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L-3 Communications Holdings (NYSE:LLL)

Q3 2011 Earnings Call

October 27, 2011 11:00 am ET

Executives

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

Eric Boyriven - Investor Relations

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

Analysts

Howard A. Rubel - Jefferies & Company, Inc., Research Division

Robert Spingarn - Crédit Suisse AG, Research Division

Joseph Nadol - JP Morgan Chase & Co, Research Division

Peter J. Skibitski - SunTrust Robinson Humphrey, Inc., Research Division

George Shapiro - Citi

Myles A. Walton - Deutsche Bank AG, Research Division

Cai Von Rumohr - Cowen and Company, LLC, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Third Quarter 2011 L-3 Communications Holdings Inc. Earnings Conference Call. My name is Tahisha, and I'll be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Eric Boyriven. Please proceed.

Eric Boyriven

Good morning, and thanks for joining us for the L-3 Communications 2011 Third Quarter Conference Call. With me are Michael Strianese, Chairman, President and Chief Executive Officer; and Ralph D'Ambrosio, Senior Vice President and Chief Financial Officer. After their formal remarks, management will be available to take your questions.

Please note that during this call, management will reiterate forward-looking statements that were made in the press release issued this morning. Please refer to this press release, as well as the company's SEC filings for a more detailed description of the factors that may cause actual results to differ materially from those anticipated. Also, please note that this call is being simultaneously broadcast over the Internet.

I would now like to turn the call over to Michael Strianese. Mike, please go ahead.

Michael T. Strianese

Thanks, Eric. Good morning, everyone. Thanks for joining us this morning. I'll begin by saying we performed well in the third quarter. We have a lot of new awards and received a number of key follow-on contracts. As you've probably seen, that's reflected in our book-to-bill ratio, which was 1.18 for the quarter, higher than we were expecting. And our business continued to execute well on virtually all of our programs. As always, I want to thank our employees, our management team, our group presidents for their hard work and outstanding program execution in what continues to be a very challenging industry environment.

The results include our continued strong cash flow of about $465 million for the quarter, and we remain on track for the year on cash flow. The ISR business continues to show strong growth, and AM&M logistics services not only is performing well but is managing a steadily increasing backlog and is growing its market share. In AM&M overall, delays in the 2011 JCA orders, Joint Cargo Aircraft program, did impact the growth rate, but we don't see this as a major concern.

In the Electronic Systems segment, we also saw strong performance in our EO/IR, integrated sensor systems business, as well as in our electronics for our commercial ships.

Government Services continues to experience sales declines due to the accelerated timetable for drawdowns in Iraq and Afghanistan and a very competitive environment, which is more than offsetting growth in our cyber and IT services businesses. In keeping with our strategy, we're taking the appropriate actions to enhance our ability to anticipate and effectively address customer priorities and promote growth.

We continue to work on improving profitability through better integration of our divisions, which reduce our costs, and increase our productivity. We focus on collaboration within our business units to develop new products that meet customer requirements, which is becoming increasingly more important to stay in alignment with the customer requirements as there's little room for extras and there's little development funds available. So we are spending extra time really understanding as best we can the direction our customers want us to go in and taking initiative where we find it appropriate to invest.

We've also -- continue our consolidation within the business units. As you know, we've combined the Products group with Electronic Systems to form the Electronic Systems group as part of the Electronic Systems segment. But it really is starting to come together very nicely and generating some synergies that will help us through next year. These are positive moves for L-3 that support the business model we have and position us with our customers who are looking for these types of moves and synergies.

In terms of the Engility spin-off, we've been making good progress. Once the transaction is complete, as you know Engility will be a leader in SETA, training and operational support where L-3, however, will remain -- retain its Cyber, Intel and Security businesses that will be renamed National Security Solutions or NSS. The Engility spin-off is on schedule. We've submitted our IRS ruling request regarding the tax-free structure of the spin and expect their ruling early 2012. All the other actions that are needed to complete the transactions are in process and we anticipate will be completed by midyear 2012.

With regards to the DoD budget, I'm not going to spend a lot of time. I'm sure you have questions, and it's no shortage of press on what's going on. But let me say that it's the core of our strategy to constantly strive to deliver greater value to customers, and efficiencies we've put in place across our operations do align with the DoD goals. We're confident that the savings that will result from the DoD's cost reduction initiatives will be used to invest in many of our core areas, C3ISR, intelligence support, our EO/IR sensors, logistics support, platform upgrades and counterterrorism initiatives.

Along with our industry peers and our colleagues in government, we're looking at the various scenarios including sequestration and how they would affect our business strategy and operations. Again, as you know, there are very few specifics as to the amount, timing and subsequent battles that may occur. So we're being cautious on how we're proceeding and thoughtful about how we're structuring our business plans for next year to maximize our flexibility so we can respond to the changing environment.

So that said, we're all watching anxiously, as I'm sure you are, as to what this joint congressional committee recommends next month and the subsequent vote in December.

On the financials, I'll give you a brief summary. Ralph is going to give you plenty of details. Earnings, as you've seen, were up 8% to $2.24 a share compared to 2010 this third quarter. Sales were down about 1% to $3.8 billion, and orders were at $4.5 billion for the quarter. That's a 27% increase from last year's third quarter. And we closed the quarter with a funded backlog of about $11.5 billion.

