L-3 Communications Holdings Q4 2009 Earnings Call Transcript

Jan.28.10 | About: L-3 Communications (LLL)

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

Q4 2009 Earnings Call

January 28, 2010 11:00 am ET

Executives

Eric Boyriven - IR

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

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

Analysts

Robert Spingarn - Credit Suisse

Cai von Rumohr - Cowen and Company

Joseph Campbell - Barclays Capital

Brian Ruttenbur - Morgan Keegan

Troy Lahr - Stifel Nicolaus

George Shapiro - Access 342

Howard Rubel – Jefferies & Co.

Michael Lewis – BB&T Capital Markets

Operator

Good day, ladies and gentlemen and welcome to the fourth quarter 2009 L-3 Communications earnings conference call. My name is Malelia and I’ll be your coordinator for today. At this time all participants are in a listen only mode. We will be facilitating a question and answer session towards the end of this conference. (Operator’s instructions). As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s conference, Mr. Eric Boyriven with L-3, please proceed.

Eric Boyriven

Good morning and that’s for joining us for L-3 Communications fourth quarter earnings conference call. With me are Michael Strianese, Chairman, President and Chief Executive Officer, and Ralph D'Ambrosio, 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 pres 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 will now turn the call over to Mike Strianese. Mike, please go ahead?

Michael T. Strianese

Thanks, Eric. And good morning everyone. Thanks for joining us for the fourth quarter earnings call. I’d like to being by thanking our employees who did a great job in the fourth quarter and showed very strong commitment to our program performance and satisfying customer needs. As well as our group presidents, their continued leadership and excellent performance.

Overall, we had a strong finish in 2009 and in our view a good fourth quarter. Our sales were up 5% to $4.2 billion. Earnings per share grew to $1.93 but while reported GAAP earnings were down 11%, when you compare to last year’s fourth quarter. Operationally earnings grew significantly. So in 2009 we had higher pension expense, and debt retirement charge in 2008’s fourth quarter we had gains both from a divesture and from an income tax matter that had closed. So when net those items out and you compare apples to apples, operationally earnings were up 18%, earnings per share.

Overall, we saw some of the same business trends in Q4 that we saw all year. The ISR business continued to do very well with significant growth. About 17% percent in the quarter, ahead of planned. And offsetting some of the weakness we saw in government services in our commercial businesses.

In addition, a few business areas in electronic systems that were not in the commercial space also did very well. And by the way, as you notice, we renamed specialized products electronic systems to better reflect the nature of our business. Which has been growing to be more of a systems business than a product business.

In the fourth quarter though in electronic systems, EOIR microwaves and procession engagement grew, benefiting from the ISR surge, as well as preliminary power and control systems and the marine services, parts of the business.

Declining in the fourth quarter, however, were our combat population systems and simulation and training sales, due to funding cuts and other delays that we experienced earlier in 2009. In addition, sales also declined in security detection systems, mostly due to timing and display systems with fewer new military air craft starts. And also aviation products were down because of the recession induced commercial aviation downturn.

Our backlog at December 31, was $10.9 billion. With fourth quarter orders of $4.2 billion and our book to bill was slightly over 1 at 1.01, reversing the below 1 book to bill ratios we had in both Q2 and Q3 of 2009.

Our book to bill for the full year, however was 0.94. Our free cash flow in the quarter was $372 million. We had some significant wins in the fourth quarter, several of which were competitive. They include imagery analytical services, gun ship modifications, the multi national forces, Intel support, services re-competition, the maritime security enhancement program for equatorial Guinea and two large and important classified contracts that were both competitively won.

In addition, we had a lot of follow on orders on our important legacy programs, which included our UAV com systems, our Rover product, Phoenix systems, the Compass Call aircraft, CF8 18s, LEP or the Law Enforcement Professionals training contract, Contract field services, our Fort Rucker maintenance work on rotary wing aircraft, project Liberty and other small aircraft ISR programs, River Joint, the P3s, M734 Fuses, AVCATT, C12 logistic services, and BLIR turrets, of course. So there’s a lot of activity.

In terms of major re-competes, the only outstanding re-competes continues to be the special operations force support contract, known as JOG. Where that stands as of today as cellcom is currently taking corrective action in response to our protest. They have indicated they will amend the RFP and obtain new proposals or amended proposals, I guess.

Our period of performance is scheduled to end in February, the end of the month. But we’re still awaiting an amended or extended contract. So our guidance currently anticipates about another three months. So it’s in the numbers for 2010 through the end of May.

As you know the contract is worth up to $5 billion over 10 years. It’s a very important program for us that we expect to see grow because of the work for special operating forces.

Some of the other high profile large programs that I’ll going to make some brief comments on, are the JCA program. We still see significant support for JCA in both the House and the Senate. The Army and National Guard have indicated that they would like more aircraft. The Air force also has said that that 38 currently ordered will be the minimum buy. We expect orders for eight aircraft in the fiscal ‘10 DOD budget and other eight in fiscal ‘11.

