Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

L-3 Communications Holdings (NYSE:LLL)

Q2 2010 Earnings Call

July 27, 2010 11:00 am ET

Executives

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

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

Eric Boyriven - Investor Relations

Analysts

Cai Von Rumohr - Cowen and Company, LLC

Howard Rubel - Jefferies & Company, Inc.

George Shapiro - Citi

Joseph Nadol - JP Morgan Chase & Co

Ronald Epstein - BofA Merrill Lynch

Robert Spingarn - Crédit Suisse AG

Myles Walton - Deutsche Bank AG

Troy Lahr - Stifel, Nicolaus & Co., Inc.

Operator

Good day, ladies and gentlemen, and welcome to the L-3 Communications Second Quarter 2010 Earnings Conference Call. My name is Stacy, and I'll be your conference moderator for today. [Operator Instructions] I would now like to turn the presentation over to your host for today's call, Mr. Eric Boyriven of FD. Please proceed.

Eric Boyriven

Good morning, and thanks for joining us for L-3 Communications Second Quarter Earnings Conference Call. With me here are Michael Strianese, Chairman, President and Chief Executive Officer; Ralph D'Ambrosio, Vice President and Chief Financial Officer. After the 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 will now turn the call over to Mike Strianese. Mike, please go ahead.

Michael Strianese

Thanks, Eric, and good morning, everyone. Thanks for joining us for our second quarter earnings call. Overall, we had a good second quarter underscored by orders of approximately $4.1 billion. That's up 22% over the 2009 second quarter resulting in a book-to-bill ratio of 1.03, and our backlog grew to over $11 billion at the end of the quarter, about $11.1 billion.

Our earnings per share were $1.95. That's up 7% compared to the 2009 second quarter, when you exclude the $0.09 per share charge we took for our successful debt refinancing, which we did back in May. Operating margins and cash flow, we were particularly happy with, which were very strong.

Overall, sales were up about 1% to $4 billion, with C3ISR continuing to do very well with significant growth. JCA [Joint Cargo Aircraft] sales also grew. And together, these items increased -- sales increases rather, offset some of the declines we had in other areas of the business.

Some of the more significant awards in the second quarter, several of which were competitive included the U.S. Army's C-12 logistics support contract, the space mission data module and the Apache data link. Also, we had numerous follow-on orders on several important legacy programs, including the JCA, UAV Communications Systems, a very strong growth in the EO/IR turrets, Rover ManPacks, our Compass Call program, Afghan training, law enforcement professionals, the Whole Body Imaging systems for airport security, Contract Field Teams, Rivet Joint, the P-3s, Flight School XXI and continuing upticks in our helicopter cabin assemblies.

In terms of major recompetes, we currently have no bids outstanding for major recompetes that will affect 2010 sales. On significant programs, on June 3, we received the fiscal '10 order for eight additional JCA aircrafts bringing the orders to date to 21 aircraft. That order was about $230 million. We expect another eight in fiscal '11. Total U.S. Air Force buy is expected to be 38 aircraft, with the final nine coming in fiscal '12. We expect to deliver four JCAs in 2010, of which two have already been made, bringing the total deliveries now to six airplanes.

We see continued interest, the National Guard is still projecting the need for additional aircraft, so there is a potential for plus ups in fiscal '12. We also feel strongly that if the JCA finds his way over to Afghanistan and gets put into the theater, that there will be continued interest once it gets to perform in the line of duty. There are also several foreign military sales opportunities for JCA, some of which are slipping out a little bit due to government fiscal pressures. But again, the program still has a lot of interest.

For Project Liberty, as you recall, we're modifying 37 MC-12W aircraft for the U.S. Air Force. We have delivered 35 aircraft to date on time, on budget and our deliveries are surpassing the contractual schedule. We expect to deliver the final two aircrafts by October. We look forward to continuing to apply L-3's experience to other small aircraft ISR [Intelligence, Surveillance and Reconnaissance] applications, both within the U.S. DoD and with our international customers.

For example, we are currently expecting the Air Force to expand the Liberty fleet by five aircraft sometime later this year for the fiscal '10 OCO [overseas contingency operations] request. We're also currently competing as a prime for the U.S. Army's EMARSS program.

With regard to the 35 aircraft delivered, they're performing very well. We're told with over 98% mission availability, not one has been lost and we're very proud of that accomplishment, as are the Air Force folks that we're involved with this procurement, so it's been a very successful program.

I mentioned EMARSS, and as you know, the Army is currently proceeding with a competitive procurement for the Enhanced Medium-Altitude Reconnaissance and Surveillance System to focus on a regular warfare missions, which includes SIGINT, COMINT, electro-optical, infrared sensors and communications equipment. EMARSS is the replacement for the canceled ACS, Aerial Common Sensor program, and the possible replacement for the aging Guardrail fleet. EMARSS is expected to be a $1.5 billion five-year program of record.

The configuration is a small aircraft similar to the Liberty MC-12. The initial buy is expected to be four EMD [Engineering and Manufacturing Development ] aircraft, with a four aircraft LRIP [Low Rate Initial Production] option. And it's expected to grow to at least 30 aircrafts, so this is a significant opportunity. Bids were submitted last month, and we expect the Army to make an award by the end of September.