Just to give you some comparisons which we'll start reporting some pro forma disaggregated information for Engility, but just a couple of key numbers: Where our sales were down 1% for the quarter, Pro forma L-3 x Engility, they would have been up 1%, 1.5%. So it's almost a 300-basis-point swing.

Our margins, reported margins, were 10.7%. Pro forma for the spin, they would have been 11.1%. So again, 300 to 400 -- 3 to 4 -- I'm sorry, 30 to 40 bps up. And the operating income growth rate, the reported number was down 7%. Pro forma x Engility would have been down 2%. So I think you could see the significant impact the spin-off will have on our numbers.

In terms of some of these more significant awards and milestones, in C3ISR, we continue to receive funding for upgrades and logistics work on existing Liberty aircraft, demonstrating, of course, business segment capabilities with sensors and comm systems from our ES businesses and in service platform systems support provided by AM&M. So we got 3 segments working together to deliver a great capability.

We recently introduced our Spyder [ph], small manned ISR aircraft for the government and for international military and civilian use, with demonstration flights that will start next month at the Dubai Air Show. And that's -- you might look at that as a derivative from the Liberty program where we've changed out sensors and essentially developed the export version at a very, very I would call it almost a disruptive price point for the performance this system will put out. So we're excited about getting it in customers' hands. And I think this is the new way of the world in this space in that you need to come with hardware that works that customers can use, in many cases. So we are adapting for that new reality.

We continue to provide our common data link system, the HawkLink terminals to the U.S. Navy for secure, real-time, high-speed, air-to-surface digital transmission. That's for imagery, sensor data, communications and radar information. We also received a follow-on for our integrated communications system for the Navy's Virginia-Class Block III [ph].

On Electronic Systems, we continue to see strong orders in EO/IR. There are sensors, including systems for the Army's aerostat initiative known as PTDS, Liberty and the LUH program. We got an order for 300 of our ProVision ATD systems, automatic threat detection, from the TSA, and a separate contract to upgrade our existing base for the ATD configuration. As you might recall, that's the version where it provides the privacy and is more of a generic mannequin figure, not an actual image of a person. So one, we're the only contractor that has that capability, and it's really showing in our orders and the fact we've gotten an in-field upgrade. We have about 900 systems in use today or on order, and a growing book of business in that space. We also got additional funding for our F-16 Mission Training center, along with funding for enhancements in addition to PMEX [ph] training system as well.

Under our multiyear award, we're going to provide over 5,000 laser rangefinders for soldiers and tactical vehicles. That's from our Warrior Systems sector.

In AM&M, we had several contracts for airport -- aircraft depot sustainment and logistics work, including 2 contracts in support of Army helicopters. As the prime, we delivered and deployed 2 C-27Js, Joint Cargo Aircraft, to Afghanistan. I'm happy to report they were performing well in theater with a service rate exceeding 95% and hopefully taking some of the pressure off the other lift vehicles that have to bring supplies up to the more hard-to-reach areas.

We were awarded contracts from the Navy for T-34, 44, and T-6 aircraft maintenance and logistics support on seating and incumbent in what was a very competitive process. We delivered a C-130 military transport aircraft to Poland over 2 months ahead of schedule, and we're putting a new SATCOM capability on the EP-3 platforms for the Navy.

In services, as we said, we're seeing additional pressure because of the accelerated drawdowns in both Iraq and Afghanistan, as well as an extremely competitive environment in terms of the number of players that are coming to bid and the margin pressures, changing contract vehicles, the fact that programs are being bid on ID/IQ basis instead of single awards. So basically, the perfect storm there.

However, we've been taking a few actions to bolster our cyber initiatives, and we’ve recently announced the formation of a cooperative partnership in cyber research and development with Virginia Tech, who is a recognized leader in cyber R&D. We expect the partnership will enhance our ability to deliver innovative national security solutions, particularly in advanced analytics, cloud computing, virtualization, communications and mobile security as well as cyber training and education.

In terms of our capital allocation in M&A activities, as you know the share repurchase program has been a central element of our capital deployment strategy and reflects our ongoing commitment to deliver value to shareholders. During the quarter, we repurchased $371 million of our common stock and also paid dividends of $46 million, resulting in year-to-date numbers of about $943 million of cash returned to shareholders through the buyback and the dividend. So our commitment to our capital allocation strategy is unwavering. At the same time, we are committed, however, to preserve our investment-grade ratings, which we –- we’re doing.

Finally, a few words about the M&A environment. While we haven't closed on anything of any significance in size this year, we have reviewed a number of companies, numerous companies, and we're close on a couple of acquisitions in several hundred million dollar neighborhood. As always, we're being very selective to find value in companies that are a good fit and remaining very disciplined in our price. Generally, we are looking at approximately all multiple, maybe a little bit more, but when you factor synergies, these would all be value and earnings accretive. I think that we're starting to see sellers' price expectations moderating from where they have been. So we think that there are good deals to be had. We're focusing on building out our company's portfolio in those areas where we have strong market positions and see stable budget environments in the future. And that's a change from the past now. We're very mindful of the direction the DoD is going.

