Exelis' (XLS) CEO David Melcher on Q2 2014 Results - Earnings Call Transcript

Aug. 1.14 | About: Exelis Inc. (XLS)

Exelis (NYSE:XLS)

Q2 2014 Earnings Call

August 01, 2014 10:00 am ET

Executives

Katy Herr -

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

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

Analysts

Howard A. Rubel - Jefferies LLC, Research Division

Ross Cowley - Crédit Suisse AG, Research Division

Joseph B. Nadol - JP Morgan Chase & Co, Research Division

Gautam Khanna - Cowen and Company, LLC, Research Division

Steven Cahall - RBC Capital Markets, LLC, Research Division

Operator

Welcome to the Exelis Second Quarter 2014 Financial Results Conference Call and Webcast. Today's call is being recorded. [Operator Instructions] It is now my pleasure to turn the floor over to Ms. Katy Herr, Vice President of Investor Relations. Please go ahead.

Katy Herr

Thank you, Randy, and good morning, everyone. Thank you for joining us today on our second 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, 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.

David F. Melcher

Thank you, Katy, and good morning, everyone. Thank you for joining us today. As you saw on our filings this morning, we delivered a second quarter broadly in line with our expectations. Importantly, with the book-to-bill over 1:1, and a significant year-over-year increase in funded backlog, we see encouraging signs for both the top and bottom lines for Exelis upon completion of the Mission Systems spin-off.

From a consolidated perspective, revenue and profitability were challenged by a more rapid contraction in Afghanistan programs in the Mission Systems division. As a result, we are reducing our full year consolidated guidance, which we will discuss in more detail in a few minutes. For the second quarter, funded orders were $1.2 billion, and we closed the quarter with funded backlog 17% higher than the second quarter of 2013. Including incremental funding on current contracts, 90% of our remaining 2014 revenue is in backlog. Revenue for the quarter of $1.1 billion was slightly below our expectation, again primarily due to the more significant deceleration in the pace of operations in Afghanistan. However, if we exclude Mission Systems, revenue was down 3% from the same period in 2013, in line with our expectations. Second quarter adjusted operating income reflects anticipated margin normalization in the Information and Technical Services segment, primarily again in Mission Systems. If we exclude Mission Systems, Exelis profitability increased over 30%, driven by a 60% increase in C4ISR segment adjusted operating income from the second quarter of 2013. We generated $174 million in free cash flow during the quarter and $14 million year-to-date. The quarter demonstrated sequential improvement in collections and lower year-over-year capital expenditures as we completed the buildout of the ADS-B ground network. We also returned approximately $50 million to shareholders via dividends and buybacks, bringing our year-to-date total to approximately $90 million.

Please turn to Slide 4. As I mentioned earlier, year-over-year funded backlog increased 17%. Contributing to the growth, particularly in the C4ISR segment, is our success in bringing our products and solutions to international markets. Year-to-date, international orders are up 14% from the first half of 2013. For the full year, excluding Mission Systems, we anticipate that international orders will comprise approximately 20% of orders. In addition, we continue to advance our 4 strategic growth platforms with orders that included a multimillion dollar award from Airbus to supply composite floor beam struts for the A380 aircraft. This is our first aero structures award with Airbus and our first contract for the recently announced Exelis struts, tubes and rods or STaR product line. This contract expands our content footprint with original equipment manufacturers and expands our composite solutions to include structural hardware. In this case, floor beam struts, but other applications include wing box struts, torque tubes and control rods. We also received a contract from NASA, worth up to $208 million to build the radiation budget instrument, a satellite payload that will help to improve scientific understanding of climate change. During the second quarter, we were also awarded positions on 2 large strategically important federal IDIQ contract vehicles. EAGLE II, with the Department of Homeland Security, and the OASIS contract, run by the General Services Administration. Both contracts are new prime contractor opportunities for Exelis and give us an opportunity to deliver our products and solutions to a broader customer base. It's important to note that while these contracts are strategically important, we only include task order awards in our backlog calculations, not the IDIQ contract ceiling value.

We continue to see support for our legacy product areas as well. During the second quarter, we were proud to be 1 of 4 vendors selected to provide the SRW appliqué technology for the Army SINCGARS radios. We were also awarded a contract to deliver high-capacity data radios to NATO, as well as a contract from General Dynamics U.K. to continue to support the tactical communications, modernization and logistic support for the United Kingdom Ministry of Defence.