Moving on. The U.K. Air Seeker program, formerly known as Springtime, the letter authorization or LOA for this FFS [full-flight simulator] program was signed by the U.K. MoD [Ministry of Defence] and the U.S. Air Force in March. The Air Seeker will be a significant program for L-3 with $800 million volume over about seven years. The program consists of three U.S. Air Force RC-135 aircraft to replace the U.K. Nimrod ISR fleet. The first aircraft delivered to the MoD is expected to be in April 2014. We expect to receive the first aircraft in Greenville in January 2011. So we're expecting to induct the first aircraft for conversion right after the first of the year. We are already beginning preliminary work on long lead items and planning. We're negotiating with the MoD and expect the conversion kit contract by early next year, and we have received the long lead material contract in the second quarter. The program will be incrementally funded over the seven-year period of performance. In addition, there's expected to be logistics and sustainment activities that will be provided under a separate Air Force MoD agreement. The scope right now for L-3 is the ISR admission data systems, installation, logistics services and sustainment.

In our airport security area, the Whole Body Imaging product is starting to really get a foothold at airport checkpoints. Today, as you know, there's only two qualified vendors in this space. One of them is us, of course. On April 27, we received the TSA [Transportation Security Administration] order for 202 systems valued at $31.7 million. This the first order placed on a five-year ID/IQ contract from the TSA. That whole contract is valued up to $167 million. All 202 of those systems, we expect to deliver in the second half of 2010.

We also expect the next TSA order in the first quarter of 2011. The TSA is stating that future orders of WBI [Whole Body Imaging] systems, are dependent on the testing and acceptance of the order detect software, which is planned to be deployed in the first half of next year. This situation continues to evolve. Obviously, with a new product, and we'll keep you posted as more developments in that space.

In terms of new business opportunities for 2010 and beyond, we continue to have several large new business opportunities, but several of them have moved a little bit to the right, so later in 2010 or the beginning of 2011 because of funding delays. They include EMARSS and the U.K. Air Seeker, which I just told you about; the CNTPO Afghan police training task order competition, which was delayed because of a competitor's successful pre-award protest, the RFP [request for proposal ] was withdrawn and the Army is conducting a full and open competition. The draft RFP for this new single award contract was issued on May 25. The final award is expected in November 2010, with work starting in January '11.

We are evaluating whether to compete here as a prime or teaming as a sub. We'll certainly be in the competition either way. In terms of Linguist, the INSCOM [U.S. Army Intelligence and Security Command] issued the draft RFP back in May, and we expect the final RFP to be released on or about July 30 for the worldwide linguist contract recompete. The new contract is expected to be a multiple award ID/IQ, with several task orders dependent by U.S. contingency operation requirements, which each will be competed. We still expect it to be awarded in the fourth quarter with work starting in March 2011.

The U.S. Army C-12 CLS competition, the update there is we won this contract competitively on June 1. We expected to start the transition on June 2. However, there was a protest filed and it's now a with the GAO [Government Accountability Office]. However, we feel pretty confident that this will be sustained in our favor. Again, with protest, you'll never know. This one, is I'd say is on solid ground, I think.

The Department of State Criminal Justice Programs Support, formerly known as Civilian Police Training. We submitted our proposal last month. We expect an award sometime in the fourth quarter, with work beginning in February 2011.

And finally, the Army CECOM [Communications-Electronics Command] S32G competition, which was slipping to next year and was likely to be segmented into three to five elements, including one element for our existing SSES [U.S. Army systems and software engineering and sustainment] prime contract. We now expect the existing CECOM SSES prime to be recompeted with RFP in November and an award in the first quarter of 2011. Of course, the timing of all these awards could be impacted by protests and procurement delays. So we'll keep you posted on this as more facts develop.

In terms of our capital deployment, we repurchased $131 million of our stock in the second quarter. Our remaining authorization was about $172 million at the end of the quarter. On July 13, our Board authorized a new $1 billion share repurchase program that should cover us through December of 2012. So we surely will be active in being opportunistic in repurchasing our shares, when we believe they represent a good buying opportunity for the company.

With respect to acquisitions, as you know, we acquired Insight Technology on April 14 for $613 million, and continue to evaluate several other companies. We currently have some very good opportunities, and we expect to have a couple of more acquisitions in 2010 just based on the pipeline, we're certainly in a different place from we were last year, where acquisitions all but ceased due to the market conditions.

Overall, in terms of our balance sheet, our liquidity is excellent and even stronger with our recent debt refinancing of $800 million. So as you've seen, we've updated our 2010 guidance to date. The new EPS range is $8.05 to $8.25 a share, up 7% at the midpoint versus 2009. Ralph will take you through some of the details of on the update. Of course, it reflects the loss of the JOG [Joint Operations Group] program, as well as the charge for the debt refinancing. We're expecting sales to come in at about $16 billion to $16.1 billion, again up 3% at the midpoint.

The other item I'd like to talk about, which is reflected in this, is the SSP [Special Support Programs] division or JOG temporary suspension and the Integrated Systems LP show clause. As we mentioned in our release this morning, we expect to execute an agreement with the Air Force today, under which the Air Force will lift the suspension of L-3 Special Support Programs division, and the Air Force will agree also to not suspend the Integrated Systems. I can tell you that agreement has already been executed this morning, and we're happy to have concluded that matter.

As far as the DoD budget is concerned, the budget remains healthy and robust with modest base budget growth plus the OCO supplementals. Of course, Iraq and Afghanistan continue to determine near-term resource decisions, and constraints continue as reflected by the fact that there are few new starts, and we expect future funding rationing and reprogramming to continue. The tightened budget situations has been underscored recently by Secretary of Defense Gates [Robert Gates] And Under Sectary Carter's [Ashton Carter] comments.

Back in May, in his Eisenhower Library speech, Secretary Gates said, that given America's difficult economic circumstances and fiscal conditions, military spending should expect closer, harsher scrutiny. The secretary wants to reduce overhead cost and transfer those savings to pay for future, force structure and modernization, and to accomplish the equivalent of Gates vision of 2% to 3% real budget growth for modernization and capability.