And one thing to say on the overall environment that I want everybody to recall is that some of the best additions in the L-3 portfolio occurred during the last downturn. That's when the best deals were had, and that goes back to the -- even to Loral days in the early ‘90s. So we expect to be able to build out our portfolio. Given our size, we would think that this would be value accretive and also help to offset any potential declines we'll have in the future.

So with that, let me turn it over to Ralph and he'll cover some numbers, and then we'll take the Q&A.

Ralph G. D'Ambrosio

Thank you, Mike. Good morning. I'll add a few comments about the third quarter results and the changes to our 2011 guidance.

For the third quarter, earnings per share were $2.24, up 8% versus the third quarter of last year. Lower taxes, interest expense and shares outstanding offset a 1% decline in sales and 70 basis points of a lower margin, which reduced operating income by 7%. Generally, the third quarter results were in line with the outlook that we provided on July 28. The exception, the largest exception, was sales were about $50 million lower than we expected, and that was primarily due to the Joint Cargo Aircraft, or JCA, order delay.

Free cash flow was very robust at $418 million, up 14% versus 3Q of 2010, and it was more than $100 million higher than we expected. And that was due to better receivable collections and lower tax payments.

Regarding the full year 2011 guidance update, we increased EPS by $0.05, and that was primarily for a lower estimated tax rate minus Engility spin-off transaction expenses, which raises the EPS range to $8.70 to $8.80. The other guidance changes, essentially net to 0 on the EPS line.

With respect to sales, we lowered the consolidated guidance by $200 million, or 1.3%, making the new sales range $15.3 billion to $15.4 billion. If you'll recall on the first and second quarter earnings calls, I talked about the downside risks that we had to sales and said that they would be sorted out in the second half. The largest risk concerned the Joint Cargo Aircraft order delay, which was supposed to be for 8 aircraft. Well, as of today, we do not expect to receive that order this year, and that is subtracting about $80 million from 2011 sales. And so, we are now at the $2.4 billion or low end of our sales guidance range for the Aircraft Modernization and Maintenance segment. The rest of the sales risks in the second half pertained to funding affecting Electronic Systems and small aircraft ISR in the C3ISR segment. And those risks stemmed from the DoD FY '11 continuing resolution and then the appropriation cut which happened in April, which was 3% lower than the budget request for 2011.

And generally, changes in the budget and funding environment are going to impact L-3 sooner than later because most of our businesses are short cycle in nature. In any event, those sales related to those funding items will be less than planned, and they're going to reduce our full year sales estimate by about $120 million and place our sales estimate in C3ISR at the low end of the guidance range, and they’ll also reduce the Electronic Systems segment sales guidance range by $100 million.

With respect to the fourth quarter, we expect sales to be between $4.1 billion and $4.2 billion, earnings per share somewhere between $2.36 and $2.46, and free cash flow of about $430 million. Our operating margins will be about 10.5%.

For the book-to-bill ratio, the fourth quarter is going to be lower than what we experienced in the third quarter. There were a lot of timing items that improved the orders in Q3, and we still expect the full year book-to-bill ratio to be close to 1.0. That includes my comments. Thank you, and we'll go to the Q&A now.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of George Shapiro from Access 342.

George Shapiro - Citi

A couple of questions. Ralph, in the AM&M area, you've got margin guidance of 9% to 9.2%, but the year have been 10.1% so far. And are you factoring in some charge for JCA in the fourth quarter? Or what's causing the sharp decline?

Ralph G. D'Ambrosio

Well, the fourth quarter margins are -- I agree on the conservative side. I do have some contingency in there for JCA. And, well, we're also -- we've also been starting on the new -- a few CLS programs that we recently won, and we have some start-up costs on those contracts and they get expensed as incurred. So that's what's happening in that segment, George.

George Shapiro - Citi

Okay. And then just in general, Mike, we’re looking for the Engility spin, I mean, are you looking at anything else to do from that perspective with the company given the environment that we're headed into?

Michael T. Strianese

Well, where we are now, George, is we completed a rather expensive exercise in the middle of the year and worked closely with our management and our Board in developing a plan that would create the best value and move some of the headwind away and re-focus our services segment in the areas where we see growth while freeing up Engility to go after things that they couldn't, like the OCI business that we can't chase to see the business, or to go out to be a little higher leveraged so they can go out and do lower-margin type work. Beyond that, as I said in the last call, we had no other candidates for divestiture at this time. Now this environment is changing rapidly, but anything we would decide now would be a guess. So we'll stay flexible, as always, and we'll adapt to the environment.

George Shapiro - Citi

Okay. And then on the M&A front, Mike, are you seeing prices come down yet at all? Or kind of give us a status of where that is at this point?