We also expect to deliver four JCAs during 2010. We look at JCA as a very important long term program for us. And we expect more than 38 aircraft for the US Military. The QDR could also address the DOD, JCA strategy, when that’s released in the next couple of weeks.

Also this strong FMS interest for JCA expressed by five international customers. It’s Australia, Taiwan, Ghana, Cutter and Saudi Arabia. With pricing and availability request for see for a total of 33 aircraft.

Just note that as with all international orders, the sale cycle is long and I would not expect to see these impact 2010 from a sales perspective. Certainly at this point we don’t see that happening. Perhaps in the order side.

Project Liberty, as you recall we’re modifying a total of 37 MC12W aircraft for the US Air force. It’s a totally funded program. We’ve delivered the first 10 aircraft on time or ahead of schedule. Our aircraft deliveries are surpassing our contractual schedule. As I mentioned. And phase 2 aircraft deliveries which is a new configuration that effects the aircraft 8-31 are being accelerated at the customer’s request.

I’d like to just insert a special thank you to all the employees of integrated systems in Greenville. And the other L-3 units that have been working on this program. They have been working 24/7 for about the last year on this program. So they’ve done a great job in responding to the customer requests.

We look forward to continuing to apply L-3’s experience to other small aircraft, ISR programs.

Arial common censure, which was a future program. It’s expected to be to replace the army’s guardrail in airborne reconnaissance low or ARL, ISR aircraft fleets. However, the army is not proceeding with the AFACS program in the near term as we understand it. And they’re currently – there’s no funding for ACS in the DOD budget. Instead the army is significantly restructuring its reconnaissance surveillance and target acquisition approach to focus on today’s fight with some mission redefinition towards a regular warfare.

The army is currently proceeding with a competitive procurement for what’s known as EMARs, or the enhanced medium attitude reconnaissance surveillance system to focus on the irregular warfare missions. And this is a real visible change in acquisition strategy as the Secretary has been saying to focus on fighting today’s fight. So, I mean, you can start to see some of the programs that are affected.

The EMARs configuration will be a small aircraft similar to the Liberty MC12 platform. We expect a rapid acquisition process. A draft RFP was recently released and a contract reward is likely in Q3 of 2010. Initial buy is expected to be six aircraft which could grow to about 30. We intend to bid this as a prime contract.

The UK Springtime, which we’ve been talking about for about two years now, also known as Nimrod, is still in process. As you recall the Ministry of Defense had requested now a US Air force River Joint aircraft as an FMS replacement for the UK Nimrod ISR aircraft.

Where we are today is we expect the UK letter of authorization by the end of February, next month. After the (inaudible) completes their proposed 2010 budget. The award is a high probability of occurring. But I have to caution, it’s not a done deal because there is political process involved and that could always be a wild card.

That said, the contract (inaudible) happen in the second quarter with the first aircraft being delivered in 2013. And our performance extending through December of 2016.

The program was intended or will provide three UK River Joint aircraft plus ground training and equipment. The planes will come from the KC135 tanker inventory. Logistics and sustainment will be provided under a separate US Air Force/MOD agreement. Our scope would be the ISR admission data systems, installation, logistic services and sustainment with an estimated value of about $700 million over seven years. Our team does include UK industry partners and suppliers.

Finally, I wanted to just mention, I’m sure you’re going to have questions. This whole matter of whole body imaging, at airports. In response to the Christmas Day attempted bombing of a US bound passenger plane, the TSA and several foreign or international customers intend to increase their screening capabilities to detect more explosive threats with whole body imaging systems or what’s becoming known as AIT, advanced imaging technologies. Deployment strategies entail more than just procuring these machines. Logistics and timing and training are also significant factors.

On December 30 of the end of the year, of 2009, we received a five year IDIQ contract from TSA, valued at up to $167 million, depending on quantities that are ordered. And we recently booked about $17 million of orders from international customers. Our whole body imaging self price per system is approximately, not this is an approximate number, because I know you’ll ask, $150,000, depending on configuration.

As a result, we expect to see some upside in WBI sales. But again, given the (inaudible) prices, we have to deliver a lot of machines for it start to make a difference in our numbers. We had sales in 2009 of about $5 million in this base. We expect it to grow from $50 to $60 million this year. And orders should exceed sales for the year. So again, the trend is up.

The TSA is expected to deploy about 300 systems soon. As you probably know, there are only two TSA qualified suppliers in this space. We are one of them. Our systems use millimeter wave technology and not X ray.

WBI situation is unfolding, as you know. And we’ll keep you posted as it evolves. But that’s the best we know as of today.

In terms of other new business for 2010. As I mention EMARs and Springtime, which I covered with you. There’s significant training work in Afghanistan, especially with police force and international army. The World Wide Lingus (ph) contract will be re-competed later this year. It’s expected to be a multi award, IDIQ contract.

The department of State Civil Police training, C17 training systems and sustainment, the US Army C12 logistic services competition and the Army CComs S32G competition, all would happen this year. The actual timings of these wards could be impacted by protest and other delays. But we’ll keep you posted on these. These are some out of the box ones that we’re watching carefully.

