan and into other areas in the Middle East, is another one that we won just in the last year, which has durability for several years as well. We're on the prepositioned stocks contract. And while that one was supposed to be recompeted here, more near term, it has gotten extended a bit more to the right, through now most of 2014. And the same is true for our contracts in Afghanistan, for Afghan North and Afghan South and our LOGCAP work with our partners. That work has been funded in advance well through 2014. And while there might be a recompete and extension of that kind of work beyond '14, for now, it looks pretty solid through '14. So I think that there is a lot of durability to these contracts. Some were funded with OCO funding. They could continue to be funded with OCO. But as that draws down, some of these power projection contracts out of Kuwait are going to be funded ultimately in the base.

William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division

And can you just remind us how much of the revenue mix in the third quarter was tied to more variable support levels? So in other words, if troop levels continue to go down through '14, what that mix is that will be negatively impacted?

David F. Melcher

Yes, the figure that I like to touch back on is, as a percent of our overall revenues, about 8% are tied to OCO funding. But OCO funding, as you know, never goes to 0, at least in any projections we see for the next couple of years. I think it stabilizes at about $50 billion or so. So as long as we have people deployed or supporting those kind of efforts, there's going to be funding to take care of that.

William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And then just one quick one on the LISC contract, I saw you got some -- you got a funding extension. Is that getting pushed out?

David F. Melcher

Which contract was that, Bill?

William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division

The Launch and Test Range Support contract?

David F. Melcher

Yes. Right, yes, we're of course competing for LISC. That will hopefully be decided sometime in 2014. But in the meanwhile, our space, ground, range business contracts continue to get extended to the right.

William R. Loomis - Stifel, Nicolaus & Co., Inc., Research Division

Okay. So no decision there until what, do you think first or second quarter of 2014?

David F. Melcher

I wish I had a crystal ball that could give you that answer. But I would say at least in the middle of 2014 and possibly later, depending on what happens with other government issues and deliberation.

Operator

We'll go to our next question from Peter Skibitski with Drexel Hamilton.

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

Let's see, I have a couple questions here, I guess. Revenue was down pretty meaningfully in C4, but margin rate was up actually pretty nicely year-over-year. I'm just wondering what the real tailwind was there. Was it mix of some sort or actually maybe did the cost reductions actually outweigh mix? Just wonder if you could give us any color on that and going forward.

Peter J. Milligan

Sure, Pete. This is Peter. A combination of all that. I mean, taking the restructuring actions early in the year certainly helped. If you look at our SG&A, we're down in the year, so that helps margins. We also had -- the gross margin is up. And that's a combination of taking those restructuring actions and some EAC adjustments as well, but again, not the same level we've seen in the past. So that's all helping. And again, when you take out the restructuring from the third quarter for a second, the margins approach 15%. We expect margins in the fourth quarter in this segment, because of the mix shift, to be in the upper teens. We've seen that in the past in certain quarters, and this quarter is expected to be pretty strong.

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

Is Q4 going to be your highest international mix, Peter?

Peter J. Milligan

Yes, it should be.

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

For the year?

Peter J. Milligan

Yes, absolutely.

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

Okay, okay. And then I guess maybe one for Dave. Dave, as an ex-Army guy, the Army -- AUSA seemed to be really, really concerned about the '14 sequester. And it sounds like you guys are talking about maybe the C4 segment kind of stabilizing revenue-wise, maybe modestly down. How -- can you connect that back to us? I mean, is the Army maybe -- I don't know, I'd think what would [ph] take a lot of costs out would be a force structure so procurement doesn't get hit a lot. I'm just wondering what your thoughts are there in terms of the Pentagon being very, very concerned about the sequester and kind of how you guys deal with that environment.

David F. Melcher

Well, I can't speak for the Army, but the Army leadership has done a pretty darn good job of speaking for themselves. And that is to say that the impact of the $20 billion of additional sequester cuts would, probably in their minds, disproportionately affect the Army in 2014. Why? Because while they want to reduce their force structure and end-strength because manpower costs are the biggest part of their budget, they can't actually do it fast enough to accommodate those kind of budget reductions in 2014. So for the Army, it is a choice of, "How fast can I get the structure down in order to protect my modernization accounts?" And that is the prisoner's dilemma that they face as they look at the budget picture and potentially greater cuts from sequestration. So they're going to have to make their own case about what that means for readiness and what that means for future capability in line with the overall strategy of DoD. It's a tough spot to be in.