As you can see, I&TS total backlog declined during the second quarter. If you will recall, Mission Systems received sizable awards for several key programs during the third quarter of 2013, and you can see on these charts that they are working through that backlog, accounting for approximately 3 quarters of the change in total backlog. However, earlier this week, Mission Systems was awarded a $443 million fully-funded option year on the Kuwait base operation support services and security contract. The K-BOSSS contract provides essential base operations support for Camp Arifjan and other sites, and accounted for 8.5% of total Exelis revenue in 2013. It's projected to comprise the same amount in 2014. This option year award validates Mission Systems' continued excellent performance on this contract and should contribute to stabilizing revenue in Middle East programs. You should see this order reflected in backlog next quarter.

Let's turn now to Slide 5 for an update on the pending spin-off of Mission Systems, which will be known as Vectrus, upon its spinoff. As I mentioned earlier, operations in Afghanistan are winding down faster than originally protected, resulting in lower second quarter revenue in Mission Systems than we expected. We now expect that for the full year, revenue will decline 20% to 25%. As a result of the lower revenue expectations, as well as contract adjustments to reflect site closures and lower service levels in Afghanistan, we now expect that Mission Systems 2014 margins will be in the range of 4% to 4.5%. Mission Systems continues to manage a robust pipeline of opportunities. They currently have over $9 billion of qualified new and recompete opportunities for pursuit over the next 36 months. We continue to move through the regulatory and legal requirements to execute the spin-off. We anticipate that the spin-off will occur later this summer or in early fall. We'll continue to keep you updated.

Before I turn the call over to Peter, I'd like to take a moment to discuss some of our investments for future growth. Our strategic growth platforms continue to be the priority for internal and external investments. Earlier this morning, we announced an agreement to acquire Barco Orthogon. Orthogon provides applications for air traffic flow management and decision making to airport operators and air navigation service providers, or ANSPs, around the globe. This acquisition supports our critical network's strategic growth platform by expanding our aviation solutions portfolio. And in June, we completed the acquisition of SelectTech, which provides advanced signal processing and communication systems, engineering services and product development for satellite and terrestrial wireless solutions. This acquisition expands our data analytics capabilities set and supports the intelligence, surveillance, reconnaissance and analytics strategic growth platform, as well as our electronic warfare. We also continue to invest internally to bring the market open architecture and modular solutions that integrate technologies from across the company. An example of this is our JAGWIRE technology, which is a cloud-based solution to quickly and efficiently process, analyze and share full-motion video, imagery, radar and geographic information. JAGWIRE reduces the time from data collection to decisions and delivers them within seconds, even to the disadvantaged user in austere environments. JAGWIRE is also a key enabler of our Individual Soldier System, which as you may recall, is a network night vision goggle with realtime intelligence-sharing capability, currently being marketed internationally. JAGWIRE is also integrated with a variety of payload solutions, such as the CorvusEye product, which we launched during the second quarter. CorvusEye is a wide area airborne surveillance system that captures color video for multiple views of a large area, allowing users to simultaneously monitor multiple areas that might go unnoticed using traditional surveillance.

In closing, I'm encouraged by the strength of orders year-to-date and the growth in funded backlog year-over-year. We're seeing positive trends in our ex-Mission Systems business with stronger orders, particularly in international pursuits, stronger international sales and improving profitability. At this time, I'd like to turn the call over to Peter.