Under Secretary Carter's acquisition memorandum, he focused on eliminating unproductive, low performing programs, redundant programs and low-value overhead. The objectives include delivering the needed war fighter capability within the DoD budget, as well as restoring affordability to defense procurement. In essence, doing more without more, and we support those efforts.

More importantly, the objective here would be to avoid the program turbulence and the funding turbulence that causes these unexpected starts and stops and creates tremendous difficulty and inefficiency in our industry. And that goal is one that we really support, as does the whole industry. The ultimate goal of course is to maintain a vibrant and financially healthy defense industry in the U.S.

The implication for the defense industry, therefore, is to be a responsible partner for the government, and the community must outperform our contract schedules and cost objectives. Of course, the geopolitical scene remains complex and fluid and will likely continue to require a healthy DoD budget, and I think we can all agree that national security is not an option. Therefore, the industry should be okay going forward, provided the defense community take a disciplined approach to Gates' comments and Secretary Carter's memorandum, which we will.

Overall, L-3's portfolio of businesses and capabilities plus our strong program performance and quick-reaction culture are well positioned for the new and evolving DoD priorities and procurement processes.

In conclusion, overall, we believe we'll continue to thrive and grow in a new emerging greater efficiency environment. Our culture and dedication to outstanding program performance, on meeting budgets, achieving and exceeding delivery schedules plus the quick-reaction capabilities that we demonstrated on Project Liberty positions us well. Our strong ISR EO/IR and intelligence support market positions will continue to drive growth, as well our broad portfolio of products and services that sustain, maintain and upgrade and enhance existing platforms.

Our balance sheet and cash flows as I said are very strong, and we can use them to augment our organic growth and increase shareholder value through acquisitions, share repurchases, dividend increases as we have been doing. So overall, we are positive on the outlook, and we think that growth will continue although at lower rates than we've been used to over the past decades.

That concludes my remarks. Ralph will give you some financial detail, and then we'll be happy to take your questions.

Ralph D'Ambrosio

Thank you, Mike. I'll highlight some key trends in the second quarter results, review the changes to our full year financial guidance and finish with some comments about the capital structure.

We had a solid second quarter results attributable to good growth and operating income, which was up 6%. And that was driven primarily by very strong margin performance plus 1% sales growth. That growth in operating income drove increases in earnings per share and continued strong cash flow, which again, exceeded net income.

Diluted earnings per share was $1.95, and that included a debt refinancing charge and related incremental interest expense of $0.09 per share. Excluding these debt retirement costs, EPS was up 7% over last year's second quarter.

With respect to sales, second quarter consolidated sales grew $37 million or 1% to $3,966,000,000. At the segment level, growth in C3ISR and Aircraft Modernization and Maintenance was largely offset by declines in Government Services and Electronic Systems.

C3ISR segment sales grew 7%, led by growth on Project Liberty. We expect growth to exceed 10% in the second half with increases on ROVER, Phoenix, small aircraft ISR programs and classified airborne ISR work. Our second quarter Aircraft Modernization and Maintenance segment sales grew 9% versus 2Q of last year and that was mostly due to the Joint Cargo Aircraft, which increased by $73 million.

Additionally, gains on the Fort Rucker fleet support contract, MHP [Maritime Helicopter Project] and gunship modifications were offset by declines on SOFSA [Special Operations Forces Support Activity] and Contract Field Teams. The SOFSA contract loss will be a drag on second half sales growth, as will the quarterly timing on JCA sales.

In Government Services, sales declined by 4%, and that was driven by two items. Again, we had the negative comparison on the lower subcontract pass through sales on the Army SSES task orders, as well as the lower sales on Linguist contract. We expect growth to improve in the second half because of easier comparisons versus 2009 for SSES and Linguist. And also, growth from a large competitively won classified IT contract that we started working on in April.

In Electronic Systems, sales decreased 2%. What happened there was growth in EO/IR, Security & Detection Systems and Microwave Communications was offset by declines in Combat Propulsion Systems due primarily to the Bradley Fighting Vehicle funding cuts, simulation and training, undersea warfare due to work near completion on certain contracts and also the Marine & Power Systems driven by lower commercial ship building product sales. Sales in Security & Detection Systems increased by $16 million primarily due to the international eXaminer sales that slipped out in the first quarter into the second quarter.

Moving on to operating margin. Consolidated margin was very strong at 11.1%, up 50 basis points versus the second quarter of last year. Margins expanded significantly in Electronic Systems. We had improvement in contract performance and continued better, higher profit margins sales mix. Margin was weaker in Government Services on some timing items and continued competitive pricing pressure that we're seeing in that segment. Overall, we continue to make good progress on expanding our margins. Free cash flow for the quarter was very strong at $281 million, and that's on track with our full year estimate of $1,260,000,000 of free cash flow.

Moving on to the 2010 financial guidance update. We lowered our earnings per share estimate by $0.08 on both the low end and high end, making the new guidance range $8.05 to $8.25.

At the midpoint, three items primarily caused the decrease: First, we had the debt redemption charges of $0.09; secondly, the SOFSA contract loss will subtract $0.04, and those two were partially offset by the higher estimated operating margins for Electronic Systems and C3ISR, which will increase EPS by $0.05. And on the debt retirement charges, I'll add, that prospectively, that refinancing is going to reduce our annual interest cost by about $11 million or $0.06 per share, and we'll see that fully once we get to next year.

With respect to sales, we lowered our consolidated sales guidance by $200 million, making the new range $16.0 billion to $16.1 billion. At the segment level, we reduced sales guidance by $200 million for Aircraft Modernization and Maintenance. That's due to the $150 million of lower sales that we expect to generate in the SOFSA contract, with it going away sooner than we expected.

