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Exelis Inc. (NYSE:XLS)

Q1 2014 Earnings Call

May 2, 2014 10:00 a.m. ET

Executives

Katy Herr – VP, IR

Dave Melcher – President and CEO

Peter Milligan – CFO

Analysts

Christopher Sands – J.P. Morgan Securities Inc

Gautam Khanna – Cowen and Company

Steven Cahall – Royal Bank of Canada

Howard Rubel – Jefferies LLC

Bill Loomis – Stifel Nicolaus

Pete Skibitski – Drexel Hamilton

Robert Spingarn – Credit Suisse

Joe Nadol – J.P. Morgan Securities Inc

Operator

Welcome to the Exelis First Quarter 2014 Financial Results Conference Call and Webcast. Hosting the call today from Exelis is Ms. Katy Herr, Vice President of Investor Relations. Today's call is being recorded. (Operator Instructions). It is now my pleasure to turn the floor over to Ms. Katy Herr. Katy, you may begin.

Katy Herr

Thank you, Greg. Good morning, everyone. Thank you for joining us on our first quarter 2014 conference call. During today's call, we will reference supplemental information in the form of a presentation that you may access at investors.exelisinc.com.

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

During today's call, we will refer to non-GAAP measures, which are defined and reconciled in the appendix of today's presentation and available on our website.

Joining me on the call this morning are Dave Melcher, our Chief Executive Officer and President; and Peter Milligan, our Chief Financial Officer. As always, we encourage questions at the conclusion of our remarks.

And with that said, please turn to Slide 3. And at this point, I would like to turn the call over to Dave.

Dave Melcher

Thank you, Katy and good morning, everyone. Thanks for joining us on today's call. As this morning's press release details. Our first quarter demonstrated improved year-over-year enterprise profitability and another solid quarter of funded order intake.

Funded orders for the quarter were $1 billion essentially one-to-one with revenue. We closed the first quarter with funded backlog 21% higher than the first quarter of 2013. Giving us good visibility into the year with almost 70% of 2014 revenue already in our funded backlog including incremental funding on current contracts over 80% of the remaining revenues in total backlog.

Revenue for the quarter of $1 billion was slightly below our expectations. Primarily due to a more significant deceleration in the base of operations in the Middle East and Afghanistan. However, if we carve out the Mission Systems division revenue was down 4% from the same period in 2013 essentially in line with our expectations.

Free cash flow was affected by an accelerated pension contribution of $30 million and seasonal outlays that pressure the first quarter each year. However, beyond these factors free cash flow generation in the first quarter was not up to par. Despite the slow start, we fully expect our free cash to improve as we move through the year and do not see any change through our full year guidance of $250 million.

It's worth noting that we returned approximately $44 million to our shareholders during the quarter via the dividend and share repurchases. Let's turn to Slide 4, as a result of solid orders intake. Funded backlog remained stable from the end of 2013.

As you can see on this chart, the C41SR segment funded backlog improved almost 20% due in large part to the orders you see described on this page including, a $92 million Full Rate Production Award to manufacture and deliver 42 Integrated Defensive Electronic Counter Measure systems or IDECM to United States Navy and a $34 million award from Sikorsky to produce system demonstration test articles for the CH-53K heavy lift helicopter.

We also continue to make progress in advancing our international footprint with awards including a multimillion dollar commercial contract to build the primary payload for a climate monitoring satellite for the Japanese Aerospace Exploration Agency, an $80 million award to provide airborne electronic warfare equipment to the Turkish Air Force and $50 million in awards from international customers for the I-Aware Tactical Mobility-Night Vision Goggles or TM-NVG.

If you will recall, Individual Soldier System during our fourth quarter call. These night vision goggles incorporate real-time video and imagery via integration with our SpearNet radios giving leaders better situational awareness at night than ever before.

We continue to see a deceleration in the operational tempo in the Middle East and Afghanistan. If you'll recall the Mission Systems division received sizable awards for several key programs during the third quarter of 2013 and you can see on these charts that they're working through that backlog.

At this time, with our current backlog position we do not see any change to our 2014 expectations. In addition, as we review the recent budget and strategic documents including the Quadrennial Defense Review, we continue to seek priority given to areas that are strategic growth platforms electronic warfare, ISR and analytics and critical networks.

We've continue to align our resources. Personnel, bid and proposal and [IRAT] in support of these mission areas. At the macro level, the Bipartisan Budget Act is helping to alleviate some of the uncertainty we've seen over the past few years. The procurement process continues to operate at its own pace, but the fact that there is a 2-year budget in place is helping.

We continue to see a challenging trend for our short cycle businesses, but we do see good opportunities in our longer cycle businesses and are particularly encouraged by our international opportunities. Please turn to Slide 5 for the discussion of the pending spin-off of the Mission Systems business, which we announce will be known as Vectrus following its spin-off this summer.