Getting back to the company, in terms of the capital deployment and acquisitions. We bought about $109 million of stock in the fourth quarter. And just north of half a billion for the year, $505 million. Our remaining authorization is about $426 million at the end of last year.

The fourth quarter, as you probably have noticed, we also refinanced a significant portion of our debt. And reproduced our existing outstanding debt by $400 million. Notwithstanding, we still ended 2009 with over a billion dollars of cash on the balance sheet. And we did get the upgrade to investment grade. Which we viewed as an important milestone for the company.

With respect to the acquisition pipeline, we’re seeing more activity and are in evaluations of several companies. We currently have very good opportunities and plan to invest more in 2010 then we’ve had in the past two years. So we will see M&A this year. Overall, we’re very happy with the balance sheet and liquidity positions.

In terms of 2010 guidance, Ralph will take you through the details. But as you’ve seen, we have increased modestly sales EPS and cash flow for 2010. We do continue to take a conservative position with the SOFSA contract, only assuming it until the end of May. We do have upsides from a future extension, winning some for those new business opportunities I discussed. A few which pertains to Afghanistan and from deploying our excess cash for M&A or for the share repurchases.

So, the guidance today in our release was updated increasing the earnings per share range to $8-$8.20, up 6% at the mid point versus 2009. We expect to see sales between $15.8-$16 billion, up 2% at the mid point. And of course, again, a factor in that number is the JOG is only in for half the year this year versus a full year last year which is significant.

So to wrap up, one of the things I want to mention is as we have been saying as we said at our investment day in December, due to the conflicts in Iraq, in Afghanistan, and the current global geo-political environment, we did not see an occasions for significant reductions in defense spending. I think that given the State of the Union last night and comments made by Secretary Gates back in January when he met with an industry group, the AIA, Airspace Industry Associations executive committee, which is essentially the airspace and defense companies, that’s pretty much been solidified. I mean, some of the comments made were that it’s important to see steady and consistent growth in the defense budget. And I interpret that to mean 2%-3% above the inflation rate. It’s been recognized in the DOD that the boom and busts of the past decade help neither industry or the government, because of what they do to us, in terms of planning resources, increasing costs.

So it was a very, very positive meeting. Recognizing that the partnership between industry and the DOD is critical for national security. It was all very, very positive. So therefore, I’m expecting to see a stable environment for this defense spending going forward.

And I think based on those remarks and our business plan for 2010 we’re looking forward to another solid year for L-3.

So with that, we’ll turn it over to Ralph to give you some color on the numbers. And then we’ll take questions.

Ralph G. D’Ambrosio

Okay. Thank you, Mike. I’ll highlight some key trends, the fourth quarter results, discuss the updated 2010 guidance and conclude with some comments about our year end ’09 balance sheet and capital structure.

So for the fourth quarter, starting with diluted earnings per share, as Mike said, we had a very solid strong fourth quarter with EPS of $1.93. There were several items between Q4 this year and of last year that affected the comparability of those earnings.

With respect to sales, consolidated fourth quarter sales grew just about 5% or almost $200 million. Growth from acquisitions, (inaudible) divestitures was $42 or 1%. The C3ISR segment again, grew the fastest. It was a little better than we planned. And it grew 17% or $123 million.

Sales in the government services segment were flat in the fourth quarter. What happened there was growth from acquisitions and on training services, that growth was offset by lower Iraq related support services. And lower subcontractor pass through on a large army contract where our task order renewals had migrated to a new contract where we’re not a prime. This changing contract vehicle will also reduce sales in 2010, versus 2009 by about $120 million.

Now fourth quarter aircraft modernization and maintenance segment sales grew 1%. And what happened there was growth on JCA, the For Rucker maintenance contract and modifications for the US Navy P3 aircraft were offset by lower expected sales on contract field services which declined by $37 million.

And finally, in the electronics systems segment, sales grew a little more than 4% or $65 million. As Mike said, what happened there was a growth that we had in the EOIR, microwave communications and power and control systems, business areas were partially offset by declines in propulsion systems and in our simulation training devices. And that was due to the funding cuts and delays that we experienced in those areas earlier in 2009.

Moving on to the operating margins, consolidated margin for the fourth quarter increased 20 basis points compared to the fourth quarter of 2008 to 10.6%. And that was even though we had higher pension expense in Q4 of ’09. Which reduced the operating income by $23 million and the operating margin by 15 basis points. So, very good underlying operational performance in the margins in the fourth quarter. And for the whole year for that matter.

Cash flow for the fourth quarter was also very strong, at $372 million, up $85 million from Q4 of 2008. The cash flow increase was mostly due to lower receivables DSO which declined by four days to 66 days and by lower CAP Ex. Free cash flow for the full year was $1, 225 million, to $25 million than we expected.

Our free cash flow per share for 2009 was $10.34, up 8% versus 2008 and 36% higher than our GAAP EPS for 2009. So I think that underscores the powerful cash flow that we generate at L-3.