And we also lowered Electronic Systems segment sales by $100 million due to a few items: First, the recent weakening of the euro currency will cause us to translate euro-denominated sales into about $35 million less of U.S. dollar sales. And we also had some reductions coming from order and procurement delays that we're experiencing in the Training & Simulation Devices and Combat Propulsion Systems business areas, and it's both with DoD and foreign customers. And then lastly, there was a surprise funding cut on the profit program in our Microwave Communications business area.

With respect to the operating margins, we raised the guidance by 10 basis points to 10.9% due to the strength in Electronic Systems and C3ISR, and so we now expect margins to expand by 30 basis points on a consolidated basis this year versus last year.

Looking at the third quarter, we currently expect sales to be slightly above $4 billion, with earnings per share of about $2 and free cash flow of about $200 million. The third quarter will also include debt refinancing charges of $0.02 related to the $400 million of subordinated notes that we redeemed on July 15.

The book to bill in the third quarter is going to be below 1.0, and we expected to rebound in the fourth quarter. It's due mostly to timing and anticipated orders in the second half. Also, our third quarter will close on September 24, leaving four business days on the month of September, moving into our Q4, and we expect to book a lot of orders toward the end of the month of September. And for the full year, we still expect the book-to-bill ratio to be about 1.0.

Mike gave you the highlights on the balance sheet. We have ample cash. We expect to end the year with about $1 billion. That's after repurchasing $0.5 billion of our common stock, paying our dividends and paying for the Insight acquisition. We have $1 billion revolver. So overall, we have a very strong balance sheet with ample liquidity.

And that concludes my comments. We'll go now to the Q&A. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Cai Von Rumohr with Cowen and Company.

Cai Von Rumohr - Cowen and Company, LLC

One thing you didn't mentioned was international potential for Project Liberty type aircraft. Could you comment on what other potentials you might have there?

Michael Strianese

Yes, Cai. There is international interest. Broad international interest for the small, ISR-type aircraft with varying levels of capability and sensors and comm [communication] systems, some of which are in the classified space right now, so I can't give you specific customers. But I will tell you that there are interests that have been expressed from several countries wishing for this capability. And this is one you're going to have to be patient with us, and we'll provide you future updates. As you know, these foreign sales takes a couple of quarters. So it's not going to be something that will happen next week, but it's something that I hope to see some activity by the end of the year. In terms of number of aircraft and the like, most initial buys are probably going to be for modest numbers, three, five or whatever, depending on the application. And by that, the applications are anything from border, coastal control, internal security, monitoring critical assets, power plants, water supply. Your imagination can kind of fill in the blanks on that. But we've been very pleased to see that there's been a growing interest.

Cai Von Rumohr - Cowen and Company, LLC

And you mentioned that the margins were particularly good in Electronics because of better performance on EO/IR. Could you give us some color, where were the EO/IR margins and kind of what should we expect for sales and margins for that sector for the year?

Ralph D'Ambrosio

Well, the margins were strictly strong in the airborne ISR, airborne EO/IR work that we do, including on Aerostats, Cai. And the mix across the products that was done has turned out to be very favorable. We're expecting the margins to be a little lower in the second half, at least that's what's implied in our guidance update for Electronic Systems. And frankly, we have some upside on that account, so long as the mix holds up.

Cai Von Rumohr - Cowen and Company, LLC

Maybe update us where pension might be next year, if we close kind of where we are today? And kind of you mentioned the four business days kind of slipping. How many business days did you have in the second and you expect in the third and fourth quarters, just so we can account that?

Ralph D'Ambrosio

Well, your first question was on pension. This year, our FAS expense is $148 million. If conditions hold up in the financial and credit markets in line to where they are about today, pension expense should be about the same next year. The actual return is lagging the assumption a little bit but not by a lot. So we'll have a better update on the pension once we get to the latter part of the year. And certainly, we'll have an update on the 3Q call. With respect to the days in the quarter, in Q3, I just was pointing out that we tend to book a lot of orders right at the month end in September. And it just so happens that this year in Q3, we're going to close on September 24, and we're going to have four business days that happened in September that fall into our Q4. That's the only anomaly in the orders. There isn't much of the delta in terms of days, when it comes to the other results metrics.

Operator

Your next question comes from the line of Rob Spingarn with Crédit Suisse.

Robert Spingarn - Crédit Suisse AG

I'm not sure, Mike, if this is for you, maybe it's for you, Ralph. But on Government Systems, I wanted to talk about the trend over the last several quarters recognizing that you've had this reclassification. But it seems like we have a 5% adjustment upward in the second and fourth quarters over, let's call it, the last six in revenues. So it's about, $1 billion and about $1.050 billion and then down to $1 billion again. We had a lower first quarter here and there were back up again in the second quarter. Is there a seasonality to this? And then, if you could speak to the margin guidance for the year relative to what you've done in the first half.

Ralph D'Ambrosio

Well, in Government Services, a couple of things that I commented on an earlier were, that we've had some negative comparisons in the first half on the CECOM SSES/S3 contract in Linguist. And those negative comparisons are going to be less in the second half. So that's going to improve the growth rate on its own. And then, we also won a large contract in the classified IT area that will ultimately again do $100 million a year on sales on it. That started in April. So we're going to have the full impact of that new business in the second half. So those are going to be the major items reversing the sales trends in the Government Services segment.

Robert Spingarn - Crédit Suisse AG

It would seem, Ralph, that you would need to have an incremental $100 million in one of these forward quarters, in order to hit the midpoint of your revenue guidance of $4 billion to $4.1 billion. You have to have a quarter at $1.1 billion.

Ralph D'Ambrosio

Close to it.