Mission Systems revenue in the first quarter declined more than we expected as a result of an accelerated draw down in Afghanistan. We now expect that this business will see revenue declines in the high-teens during 2014. As a result of the lower volume and contract adjustments to reflect the slowing pace of operations.

We expected Vectrus 24 [team] margins will be in the range of 5.5% to 6% in line with its historical margin profile. We continue to move through the regulatory and legal requirements to execute the spin-off. I'm pleased with the pace of the progress to-date and we've continue to anticipate that the spin-off will occur this summer as planned.

We will continue to keep you updated as we progressed through the spin process. At this time, I'll turn the call over to Peter.

Peter Milligan

Thanks, Dave and good morning everyone. Please turn to Slide 6 for discussions of our segment results. Funded orders in the C4ISR segment were up 18% compared to the first quarter of last year. The book to bill in this segment was 1.4 times was reported by three of the four divisions in the segments each delivering over 20% growth from the first quarter of 2013.

Importantly, international customers accounted from almost 40% of the segments funded orders in the quarter. Timing of international orders can be lumpy, however for the full year we expect that international will comprise about a third of C4ISR's.

Revenue for this segment was down 4%, primarily due to lower sales of night vision products, ground electronic warfare systems and the completion WorldView-3 satellite payload. Sales of tactical radios and domestic airborne electronic warfare system somewhat offset the decline.

For the year, we expect C4ISR revenues will be flat to slightly positive with just over half of projected sales expected to occur in the second half of the year. Adjusted operating income in this segment was up 147% due to lower restructuring charges in pension expenses.

We continue to expect that full year C4ISR adjusted margins should be in a low teens. The cadence of the C4ISR profitability looked similar to 2013 and approximately 75% of that segment revenue came in the second half of the year. In 2014, about two-thirds of the segments profitability is expected to occur in the second half of the year.

Due to lower restructuring charges, timing of program milestones as well as some anticipated booking ship that will shift the revenue mix. Please turn to Slide 7, funded orders in the I&TS segment were down 33% compared to the first quarter of 2013.

However, Mission Systems received significant funding on some contracts a full year of funding in September of 2013 for the 2014 fiscal year. As Dave discussed earlier, you can see this reflected in the backlog trends. If we carve out the Mission Systems orders for both 2013 and 2014 orders in the I&TS segment were roughly flat.

Year-over-year revenue was down 18% in segment primarily due to lower revenue on Middle East and Afghanistan programs. Somewhat offset by higher revenues on FAA programs. On a segment basis, we expect full year revenue will be down on low teens.

Again, most of that decline is driven by the Mission Systems pressures we discussed earlier. Following, [extremely] profitable 2013, we are seeing adjusted operating income return to a level more characteristic of the business. Adjusted operating income declined 11% from the first quarter of 2013, although margins did increase due to lower restructuring cost.

On a consolidated basis or in a segment basis. We expect that, this margin to be a 7.5% to 8% range for the full year. Please turn to Slide 8; we are off to a very good start in our order intake giving us significantly stronger backlog in this time a year ago and a good amount of near term visibility.

Much of the strengthened backlog is a result of our continued progress in international orders to accounted for a quarter of total orders and just over 10% of revenue in the first quarter. We expected international customers were comprised approximately 15% of full year revenue. Although profitability in the first quarter was about $5 million short of our original projections, we do remain on track to achieve our full year earnings guidance.

Looking at our profitability trend across the year. We anticipate generating approximately 60% of our profit during the second half of 2014. Second half of the year will benefit from lower restructuring and higher C4ISR segment profitability and now I'd like to open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question today comes from Rob Spingarn with Credit Suisse.

Unidentified Analyst

Good morning, everybody. This is actually Ross on for Rob. I was Peter, just wanted to talk a bit about the spin and have you had any further thoughts about the potential dividend that XLS could end up receiving from that spin. I think before you said kind of two, three times EBITDA was the [indiscernible] what ambitioned have you got any update on that?

Peter Milligan

Yes, essentially it's really our thinking is the same, within the same range. If you think about what we talked about this morning. We would expect to see dividend based on 2015 profitability, so if you take the number that we are implying from the guidance and the commentary this morning. You'd see Mission Systems this year on an all in basis would be instead of that $70 million in profitability and you'd expect, so that's for 2014.

Now for 2015, you certainly don't want to give too many – you know get too specifics on our views for 2015 but certainly there will be some incremental pressure as you move out as Afghanistan still remains under pressure.

So you'd expect some profitability pressure in 2015 as well certainly nowhere near significant as a change from 2013 to 2014 but another less, that's sort of the proxy in which we were going to use to determine how to leverage that business. So figuring that two to three times ranges off of that projected profitability and that should be a pretty good estimate, but of course that's subject to a number of different decisions but ultimately it's the decision by the board.