Moving on to the guidance update for 2010. As Mike said, we increased the earnings per share range by $0.15 on both ends. It’s now $8-$8.20. Two items caused that increase. First, lower pension expense adds about $0.12 and it comes from the higher asset returns and a lower discount rate compared to what we assumed in our initial 2010 guidance.

And secondly, the additional $100 million that we’re assuming now on the SOFSA contract adds $0.03 GPS.

On the sales guidance, we increased the range by $100 million on both ends. At the segment level, we increased sales guidance by $100 in the C3ISR segment and the aircraft modernization and maintenance segment. And reduced it by $100 million in electronic systems.

I just talked about the increase in the aircraft modern to maintenance segment which was the additional SOFSA sales. In C3ISR, the raise relates to the continued strength that we see in our ISR businesses. Again, which was evidenced by a very strong results in the fourth quarter of 2009.

And we continue to expect C3ISR to be our fastest growing segment in 2010.

The $100 million decrease to the electronics system segment is primarily due to the spill over or carry over effect from ’08 where the shells (ph) were slightly lower than we expected. And we’re also applying conservativism in several business areas in that segment for 2010.

The operating margin for this year, 2010, remained unchanged at 10.7% which would be 10 basis points better than 2009. I’ll tell you that we’re being conservative on the margin and we’re going to try to do better.

The tax rate is going to be higher than it was in 2009. And that higher tax rate is an $0.18 headwind to earnings per share.

Now free cash flow guidance remains unchanged at $1.25 billion. Major assumptions there include a $73 million increase in pension funding, to about $140 million for 2010. And an increase in capital expenditures.

Finally, on the guidance, looking at the first quarter of 2010, we currently expect sales to be close to $3.7 billion with EPS of about $1.75 and free cash flow of about $100 million.

Finally, a few points on the capital structure for the year end balance sheet for 2009. As Mike said, conditions in the bond market have been attractive. And early in the fourth quarter we opportunistically redeemed our$750 million, seven and five eight subordinate notes. And we paid our $650 million term loan with a new 10 year $1 billion, 5.2% senior notes offering, plus cash on hand. Those new senior notes represent L-3’s first investment grade debt offering.

Additionally, we also entered into a new three year revolver in October replacing the old one that was scheduled to mature on March 9 of this year. And it’s for the same size, at $1 billion.

As Mike said, we ended the year with a billion dollars of cash. We expect that to increase to about $1.7 billion during 2010. And that’s after assuming half a billion dollars of shared purchasing and paying our dividend.

Bottom line is it leaves ample cash for us to either make acquisitions or to make more share purchases.

And as Mike said, the debt declined by $400 million in ’09. More importantly with the refinancing that we did early in the fourth quarter, we significantly improved our debt maturity profile. And also gained access to a new source of capital with the investment grade debt market.

We believe we have a very strong balance sheet and very strong liquidity. Again, with ample cash, free cash flow and the available revolver.

That concludes my comments. Thank you and I guess we’ll go to the Q&A now.

Question and Answer Session

Operator

(Operator’s instructions). Your first question comes from the line of Robert Spingarn with Credit Suisse.

Robert Spingarn - Credit Suisse

Good morning guys. Mike, couple of things. You gave us a lot of great detail, you and Ralph, so thank you. Two fairly different questions, one broad based, one more detailed. On the broad based side, what do you think the potential is here for supplementals to actually rise? That perhaps what we see on Monday is the beginning of increasing funding for Afghanistan, etcetera?

Michael T. Strianese

Okay. I guess you always have that potential, Rob. A couple of things going on. One, there’s a definite desire, I know on the Hill, to have those supplements baked into the budget. As you know that’s been a stress point for years. And I expect that to continue.

On the other hand, the demands are increasing in the short term, anyway. Both because there’s operations that have been carried out in both Pakistan and probably some level of effort going on in Yemen as well. And you have the Iraq elections that’ll happen next month which will be an indicator of how stable ready we are to transition and hand over operating control of security, really, of the country. So there’s a lot of factors. But there certainly is the potential for them to increase in the short run of the course.

Robert Spingarn - Credit Suisse

Yeah. And the reason I ask the question is we’re hearing is there is a lot of upward pressure. The slug of FY (inaudible) my exceed expectations. The piece associated with the Afghan surge and therefore or FY11. On that note, I’d like to segue into the other question which has to do with ISR aircraft. If you could talk a little bit about specifically the opportunities, how we should think about the complexities? You mentioned aerial common sensor before. There’s EPX which has had a lot of headwind. How do you see the landscape evolving here? What are the other opportunities for project Liberty type ISR, etcetera?

Michael T. Strianese

Well, again, Rob, I’ll answer it – I’ll try to get it specific as I can. But really what you’re seeing is a general trend. Of course a number of things, ACS is just one indicator. I think you could but EPX, the proposed EPX of a success with the EP3 in the same camp as that. And that trend is to rely more on both the UAVs and the small aircraft ISR given the current position we are in as a nation in the conflicts that we’re dealing with.