Robert Spingarn - Crédit Suisse AG

So we should be looking for that when? Is that a fourth quarter event? It just seem sizable, and is it all attached to this one contract?

Ralph D'Ambrosio

Well, we did about $1 billion in second quarter in the segment. Sales should be about $50 million higher in Q3, and then approach $1.1 billion in 4Q on Government Services.

Robert Spingarn - Crédit Suisse AG

And then, Mike, if you could just give us some sense of the size of the international opportunity for JCA?

Michael Strianese

Size? I've quoted in terms of the level of interest, the number of aircrafts anywhere from say, 15 to 25 aircraft. But again, Rob, that's not a closed-in opportunity. That opportunity is going to be spread out over numbers of years. And of course, the production schedule, as we know it now, is essentially consumed by our U.S. customer, the U.S. Air Force, and they are top priority to get these planes delivered in accordance with the contract. So the result of that would be that these international opportunities would certainly fill the outyear pipeline, if you will, which we're happy with, and we'll see where that goes. But there's been numerous letters of interests coming from all parts of the world, certainly, places like Canada or Australia, places in Africa, et cetera, where the application has been everything from search and rescue to that west tactical mile transport and even the possibility of putting ISR packages on the airplane, as well as the potential for a gunship version for the U.S. So it's not only the international, but it's the varying potential even in the U.S. that should provide some legs to this. As you know, when the initial quantities got reduced from mid-70s to the current 37, 38 airplanes, our partner, Finmeccanica's decision was to not proceed with the production facility in Florida, and that has constrained the production capability, the quantity that you can produce in Europe for the short term, anyway. I'm hoping that, that gets readdressed given the interest we have, and that can get increased at some point in time. But right now, this is going to be slow and steady for a while.

Robert Spingarn - Crédit Suisse AG

And then just finally, on the agreement with the Air Force, does this fully close the book here? Are there any changes in oversight that we should expect going forward?

Michael Strianese

Well, as with any administrative agreement, there are. But let me cover that for you. First of all, it means that neither SSPD or Integrated Systems will be prevented from pursuing any business opportunities or accepting new contracts, and we anticipate that the actual suspension of SSPD is going to be lifted today. What it means in terms of what we need to do is L-3 has agreed to conduct some additional training and provide certain reporting information to the Air Force during the three-year term of the agreement. And there's a number of things that we will do in support of that. I guess, I'd like to also point out that within the agreement, I mean, this is kind of an unfortunate set of circumstances, but I'm happy to tell you that although there is an ongoing investigation and evidence in the record to date indicates that government emails were not intentionally journaled and no L-3 employee reviewed, opened or used any government e-mails, and therefore, we expect this to be closed in time as the agencies do their jobs. But in terms of any penalties or fines, there aren't any, except we did agree to pay restitution for the employees' time spent and fee associated with these email issues of approximately $273,000, as well as reimbursing the Air Force for its investigative cost of about $60,000. So as you know, we take matters like this very seriously. Our people, including my office staff and part of this immediately, we don't like to hear things happening within the company. We pride ourselves on running a very tight ethics program but only in that, by having a very, very tied up. It's culture within L-3. So any type of issue like this comes up with deep concern to me personally, and I get in front of it. And I would have to credit not only our folks for their cooperation and support with the government in their investigation and getting this done, but also, the support and the cooperation and attention paid by the Air Force Office of the Deputy General Counsel and really working with us, and I'm talking about evenings and weekends to get this resolved and get the settlement in place. And I think we did as good as we could have done in the circumstances.

Operator

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

George Shapiro - Citi

First question, the book to bill for C3I has been about one for the past 12 months. On Project Liberty, delivery's winding down, and yet, the growth has got to accelerate some in the second half to 10% to get the low end of your guidance of 3%, 4% and a little bit more to get the high end. So what's going to happen to allow that to occur?

Ralph D'Ambrosio

Well, in the second half, we're going to book a number of orders, both on legacy programs, stuff like Rivet Joint, and we're also going to book new orders on Project Liberty, some classified work. There's been a bit of a timing issue as to when we book the orders. And also, on the U.K., Air Seeker, which used to be called Springtime, we'll also expect to start booking orders on that in the second half into next year.

George Shapiro - Citi

So you're pretty comfortable, Ralph, we'll see that acceleration in the growth rate?

Ralph D'Ambrosio

Yes, we expect the bookings to improve in C3ISR in the second half.

George Shapiro - Citi

And then just maybe a little more gen one, but Carter's proposal is to phase out time-and-material contracts because I think it's somewhere around 15% of your sales. What kind of impact, if any, do you expect to see?

Ralph D'Ambrosio

Well, the marginal impact will be that -- now a lot of that T&M work is going to convert to cost reimbursable contracts. And as you know, you can't earn lower profit margins on cost reimbursable work versus time and material, so the incremental impact would be that, lower margins on that type of work. Most of our T&M work today is in the Government Services and Aircraft Mod and Maintenance segments, but we're anticipating our margins to continue to expand in the other two segments, which is where we do most of our hardware and systems work, and a lot of that is on fixed-price terms.

George Shapiro - Citi

The aircraft A&M margin was a little lower than I thought. I mean, it almost seems like you got to be booked in the JCA close to zero, some minimal profit I would guess.

Ralph D'Ambrosio

Well, your guess is pretty good. It's the profit margins, very low on JCA.

Operator

Your next question comes from the line of Ron Epstein with Bank of America Merrill Lynch.

Ronald Epstein - BofA Merrill Lynch

On the international front, it seems like a lot of companies have been focusing that direction. It seems like there's more activity on the international front. Have you seen increased competition in the competitions that you've entered internationally?

Michael Strianese

No, we don't.