Unidentified Analyst

Okay, great. Thanks and if I could just follow-up on one further question. I think you said, last quarter that the expectation for this year was a 5% to 8% decline in the domestic business and then some growth in commercial and double-digit growth in international. Are you able to pass out how those various blockage trended in Q1 and whether there's an update to the full year expectations for the quite, rates of each.

Peter Milligan

Sure, no actually they're on track. Slight change maybe just in domestic because we see a little bit of pressure from Mission Systems as we talked about, but not enough to change our view for the year, but certainly we are – I think we're definitely on track for very strong international growth as well as continuing growth in commercial.

So no macro changes there at all, Ross.

Operator

Next we will hear from Joe Nadol with J.P. Morgan.

Christopher Sands – J.P. Morgan Securities Inc

Good morning, it's actually Chris on for Joe. Peter, I wanted to dig more into the C4 margins. As I struck out restructuring separation and kind of pension assumption. I'm getting that margin was down almost kind of 300 basis points year-over-year and noted that the net EAC adjustment comp were negative in the quarter. So I assume, it has something to do with that can you provide some more color there, please?

Peter Milligan

Sure. You're right in part, certainly the EAC adjustment do drive some lumpiness in profitability which obviously is, it's hard to – it's impossible to specifically predict but if you look at last year that C4ISR division had about $15 million or so in EAC adjustments and in this first quarter, it had essentially nothing, a slight negative.

There was a $2 million negative on the other division on the I&TS segment as well. When you think about, what rise those cumulative margin adjustments. There of course, they're different at every program. Last year, what we saw on the services side was well on the I&TS segment. There is some fixed price jobs there as you know, we saw a really strong performance there. We saw higher award fees, we saw some change orders that came in at higher margins.

So really outstanding performance as you know, this year we did not expect to see those levels of adjustments and we certainly didn't see that in the quarter and that's why I think that the segment margins that we saw even in the first quarter are likely to trend down throughout the year for the I&TS segment, not dramatically but in line with what we talked about couple minutes ago.

On the C4ISR business, this quarter we did see a cost growth on a couple of programs, but no one program or two that was anything significant to highlight but the truth is, also there's a mix shift that's going on. That mix shift, we had a lot of book to build in the fourth of last year, which drove profitability in line with what we expected, but it did happen sort of in a non-linear fashion.

And then this year, we are seeing something very similar. So as you think about some of the new programs we want and they've been significant. As you start those programs and you put your original margin expectations together. You're unlikely to see any major changes in the early stages right because you just started.

Overtime, if you perform well, and this industry has done that, we have as well. And you can drive some productivity into the program. You'll see those pickups, but in this quarter when you see – the beginnings of lot of the fixed price work that we just won recently and that we also won in the quarter. You didn't see nearly as many margin adjustment.

Christopher Sands – J.P. Morgan Securities Inc

And you'd expect that to be true for the rest of the year thus giving the mix with newer program as opposed to more matured programs?

Peter Milligan

I think for the full year, again impossible to predict but I would expect there sort of relatively minimal margin adjustments in the I&TS business, but driven by milestones and other activities on the C4ISR business. I would certainly expect to see some positive cumulative margin adjustments in that segment.

Christopher Sands – J.P. Morgan Securities Inc

Okay, great and then one just switching to Mission Systems. I kind of look at the 4% year-over-year decline for the entire company, X-Mission System I think I'm getting close to something like 30% year-over-year decline for Mission Systems in Q1 versus at accurate and if so, how do you get to kind of the mid-teens decline for the full year?

Peter Milligan

Sure. So couple things, if you take out the – or actually Mission Systems itself we are down in the sort of 25%, 26%. We are actually 26% range in the first quarter. You expect the second quarter to sort of have declines in and around that number and in a very different trend in the second half of the year.

Basically driven by, sort of started out lapse where the big program reductions have come in Afghanistan. So second half of the year, last year was what we started to see that pressure. So on a year-over-year basis, you don't see that same pressure in the second half.

But if you took out the two segments, then you see the you certainly can see from the numbers today. The C4ISR segment was down about 4% range and as Dave said, largely in line with our expectations. We probably would have like to see it down maybe 1% or 2% but for the year, that segment is on track to be flat maybe slightly up, but certainly the backlog supports that and then again x-Mission System just for a second, which now you know is our expectation at least is down in the high-teens, that would imply that the remaining business is sort of down a 2%, but on a short cycle business, but certainly trends that have improved.

Christopher Sands – J.P. Morgan Securities Inc

Your Mission Systems had better comp in the second half?

Peter Milligan

Correct.

Operator

We will next move to Gautam Khanna with Cowen and Company.

Gautam Khanna – Cowen and Company

And so just to follow-up on the Mission Systems trend in Q1, it sounded like it got incrementally worst relative to your expectations. What specifically is driving that and how confident are you that, risk is now bounded that it won't get worse?