Michael T. Strianese

We do, George. Some of it is a function, of course, on the property. Obviously, things that are in cyber, Intel, sensors are going to carry more, a little more of the EBITDA multiple, if you will, than things that are in areas that are not so growth oriented at this time. Having said that, some of the richer deals that you've seen in the past I don't think are going to be recurring. If they do, they're going to be few and far between. I think everybody gets it in this industry that it's difficult to rationalize to yourself or shareholders or anybody really paying tremendous margin spreads from your trading versus buying. And I -- so the answer is yes, I do see prices moderating and its expectations coming down. You don't see a lot of the busted auctions [ph] like we saw last year. So -- and deals are getting done. The ones that are getting done are getting done at reasonably good prices.

George Shapiro - Citi

Okay. And then, let me just give one other quick one for Ralph, back in AM&M. Ralph, as I look at -- without SOFSA in the third quarter, the revenues grew 3%. SOFSA is not the headwind in the fourth quarter. So the low end of the guidance still suggests a pretty sharp decline. I mean, any reason for that?

Ralph G. D'Ambrosio

Well, part of it is JCA, which is -- we expect to decline again in the fourth quarter due to the delay that I talked about. And then, some of the equipment maintenance work that we do in Iraq is ending, and that's also a factor.

Operator

Your next question comes from the line of Joe Nadol from JP Morgan.

Joseph Nadol - JP Morgan Chase & Co, Research Division

You upped your guidance for C3ISR. And across industry, I have to say that's one of the very few segments that -- where numbers got boosted this quarter. So I was wondering if you could offer a little more insight there. What's incrementally driving the strength versus where you were 3 months ago?

Ralph G. D'Ambrosio

Well, we maintained the sales guidance range, and we just increased the operating margin range by about 20 bps.

Joseph Nadol - JP Morgan Chase & Co, Research Division

Right. So where there contract closeouts or performance…?

Ralph G. D'Ambrosio

Most of it pertains to -- we're doing -- we're experiencing better efficiencies than we anticipated on the fleet support and CLS work. So I wouldn't call it a contract adjustment. It's just that volume has been increasing, and we're being more efficient with the costs that we incur there.

Joseph Nadol - JP Morgan Chase & Co, Research Division

Okay. Any initial thoughts on next year, Mike or Ralph? Usually, you give it in Q3. I know the environment is very uncertain. But even directionally, sales, margins, that sort of thing?

Michael T. Strianese

Yes, Joe, it's -- it would be really a wild guess, so we'd have to have so many caveats around it. I don't know how meaningful it would be. We plan on our Investor Day to give that guidance, on December 6. And candidly, I don't know that we'll be in a different place by then. But by then, we'll have lots of charts and things that'll give you all the assumptions that we're on, we're looking at. I mean, some of the same trends are going to continue with ISR being strong but slowing. I can talk to it in a macro sense with you. There'll be pieces of Electronic Systems that will be growing and pieces that will be flattening out. It's balanced. It shouldn't be a big swing, up or down a couple of points on the top. I'm talking top line now. Let's see. AM&M, JCA is going to be a swing item as to what they do. The Air Force does on their Roles and Missions Review whether they continue the program or not. It will be an impact on the top line should they decide to not continue the program. On the bottom line, as you know, it's pretty much a non-event. So not too concerned there, although I wouldn’t like to see further volume decreases. But that -- I won't be able to help that one. And the hope, by the way, on that is that the fact that we have 2 in-theater performing might drive that position a little bit, and our -- every feedback we've gotten is they're performing well. So it's -- that's -- it's a little bit hard to call. And services continues -- will continue to be a weak spot on the -- one, the Engility side. But it's not -- the business isn't going to 0, but it'll continue to have some more weakness because of the drawdown situation and the fact that they really can't get out and – go after the SEDAR work. And the lower-margin things, we -- we can kind of let them out a little bit now to pursue until we do the spin. On the Cyber and the Intel side, there's a number of opportunities, but they're all competitive. So that's, again, a bit of a jump, all depending on what you win and what you defend in re-compete situations. So all in all, I would say top line is -- could be down a couple of points depending -- not material. Not -- but I -- there's nothing I see that – would tell me it's going to be down materially in a 10% and 20% event at all under any scenario, by the way. But we're trying to fine-tune it as best we can. Margins should be relatively consistent, up -- it's in a narrow range. Share count, we -- we're very aggressive in the third quarter with the buyback. When shares were down, we were there. And that'll help. We do expect earnings growth next year due to the share repurchases. I guess Ralph can give you a little color. And you got a pension headwind out there that's not resolved yet for next year. It could happen depending on where the interest rate ends up at the end of the year, the discount rate. So again, we -- we're planning a fairly comprehensive Investor Day. I don't think there's going to be anything earth shaking that you didn't expect, though.

Joseph Nadol - JP Morgan Chase & Co, Research Division

Okay. Well, that's very helpful. And then just finally, you've referenced there's a couple of acquisitions coming, a few hundred million dollars, which is reasonably-sized. Presume -- is there anything you can share? I appreciate the fact that you may not be able to really share much more than that. But for example, can we presume that these are products, not services? Is there anything else you can share? And just big picture, we're looking down sort of the -- down the side of the mountain. We don't know if it's a bunny hill or a black diamond here for [indiscernible] a few years. So what's giving you the confidence that now is the right time to step up rather than wait and sort of save your precious capital for a year or 2 from now?