Ralph D'Ambrosio

Ron, most of the work that we compete for internationally is in the systems hardware area. And there's fewer competitors, just for that reason alone, and we tend to see the same competitors today as we have in the past.

Michael Strianese

A probably specific question is are there more companies entering the spaces we're in? Yes, the answer is not yet. And given the barriers to entry in many of the things we do, probably not expected unless companies want to invest in markets that are not expanding exponentially right now. And we have strong, strong, incumbency positions in everything from data links to our sensors to our integration capabilities and the like. So there are competitors but usually the same companies every time.

Ronald Epstein - BofA Merrill Lynch

On the M&A front, it seems like there's a lot of activity going on right now, folks trying to sell businesses, spin businesses, a lot of things going on. Is there anything out there that is attractive to you guys? I mean, has the M&A marketplace changed much in the last couple of months?

Michael Strianese

Well, you're absolutely right, Ron. There are more companies that have been brought to market this year. Last year was probably the lowest defense M&A year in a decade. And when you compare it to last year, it's turned around 180 degrees. We don't comment on specific opportunities, but I will tell you that we are actively looking at, at least two or three companies where we're in various stages of due diligence. They were all competitive auction-type scenarios, so we will stay disciplined on prices we're willing to pay, but we're very focused on the areas that we're looking to expand in. And cite some great example of that, and before that, a couple of years back, we bought the EOS business, electro-optical systems business from Northrop Grumman, demonstrating our desire to continue to grow that space within L-3. So we're following a model we've always followed. Given our liquidity and capital resources, we're prepared for medium, larger -- I mean, we're flexible, and we will be opportunistic in that area. But I could tell you, we're going to stay disciplined on price and be mindful of sticking to areas that we are committed to that we think they're going to grow.

Ronald Epstein - BofA Merrill Lynch

And maybe one follow-on to that, I mean, how are prices now in the private marketplace?

Michael Strianese

Well, there's a bid and an ask, and I could tell you, there's a gap. We thought that we had a fair price on our Insight acquisition in terms of the multiple given the company's performing and growth prospects. I think you saw our deal announced over the past month or so about Argon ST with Boeing. That's more than we would have liked to have paid for a company of that type. So what I want to pay is not necessarily what the market is going to do at certain circumstances, but I think that there's kind of a scarcity premium there for certain technologies. So depending on where you are, I'd say if anything has cyber attached to its name, or ISR in a sense, the growth there is they're going to tend to be at multiples, probably north of 10%, and other things that have slower growth are going to be well below 10%. My comments aren't all-inclusive. I'm giving you examples just to show you there is a pretty big scale depending on what space you're in.

Ronald Epstein - BofA Merrill Lynch

And then, Ralph, just maybe one quick one for you, I might have missed this, but usually, you give us orders by segment. Did you through that? If not, could you?

Ralph D'Ambrosio

Sure, orders were $800 million in C3ISR, $1,076,000,000 in Government Services, $915 million in Aircraft Modernization and Maintenance and just under $1.3 billion in Electronic Systems. Consolidated was $4,068,000,000.

Operator

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

Joseph Nadol - JP Morgan Chase & Co

On the orders for the year, just wondering, I guess, two things, how we think about EMARSS in that context? That looks like it might be a Q4 order if you win because of their early close to Q3?

Ralph D'Ambrosio

That's correct.

Joseph Nadol - JP Morgan Chase & Co

And do you have to win that to hit your 1.0 for the year?

Michael Strianese

No, we do have something in our forecast for EMARSS, but it's factored, so it's a bulk number.

Joseph Nadol - JP Morgan Chase & Co

Okay, so you can still get there even if you don't win? Because I know you have a strong offering there, but that's a multi-handed competition obviously.

Michael Strianese

Joe, you're right. It's a heavily competed program but certainly not in our numbers that it is award value at all.

Joseph Nadol - JP Morgan Chase & Co

And so then as we think about just in that context next year, so we're at 1.0, I think we're in the 1.04, I think, last year range. Mike, you mentioned that some things are slipping to the right. Too early for sales guidance I know, but what are you thinking here? Is it low single-digit growth next year? Can you continue to grow C3 at double digit or close?

Michael Strianese

The outlook now -- and you're right, it's too early for guidance, but we're hoping to see growth in C3ISR. Remember, the CAGR there has been about 15% over the last five years, not going to be 15% going forward. That I could tell you absolutely is true. How much lower? I don't know. I can't sign up to 8% to 10% yet. I think it'll stay close to double digits based on the level of activity we see today. But as you know, we'll give you some solid guidance when we do our third quarter call in October. Then we'll give you the guidance when we see one in the Investor Day in December. But the things that are more problematic though, they're slipping to the right and everything were pushed. The services side where things are getting -- two things are going on there, maybe more than two things. One is everything is more competitive as everybody's competing on everything to the extent they can. And number two, a lot of the larger programs, when they come up to recompete are being broken up into IDIQs with past quarters. So it creates a much more competitive environment for lower dollar opportunities. AM&M, we're going to have a headwind from JOG for the next year, as you know. But if you break that segment into two pieces, the service side, if you will, the base support versus the actual life extension of an air frame and modernization, the modernization side should start to continue to grow in the mid-single digits, but we're going to have a negative on the service side. And products is mixed now. We have headwinds on the Marine & Power Systems because of the substantial slowdown in the commercial shipbuilding area. Only things that are showing signs of life at the moment are cruise ships and the offshore oil work. Compounding that is the euro weakening, which our operations are done in euros, so that's a bit of headwind. The Combat Propulsion Systems business with the Bradleys is also a headwind in the segment. But going the other way, there's strong growth in EO/IR and a number of other areas and products. So products should probably stay again, mid- to lower-single digits. So I gave you a lot of color and long answer. Where we are now is we continue to see low- to mid-single-digit growth looking out into 2011 at this point. And we'll be mindful that we're going to be updating that as we get to the third quarter because things can change depending on slippages and the like.