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

Okay. So your thought is basically, you've had so much in a way of a headwind so far in terms of the war funding that maybe between the incremental international orders and the other services, the rate of revenue decline in C4 will maybe decelerate for you guys, is that fair to say?

David F. Melcher

Yes, I think that, that's a fair characterization. And interestingly enough, I mean, we participated in the AUSA show. We had an awful lot of meetings with customers at that show, both international customers and domestic. The biggest item of discussion among domestic customers was, "What can we do to better upgrade the installed base and capability that we have out there?" Night vision, radios, jammers, other things like that. That's a welcome conversation for us because we know we can do some things to really bring on better capability at less cost. We also see bright spots internationally with not just radios and communications, but also space payloads and other opportunities. And so I think that you're going to see, as you stated, a decrease in the decline in the C4ISR. And that's something that is going to, I think, hold us in pretty good shape in 2014.

Operator

We'll take our last question from Howard Rubel with Jefferies.

Howard A. Rubel - Jefferies LLC, Research Division

A couple of things. First, Peter, to go back to restructuring, kind of 2 points on that. First, can you elaborate a little bit on why you've increased the amount? And does it sort of offset some of the inception-to-date contract adjustments we've seen? Is that how you thought about it or can you give us a little more color?

Peter J. Milligan

Yes, I'm sorry, Howard. Not necessarily. I mean, I think a couple of things. We sort of always want to make the best economic decision. And if the economics tell us to move out earlier on certain activities, then we should do that. The reality in this year is as we changed the pension in the middle of the year, that gave us a little bit of a tailwind on pension that was a little bit unexpected as we entered the year. So you could sort of say that we used some of that upside to accelerate some restructuring into 2013.

Howard A. Rubel - Jefferies LLC, Research Division

So then, we should see that benefit in '14?

Peter J. Milligan

You should see that benefit in '14, right.

Howard A. Rubel - Jefferies LLC, Research Division

And that really goes to something that you talked about earlier is that while you expect contract terms to run off over time for obvious contract reasons and competitive reasons, the reality is a number of these contracts you've just won, you've now created some headroom with this restructuring actions and so on. So why wouldn't we expect to see high-single digits for several years?

Peter J. Milligan

High-single digits on the I&TS side?

Howard A. Rubel - Jefferies LLC, Research Division

Yes, sir.

Peter J. Milligan

Yes, I mean, some of it is -- that's basically cost-plus, right? So even if we do that restructuring, you're going to true-up against your actuals every year. So even when you win a contract, you can win it on a certain rate structure, and if your rates change and they go down, then you're going to give that back. So that's the biggest driver on the I&TS side really, it is that mix shift. There is about 20%, maybe a little bit more, of that revenue that's fixed-price. And that's, in part, what's helped this quarter. And actually I want to correct what I said. I think I changed or I mixed up the EAC numbers, and I'm going to give those again in a second. But we had really strong award fees in a couple of the key contracts. And those aren't handed to you, you have to earn that. So that's a result of really outstanding operational performance on both the base operating support work and the other segment in I&TS as well. So the management or the leadership teams and the program folks have done an outstanding job for the company, no doubt. Just real quick before I forget, I do want to say I think, Chris, I may have flipped the number on you before. And that is for I&TS, we had 10 million of EAC adjustments in the quarter, 6 million last year. I think I may have flipped those, so I apologize for that.

Howard A. Rubel - Jefferies LLC, Research Division

And you mentioned pension, and then I have one other one after that. So how did -- how's the plan performance year-to-date?

Peter J. Milligan

So 2 things. On the interest rate side, we're probably up about $400 million, or the liability is down about $400 million driven by interest rates. On the asset side, we're sort of broadly in line with what we expected. And then we see a little bit of a benefit because of the change in the terms of the plan as well. So we should be down if the interest rates were close -- as they close at the end of September. I know they've come back in a little bit since then. But in that $400 million to $500 million range, in terms of reduction on the overall liability, which we started with in that $2 billion range. So clearly a meaningful reduction in 2013. The assets are broadly in line with our expected return, which I think -- well, I know, for the year we're saying it's 8.5%.

Howard A. Rubel - Jefferies LLC, Research Division

And finally, Dave, you talked about a pipeline of $7 billion worth of proposals and opportunities. Two parts to this. One is that as you look at what you've won, can you say -- I mean, how would you define your market share in terms of bid wins or percentage wins versus proposals? And then the second part of that is could you characterize the $7 billion in terms of what you call the strategic-focused elements versus non-strategic.