Right, we’re not using fighters we’re using ISR. So it’s a totally different mission to gather this information. And to operate in the theater as required it needs numerous sensors and processing capability, data links, ground terminals, you name it. So, that is a trend that we expect to continue. That has been driving and expect it to continue to drive the ISR space. And the most specific example I could give you was on the aerial common sensor transitioning to this EMARs capability, which is another small aircraft based proposed ISR system. But I would say watch carefully what happens with EPX whether that gets funded or that mission dissipates to UAVs and other small aircraft.

Robert Spingarn - Credit Suisse

And that’s what I was going to ask you. Because I think that mission may – EPX may be gone next week. And does that migrate into something that’s even more in your wheelhouse.

Michael T. Strianese

Yeah. As you know the requirement is still there to do maritime surveillance and patrol. So there’s other ways to do it, I guess. And it certainly does work in our space very well. From a sensor capability, from many things we do. As you know it’s the sensors, it’s the data links, it’s the integration of the airframe. It’s ground stations, it’s the microwave capability, gathering (inaudible). We kind of have end to end capability on the whole intelligence gathering, processing, dissemination, achieving chain. So it is a potential for us. Certainly.

Robert Spingarn - Credit Suisse

And do you see where the River Joint discontinue has his or did that change over time?

Michael T. Strianese

No, we see River Joint actually continuing as is for quite some time. And we look at this all the time, because it is so important to us. And I dread to ask the question, when is River Joint going to get replaced. But it really is not on the table at all. And probably good for about a decade given some of the upgrades that have been done. At least a decade, I guess, for the way that operators. But again, that’s a broader theater type of system.

Robert Spingarn - Credit Suisse

Okay. Mike, thanks for the help.

Operator

Your next question comes from the line of Cai von Rumohr with Cowen and Company.

Cai von Rumohr - Cowen and Company

So, what are you assuming now for linguist? The sales were up sequentially in the fourth quarter.

Ralph G. D’Ambrosio

Linguist for 2010, we’re assuming to be about $120 million. We did $225 million – I’m sorry, the actual sales for Linguist for the full year ’08 (inaudible).

Cai von Rumohr - Cowen and Company

It was $173 last year. So it basically it was flat at about $40 million last three quarters. Why wouldn’t it continue at that rate, particularly going into, a re-compete where you probably have a chance to get more business.

Ralph G. D’Ambrosio

The Administration stated plans are to (inaudible) removes combat troops from Iraq by the end of August. Just leave behind a support force. So that’s why we’re assuming that it’s going to decline by a little more than $50 million in 2010.

Cai von Rumohr - Cowen and Company

Okay. And then I missed, at the beginning you talked about $100 million, $0.03 more from SOFSA. How long are you assuming that expansion will be?

Ralph G. D’Ambrosio

Through the end of May. And our ability to continue to retain the SOFSA contract is a significant upside to our sales for 2010. And we’re working very hard to do that.

Cai von Rumohr - Cowen and Company

And it has officially been extended till the end of May or is that what you expect?

Ralph G. D’Ambrosio

No. Our contract ends, well the current period of performance ends the end of February, with more than a month to go we’re expecting an extension for at least three more months.

Cai von Rumohr - Cowen and Company

Got it. And then last question. Your first quarter, $3.7 billion would be essentially negligible growth, maybe 1%. What are the areas that you expect to be down, that looks a little light given the way you’re holding your expectations?

Ralph G. D’Ambrosio

Well, we’re expecting the government services segment to decline in 2010 versus ’09. And that’s in the guidance. We’re also expecting a decline in the aircraft modern and maintenance and that’s (inaudible) offsets. And that won’t happen in the first quarter. And then we’re being conservative, particularly in electronics systems segment. Yeah, the commercial business is out there. We saw some funding cuts on Browerly and some other programs.

And it’s only January, we want to see what happens. So I think we’re appropriately apply conservatism.

Michael T. Strianese

And I haven’t seen the budget yet either, so.

Cai von Rumohr - Cowen and Company

So the first quarter what you’re saying is that, that hopefully a conservative number, that $3.7?

Ralph G. D’Ambrosio

Yes. (Inaudible) getting out too far ahead of us.

Cai von Rumohr - Cowen and Company

Got it.

Operator

Your next question comes from the line of Joseph Campbell with Barclays Capital.

Joseph Campbell - Barclays Capital

Mike and Ralph, one of the things that I’ve notice just in conversations with investors about L-3 is that there’s several items and you’ve mentioned some of them pension and the SOFSA extension and so on. That allow one to take the previous guidance and to say, well, it looks like it could be a little bigger. And I was wondering whether is the softness that mentioned in – I mean, has this intended to be a cushion or is this just – I mean, it’s a little confusing about why not put things that seem pretty oblivious in and hedge things that seem more uncertain in terms of the way people are thinking about it. It seems to me there’s a reasonable number of people that some how or other think that the number should be 8.50, not 8.

Michael T. Strianese

Joe, we view our guidance – first of all, we have a track record –

Joseph Campbell - Barclays Capital

I understand. I was just trying to get a sense of whether there’s something in there that you think might be soft that we’ve just talk less about?