Joseph Nadol - JP Morgan Chase & Co

Mike, on the U.K., you booked the long-lead contract in the quarter. We had a change of government. It looks like a lot of, sort of issues, I guess, with the MOD budget here, a contract cancellation for another U.S. contractor recently. It's one of the things they've been saying. Are you confident that Springtime's going to go forward?

Michael Strianese

I am confident that it's going to go forward, Joe. As you might know, last week was Farnborough [Farnborough Air Show], and I was over there for the week. And I'd like to tell you the mood is yes, people are worried about programs being canceled and renegotiated. However, the feedback that I have hearing on that this is a solid requirement that is supported and is going forward. It's also viewed by the MOD as a very necessary capability that they don't have anymore because that Nimrod fleet is being phased out. And in terms of alternatives, being part of a fleet of 20 airplanes -- consider the U.S. fleet of 17 plus the three we're to deliver, it's a much better leveraging of technology than trying to build a fleet of three. So on top of that, the U.K., the Royal Air Force personnel, are going to begin some training exercises with the U.S. Air Force, being resident on the U.S. Rivet Joint airplanes now, so that they'll be able to hit the ground running when these planes get delivered. And finally, I'm very confident, expressed my confidence in our Integrated Systems business unit's ability to deliver these programs to the U.K. on time and on budget, which is, as you know, important at a time when they're facing such fiscal constraints. So all in all, we think they recognized the value in this contract, and it's a capability that they will lose if this doesn't go forward. So I am confident.

Joseph Nadol - JP Morgan Chase & Co

Ralph, you're at 8.3% for the first half of the year, and Government Services margin, your guidance at 100 bps higher than that, so you have to do over 10% in the second half. How do you get there?

Ralph D'Ambrosio

Well, we get there two ways, Joe. First, the higher volume is going to translate into incrementally higher operating margin because we period expense virtually all of our SG&A and overhead in that segment. And there's a couple of significant programs, and once you get toward the end of this year, we should have retired some risk on those programs, and that should enable us to realize some profit improvement on a couple of large contracts.

Joseph Nadol - JP Morgan Chase & Co

Can you quantify what key adjustments, anticipated key adjustments are?

Ralph D'Ambrosio

Well, it's probably going to raise the margins by over 100 bps in the segment.

Operator

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

Howard Rubel - Jefferies & Company, Inc.

Mike, first, just to go back to the M&A market for a moment, have you thought about selling some assets? I mean, if some of the parts is greater than the whole, maybe there's some value in doing that?

Michael Strianese

Yes, Howard, as you know, over the past couple of years, we've shed some smaller segments that really were not aligned with any of our core capabilities. We have identified a couple of more small, that I mean small, business units. I mean, we're always looking to improve the portfolio. Given that, I could tell you that there's nothing, at this point, that I would view as significant. But that could change because there is, I think, what you're going to see here some rationalization among companies where one contractor may decide that their business, their asset is worth more to somebody else, and rather trade out of something and trade into something where it's more core. And that's something that we're just starting to look at to see if there's anything there that makes sense. Of course, we're also looking to add to places like ISR, EO/IR systems, training and simulation, et cetera, areas that we have a very strong position in, in areas where we can buy something and actually make it more valuable. So right now, there's nothing significant on the table.

Howard Rubel - Jefferies & Company, Inc.

Just to follow that, the Pentagon seems to be dragging its feet in awarding contracts, and they seem also to be changing the risk profile so that all of the contractors are bearing more risk or taking more undefinitized contracts and then getting a lower profitability later. How are you working that through so that this doesn't show up as lower returns for shareholders?

Michael Strianese

Well, first of all, we're not really seeing there are any significant impact on CI from that activity. In terms of pushing more risks to contractors in undefinitized contracts, we've been very disciplined over our lives here 12, 13 years on our program performance, and, knock on wood, where program performance has been pretty good over that period of time. I can't recall any major leaders, if you will, in programs. So I don't think that we're going to see wholesale pushdown of fixed price development work to companies because one, I don't think that we have that. The industry has the risk tolerance to do that, and at the same time, we're not going to take on that kind of risk and not get paid for it. But I would tell you, sometimes, no matter what the fee is, the risks would not be worthwhile. I will tell you though, I think that there's more rationality, that's what's going on at the Pentagon, and with the way they're looking at things, then I expect a reasonable approach. So what I mean by that is that the art here is where to draw the line between when a contract transitions from a cost-plus development to a production. And there's some tension on where that line should be drawn, and that, we're going to have to be disciplined with. And so the answer is we're going to stay focused on more margins and on program performance as we always have, and I don't see anything now that's going to cause any changes there for us.

Howard Rubel - Jefferies & Company, Inc.

And so like, if I kind of asked you to, like, rank programs, green, yellow, red, say, that you don't have any red programs today, maybe a few yellow and something like that?

Michael Strianese

That's absolutely correct. A couple of yellows and no reds.

Howard Rubel - Jefferies & Company, Inc.

And then finally, you do have modest Commercial businesses either in as you talk about marine or in aircraft. Are you starting to see a change in the orders there as well? And have you situated the business so I can take care of the opportunity for upside of those volumes?