Michael T. Strianese

Yes, I'll talk to that in a kind of macro sense, and I think you'll have a sense what our strategy is. First of all, it's not in Services. And if you were to consider the spin-off of Engility, $1.5-billion-plus, $1.6 billion, $1.7 billion, and the fact that we're looking in the product, ISR areas, AM&M -- the remaining areas, there could be -- a part of the story here is shifting the portfolio into -- out of the lower-growth, lower-margin areas and into the higher or more stable-growth, higher-margin areas. So that's the overall strategy: how do we gradually build the portfolio in a sense that improves it? We're not going anywhere outside of the space where we're core. So it'll be building out areas where we have very core capabilities, 1 or 2 in our market space, so it's relatively low risk for us and we see secure programs there that under any of the scenarios, will be fine. They may be flat, but given the prices we're paying and the synergies we'll get, they'll be value-accretive. And the other thing I would say is that we're also looking, I said, not outside of our space, but there are some assets there that we've considered that can move some of our technology into very closely related commercial space. Not a stretch by any means. But -- so it's building on what we have in those core areas where we're market leaders. But certainly, in the Product Systems side, not the Service side. And the end goal here would be a gradual improvement of the portfolio and a disciplined way to higher growth, more stable program and higher-margin opportunities.

Operator

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

Cai Von Rumohr - Cowen and Company, LLC, Research Division

If you haven't already, could you give us some color on the pension issues for next year? Like, what's your performance year-to-date? Where do you see, if we close the books today, where the discount rate would be? And kind of any changes and assumptions or are there others you might be considering?

Ralph G. D'Ambrosio

Sure, Cai. So just to review, I’ll [indiscernible], with what our assumptions are for 2011, and that was for pension asset returns of about 8.5% and a discount rate of about 5.6%. Based upon the prevailing conditions, the discount rate is currently at about 5%, and our year-to-date asset return in the pension trust is about 3%. If those returns and discount rates stay the same till December 31, which is when we set the assumptions for 2012, they would translate into increased pension expense next year versus this year of approximately $30 million pretax at the operating income line. In terms of the sensitivity to those 2 major assumptions, a 1% change in the asset return for 2011 either way would have the impact of changing next year's expense by $3 million pretax. And when you look at the discount rate, a 25-basis-point change in either direction has the impact of changing next year's expense by about $11 million pretax. So that's sensitivity, and we'll update you again where we are at the investor conference. And like I said, we'll finalize it on December 31.

Cai Von Rumohr - Cowen and Company, LLC, Research Division

And a quick follow-up, Ralph. Any thoughts about increasing your pension contribution to offset some of that?

Ralph G. D'Ambrosio

Well, that's one of the items that we're considering with respect to our capital allocation, and that's something that we'll sort out before the end of the year.

Cai Von Rumohr - Cowen and Company, LLC, Research Division

Terrific. And then if someone hasn't asked already, your book-to-bill was -- I think you’d indicated you expected 1.0, and you really did 1.17. Where are the increments? And are you still looking for 1.0 for the year or could it be a little bit better?

Ralph G. D'Ambrosio

Well, for the year, in my comments, I said we expected the book-to-bill to be close to 1.0. So we still are expecting that for the full year, Cai. And then, as to what happened in the third quarter to drive up the book-to-bill ratio is mainly, there were a lot of timing items. So a lot of our large contracts in every segment, except Electronic Systems, which is where we have larger contracts, we had large orders in the third quarter, a lot of it being pulled in from what we were expecting to happen in the fourth quarter. We also had a couple of wins that we thought we were going to book in the fourth quarter that happened right at the end of the third quarter. An example of that is the ProVision automated detection system and security detection systems. And we finally booked some international work in Electronic Systems as well that we were expecting to happen in the fourth quarter on the combat propulsion side.

Cai Von Rumohr - Cowen and Company, LLC, Research Division

Okay, terrific. And the last one, have you seen any pickup in demand from some of your key commercial businesses like commercial avionics or ship building?

Ralph G. D'Ambrosio

Well, while we haven't talked -- we didn’t about it yet today, our commercial businesses have been recovering and improving nicely all year long. And when you look at the -- our sales for the third quarter on an organic basis, excluding the FUNA acquisition that we did at the end of last year, our commercial sales grew by 12%. Now some of that was helped by this growing euro in the commercial ship building space, but the business is growing nicely compared to where it's been the past couple of years.

Operator

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

Howard A. Rubel - Jefferies & Company, Inc., Research Division

Mike, couple questions. One is, can you talk a little bit about how your Cyber business differs from some of the other folks out there? I mean, it seems like a black hole in some ways. And I know you got to be careful but still, in all, where do you stand out?