Michael T. Strianese

No. Listen, the softness in the plan both last year and looking forward is in the services area. And we’re really waiting one to see what the funding profile is going to come in some of these programs. We also have the potential of the draw down in Iraq hurting that sector even more. So that is that downside in the hedges, things like (inaudible) going out a little further.

Joseph Campbell - Barclays Capital

Yeah. So it just seems that people should be careful before they add the things that look easy and because some of the other things are harder to call and have been a little less talked about. To prevent people from getting ahead of – 8.20 seems reasonable.

Michael T. Strianese

That’s exactly right. And we do provide quarterly updates as we go through the year on it. As we see things develop more, but there has been no change in our philosophy or strategy in how we give our guidance. It’s the same as its always been. And in a less clear and less certain environment. So, that needs to get factored in. The predictability, if it was 95% two years ago, I would tell you it’s 85% or 80% now. So there is a little less predictability just due to the environment.

Joseph Campbell - Barclays Capital

Great. I just wanted to get that cleared up. I thought way too many people were talking about 8.50 as if it might be easy.

Michael T. Strianese

(Inaudible).

Joseph Campbell - Barclays Capital

Yeah, exactly. I’m in your camp. Thanks very much.

Operator

Our next question comes from the line of Brian Ruttenbur with Morgan Keegan.

Brian Ruttenbur - Morgan Keegan

Thank you very much. Very good quarter. Question I have is on operating margins. You gave some guidance for revenue and earnings in the first quarter. Can you talk a little bit about operating margins and where you think operating margins will shake out on the full year? You said 10.7. It seems like you’ve been going up more than that per year. It seems like it’d be more logical to be 10.8 by the end of the year. First address the first quarter and then on the year.

Ralph G. D’Ambrosio

Well, Brian, like I said in my commentary, we think our margin guidance is conservative and we’re going to try to do better. In terms of where we think we’re going to have the most improvement it’s going to be in the C3ISR segment. And the margins in ’09 were very strong in electronic systems. And we’re being conservative there in particular.

Brian Ruttenbur - Morgan Keegan

Okay. How about first quarter?

Ralph G. D’Ambrosio

The comments I made apply to the first quarter as well.

Brian Ruttenbur - Morgan Keegan

Okay. And then just as a follow up, just trying to understand the C3ISR, is going to have fast growth this year, with the surge and everything going on, you expect that to go into ’11?

Ralph G. D’Ambrosio

Well, based upon everything that we know today, we expect C3ISR to be a good growing segment for the foreseeable future.

Brian Ruttenbur - Morgan Keegan

Okay. And then on the government services side, do you see recovery in the out years to more stability then down?

Ralph G. D’Ambrosio

Yes. And as a follow on to the previous question, we’re deliberately being conservative particularly in the government services segment. One of the things I said at the investor conference last month was that in ’09 we were continually surprised by weakness there. And we had to lower the guidance on the top line, two or three times. And we don’t want that to happen again this year. And I think that’s reflected in the guidance.

Brian Ruttenbur - Morgan Keegan

Okay. Thank you very much.

Operator

The next question comes from the line of Troy Lahr with Stifel Nicolaus.

Troy Lahr - Stifel Nicolaus

Could you just give us an update on what you’re looking at for Iraq and Afghanistan revenues in 2010? And maybe kind of walk us through those contracts.

Ralph G. D’Ambrosio

Sure, the sales estimates in the 2010 guidance for both Iraq and Afghanistan are essentially unchanged from what we talked about at the investor conference. Which calls for about $800 million in Iraq and about $350 million in Afghanistan.

The Iraq work is comprised of ISR and Intel support activities at about almost $200 million. About $150 million in training and law enforcement work. I talked about $120 million for linguist. And the balance will be equipment maintenance on the CFT, CFS programs and some sales related to SOFSA.

The balance is about $200 million or so in a variety of product areas, namely communication terminals, some BOIR turrets and the tactical quiet generator or TQG.

What’s in the Afghanistan sales estimate is about $50 million for contract field services. Another $50 for a special operation forces support. $40 million for Intel support. And then the rest of is training and law enforcement activities.

And we talked about the up side that we think we have on the training side in Afghanistan. But that is going to require us to wind a competition. And there’s on currently going on right now. We want to wait and see what happens before we increase the guidance with respect to the training work there.

Troy Lahr - Stifel Nicolaus

Okay. And then lastly, just on electronic systems. Where specifically are you being conservative? What particular business lines do you think that there’s up side?

Ralph G. D’Ambrosio

Again, we’re continuing to be conservative in the simulation device area, also in propulsion systems. That the two areas that we had surprise funding cuts or order delays last year. On the display side, we’re assuming the business is pretty flat. This is the military side. You don’t have a lot of new aircraft bills going on for the US military right now.

And then we’re continuing to be cautious about the commercial business outlook. In fact we’re assuming that the commercial business has declined by about $100 million this year versus 2009. Most of that in the ship building products area.