Michael Strianese

Yes, we've obviously rightsized the -- to rationalize both those businesses over 2009 and early 2010, but they're two different stories. One, the commercial aviation or our Avionics segment is actually going to have a modest uptick this year. More importantly, we're carefully watching the decisions being made about the government funding of this next-gen equipment, the equipment that goes on the airplane, as well as the Ground segment because we are a major supplier of the airborne equipment. This is for ADS-B [Automatic Dependent Surveillance - Broadcast], and we are hopeful that there'll be an acceleration in that capability, and we are prepared to ramp up if and when that happens. And I'm hoping we'll see it happen over the next six months. That's something -- it's done there. It's been on the table in Congress and at the FAA [Federal Aviation Administration], and it is a good chance if that does happen. The Marine & Power Systems Group, it's more of a longer cycle because of the international nature of the shipbuilding. So we have plenty of lead time to start to ramp up, but right now, the way it is, the new orders for bulk carriers, if you will, and everything is slow because there's a lot of excess capacity. If you've looked outside of Singapore, it's a parking lot of cargo ship sitting there, and until they get back to work and operators start to see demand that warrants new shipbuilding, that's going to be slow. So the business isn't at zero. The business is still a significant business, but the growth is out of it for the short term anyway.

Operator

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

Troy Lahr - Stifel, Nicolaus & Co., Inc.

Just wondering if you guys can touch on the margins again at electronics in the back half, why did they fall off? I mean, you guys were averaging close to 14% in the first half, and you're going through maybe a high 11% in the back half. I guess you said there's some conservatism in there, but what's the next that's going on?

Ralph D'Ambrosio

Well, there is some conservatism in there, Troy. We're expecting to start some new work in the second half that has lower margins, number one. And number two, we're holding a cushion there in case we see some more of sort of passing the top line in the second half in Electronic Systems. So we're planning conservatism there, and it makes sense at this point to do that.

Troy Lahr - Stifel, Nicolaus & Co., Inc.

And for 2011, can you just maybe refresh us with what recompete you have coming through? I thought that there wasn't that much, is that correct?

Ralph D'Ambrosio

There's nothing on a scale of a SOFSA-type contract or the years before that on Linguist. But one of the big programs that we're going to recompete early next year is the P-3 modification work that we do in the Aircraft Modernization and Maintenance segment. That's about $90 million a year in sales. So that's going to be one of the important recompetitions that happens next year.

Troy Lahr - Stifel, Nicolaus & Co., Inc.

And then lastly, just Iraq and Afghanistan sales, are those now tracking to maybe about $1 billion in revenues for the year? And maybe kind of what should we think for 2011, just combined Iraq and Afghanistan?

Ralph D'Ambrosio

Well, last update that we gave you on the first quarter call had Iraq and Afghanistan at about $1.2 billion for this year. With the early loss of the SOFSA contract, it's going to be down a little bit from those amounts but not $200 million. Still somewhere between $1.1 billion and $1.2 billion.

Troy Lahr - Stifel, Nicolaus & Co., Inc.

And thoughts for next year?

Ralph D'Ambrosio

Next year, Iraq work likely declines somewhere between $115 million to $300 million depending on how quickly the drawdown happens and to what extent it happens. And the Afghan work just stay where it is this year, and if we win some of those large contract competitions that Mike talked about earlier, we can actually see an uptick in the Afghanistan sales.

Operator

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

Myles Walton - Deutsche Bank AG

Mike, just a quick question, clarification, I'm not sure I heard it right, the share repurchase authorization of the $1 billion, where did you expect that to extend you through?

Michael Strianese

The end of 2012. We've been completing all our share repurchase authorizations much earlier than planned. So that's the period covered. Of course, that doesn't mean that, that's when it'll actually -- more than likely execute over a shorter period.

Myles Walton - Deutsche Bank AG

And I guess a higher level question on maybe a follow-on to Howard's question about M&A and divestitures, but L-3 really started as a products-based company, and it went where the dollars were going into the services. At this point in time, given kind of the two different trends you see and kind of the customers' viewpoint towards products versus services, do you still see your Government Services organization as core to the business? Are there real synergies that you bring through to the organization?

Michael Strianese

Well, obviously, not as much in the products and systems side, but we're trying to drive more and more synergies as we look at future opportunities. I think that the capabilities in our Services segment, which I can define into two broad areas. One is direct support to the warfighter, principally through MPRI. And then the technical services, if you will, where we have a workforce of people that have very top-level security classifications that can work in the intelligence area are both areas that I expect to see grow. And we are focusing more and more on the cyberspace, intelligence support work. And as you know, on the direct support work, nation building, training the militaries of both Iraq, Afghanistan, but those are not the only two places in the world where we're doing that type of work. And I guess they are both I would characterize as unique spaces, less commodity type, which accounts for our margins being where they are. It's not seat management in an IT space, if you will. It's more of very specialized capabilities. And given that, it's an area that we're going to continue to pursue growth in.

Operator

And at this time, I'd like to turn the call back over to management for closing remarks.

Michael Strianese

Okay, well, as we said, we're optimistic about the outlook going forward. The comments made at the Pentagon level about efficiencies and trying to maintain a 3% growth level on the procurement side are certainly encouraging. Given the overall budget, it's still north of $700 billion. I believe that will continue to drive a robust aerospace and defense industry. Although, again, the growth rates we saw over the last ten years have come down. And we're prepared to work in that environment. We've done it before and have been able to generate shareholder returns, and we're certainly prepared to do it going forward. I'd say the top line growth will be in the mid- to lower-single digits, but we're also targeting our earnings growth to continue to be much more north of that, just slightly below 10%, continue to drive cash. So we look forward to speaking with you on our third quarter call, and thanks for joining us.

Operator

We thank you for your participation in today's conference. This does conclude your presentation. You may now disconnect, and have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: L-3 Communications Holdings Q2 2010 Earnings Call Transcript

Check out Seeking Alpha’s new Earnings Center »

This Transcript
All Transcripts