Dave Melcher

Well, I think part of – this is Dave. Part of that downturn can be attributed to an increasingly pressurized environment with respect to operations in Afghanistan more than probably anything else. And I think some of that is prudent lever pulling on the part of the government customer to try and adapt to what they see as a changing circumstance. Overtime we still see relative stability in the projections that we had for Afghanistan but we were stepping them down from 2013 from 2014 and into 2015 because we expected that to happen with the potential draw down of troops.

Now to counterbalance to some of that is, as things drawn down in Afghanistan sometimes things picked up in Kuwait, where we are doing preposition stocks contract and supporting the base operations and the communications there. I think, we expected a bit of a step down, it'll be good to have a little more certainty as we get towards the end of the year in the elections in Afghanistan are completed and you know the US has a chance to consummate a security agreement with that country.

Peter Milligan

I think – Gautam this is Peter just a couple of additional highlights maybe, we think about as we talked about on I think on Slide 7. It is Middle East and Afghanistan program driving most of that variance. Our work in Afghanistan specifically was down probably a $30 million and in Kuwait down $30 million as well.

In each of those cases it was down probably $5 million to $10 million more than we expected and that's just quick response type thing, so when the customer ask for less then you adjust quickly. Again variable cost, so there's no sort of stranded expenses if you will but we did see that and then as I mentioned I think on the last question to talk about why would the trend improve just from a year-over-year percentage.

The other reduction we saw in the first quarter was the onback Huachuca award which we – one that recompete last year and we saw right away. As we won in the middle of the last year that step down, so that step down in second half of the year continues to step down now, but as we get to the second half of 2014 then the comp becomes easier.

Gautam Khanna – Cowen and Company

Okay, that makes sense. So could you remind me Peter on the dividend capture from the spin that's a taxable dividend, correct for the parent?

Peter Milligan

Well, I mean the way these spin generally work any sort of pull back of capital to the extent you have basis in the asset generally is tax free. Our basis in that asset isn't all that high, but we are looking at and trying to drive the most efficient tax structure we can to minimize the impact to that.

Gautam Khanna – Cowen and Company

So what should we be expecting, will you get the full proceeds or like only 65% of those proceeds?

Peter Milligan

Yes, I mean we're still trying to finalize that. I mean to be honest with you, we're still working through its [factoring] with our law firm and a couple of other things but, if you think about the normal effective tax rate on a cash basis of 36%, 37% it's nowhere near that.

Gautam Khanna – Cowen and Company

Okay and one last one, the SRW Applique contract Award, what are your expectations on that? Are we seeing opportunity to really put it play despite – what [indiscernible]?

Dave Melcher

Yes, we were very of course very pleased to be one of the four companies that were selected for that contract for SRW Applique. We are preparing as our most for another round of testing and evaluation of the offerings at the Network Integration Evaluation 15.1 which his coming up here in the fall.

So that's still a necessary step, I think that the Army wants to go through before they start offering some task orders on that IDIQ contract. So we are staying the course, we're continuing to work with Army customers make sure that everything gets looked out properly and my belief is, that as budgets get more pressurized and tighter over the next couple of years, things like SRW Applique given hands capability for the installed based are going to be ever more important.

Gautam Khanna – Cowen and Company

Do you have any way to seize the opportunity of the mix, couple of years?

Dave Melcher

Go ahead, please?

Gautam Khanna – Cowen and Company

What the requirement might be over the two years, probably?

Dave Melcher

We're trying to keep our expectations relatively in check and the reason for that is, I think at best what the Army is trying to do is to field increments of brigade capability in line with their readiness models, which just says, you take small bits at a time buying this incremental capability and they pushed a lot of the funding that they had for the network out a bit.

So I think, we are going to work our way through this testing. We'll see what the future holds for 2015, but I don't expect this to be a win fall near term.

Peter Milligan

And I think the other thing, Gautam is that, we as you know have our customer leaf says a lot of inventory out on products that we make and certainly there's always the case to be made for upgrade, whether it's in something like we just talked about in the SRW realm or night vision and we certainly are in a position to capture any of that, but as Dave said we have virtually none of it or very, very little of it in the plan and view that as upside opportunity should have come to fruition.

Operator

(Operator Instructions) Next we will move to Steven Cahall with Royal Bank of Canada.

Steven Cahall – Royal Bank of Canada

I was wondering first just on the services side, if we sort of parse that out for the Mission Systems in business between Afghanistan and Kuwait. Some very helpful color already on the Afghanistan side, but on Kuwait I'm a little confused maybe why the orders were down, so dramatically in the quarter. I would think that the camps there, have a bit more stable off tempo at this point.

So if we think about Mission Systems going forward, can you give us a little bit color on the KBOSSS side of things for how you think orders and sales will be trending?

Peter Milligan

Yes, sure. I'll give a shot at that, I'm certainly from a KBOSSS perspective there will be some contraction in that program but from an orders perspective, the thing to remember is that we received very significant set of awards back in third quarter of last year, almost for a full year and actually it was for full year.

So it had in accelerated funding and that's why you see that sort of unfunded backlog sort of converted to funded backlog but not show up in the comparison as you're looking at it.