Peter J. Milligan

Thanks, Dave. Good morning, everyone. Please turn to Slide 6 for a discussion of our segment results. C4ISR segment continues to deliver solid funded orders with a second quarter book-to-bill of just under 1:1 in a tough compare quarter. Year-to-date, C4ISR book-to-bill approaches 1.2x and funded backlog is up 5% year-over-year. International customers continue to play an important role in this segment's outlook, accounting for 30% of year-to-date orders. We continue to expect that international orders will comprise about 1/3 of all C4ISR orders in 2014. Revenue increased 1% on higher sales of domestic airborne electronic warfare systems, ground counter-IED systems, and i-Aware tactical mobility night vision goggles or TM-NVG, somewhat offset by lower sales of domestic tactical radios. Our focus on international markets resulted in a 26% increase in revenue from the second quarter of 2013, reflecting higher sales in satellite payloads, communication systems and TM-NVG systems. We expect C4ISR revenue to continue to demonstrate positive year-over-year comparisons through the rest of 2014. Full year revenues will be flat-to-up low single-digits, with the fourth quarter delivering just over half of the expected second half sales. Adjusted operating income in the segment was up 60% on an improved revenue mix and lower restructuring and pension expenses. We continue to expect full year adjusted margins in the low teens. As we discussed last quarter, the cadence of C4ISR profitability looks similar to 2013. We anticipate about 60% of the segment's second half profitability in the fourth quarter, primarily due to the timing of program milestones, as well as some anticipated book-and-bill revenue.

Turning to Slide 7. Funded orders in the I&TS segment were down 7% compared to the second quarter of 2013. It's important to note that excluding Mission Systems, I&TS delivered a year-to-date book-to-bill of over 1x. Year-to-date revenue was down 19% in the segment, primarily due to lower revenue on Afghanistan programs, somewhat offset by higher revenues on FAA programs. We expect full year revenue will be down in the low teens, reflecting lower revenue for Mission Systems. Excluding MS, we expect full year revenue down in the low- to mid-single digits. Following an exceptionally profitable 2013, we are seeing adjusted operating income return to more typical levels. Adjusted operating income declined 46% from the second quarter of last year, due to fewer favorable contract modifications, which drove much of the 2013 margin performance. For the full year, we expect I&TS adjusted margins in the range of 7.5%.

Let's turn to Slide 8 to discuss our revised 2014 guidance. We now project 2014 revenue of about $4.45 billion. 90% of second half revenue is already in backlog. The vast majority of the change we're making is due to lower-than-expected Afghanistan revenue at Mission Systems. We expect that the adjusted operating margin will be about 10.5%. If we exclude Mission Systems, we would expect to see margins in the 12% to 13% range. Adjusted EPS is now expected to be between $1.44 and $1.50, reflecting the lower revenue and margin in the I&TS segment. And we've reduced our restructuring expenses slightly to $15 million. Free cash flow is now expected to be approximately $200 million, primarily driven by lower income at Mission Systems and some delayed awards in sales that although we forecast will occur in 2014, the timing will make it difficult to convert to cash before year end. Looking across the second half of the year, I expect the third quarter should be in line with the second quarter. Higher sales and improving profitability in the C4ISR segment is somewhat offset by declines in the I&TS segment, and free cash flow is weighted towards the fourth quarter as it has been for the last several years. And now, I'd like to turn the call over to questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll now take our first question from Howard Rubel from Jefferies.

Howard A. Rubel - Jefferies LLC, Research Division

Couple things. How big was Orthogon?

David F. Melcher

Orthogon is a company that -- it's relatively smaller scale. I think the revenues for Orthogon are somewhere in the high-teens in terms of U.S. dollars. And the thing that's really important about Orthogon though, is it gives us some international opportunities and a global reach that we haven't had prior to the purchase of this company. It fits very well with our Symphony product line, which has already now gained a lot more acceptance at U.S.-based airports. And I think it will also pair very well with our C4i business that we bought in Australia about 1.5 years ago. So as you can see, we're starting to get a little bit more global reach and more opportunities will be created from that.

Howard A. Rubel - Jefferies LLC, Research Division

Dave, I just have 2 more questions. One on cash flow and there's kind of a little bit of pension thrown in there. First, a $50 million decline in cash flow doesn't seem to totally foot with the decline in Mission Systems. I mean, was there some profitability or receivable collections or something else that's just not falling into this year?

Peter J. Milligan

Howard, this is Peter. I can take that one. Sure, yes, so $50 million, the majority is Mission Systems, as we mentioned, because you see essentially a $30 million reduction in their profitability for this year. And you also have, as I mentioned, I think in the prepared remarks, that some of the skew towards the fourth quarter puts us in a spot where my best view is that it's going to be a little tough to convert some of that cash in the year. Now, as I know you know, there's no receivables risk or anything like that for us. And last year was interesting because at the end of the year, we saw some significant collections, much better than we thought we were going to have. In fact, when you look at working capital at the end of last year, because of those strong collections we had, excluding cash, of course, the working capital was under 5% as a percent of last year's sales. Now, it's in the 7.5% range, obviously always something we target to do better, but there's nothing structurally changing in the business at all, other than the change that we're talking about with respect to Afghanistan.