Michael T. Strianese

Well, Howard, it is a black hole, and there's very little we can talk about. But let me tell you a little bit about our strategy in approaching it. It's an interesting market, as I'm sure you appreciate. First of all, it's a resource-constrained marketplace. So the talent, the raw material you need to be successful here is a very precious commodity. We have an extremely talented assembled workforce, if you will, of professionals that all have high-level clearances. And we have signed now at least 2, maybe more -- no, at least 3 agreements now with universities where we're starting to cultivate our future colleagues in those universities, out of cyber programs, and I had mentioned previously the University of Virginia partnership as well. So one, that's how we're addressing the resources. In terms of the -- how we deal in the marketplace, well, we have unique capabilities in our products and systems area. So for example, we're a leader in the encryption capabilities that come out of communication systems east, the Camden business. We have data link waveform capability that is out in Comm West, the modems, data links. Cyber and communications are getting to be synonymous. You don't really -- you can't talk about one with talking about the other. And we are taking a solutions-based approach where we can use our proprietary technologies as discriminators when we offer L-3 solutions to our customers. So in terms of how are we different, well, we have all lot of intellectual property in our products that we can bringing to the table. And fusing that with the service, the folks that have those clearances that can work within those agencies, that is the way we are proceeding. And of course, like everyone, we have developed a cyber center down in the Bel-Air [ph] area, bring customers. And I don't think that's unique, but we are spending more time with current problems that customers are having and trying to be as proactive as possible. But it's a very close community given the nature of this work. But hopefully, that gives you some insight to how we're approaching it.

Howard A. Rubel - Jefferies & Company, Inc., Research Division

And growth is kind of -- it's hard to calculate, but it's got to be close to double digits?

Michael T. Strianese

Yes. And maybe it's looking at the orders right now. But in terms of what's in, it's not that big rate now. It's, I'd say, flattish right now because there's been some puts and takes over the year. But again, it's an area where there's increased funding. It's very -- you don't see major competitions for cyber work generally because of their very nature. So many times, it's done in the classified world, and it's funded under existing contract vehicles and the money flows very slowly. So the bang is -- I don't think you're going to see a bang. You're going see a gradual uptick as some of the traditional defense work levels or declines. That will make the cyber piece stand out a little more. I think that's something to look forward to in the next couple of years. I can't say it's all there now though.

Howard A. Rubel - Jefferies & Company, Inc., Research Division

I got it. On EMARSS, I mean, you're still doing part of this. And can you -- but yet, at the same time, the market looks like it's opened up again because of your capability?

Michael T. Strianese

Yes. Well, at last count, and you maybe more current than I am, but –- it’s hard to keep track on EMARSS. It's moving back and forth so much. And I believe that the intention is to provide Liberty aircraft to the Army for their mission, which would -- which could result in some changing capabilities and possibly additional aircraft for us. We were also on the winning team. We were a prime [ph] but also on the winning team with regard to some sensors and data links. And believe it or not, we already delivered all our product even though the program is not going forward necessarily in its original form. And the Army can inventory and use those products elsewhere since they’re common data links that you can put on multiple different platforms, I guess. So -- but that -- nothing's coming back to us. But it is a mild positive for Liberty. Maybe it's more than a mild positive. But we don't – there’s not enough that's been done yet. And this Roles and Missions Review that I'm sure you've heard of is going to be done in conjunction with the budget reductions and how they're going to be allocated. Rather than the peanut-buttered approach, the country should have a national defense strategy in roles and missions and then fund it accordingly. And that's supposed to happen first quarter. I would expect it's going to maybe by April. And things like the role and mission of an EMARSS versus a Liberty hopefully will get clarified. But for now, I think EMARSS has been tabled and Liberty is what's being used.

Howard A. Rubel - Jefferies & Company, Inc., Research Division

Yes. I mean, that's not all bad then, and I get it.

Michael T. Strianese

Well, for us.

Howard A. Rubel - Jefferies & Company, Inc., Research Division

Yes. Well, that's my point. I mean, it's -- you want -- when you win, you want to take advantage of it.

Michael T. Strianese

Exactly.

Howard A. Rubel - Jefferies & Company, Inc., Research Division

Or when you perform, you want to take advantage of it. The last thing is with respect to Engility, sometimes a dual track ends up working out really well. Have you been approached by others about the collection of businesses you've formed so that -- and you could find an opportunity to sell to them?

Michael T. Strianese

That's a dicey question because we never really comment on M&A and divestitures or like that. What I can tell you, as I mentioned during my monologue this morning, is that we're on track as the plan -- on the plan that we described back in July and that we're going to proceed with the spin-off. So there's nothing that's occurred that's changed that, and I hope you can read into that and conclude the answer to your question.

Operator

Your next question comes from the line of Robert Spingarn from Credit Suisse.

Robert Spingarn - Crédit Suisse AG, Research Division

Mike, Ralph, I don't know which of you should answer this question. And I want to preface it by saying I think we certainly know how tough it is to forecast in this environment. But when I add the $100 million spreads in your revenue guidance for each segment, there's a $400 million spread for Q4, basically $4 billion to about $4.4 billion. And I know that you’ve guided $4.1 billion to $4.2 billion, but is this a -- is this $400 million, is this a fair representation of things that can slip to the right? And if so, you mentioned JCA, what are the other big pieces?

Ralph G. D'Ambrosio

Well, the -- we've always had that size of a range and the aggregate level at the segment -- for the segments. So that's the way we always do it. And we narrow it with the consolidated guidance because the segments cancel out some variability on a consolidated basis. So you should not read anything into potential major swings in the fourth quarter, and go with what I said or with what we expect the fourth quarter sales to be right now.