Steven Cahall – Royal Bank of Canada

Okay and then maybe just a follow-up, sort of relatively in the short cycle part of the business that C4ISR, are you seeing any improvements in terms of the amount that's been proposed all that you have out or allow the awards that you're expecting adjudication on some of the peers in that space have talked about some improvement there, have you seen any change in the trend in your market?

Dave Melcher

You know we really haven't seen any macro levels changes in terms of the priorities that were established by the customers or the level of funding is represented by either the appropriations bill or the outlays that have been coming our way for the C4ISR segment and I think, we have a pretty good mix of new products that we're going after as well as recompetes in the C4ISR sector going forward and as a company, we've got nearly $7 billion of proposals in evaluation right now, across the whole company.

Steven Cahall – Royal Bank of Canada

Is that up sequentially or year-on-year is that unusually high level. I'm sorry, I don't know what the company is?

Dave Melcher

It's actually up a little bit from what I would have cited for you last year at this time. So we are working hard to increase the tunnel of opportunities for every one of our businesses.

Steven Cahall – Royal Bank of Canada

Right and then just a final housekeeping one, I was wondering if you could give us a sense of what you're expecting for separation cost. The quarterly run rate a good metric to you then and do those continue after the sort of summertime spin you're expecting.

Peter Milligan

Yes, in total we expected about – we're expecting around $25 million or so probably ramps up a little bit in the second quarter. We had a little bit in the fourth quarter, I'd assume you know there is a little bit trailing as well but we're still on track for the original estimate.

Operator

And our next question comes from Howard Rubel with Jefferies LLC

Howard Rubel – Jefferies LLC

Good afternoon or good morning I'm sorry, its day already. Dave, could you talk a little bit about Afghanistan and sort of maybe a scenario now, so how you think what are opportunities if US has a reasonable size force there or in fact virtually de minimis?

Dave Melcher

As I think you know, as the Administration haven't made any decisions yet on what the size of the US force is going to be in Afghanistan and that's probably going to be forthcoming here in the next several months. The Combatant Commander, General Dunford of course testified, he thought that what was – it was somewhere between 10,000 and 12,000 troops on the ground to be able to support the post-election new President and the aims had been established for security in the country.

I think, you know as you look at what Pentagon planners are taking a look at, they're certainly looking at a range of alternatives that probably started 10 and worked their way downwards to some lower numbers and they're trying to figure out what that means, both in terms of cost and commitment going forward.

The thing that I always like to remind everybody about is, of course our biggest work in Afghanistan is tied to LOGCAP and a contract we have with the Army for Engineers called Afghan North and South, which is providing the base operations and support for the Afghan Military and Security Forces, not our own.

So some of the projections that we've made going forward assume that almost under any circumstance, whether by its US aid or through US Military funding that makes its way into funding some contract efforts like that. There is going to have to be some continuity of that effort because you can't just shutdown all the Afghan security bases at the same time, you say you're withdrawing your own forces.

So you know that's why we see some stability, although it's going to be step down. So we've run our own internal scenarios and I think, the projections we've established for this year were pretty closed, pressurized a little bit more here early in the year than we saw it, but I think people are just being conservative a bit.

Howard Rubel – Jefferies LLC

Environment remains volatile to at least, so there is still some scenarios where we're not going to be welcome or where, you know while I appreciate the fact that, you helped the Afghanistan forces grow up, would be a way to describe it best. There is still some risk that, we could be at lower levels than where we are today, where your forecasting does that – I mean, I kind of want to understand a range of what you're thinking?

Dave Melcher

I guess, we are not giving any guidance for the next year. The assumptions that we made for that business going into this year, was that it was going to step down certainly double digits and we've seen that of course is been true. Most of that pressure has been in Afghanistan, although a little of it has been in Kuwait as well.

The [OKO] budgets, I think that it has been established for this year are still relatively healthy. I think in part, a reflection how does that money going to be spend as we go throughout the year more than it is, the intent to try and make sure those contracts are maintained?

So it's hard for me to give you any scenarios, Howard other than to say that we stepped it down significantly in our own expectation for this year and next.

Peter Milligan

Yes, I mean at macro level Howard this is Peter, good morning about $500 million as you know is the revenue last year from Afghanistan all in Mission Systems. This year, we're assuming $300 million maybe it's little light of that and we certainly expect another step down next year and I'm sure that team will be talking more about, I've go through the remainder of the year.

Howard Rubel – Jefferies LLC

No, I appreciate I color. I mean, it would be ashamed if all that work, it's just hard to call and – the second item is, you have a great imagery – satellite imagery business and with WorldView-3 essentially done, what are the opportunities are there some things in the pipeline that you can talk about that would give us some comfort that there is another it's not going to be commercial but maybe something else, we would see that – help that side of the business?