Howard A. Rubel - Jefferies LLC, Research Division

So how do you get much value out of the spin? Because if we're going to leverage the business at some multiple, we've seen some -- I don't know, whether it's a structural change in the profitability of Vectrus or whether it's one-time? Or how are you thinking about it in terms of making sure that you get a fair price for a dividend going forward?

Peter J. Milligan

Well, I mean ultimately, as you know, the market's going to determine not the dividend, but the equity price. And as far as the dividend, what we've talked about since the announcement, was that we'd be looking to have a capital structure that met the objectives as outlined by the board, which is to give them some optionality. We also want to have a capital structure that reflects the amount of leverage that allows that business to perform well, and that's what we have sort of always thought in sort of the 2.5 to 3x range. And of course, their EBITDA and EBIT are just about the same, there's no D&A. So even if you looked at this year's numbers now, which are in that $50 million range for profitability, you're looking at a return in the form of a dividend, which would be in $130 million to $150 million range. Now, a couple of things. Of course, the board has to approve that and we have to secure that financing. So those are a few things to think about. Now, with respect to structural changes in profitability, last year wasn't a typical year, no doubt. We saw margins in the high-single digits for that business and as we had commented throughout 2013 and as we predicted, as we moved into 2014, we did not expect to see continuations of those levels of profit. Last year, as you know, since all companies disclose some of their catch-ups, we had a lot on that business. They had fixed priced business, some of it in Afghanistan, which they had performed well on, and in some cases, recovered losses from prior years. But structurally, the business is in this 4% to 4.5% range, is probably where we see it based on the competitive dynamics in that market.

David F. Melcher

Howard, this is Dave. If I could just sort of zoom up from that to sort of the strategic level on the logic behind the spin-off. I think as we've talked about before, the purpose was really to create 2 businesses that are, in many ways, very different out of the spin of Mission Systems. As you know, we didn't invest a whole lot in that business. I think they're going to have a great opportunity to invest in themselves and then expand into some markets that previously, perhaps, they didn't have access to. Exelis is going to be a much more focused company on C4ISR and networking. And things that we call strategic growth platforms today, probably go from maybe 50% of our revenues to well over 80%, as we invest and grow those strategic growth platforms. So I think this is going to create great value for shareholders, for those who hold Vectrus and those who hold Exelis. And Howard, I think you've even commented on the strength of this leadership team in one of your notes. We share that same confidence and we think they're going to be fabulously successful as an independent public company.

Howard A. Rubel - Jefferies LLC, Research Division

No doubt about that. And then just MAP-21 and then I'm done. There was the pension smoothing that passed the Senate, I guess, yesterday. And Peter, does that give you some more cash opportunity?

Peter J. Milligan

Yes, so let me go through a couple of things on that. I think we expect, as many do, that the President will sign that legislation. So if enacted, it does give us some benefit, certainly from a cash perspective. It's not in the guidance. I want to make sure that, that was clear. We had said that our pension contribution, cash contribution, was going to be about $200 million this year, and in the $200 million to $250 million range over the next number of years. When you look at MAP-21, that probably puts us, this year, potentially again, if it's signed into law, of about $150 million in contributions. And then as we move out into the next couple of years, you may see contributions that look more like that. So certainly, a decrease from what we previously thought. Now again, it's a reduction of those contributions and an extension of those. So the lower contributions in the next couple of years, obviously mean that what we thought we would be sort of finished up largely in 2017, that gets extended a little bit. But however, I guess, clearly, my view at least is impart the intent of the law. We know it's a revenue raiser because we will be paying [ph] some more cash taxes as we pay a low -- as we contribute lower cash into the plan. But it also gives us, I think, an important time for interest rates to "normalize" to levels where I think many of us would feel they probably belong. And if that happens in a timeframe where I think many, certainly on Wall Street, are expecting, then those contributions probably permanently get lower because the interest rates really solve the problem, if you will, of having these liabilities not really reflective of what a market interest rate would be if it wasn't for all the Fed intervention.