Troy Lahr - Stifel Nicolaus

Okay. That’s great. Thanks.

Operator

Your next question comes from the line of George Shapiro with Access 342.

George Shapiro - Access 342

Hey, Mike, I got disconnected for a little bit. So if this was asked, just let me know. Can you follow up your comments, we were talking about at the conference in terms of M&A and how you see that versus, you know, what’s clearly an attractive stock price?

Michael T. Strianese

We’re taking a balance. You, George, as I said, we have been reluctant in the – over the past couple of years because of the disconnect between our trading multiple and what acquisitions costs. I mean you’ve seen it in play where we certainly have leaned heavier on share repurchase than acquisitions. But we see opportunities where that gap is closing. And I thought about that discussion because it is a very fundamental discussion on how we look at it. And some of it is science but a little bit of it is art too. And I would say that if we’re in a situation – another way I would say where the market is discounting aerospace and defense companies, to the extent it has been, 30%-40% below the S&P multiples. And a good company were to come along, would we just turn the other away and not pursue it, even though it’s in the long term interest of our L-3 to buy it. It’s almost like cutting off your nose despite your face, in a sense, that – because the market’s being inefficient or out of sync at the moment, that it should preclude an M&A deal that makes sense.

Now, having said that, we haven’t crossed that line because we haven’t seen one that done make sense to stretch for. And as I said previously in this discussion with you, we could debate this all year, I’m sure. But that chapter is closed significantly in a lot of places that we’re looking. So - where it does make sense.

George Shapiro - Access 342

Okay. And then just one little thing for Ralph. You said, Ralph, that $800 million sales in Iraq didn’t change. But why wouldn’t it have gone up to $100 million if you added for JOG to go through May?

Ralph G. D’Ambrosio

Because a small portion of what we do on JOG relates to Iraq.

George Shapiro - Access 342

Okay. That’s what I thought. But I thought maybe it was something a little bit more. Okay. That’s my questions. Thanks.

Operator

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

Howard Rubel – Jefferies & Co.

On the two recent, kind of, competitive pick ups, Mike, in imagery and gunship modes. Can you talk about the market size and the other opportunities you have there? I mean, both seem to fit in to the longer term trend that the DOD wants.

Michael T. Strianese

Yes. That’s a true statement, Howard. I don’t know if there’s a question there, but.

Howard Rubel – Jefferies & Co.

Well, I mean, yeah, can you talk about the market size and the opportunity that you see because unseating incumbencies not easy to do and this is, I think – (inaudible) called it out means that it’s not trivial.

Michael T. Strianese

Sizing these markets are hard to do absent a budget at the moment. Obviously there are important spaces for us that we intend to continue to focus on and grow. I can tell you that unseating incumbents is difficult. On the other hand, the view in this administration towards sole source is not a good one and more things are getting competed than not. So you’re going to see more shifting of contracts around the industry. You’re going to win some – you’re probably going to win more and lose more as a result of that. I mean, that’s just a fact of life. So, I would tell you that our view is embodied in our guidance and other overall growth that we’re showing in ISR and certain products areas, such is REOIR and aircraft mod. Actually if you look at that segment and you take the effect of JOG out, it’s actually growing about 5%.

And we view that as a market that we would like to see steadily grow for us because of the lack of new platforms and the need for upgrade and sustainment on existing. So, both of them are growing markets, but trying to put a number around it is not something that I certainly have the ability to do right now.

Howard Rubel – Jefferies & Co.

No, I understand that. But I mean, it puts additional arrows in your quiver that you haven’t had before. And there’s probably some other competitions that come along now that you have some bonafides that you didn’t have before.

Michael T. Strianese

That’s absolutely true. That’s a good way to look at it, Howard. And also when I said we’ll look at M&A this year, we’re looking to add capabilities in these spaces that future our ability to compete better. So that is true.

Howard Rubel – Jefferies & Co.

And then, kind of taking the same theme, you’ve been kind of bopped on the head a little bit with the Bradley transmission business. And man ground vehicle has been entirely disrupted, but at some point don’t you have, again, a capability of sort of recouping that. And this capability doesn’t go away. I mean, how are you approaching that market and some of the, I’ll call it, changes in the army vehicles?

Michael T. Strianese

Well, a couple of things, one, the requirement hasn’t gone away. You have Bradleys that need transmissions. The reason for the shift in funding and the bop on the head that you called it, was that Bradleys were not being used in Afghanistan. So was no longer a priority. And the funding was moved to other more near term priorities.

Now, there is also a recognition at DOD as said by Secretary Carter, Secretary Lynn and Secretary Gates, that industrial base is important. We are the only supplier of transmissions to Bradleys. So I’m not yet ready to go knock on doors and say, hey, if we don’t order some we’re not going to have them anymore because we can’t afford to keep the plant open. It’s just a volume issue right now. We expect the funding to eventually come back in that space.

Now, when you look at the broader vehicle market, it certainly has space where L-3 would like to have a bigger presence. And doing that in a way that did not necessitate us going out, buy a vehicle company or starting one because obviously that is not a bed we think is in the interest of our shareholders.