Dave Melcher

No, I mean it's a very good question. Of course, we have some components on a lot of different things from optics, other things that we do for our government customers to have the payload themselves. We were working on a couple potential opportunities for commercial light imagery and in international context and that is ground that we haven't broken into yet, but we certainly are working earnestly and the biggest issue we run into are either State Department preferences with respect to who you fell to or ITAR concerns about what's the level of resolution it's going to be, but we are pursuing those diligently.

And we of course are keeping all of our options open with respect to other potential commercial work coming by, it's an area of interest and concern for us as well as for the Department of Defense because we talk liberally about the fact, you really do need to maintain those capabilities as we go forward.

Peter Milligan

I mean, it's true not very many people of anybody else has applied that capability.

Dave Melcher

Right and so we're working that angle hard. We also of course are working on our weather payloads and of course as you know, the GPS payloads that we're producing, while there's a little bit of cross-transparence among engineering capability between some of those three, but the optical honestly it's a national treasure, the optical capability that we have.

Howard Rubel – Jefferies LLC

Thank you, gentlemen for you time.

Dave Melcher

Thanks, Howard.

Operator

Our next question comes from Bill Loomis with Stifel Nicolaus

Bill Loomis – Stifel Nicolaus

I think, just to be clear on – you said Afghan revenue was $500 million in 2013, $300 million in 204 and lower in 2015. What if – does that include the Middle East like KBOSSS, what would be the total, if you divided the two bucket, Afghanistan and then Middle East outside of Afghanistan?

Peter Milligan

So the numbers that I had just given Bill were just for Afghanistan and then for KBOSSS probably another about $350 million in that range.

Bill Loomis – Stifel Nicolaus

Okay and then APS-5 – how much would that be?

Peter Milligan

Probably in a $100 million range or so.

Bill Loomis – Stifel Nicolaus

With the – so the total exposure in Afghanistan you said about $300 million this year and then Middle East would it, or I should think about $450 million assuming that would be total Middle East exposure as well?

Peter Milligan

I mean, if you think the total business this year which we're sort of predicting to be in $1.2 billion in change you certainly have the majority of it is in Afghanistan or Middle East related and that's certainly a big piece of where the base operation support is and certainly where we expect it to continue to be and I know Dave has mentioned as many times, our position in Kuwait has been therefore couple decades now.

So and we don't by any means see that anticipating in any material way over the next number of years or beyond.

Bill Loomis – Stifel Nicolaus

Okay and then you mentioned the difference from Afghanistan or to the LOGCAP supporting the US and Afghan North and South. How you're seeing it step down is it as material, is what you're seeing on some of it like LOGCAP and some of the others or is it, you're just quoting Afghan Troops?

Dave Melcher

I think -- we've made some assumptions about how this thing steps down in sort of orderly fashion and I think we have pretty good clarity and visibility through our customers about what their needs are going to be going forward. So it's certainly anything is double-digit declines is more than just a passing thing, but I think we've taken stock of the full measure.

Peter Milligan

I mean at the high level, the changes that we are seeing because of the two big contracts in Afghanistan that you're certainly aware of, if you combine Afghan North and South as one and LOGCAP as the other. They're probably seeing rates of decline, they're not that different. We are looking something in the 40% range, as we said from $500 million to $300 million that's a big, biggest drivers of that of course.

Bill Loomis – Stifel Nicolaus

Okay and then switching gears to LISC update on that and how the revenue trends have been there?

Dave Melcher

I’m sorry, Bill I don't know if I got that question?

Bill Loomis – Stifel Nicolaus

Switching gears to the LISC contracts, the Launch and Test Range what's the trend there and the update on that competition?

Dave Melcher

Of course, we've had our packet for the LISC contract for quite some time. The latest intel, we've gotten from the customers that the award may flip till the third quarter of 2014. We've been answering questions and responses that have been offered by the customer on our proposal as has everybody and we'll see if it gets delayed any further, but in the meanwhile we continue to perform on our space ground and range business with good effect.

So we're anxiously waiting for the outcome of that competition just as yours.

Peter Milligan

If you think Bill, at the segment level. So look at this segment excluding for a second Mission Systems because that's the information systems business you do see, as Dave mentioned some pressure in that contract for the year as they ready themselves for the award decision the customer that is, but as we mention this morning in our materials here.

We are seeing increases in revenues with the FAA.

Bill Loomis – Stifel Nicolaus

Got it. Okay, great. Thank you.

Operator

(Operator Instructions) My next question comes from Pete Skibitski with Drexel Hamilton.

Pete Skibitski – Drexel Hamilton

I apologize, I got on the call late. I apologize, if I ask or repeat question here. I want to ask something about the spin just because it's not clear in my mind. We've seen a few of these scenarios in the space going by my recollection. I think this company has done a spin, there's been a special dividend back to the parent company and I think in general, the spin process is either been a wash or maybe even accretive to the parent company and so I want to ask you guys, the question if you're able to address.