Operator

We'll now take our next question from Robert Spingarn from Crédit Suisse.

Ross Cowley - Crédit Suisse AG, Research Division

This is actually Ross on for Rob this morning. I just wanted to come back on something you said on the cash, Peter, and how it relates to capital deployment. You have the acquisition you've announced this morning, you've done a couple of other small bolt-on acquisitions, you had a nice share repurchase, you have the dividends. Now, how do we think about the cash development going forward? And how will we think about the lower cash impact to the pension, what you might do with that incremental cash?

Peter J. Milligan

Sure. Certainly, it gives us optionality, which is always a positive, I mean, by definition. Over the last number of years, really, since the spin, we've talked about the requirements for the pension, which have gotten continuously better in many respects. And now, we know there's some mortality tables that we have to adopt and I know the interest rates right now are a little bit lower than we had expected, but hopefully, they trend back to where we think. But regardless of that, the number of things we've done on the plan to control those service costs, some of the derisking we've done on the trust side, the lump sum and some strong asset returns have put us in a really -- in a much better spot. So that has created that balance, if you will, and now gives us a little bit more choice. I believe -- I know we will be much more descriptive with everyone coming out of the spin, and I know Dave's going to want to comment on that in a second, but it does give us more optionality and I think that's the key.

David F. Melcher

Yes, Ross, and the only thing that I would add to that is, we certainly have a healthy respect and desire to return value to our shareholders through dividends and an appropriate amount of share buybacks. But we also want to invest in the business. We are becoming a smaller company, a little bit more focused as a result of this spin-off. And these strategic growth platforms, we want to continue to build the scale and the capability and the leadership positions that we have going forward. And so that requires some investments. So we're going to balance all those aims in a way that I think our shareholders will find satisfying. And we're going to really talk a lot more about that, as Peter said, post spin.

Peter J. Milligan

And one other quick point I'd make is, Ross, is as the finance guy, just to remind everybody that clearly, cash is -- that's the most important thing but we do have to also be cognizant of the GAAP earnings impact of having lower contributions, right? That does pressure earnings a little bit because you have lower dollars going into the trust and therefore, that expected return that you would normally see as an offset to pension expense, could be lower. So that's something to consider as well, but again, that's a trade that we, of course, would make because it gives us the cash in hand which we obviously want to deploy as effectively as possible.

Ross Cowley - Crédit Suisse AG, Research Division

Okay, understood. And then Dave, if I could just follow-up on the thing you said about investing back into the business. How important is this win on the A380 in the first position at Airbus and in terms of building that critical mass in the composites business?

David F. Melcher

I think it's extremely important. We had a goal when we invested in the capital, of expanding our Salt Lake City facility, of filling up that factory with meaningful work from a lot of manufacturers of quality products. And we've done that now with the announcement of the big order for structural parts with Boeing back in December, and now, more structural parts with Airbus. So between the military contracts that we have and including F-35 and CH-53K, and these commercial orders, I think we're going to have a great balance and a growing -- a certainly growing backlog, and opportunities for increased growth in revenues as we go forward. So every one of these is another building block in creating what is a very sound business that we intend to scale up.

Peter J. Milligan

One of the things, Ross, if I could just add a couple of thoughts to what Dave just mentioned. We will be attempting to schedule a meeting, an analyst meeting, as we sort of go through the second half of this year after the spin of Mission Systems. And I think it's going to be important for us to talk a little bit more about the business that Dave just highlighted because it is one of those businesses that we're really excited about the developments. I mean, they're on plan and that always doesn't happen, of course. And the mix, as Dave mentioned, between the military business that now things along the lines of CH-53 and Joint Strike Fighter, which we're going to see increases in revenue on that side, plus the mix of the aerostructures work that we've won from Boeing and now Airbus, gives us really good views on that business. And we'll probably be in a spot that we'd be able to share some longer-term views based on what that backlog looks like because we're really pleased with the work that's being done there. And Mike Blair and the leadership team in Salt Lake is doing a phenomenal job.

Operator

And we'll now take our next call from Joe Nadol from JPMorgan.

Joseph B. Nadol - JP Morgan Chase & Co, Research Division

First question is I'd like to know if you would share your bookings or your book-to-bill objectives for the year, ex-Mission Systems? I guess, you were over 1 in both divisions year-to-date so far. So do you have plans for the year?

