L-3 Communications Holdings Inc. - Shareholder/Analyst Call

Dec. 6.11 | About: L-3 Communications (LLL)

L 3 Communication Holdings Inc. (NYSE:LLL)

December 06, 2011 8:00 am ET


John C. McNellis - Senior Vice President and President of Integrated Systems Group

Steven Kantor - Corporate Senior Vice President, President of Marine & Power Systems Group, President of Services Group and President of National Security Solutions

Robert W. RisCassi - Former Senior Vice President

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

James W. Dunn - Senior Vice President, President of Sensors & Simulation Group and Chief Operating Officer of Sensors & Simulation Group

Unknown Executive -

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

Susan D. Opp - Vice President and President of Communication Systems -West

Richard A. Cody - Senior Vice President


Unknown Analyst

Unknown Executive

Well, good morning. I'd like to welcome you to the L-3 2011 Investor Conference. First of all, I'd like to start out with the Safe Harbor statement. We will be making forward-looking statements here, so give you a chance to take a look at this.

So let me walk you through the agenda for today. What we're going to do is start out with General RisCassi, who's going to give us a little geopolitical overview, transition into General Cody, who's going to talk about the budget, kind of tie those 2 things together for us as we then work our way into our President, CEO and Chairman, Mike Strianese, who will take us through an overview of L-3. We'll then spend some time on each of the 4 segments of the business, starting with Jim Dunn with Electronics Systems; Steve Kantor will take us through Government Services; John McNelis through AM&M and a portion of our C3ISR segment; and Susan Opp will follow-up with the remainder of that C3ISR segment; and then Ralph will talk to us about the financials. We'll end up with a Q&A session and then a luncheon buffet. If you can join us, we would really appreciate that.

So with that, let's go ahead and kick it off. I'd like to introduce General Robert RisCassi.

Robert W. RisCassi

Thanks, Chris. Good morning. As in the past, we're just going to take a look at various states around the world and see how they impact the conditions that we find ourselves in today. I would really like to stand up here and say everything is just about as we left it last year at this time, but it would be absolutely lying to you because there's been significant and probably significant institutional change going on in the world.

So this is the landscape we're going to talk about, selected states, and what I'd like you to take away from this is, if you think that the grand strategy of the United States today is about right, and that grand strategy is like we talked last year, beneficial security for economic prosperity, and that may be a little bit idealistic, but that's it. And we've resourced that at a level, do you want to continue resourcing at that level or are conditions in the United States and the EU and other places going to mandate a lessening of the resources to underwrite beneficial security, and how is that going to impact it?

So what I would like to do is go over these flashpoints initially. And the first one has been in the paper, Iran, and it comes in various flavors. The conditions in the state mandate that some degree of control is put on the evolution of trade going in and out of the state. So you're going to see sanctions placed on Iraq. Now sanctions -- or on Iran. Sanctions, by its very nature, unless they're international sanction and mandated by the UN, leak significantly.

But the question here is, if you don't do sanctions, what would you suggest? If you listen to Leon Panetta at the end of -- at the beginning of this week talk about Iran, and the questions from the audience all came from -- about Iran. And his treatment of the subject is you better stay with sanctions because if you don't and you want to do something positive in that state, it will reverberate throughout the entire region, and are you prepared for that?

So the question then before the states are, do you let them continue with the development of a nuclear capability, and what does that do to the stability in the region, and how is Israel going to react if that continues? This is fundamentally different than the Israeli attack on Syria because that was done in a snap of a finger, and it was a hullabaloo for a week, and then it dissipated. This one, you need tremendous overflight rights, and the distances are significant, and the targets are significantly harder.

So before you leap in changing that equation, you need to think it through adequately. And the question is, are we resourced both from an intellectual standpoint and a capital standpoint properly to do something about this or is something covert more in our kit of capabilities?

North Korea, if you remember back in '93, '94 timeframe, Secretary Perry drew a red line in the sand. He said you will not develop nuclear weapons, and they said, right, we won't do it. Scroll forward to 2011, they have a nuclear weapon. Now why isn't this in the same parlance as Iraq? Sort of an interesting question because as Iran goes, Middle East, Southwest Asia goes. As North Korea may go, Northeast Asia goes. The fundamental difference is, the buffer is China.