Robert Spingarn - Crédit Suisse AG, Research Division

Okay, does the $4.1 billion to $4.2 billion then, sounds like you're pretty focused there based on what you just said, Ralph, that excludes JCA? That assumes another slip?

Ralph G. D'Ambrosio

That excludes -- like I said, we're not expecting the JCA order this year, and that subtracted $80 million from the sales guidance. I said $50 million was in the third quarter. So therefore, $30 million was in the fourth quarter. So that excludes JCA.

Robert Spingarn - Crédit Suisse AG, Research Division

Right, okay. So JCA, if it happened, would be upside and...

Ralph G. D'Ambrosio

We're still going to have some sales, but they're going to be less than we expected because the order didn't happen.

Robert Spingarn - Crédit Suisse AG, Research Division

All right. And then, while we're talking about guidance, the -- just the drag on the government margin, slight drag here in Government Services, is this Engility or NSS?

Ralph G. D'Ambrosio

It's mostly Engility. And it -- but I don't know if you've seen the -- our website charts yet or not but in the appendix, we provide the same data on Engility and NSS that we've provided on the second quarter call. And if you take a look at it, you'll see that the margins declined significantly in Engility, and they actually, in the third quarter, improved a little bit in NSS. And that's largely due to the timing of award fees, of which we received a lot of them in the third quarter, and we talked about that in the earnings release.

Robert Spingarn - Crédit Suisse AG, Research Division

Okay. So that leads me really to my final question, Ralph, which is you and I have talked about this in the past. You kept -- you hung on to the NSS piece because of the idea that it's got growth potential in the future. Is that there for 2000 -- we're not trying to ask you for guidance here, but can that actually happen in 2012 in that business?

Ralph G. D'Ambrosio

Well, a few minutes ago, Mike said that he thought the sales will be flattish in NSS. So we're not expecting growth there, and we'll have more details on December 6.

Robert Spingarn - Crédit Suisse AG, Research Division

So it's longer term? But maybe, I should ask the question this way. Mike, you talked about cyber properties when you were referencing M&A or answering an M&A question before.

Michael T. Strianese

Right.

Robert Spingarn - Crédit Suisse AG, Research Division

When you look at these properties, are you actually seeing growth that warrants the higher asking multiples? Is it real?

Michael T. Strianese

Actually, the answer is no, it's speculative. I believe personally -- well, I believe it's there because I know the money is there. We've seen the budgets, and they're up. But the money is not on contract now and, in fact, there's many different approaches that have been taken within the government as to whether it's a holistic approach across multiple agencies, whether it's a stealth-type approach. So there's a number of things that are in play as to the overall strategy, which should drive the growth. In the meantime, what we're seeing are very specific requirements within each of the customers that we serve. But that is not what I would call driving it. So a lot of what you see in the plans of some of the small companies that are available in that space are, by their very nature, a bit speculative as to whether they are going to be the next hottest thing in the cyber space. So we're focused on our getting -- and what we do best in the comms, in encryption, in data link and our area within NSS and fusing that together so we have a solutions-based, technology-driven approach that's more proprietary and less commodity-like. And that's how we're going to deal with it.

Operator

Your next question comes from the line of Pete Skibitski from SunTrust.

Peter J. Skibitski - SunTrust Robinson Humphrey, Inc., Research Division

Mike and Ralph, I just was looking for some more color on Electronic Systems. I guess more specifics on the guidance reduction in ES. Was that on -- I think you might have mentioned the night vision area [indiscernible] training or combat propulsion. Was that right?

Ralph G. D'Ambrosio

Well, the guidance reduction was caused by numerous small contracts in several product lines where there wasn't any single large reduction affecting the guidance change there.

Peter J. Skibitski - SunTrust Robinson Humphrey, Inc., Research Division

Okay, okay. And was the margin. . .

Ralph G. D'Ambrosio

Now the business areas, Pete, it's in the night vision goggle area or night vision devices, some of the tactical communications for the U.S. Army, some manpack work. We've seen some delays on some of antenna jobs that we do for Navy as well. And while we booked -- and we're booking the security and detection systems, ProVision orders, it's happened later than we thought. So some of those sales are going to slip into next year. So there's no large single item in that reduction, Pete.

Peter J. Skibitski - SunTrust Robinson Humphrey, Inc., Research Division

Okay. And the margin softness in the quarter at ES, was that just on kind of the lower volume or. . .

Ralph G. D'Ambrosio

Well, it was -- the volume was flattish. As you read the explanation in the earnings release for the segment, where it all boils down to, it's change in mix that's causing those -- causing the margin reduction. And then last year, we had a $500 million gain on a contract that was structured, and that did not happen this year. So those are major items.

Peter J. Skibitski - SunTrust Robinson Humphrey, Inc., Research Division

Got it. And last question. Your release talked about lower Linguist sales. And I was just curious. I think you guys won that multi-award re-compete. I think it was CJPS or something. And so I was just wondering, do you guys expect Linguist sales to start to rise again at some point? Or are there specific tasks, order competition that we should be watching out for?

Michael T. Strianese

It's called -- the contract was called DLITE.

Peter J. Skibitski - SunTrust Robinson Humphrey, Inc., Research Division

Okay, right.