Peter J. Milligan

Yes, Joe. This is Peter. Certainly, we'd like to be over 1, that's definitely the goal, to be able to hold the backlog and maybe grow it a bit. As you know, from some of the contracts we just announced, some of them are big and international is a big component. A lot of them have closed, and we're thrilled with that, of course. But because of some -- as you well know, the timing on some of these things, we could see a couple of things hit and have backlog well over -- not well over, but over 1, certainly. And then maybe a couple of others missing get us closer to 1. But clearly, sustaining or maybe slightly growing the backlog is our objective and first half of the year, we're absolutely on track for that.

Joseph B. Nadol - JP Morgan Chase & Co, Research Division

And so digging into the implication to that a little bit, you have your sales stabilizing and starting to grow in C4ISR. And then on the I&TS side, you're just a little bit behind that, I think, but you're still -- but you're looking for book-to-bill over 1. So last year, your bookings were quite good. So it does seem like you've had some extension of the tail of your backlog. Putting all those pieces together and looking into next year, are you willing to say that sales -- do you think sales might be up or is that too early to say that?

Peter J. Milligan

I'll tell you I would love to say that. I think it's early, though. I absolutely agree with what you're saying that, certainly, that leading indicator of orders is really positive for us. Some of them are long term. When we win a contract on a satellite job or an international radar, we build it over a couple of years, in some cases. In some cases, longer than that. So some of the awards will be produced over a couple of years, which is not -- obviously not a bad thing at all. But I think it's a little early to get too specific on 2015, but I'll let Dave comment as well.

David F. Melcher

Yes, Joe. We love the trends, we love the way this is going, we think it's very positive. But we, like many others in this industry, remain mindful of the fact that more than likely, we'll start the year with a continuing resolution again here in the start of the next fiscal year. And while we got a little relief for 2014 and 2015 fiscal years, 2016 still goes back to sequestration levels. And we're going to continue to watch very closely, not only the authorizations, but the outlays associated with all that. I don't have any adverse news to tell you. We've been tracking that very closely. We think our programs have been well supported. But I can't predict what surprises are going to be out there. But for now, the trends look good and I would hope to be able to think our way through, at least, to remain flat in revenues going forward, and then we'll see whether there's growth beyond that.

Joseph B. Nadol - JP Morgan Chase & Co, Research Division

Okay. Just on the margins. Understood that the margin pressure in your guidance is from Mission Systems, but you took down your restructuring a little bit. So just for the core business, are you -- is that lower restructuring being offset by lower expectations elsewhere or is that -- are we talking about just some smaller numbers and it's rounding?

David F. Melcher

Yes. I mean, it's modest impact and a couple -- the $4 million, $5 million in lower restructuring is not that significant to your point. And I think with 2 quarters left in the year, I certainly am not in a spot where I'm saying the core is weaker than we thought. I don't think that's the case. So I think it is just a mix of a lot of different things, and we'd obviously like to see continued investment, as you know. And things like R&D, we're sort of on track. We're a little behind where we wanted to be, but our numbers now are showing what the forecast implies, an increase in R&D, and we certainly want to do that. So a combination of some of the internal investment and external, as Dave just mentioned about some of the things we've purchased, is really what's going to help us longer term. The other thing going on sort of behind-the-scenes, I think, which might be helpful for you to understand, Joe, is that our SG&A is down pretty significantly. If you adjust out the spin cost, we're down 10% in SG&A in the quarter. I expect those high-single digit declines to be in place for the year. And what's important is the G&A is going down faster than that. And the selling expense or business development expense, the bid proposal expense is going up. Slightly, but up. So we're holding that as we invest, not only in the R&D side, but on the sales channels. And there's been a lot of great work that's been done there. So I think under the covers, if you will, a lot of the changes that are taking place in the cost structure are the exact ones that we want to see.

Joseph B. Nadol - JP Morgan Chase & Co, Research Division

Okay. And then just one more, Peter. You mentioned that your contributions will come down under MAP-21. But how about your CAS recoveries? Wouldn't those come down as well? So if you wouldn't mind outlining what the net cash impact is, not just the gross.