So as long as China is there, the development of nuclear capability in North Korea can be, in fact, moderated to the point where it is "acceptable," if that's a decent phrase in North Korea -- in Northeast Asia. India, Pakistan, interesting both nuclear states. Pakistan's been in the paper lately, more in terms of the bombing that transpired on one of their military bases. And was it an accident, was it not an accident? What's happened is it has inflamed the rhetoric within the state to the point where it's almost an intolerable situation.

If you remember back from Ayub Khan to President Zia to Musharraf, we had pretty good relationships, all former military people that had the control of the state. We transitioned to the new government after the assassination of the former prime minister, and her husband assumes the leadership of the state. He doesn't have that finite control over the military, and General Kayani, although he is a friend and educated, I might add, at Fort Leavenworth and other places in the United States, not the prison, but the college, is in fact, a friend of the United States, but he is a nationalist.

And when this happened, it put him in a very, very difficult position. So where you are now is, though, 1 of the 2 major egresses into Afghanistan is controlled by Pakistan. And you've seen in the media the trucks backing up and the logistics portability of the troops within Afghanistan, then are metered by Pakistan. Incidentally, the other route in is controlled by Russia. So we have a very interesting dynamic that's been set up in Afghanistan vis-à-vis Pakistan and Russia.

But the issue here is nuclear weapons, and I think last year and the year before, we talked about the controllability of -- and I think I assured you that we had finite understanding of where they were, and they had a process by which they could control all of their weaponry. If you read in the paper lately, in the open press, in the white press, I'm not so sure that's a true statement.

That sets up an interesting discourse with India who also has nuclear weapons, and they are not the friendliest of states. So you have in the first 3 bullets, 4 nuclear states that are setting up a dynamic, a fragility in the areas that can cause problems unless you continually resource the understanding of what transpires in those states and makes them tick, so they don't come out of the box.

Next issue up here is Afghanistan, and I'm sure General Cody will talk a little bit about this. We're supposed to come out in 2014. We won't be out in 2014. I'll tell you as I'm standing here, there'll be some residual force left in Afghanistan after the 2014 standpoint. Trainers, yes, but I don't think we're going to walk away from 10 years of investments in that state both from lives and hard cash that we're going to leave it for the whims of the Taliban control at stake. It's a very difficult dimension, but one that has to be dealt with, and that's a resource tapped.

Iraq, I look at Iraq as good news. There's opportunities for that to become a responsible state within states. But there are a couple of issues there. One is the leadership itself, Maliki, who is in charge and by the way, he's the Prime Minister, he's the Minister of Defense, acting, and he's the Minister of Interior, acting. So he's controlling everything in the state. But he only controls that because he has Sadr on his side also. And if you look at the issues between the 2 of them, Sadr wants all Americans out, Maliki wants 3,000 to 5,000 there. And if you go to the Kurds, they want the Americans not to leave it all. So you'll have that dynamic, should we or should we not stay?

End of the month, we're supposed to all be gone. End of the month, you'll have 13,000, at least 13,000 U.S. citizens, contractors within the green zone, if you will, within Iraq, mostly security people. You'll have others there, and of course, you'll have some type of a residual force in Kuwait to respond to any issue there that may transpire.

But it could be a responsible state within the states if they can get their act together in terms of the political establishment, plus who's going to control the oil and how are they going to divvy up the oil in that state.

The Islamic nation, we're going to talk about these in a subsequent slide, but a few words on Russia, primarily because it’s in the paper. Putin ran on an un-American slate. He enjoyed going into the election as the Prime Minister, a surrogate President. 2/3 of the popular vote of the state going into that office. It looks like he's going to come out of there with probably 50%. He doesn't have the complete enjoyment of the people in the marketplace at this juncture. However, I do not think this is going to undercut his strategic imperative, which is cobbling back the states into the Soviet Union. And that's what he is all about. And if you watched him over the last year or so and watch him going forward, every move he makes, whether it's a visceral affair [ph], whether it's a pipeline or natural gas or oil pipelines, everything he does is predicated upon the controllability of the states that were lost in the -- in 1989 when the wall came down and subsequent in the early part of the 1990s.