If you expect this spin to be accretive, dilutive, just kind of what your thoughts. I know you're sensitive in terms of how much debt actually put on the Vectrus?

Peter Milligan

Yes, sure at a macro level. I mean our expectations on this are clear. It certainly going to be the earnings per share will be lower without Mission System, there is no doubt that and of course, as the dividend comes back to Exelis. Our job is going to be, to invest it as prudently as we can.

In the interim as we, as we contemplate those investments. It's certainly not going to be earning much sitting in the bank. So we have to put it to work, we know that but we certainly do expect that the transaction is going to have in impact to Exelis earnings and that's why we certainly know that as this business spin-offs. It's going to be one with positive free cash and that's our honest profile.

Pete Skibitski – Drexel Hamilton

Okay and so you're going to your minus two to invest the proceeds as soon as possible, basically?

Peter Milligan

Well again our normal capital allocation process, where we have to find the assets or the reinvestment vehicle that makes the most sense of the last number of years it has been sort of getting our feet under us, building up that cash balance, funding a lot of the pension all which we've done.

Now on a different spot, no cash flow is short this quarter but there's no reason to change the full year numbers in fact. In April, we started to see a lot of cash come back already. So we're in pretty good shape there, but we will have a substantial cash balance, we already do but, that will continue to grow throughout the year, the dividend adds to that and then we'll have a lot of work to do, we're already doing this, to figure out what the best place is, to put it but at a high level.

This is of course, is the preview of the board to guide us here but balance approaches one that we've held in the past and I would imagine we would hold too in the future.

Pete Skibitski – Drexel Hamilton

Okay, I got it, very, very good and if I could add, I wanted to verify too. The spin-off cost that you're incurring where is that heading down the income statement?

Peter Milligan

Most of that is in SG&A and if you look at the 10-Q that we filed this morning, you'll see SG&A is sort of roughly flat down a $2 million if you adjust for those spin cost it's down much higher, which is what you would expect because of the restructuring actions we've taken and of course the cost discipline that we have on the selling and general administrative line.

Also, what we expect for the year to have a slight increase in selling expense, Dave commented earlier about a question about bid activity. We have seen and want to see more investment in our front-end that's a healthy investment for the business. So we will see that, but the general, administrative expenses are things that we want to see continue to trend down, they will this year because of the restructuring efforts we took last year and they will over the next number of years, enabled by the ERP investment that we are making, which as you know couple year journey, but we've started it and we are in good shape.

Pete Skibitski – Drexel Hamilton

Okay and then on the segment base, their restructuring is it being allocated to – the spin-off cost is it all going into I&TS or to both of the segments?

Peter Milligan

Yes, it's allocated because we don't have incorporate to another segment. We allocated based on that same formula, if you look at the Reg G's attached to the presentation this morning. You'll see how it's allocated across, there really was no other way to do it, other than sort of putting it, creating and incorporate another, which we didn't want to do because we don't have that now.

Pete Skibitski – Drexel Hamilton

Understood. Okay. So I guess going in the 2015, you're going to have $25 million and spin cost as the tailwind as well as was there $20 million in restructuring costs of tailwind as well?

Peter Milligan

There will be continued analysis on the cost structure, the efforts that reduced, the footprint are ongoing will be $20 million in 2015. I mean my hope is, if throughput as it looks at least certainly to be more than stabilizing now with the backlog that we've seen, I hope a lot of the big restructuring can be behind us, but the environment that we're in for us and for everybody in this space is one that cost control, is just going to be part of the culture and it has to be continuous effort.

Certainly would not expect exceeding the magnitude of the investments we've seen in the past and then the couple other tailwinds. Also we expect to see pension trailing off over the next number of years on the f.a.s basis which is good news and of course, it felt like a long time out couple years ago, but that period in which the pension payment essentially are behind us, is coming closer and closer.

So when you think about the business from a cash flow prospect to these next couple of year's strong cash flow, lot of reinvestment opportunities some good growth across the strategic growth platforms. International is doing really well and then a couple of years out, as we fund this pension. You see a very significant benefit to cash flow couple of years ago, as the pension is essentially fully funded.

If our models hold and at this point, they have been holding and I think as you guys know who followed us for a long time, they're fairly conservative.

Pete Skibitski – Drexel Hamilton

Got it, very good. Thanks so much guys.

Dave Melcher

Thanks, Pete.

Operator

Next we will take a follow-up question from Robert Spingarn with Credit Suisse.

Robert Spingarn – Credit Suisse

Good afternoon.

Dave Melcher

Hi, Rob.

Robert Spingarn – Credit Suisse

I guess good morning.

Dave Melcher

Not long off a call.

Robert Spingarn – Credit Suisse

No, it hasn't. I had a couple of just higher level questions, I wanted to ask. Really with regard to cost control, when I think about your backlog and the fact that it's, I guess roughly a ratio of 2:1 to your sales. I'm thinking that maybe your backlog turns over around every two years.