Peter J. Milligan

Yes. The truth is, Joe, we're still looking at that. We have, as you know, I think, our CAS equation is a little trickier than some others because of the heritage part of the pension from ITT. Directionally, this year, we would expect the CAS to be about $115 million, going up next year. I think there's still some debate as to whether or not the MAP-21 changes have to be adopted in the CAS rates, and we'll do the analysis on that to make sure that we're putting ourselves in a spot to be able to cover the most at the most effective time, if you will. So we're still doing some work on that. I don't want to give too many numbers out because I just don't have the confidence level to give them yet. But I certainly will update you all as soon as I have a better view on that.

Operator

[Operator Instructions] And we'll now take our next question from Gautam Khanna from Cowen and Company.

Gautam Khanna - Cowen and Company, LLC, Research Division

I was wondering if you could comment either on how much cash you think you'll need on the balance sheet to run the post-spin entity, the Exelis post the spin?

Peter J. Milligan

Sure. I think the one thing to remember is we have a credit facility, of course. With the investment-grade rating, we have access to the commercial paper market. So you could debate that we wouldn't need all that much at all. And obviously, we're free cash flow positive. So I mean, we're looking at a number that -- and some of the cash, as you may know and is detailed in our filings, is international. And obviously, the acquisition Dave mentioned this morning utilizes some of that cash. But I don't think we need hundreds of millions of dollars of cash on the balance sheet to run the business day-to-day. We are going to be in a spot where post Mission Systems, the cash should be -- the linearity of it should improve. So it does not have it to be hundreds of millions.

Gautam Khanna - Cowen and Company, LLC, Research Division

Okay. And I just wanted to clarify on the pension comment you made earlier, directionally $150 million of cash required each year. Does that include the life expectancy changes as well?

Peter J. Milligan

Yes, my understanding on that is even though those mortality changes will impact the CAS -- I'm sorry, the GAAP rates or the FAS impact -- will impact FAS or GAAP next year. That doesn't get sort of impacted into the contribution rates under ERISA until 2017. And so we continue to analyze on the 4 or 5 different regimes we have to follow. There are some interplay there but for the most part, I don't think that the mortality rates change that in a significant way.

Gautam Khanna - Cowen and Company, LLC, Research Division

And could you just remind us what the share creep generally is, given options and what-have-you?

Peter J. Milligan

Yes. The last couple of years, it's been much more significant for 2 reasons. Number one, of course, we'd love this to continue but I won't predict anything, the stock price has increased significantly. So that obviously drives the share creep quicker. And the second thing was upon the spin, there were certain founders grants and some other things that were sort of one-time nature. So those 2 are anomalies, one of which we would hope to repeat, but won't predict it, and the other, which we know we'll not. So as a result, you're looking at maybe 1 million shares or something along those lines. I would say a percent or so a year, 1 million to 2 million shares depending on -- obviously, depends on a lot of things but I would say probably about 1% of creep per year.

Gautam Khanna - Cowen and Company, LLC, Research Division

One last one. So we should read, I guess, the guide down on Mission Systems margin that some of the higher-margin stuff got curtailed earlier? Or is it -- what explains the margin pressure that just -- will volume deleverage or is it sort of fixed price where it's at more favorable, terminating sooner?

Peter J. Milligan

Yes, it's the latter. To the greatest extent, you got them. I mean, we had some of the work that has come out has been on the fixed price side. And as you know, we have done a good job on some of those contracts, certainly. Fixed price work is something that the company has done well on in many respects, but that is the issue. Last year, again, if you're comparing it to last year, it was definitely some catch-ups that happened not only in the fixed price programs, but on higher award fees and whatnot. And again, some of those higher award fees translates into the ability to win the recompetes or the option years, and Dave mentioned an important one this morning. But overall, the issue really is -- the change of the mix is the biggest issue.

Operator

And we'll now take our next question from Steven Cahall from Royal Bank of Canada.

Steven Cahall - RBC Capital Markets, LLC, Research Division

Maybe a first one just on the C4ISR margin. If I look at what you said about the profitability weighted in Q4 and we think about the restructuring in the international components in the backlog, I'm sort of backing into an exit margin for the year of sort of mid-15s. Is that a -- am I thinking about that right? As we think about a run rate for that business going forward, am I thinking about it correctly?