David F. Melcher

Yes. No. Good question. Let me start with the second part first. I'd say that of that $7 billion, more ended on the strategic growth platforms. Why? Because those are the kind of things we're going after. That's where we're spending B&P money and that's where we're making investments to try and prepare for these competitions. Of those, that is probably split about 340 different programs that we're going after that are domestic, and about 152 or about 31% that are international. So we are trying to maintain a good international content. And most of that really is in the C4ISR side of the house rather than the I&TS side of the house. And then with respect to the size of that total pipeline that we're going after, I mean, we're just trying to size it appropriately to give us the opportunities to continue to grow those segments going forward. And if there was another point you have that I missed, please ask.

Howard A. Rubel - Jefferies LLC, Research Division

Well, maybe to be a bit more granular, how are you doing in terms of going after the night vision? Would you say you -- I mean, how would you define winning your fair share?

David F. Melcher

Okay. Well, when it comes to things like recompetes, we've always done traditionally better than even, for the most part, in the recompetes that we go after and maybe even a little bit higher on the service side of the business. With respect to night vision, I think we're winning our fair share of a dwindling opportunity. I mean, the real issue in night vision is that there are about 2 companies that are still producing for domestic night vision requirements, and those requirements were halved in this year 2013. And so each of those companies, us being one, are getting down to some sort of minimum economic quantities that we'd like to see flowing through the factory. And we've talked about that though with our customers, that's why we're going internationally. So we are seeking opportunities internationally. We've gotten some good wins on night vision. It's keeping the engineering and factory humming where we'd like it to be. And in the case of a TM-NVG contract, is what we've called it, where we've linked night vision with communications gear, we sold the first tranche of that internationally to Italy and have created some more opportunities now. And that's actually using night vision goggles as part of a network where you are transmitting information to and from the goggle using mesh-net radios that we call SpearNet. So there's great opportunities out there, and we're working hard to seize them.

Operator

And we'll go to Peter Skibitski with Drexel Hamilton.

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

Just a quick follow-up. Just wanted to ask about R&D. R&D kind of continues to trend down this year and be a little bit of a profit tailwind. Can you tell us -- are you still expecting to raise R&D in 2014? And if so, maybe kind of ballpark that for us?

Peter J. Milligan

Sure. I'll start at the high level, and I think Dave will give some thoughts as well. This 2013 is a low point for R&D, no doubt. It's going up next year. There is no doubt about that. We have, as we're putting our plans together right now, we are certainly counting on that. As Dave had mentioned early in the year, some of the restructuring efforts have been to give us the headroom to do that. The other thing to remember as well is sort of 2 parts to investing. Obviously in the future, one is R&D, while the other is capital. And we've spent -- I guess the R&D equivalent, if you will, in our aerostructures business has been capital, and we've spent a fair amount over the last couple of years. That's coming down now as we've really capitalized that facility, and you've seen -- we talked about the one award today. And I'm certainly hoping to be able to announce some other awards in the near future that are meaningful to that operation that seizes on that prior investment.

David F. Melcher

And just to add, a lot of the things that we did with restructuring this year, we did with an explicit intent to increase the R&D funding going forward. One of the logical reasons why R&D is down a little bit for us this year is it was very difficult this year to get your customers to give you a realistic picture of what their future needs are. As they were all grappling with these budget issues and trying to figure out what does it mean to their strategy, there wasn't as clear a dialogue as I think we all would like to have. I think as that mystery dissipates a bit, as we get more certainty about the budget, we're going to be putting those dollars to best effect in the strategic growth platforms, in the areas that we see as having the greatest promise. So I think that we'll be able to give you some more clarity going forward on what kind of things are we investing in and why.

Peter J. Milligan

And then the last piece, Pete, just to go one other point on this R&D question, is if you look at 2012, our R&D as a percent of product sales, and that's where the R&D is on the C4ISR side, was a little over 2.5% of sales. This year, it's a little under 2.5% of sales. So we want to see both things change, obviously, we'd like see more R&D, and we want to see a different trajectory on the sales line, of course, but that's where our heads are now.

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

Got you. Yes, I mean, it's come down probably more than half over the last few years. So I guess if you wanted to, you could probably double it. I don't know if that's what you're thinking or maybe more modest increases?

Peter J. Milligan

Yes, I don't expect to double it next year, but it's certainly going to be a meaningful increase.

Operator

And we have no further questions in the queue at this time.

David F. Melcher

Okay. Well then, I'll end by saying thank you for everybody who participated on the call. And we're going to work very hard to continue to have a good solid finish to 2013 and create conditions for a good year in 2014 as well. So thank you very much.

Operator

And that concludes today's conference call. Thank you for your participation.

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