Michael T. Strianese

And yes, it's a task order basis. There's a number of qualified offerers that were selected and qualified under the ID/IQ. Pete, I expect those task orders to be highly competitive. And -- we're going right to an issue, I think, that Engility is going to -- this -- therein is the reason for the Engility transaction. We have a number of smaller private companies that have higher leverage and can do a better return in a low-margin scenario than large defense companies can. So the question is how low are we willing to go to win this business. And there's a number there because there's the cost to that business. It's dangerous, and there's usually a long tail of liabilities on it from audits and investigations and congressional testimony and whistle-blowers and people act badly in war zones and everything. So beyond a certain number, I -- in terms of in L-3's shop, it's not something that I wanted to grow in that margin basis. But Engility, which will be smaller and more levered, will be able to pursue that, and it would be -- make more sense for them.

Peter J. Skibitski - SunTrust Robinson Humphrey, Inc., Research Division

Okay. So we're going to get rid of it, and we won’t worry about it by some point next year?

Michael T. Strianese

It's going to be part of Engility. So it will be spun off, which, by the way, let me just also add on to that on the last question from, I think, Howard Rubel. Part of the reason regarding the dual track is that remember, we -- we're evaluating delivering the best value to shareholders, and we concluded that the spin-off delivered that because of its tax restructure. So there is the answer to that question. So let me just amend that answer, so.

Operator

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

Myles A. Walton - Deutsche Bank AG, Research Division

Mike, in the release, you talk about the higher business development costs in cyber, and you touched on this a little bit in terms of it being at this point a little bit of a speculative marketplace in some senses. When do you know when you've hit it? You talk about the -- not going up against a lot of competitions but more built through trust and relationships. But I guess when do you feel like you're -- or where in the cyber space do you feel like you're in a sweet spot? And where is it more speculative for you at this point?

Michael T. Strianese

Well, in terms of, again, of our encryption capabilities, our comms capabilities, waveforms and the workforce that we have, we are tailoring technology-based solutions for customers. So let me just clarify. I don't believe the entire cyber space as a whole is speculative. It will happen. It is the largest threat that -- among the largest threats we face here at home. And it happens every day. I'm sure desktops are getting read in Washington, and it's that bad. The speculative part of my answer dealt with individual companies in the M&A space that may have a unique technology. Those solutions are speculative because they haven't decided that with the government which solution sets they want to pursue and which they don't. So that's where the guess is. The guess is on what -- the place if you're doing M&A. I think we are broader in our capability, so -- and given what we have to address this market, we have several that will be fine, that they're more broader-based solutions than the next special box that does something to protect the network, if you will, without -- I can't go too deep in this area. So the funding is there. I mean, even what's in the proposed budgets, you can get this data. Or if you want, Ralph can send it to you, I'm sure. The funding is there and increasing in cyber accounts at various places within the budget. Getting it on contract and selecting contractors, it's more of a timing game whether -- it's not a "Whether it will happen" it's a when. And I think you'll see the growth appear over the next 18 months, perhaps 18 to 24 months. It's going to be a little while because there's some strategy work that needs to get accomplished in Washington.

Myles A. Walton - Deutsche Bank AG, Research Division

So then the NSS versus the services piece, what is that -- what does the portfolio looks like within C3ISR in the encryption and secure comm side in terms of growth dynamics and profitability at this point relative to the segment?

Michael T. Strianese

Relative to their segments?

Myles A. Walton - Deutsche Bank AG, Research Division

Relative to the -- I mean, relative to whatever. Just give me a relative benchmark.

Michael T. Strianese

I'm not sure what your question is.

Myles A. Walton - Deutsche Bank AG, Research Division

So we know what the NSS dynamics are because you've disclosed that. But within C3ISR, how is that -- you obviously have technologies in there tied to cyber with encryption, secure comm. As you encapsulate that under a cyber umbrella, how do those dynamics look both on a profitability side and a growth side?

Michael T. Strianese

Well, they'd probably get similar rates as those -- similar rates today, and we expect that to raise [ph] in the future than the traditional defense parts of those segments. And the margins, we expect them to consistent because they're margins on our propriety product, they're not commodities, and we expect -- we fully expect will remain consistent with where they are today. And I'll tell you, the upside will be if we start experiencing higher volumes, we'll get more efficient. We've done a lot of restructuring in Camden in terms of both facility and headcount and refocusing that business in these areas. And that business has returned to, well, better profitability. They're always profitable, but their margins have picked up significantly over the last couple of years. It's not a huge piece of help for you, but every little bit helps in this environment. And a large part of that is in those spaces that we just talked about.

Operator

Ladies and gentlemen, that concludes the Q&A. We will now turn it back to management for any closing remarks.

Michael T. Strianese

Okay. Well, on the guidance, we will be, again, hosting Investor Day, as we have in the past, on December 26 here in New York City -- December 6, I'm sorry, not 26. And I will be there along with the management team. Ralph will have folks from Washington who will be addressing the budget as well as the geopolitical environment. We'll have our group presidents available as well. And hopefully, we can continue the dialogue with you on what the future is going to look like in defense. So thanks for joining us today.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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