Peter J. Milligan

Your math is right this year. I wouldn't say it's an exit run rate. And again, that's one of the issues that -- I don’t know if it's an issue necessarily, but it's been a trend that we've had where the margins have not been as linear as you may ordinarily think. I mean, if you look at last year, we had a fourth quarter margin in C4ISR of 15%. So you would expect to see, based on the guidance, the margins certainly in that range, no doubt. For the full year, as I mentioned before, you're looking at margins that are sort of in that low teens. And I think as we move into 2015, you'd probably see margins that are in that similar range. And I think what's going to drive that over the longer term or certainly the midterm is the reductions that we're going to be aggressively taking on the cost side are going to be driven -- are going to drive 2 things: number one, competitive positioning to help, in some cases, expand market share hopefully; and the second is to reinvest in the business, in R&D and on the bidding proposal side.

Steven Cahall - RBC Capital Markets, LLC, Research Division

Okay. And if we think about the backlog for that business, I mean, is it correct to think of the new sales that you're booking as margin-accretive or margin-neutral? Or is there just a lot of competitive pressure out there and so, in some cases, it is margin-dilutive, pre the work you're doing on cost?

Peter J. Milligan

Yes, of course. It's a mix. I mean, there are certainly some contracts that, in some ways, we would view more strategic in nature, getting into a new market that you are certainly willing to go below your average margin. It's necessary. There's learning curves and other things that you start out in the first time you get into an adjacent market that you can then hopefully leverage as you move on. There's other cases where you may be in a mature market where the competition allows for a little bit higher margin. But the truth is, it is a complete mix. I don't want to say it varies widely around that median, but it is definitely dependent. And it's not even a truism that we can say on all international it's accretive, that's not the case. In some cases it is, and in some cases it's not. So we look at each of the bids closely. We judge them on the merits of what it means strategically, as well as, of course, our chances of winning and develop our pricing strategy accordingly.

Steven Cahall - RBC Capital Markets, LLC, Research Division

Okay. That's helpful. And then just on Vectrus, and we see the slip in timing for the spin out. Is there anything that we should take away from that? Or is that just the time it takes to sit down with the lawyers and work through everything? And as a corollary, I know this is a subject that you maybe a little bit loathe to talk about, but it has certainly come up around the potential tax issues with this divestiture. And as we think about Vectrus as a standalone entity, based on what you see today, is there anything that we should be aware of, either for Vectrus or from the parent in terms of tax implications of the spin?

David F. Melcher

Well, let me start on that and Peter can chime in if he wishes, Steve. Well, first of all, there's no message in saying that we're going to complete the spin late summer, early fall. We had always been saying summer, and internally we always planned that it would be in the latter part of summer. If you remember back to our spin from ITT, that was consummated probably in a period of about 10 months. We learned a lot from that and we're proceeding on a similar timeline. And I think compared to some other things that have happened in other spins that went maybe 1 year, 1.5 years or so, we're still going to be pretty timely on this one. So no news to report there. With respect to the tax implications, we have been very careful and very methodical about complying with all the things that would be attendant to a tax-free spin-off of an entity like Vectrus. And so we really don't have any indicators for you about any tax implications post-spin really, for the parent or for the company. So I'll let Peter chime in if he wishes.

Peter J. Milligan

I agree with the Dave, and the Form 10 is pretty clear on what happens with respect to tax and certainly, nothing to update beyond that.

Steven Cahall - RBC Capital Markets, LLC, Research Division

And just the last one for Peter. Can you let us know what you think interest is going to be for the year?

David F. Melcher

This year's interest expense should be about $35 million.

Operator

At this time, there are no questions in the queue.

David F. Melcher

Okay. What I'd like to do then is just to thank everybody for the thoughtful questions that you brought forth today. It really does reflect the fact that you know our business well, and we appreciate that. We remain very upbeat on the positive trends that we were able to talk about today. We think that the building of the backlog and the focusing of the businesses is putting us exactly in the direction we want to go. And we're going to -- we promise we'll continue to invest wisely and return value to our shareholders as we go forward. And we'll keep you informed about all spin developments and capital allocation, which I know you're interested in, after the spin is consummated. So thanks for being with us today.

Operator

And this does conclude today's conference. Thank you for your participation.

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