I expect that's not perfect map and it's not quite that accurate, but just in general and then I think about the improvement to the cost structure and the restructuring, at what point might you need to pass through some of these savings as your backlog turns over to your customer or is that really already happening and it shouldn't have too much of an impact on margins going forward?

Peter Milligan

Yes, it's already happening, I mean you know one of the key things for us is to know that there's restructuring that we have been taking, puts us in a position to bid, the contracts that we are bidding now and able to close on them. So I do not expect significant margin accretion at all really in the C4ISR business.

Notwithstanding continual cost takeouts, we have positions with clients for example Lockheed we do a lot of work for, they do expect from us cost reductions and as an important customer our job is to be able to do that. I mean we have to stay competitive and keep our cost structure in line.

We have parts as you know in the Joint Strike Fighter that we're key supplier their and our job like many others in the supply chain is to do their absolute best to make sure that platform has most effective and certainly cost effective as well components that we can provide.

So I think a lot of that is going to keep us in a competitive position and in some ways, Rob also allow as we're sort of targeting this year for increased reinvestment in the business and that's another, I think key point. Sales of course, going up a little bit. Sales expense, but certainly on the R&D side as well.

Robert Spingarn – Credit Suisse

So what you're saying Peter, is your margins will reflect this as you go.

Peter Milligan

I guess yes, I think so. I think so – I just want to make sure, we are on the same page.

Robert Spingarn – Credit Suisse

Well, I thought I heard you accretion but I want to make sure – in other words, is there pricing pressure coming, is it already here, do you have enough visibility?

Peter Milligan

Yes, as I look at my full year margins this year. I'm looking something in sort of low-teens for C4ISR that feels like about the right place, right? I mean, with some of the backlog already reflects that. Some of the orders that we're driving now. We'll reflect some anticipated cost reductions to be able to price and deliver those anticipated margins.

Robert Spingarn – Credit Suisse

Okay.

Peter Milligan

Margins in that 14% range that's a pretty good spot. I mean, I certainly don't want to see them go down in any material way, but I don't see a path for us to get into the high-teens on margins in that business at all.

Robert Spingarn – Credit Suisse

Right, that's where I was going. Okay, that's very helpful and then just quickly on cash and you guys didn't see this in the quarter but a couple of others more in the services side, saw a big improvements and receivables due to early payments in fact, earlier than terms and I wondered if that is a phenomenon that might go across the sector and you might see this in a future period?

Peter Milligan

I hope so, I didn't see this period. In fact, we certainly saw some accelerated payments in the fourth quarter, but we ended last year really strong on cash flow. So that did put a little bit of bathtub into January if you will, but beyond that as you could see from the numbers this mornings. Cash flow and Dave commented on this was not good and yet I'm not concerned about the full year target, I'm not concerned about receivable risk or anything along those lines, but we had seen in some cases but not enough, but again as you think about our business.

As we transition now to more international, those payments were never are usually not as good as you would received in the US. Some case because you have some advance payments and actually we had those and this quarter, if you look at the balance you can see that we aid into some of those advance payments, which does pressure cash flow, but we also again had a really strong fourth quarter, which created a little bit of problems and I think I mentioned a couple of questions ago, that we are already starting to see April, we saw April real strong back in line, with what we expected.

Robert Spingarn – Credit Suisse

Okay, so maybe your – this first quarter was a little bit different than the fourth quarter to second quarter?

Peter Milligan

That's right.

Robert Spingarn – Credit Suisse

Okay, thank you very much. Very helpful.

Dave Melcher

Thanks, Rob.

Operator

And our next question will be another follow-up from Joe Nadol with J.P. Morgan

Joe Nadol – J.P. Morgan Securities Inc

Hi guys, one more for you. Peter there's been a lot of talk about impact of potential new mortality cables on [indiscernible] and future years. Obviously, I'm only saying there is lot of moving pieces but holding everything was constant. Do you have a feel for what that might do for you guys?

Peter Milligan

Yes, we're still analyzing it and it's pretty dynamic. My understanding is that, they're not finalized yet. So I know the one thing in the pension world is, numbers are fairly dynamic and I'm pretty sure that if I give one now would change in few months. So I'd rather not, but we certainly are looking at a close and we'll update you as soon as we feel confident that we have a good estimate on it.

Joe Nadol – J.P. Morgan Securities Inc

Okay, sounds good. Thank you.

Operator

(Operator Instructions) It appears we have no further question this time. Mr. Melcher. I'd like to turn the conference back to you, for any additional or closing remarks.

Dave Melcher

Okay. I want to thank everybody for being on the call, this morning and I'd like to assure you, we're going to remain focused on our strategic growth platforms and a balanced capital allocation strategy that certainly supports them. We are going to continue to work hard to perform for our customers and we are going to complete the spin-off expeditiously and keep you informed of developments as we go. So thank you again.

Operator

And once again that does concludes today's conference. We appreciate your participation.

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