But, we also see opportunities in areas like electric propulsion. We have introduced our integrated starter generator that is being trialed now on some of the vehicles that would have been in the former future combat system. But – or the new Humvee as a matter of fact. As well as suspensions. We’re looking at the potential for assimilating some electronic components to come up with what I would refer to as a common vehicle, electronic sweep. So it’s common from vehicle to vehicle. There’s some debate there whether that should be vehicle driven or solider driver. Where somebody comes in and plugs in there own device that takes care of things like, GPS communications, night vision, threat detection and the like. So there’s a lot of electronic content that could be developed and inserted in a family of new vehicles. And that is certainly a space that we will continue to look at and get into.

And our electronic actuated suspension systems are getting more noticed now because of the up arming of everything is causing center of gravity and tipping issues. So the electronic controlled suspension center or ECASS is starting to get serious look as well. So there is upside there but it’s been a long road to get anything, any traction in this area.

Howard Rubel – Jefferies & Co.

Thank you, Mike.

Operator

Ladies and gentlemen, our final question of the day comes from the line of Michael Lewis with BB&T Capital Markets.

Michael Lewis – BB&T Capital Markets

I read the draft QDR yesterday. Mike, the theme throughout the document was the use of ground, air and underwater unmanned vehicles. So we know where you stand with regard to the aerial systems. I wanted to know if you could size your market opportunity for us on the ground and underwater unmanned vehicle market place? And what’s out there in front of your right now?

Michael T. Strianese

That’s a hard one because there are no real programs that I’m aware of in unmanned vehicles of any significant. And the undersea areas that we’ve been involved with have to do with un-tethered mine detection vehicles. Which have been very small to date.

Now, not having the benefit of reading the QDR as you have, it’s hard for me to envision that as being a driver in both undersea and land in the short term. But in the long term it could be a significant driver for us. Just because of the components and subsystems that we would have available. And potentially even developing our own vehicle in that sense. Because we’ve done that on the airborne side with our Lobius (ph) and UAV Viking product.

So that would include again, traditional data links, com systems, ground stations, etcetera. But it’s hard to put anything around it without any real programs or record yet in that space.

Michael Lewis – BB&T Capital Markets

Okay. I agree there. Just a quick question on government services. What is the pricing environment look like? Are you seeing any situations where the government is coming in with a reverse option type methodology on pricing for contracts?

Michael T. Strianese

No. We haven’t. I could give you a little color in that space. As you know, there were a couple of things going on last year. One there was a concern about how the government would apply OCI rules and prevented some bidding on certain work across the industry. Number two, there was a concern about what was known as the in sourcing of contracts. Where the stated objective of adding 30,000-40,000 people to DOD would be taken from industry. There’s been some clarity in those two areas. One, the OCI legislation that had been served up from the Hill is probably not going to be what gets done. Which was very onerous for both the DOD and industry to live with. In fact you saw a significant divestiture last year from one of the major players in that space.

So there will be guidance that should come out, if I recall, next week. They said around February 1.. We think the DOD and the industry can live with. And with that clarity we should be able to move forward a little bit better.

In addition, the in sourcing, well, at least 10,000 of those jobs have to do with cost estimators, contract specialists, accountants, attorneys, etcetera, that are not coming from the industry. In fact, they’re new hires that are coming out of the non-contractor world. So it’s taken a little pressure off us on that as well.

In terms of the competitiveness, I think that the government doesn’t have to do anything because everybody in the industry seems to be showing up for every competition because the air was getting a little thin. And that aspect of it’s been taken care of itself.

Now, having said that, our margins have been relatively stable in our services. It has to do with the top of the type of services we offer, which I would call more in the non-commodity type work. It’s not just body shop work, if you will. It’s very specialized work, whether it’s military training, nation building, or it has to do with some of the clearance cleared work that we do for the three letter agencies, or some of the scientific engineering work that we do in the US. I mean, this is special work force that we have. So we’re able to pretty much not have to drop off pricing into the 3%-4% range as you might see on our typical IT contract.

So I think our services will stabilize this year. We’re hopeful to see how it develops throughout 2010.

Michael Lewis – BB&T Capital Markets

That’s helpful. Thank you very much.

Operator

Ladies and gentlemen, this concludes today’s question and answer session. I would now like to turn the call over to management for closing remarks.

Michael T. Strianese

Okay. Well, I thank you for joining us. And again, it’s still January, there’s both tail winds and head winds this year. Last year only looked like head winds when we had this call a year ago. And there were concerns persisted about the future of spending. I think I would characterize the environment that we’re operating in as stable. There are shifting priorities. And it’s getting more and more important to look at below the top line in what the individual areas that are going to get funded and go forward will include.

As we’ve been saying, I think we’re well positioned to do well in this environment and look forward to talking to you in the second quarter and providing a further update. So, thank you.

Operator

Thank your for your participation in today’s conference. This concludes your presentation and you may now disconnect. Have a great day.

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