Okay, let's look at recent nation state changes, which is dynamic in itself. If you look at Tunisia, Egypt, Libya, Yemen, Bahrain, Jordan, they have one thing in common. There is aging leadership, no succession planning that's outside the family. And therefore, they were susceptible to the process called social engineering when the word could run around their countries on displeasures, whether it's an economic displeasure, social displeasure or whatever it was.

So when it started, it spread like wildfire. Now the issue in all of these, probably from a strategic standpoint is Egypt. We did not come to Mubarak's aid when he needed it, and even though, he is the reason that we have kept peace in that area, especially as it affects Israel, so we have an issue changing leadership to whom? Islamic brotherhood, which got a majority seats, 37 seats in the election just finished. State is still controlled by the military, will be in July until they're going to step aside, and then the Islamic brotherhood is going to be the controlling entity.

It'll be interesting to see how this plays out. In other words, one, if the military lets that happen; and two, will they be moderate? Don't forget, funded by Iran, heavy Al Qaeda influence and they are not moderate, even though they ran on a moderate ticket. So the dynamic of Egypt that affects all of these states in this region is rather significant.

So if you look at this chart, and what I'm attempting to graphically show you up here is as the winds wave from east to west and west to east, there are certain elements that are resident in one [ph] of these states, and they -- even though they may be nationalistic, they affect a region. And that affect in the region calls for our attention.

Now Africa, in the past, from a strategic standpoint, if you go back and look at all of the national studies around the world and where should we be putting our emphasis and where can we afford to take the risk, this falls below the line. Africa fell below the line. Everybody recognized big population, a lot of issues, a lot of natural resources. But other than the migrant states, the Mediterranean states and Egypt, it really was not that significant as long as the Suez stayed open and as long the Red Sea stayed open, which was the access from a trade standpoint.

So as you start to cause this process to take hold of transferring thought that we can overthrow, in fact, what should we be doing in this area? Can we afford to continue to take the risk of benign neglect in this area or should we, in fact, set up some type of an establishment that controls the vitality of these states and channeling them in the right direction, and do we have the intellectual capacity to do that and the resources to do that? I would argue, no.

So we're left with this sort of bucket of fog sitting out there, and we're trying to get our arms around into our states within this state that really are key, and Egypt is one of them. And of course, the Suez and the Red Sea are the waterways that we absolutely need.

But this is to watch. The large bubble on the east of that chart is there's an agricultural reform going on in the State of Africa that bears watching because it affects the entire region, if you will, but this is another entity that's popped up on the screen.

Southwestern Asia, if you look at Afghanistan, we talked a little bit about that, Iran a little bit and Iraq. Notice the connectivity. Talk about one, you can't forget the other. Talk about 2, you can't forget the other. So there is a relationship that is set up here.

In other words, if you walk out of Afghanistan and leave it to its own entity, what happens to Pakistan? And that's not shown on this slide, but what happens to Pakistan? What's Iran going to do? Are they going to step into this? How about Iraq? So you have this fragility in this region where we've stuck our finger in the fan in Afghanistan and said we're going to make you whole, and then we're going to pull it out of the fan in 2014 in a fend-for-yourself without understanding the dynamic of the rest of the region. Very, very difficult issue to come to grips with from our State Department and from a military standpoint.

So if you look at all of these states and the connectivity, are we resourced properly from a national security standpoint, state and defense and others, to do what needs to be done diplomatically and by extension, militarily, in this region that ensures harmony in terms of beneficial security for everybody.

Pakistan and India, we talked a little bit about that. It's really, you have a mega-state in India, largest democracy, as you know, in the world, over 1 billion people. And we have Pakistan just to the east as shown on this chart, both nuclear states. One is stable, the other one is less stable, if you will. And so we're just going to have to watch and see how this plays out.

But I'll tell you this, India is watching what happens in Afghanistan and Pakistan because it is a direct affect on them. And what should our role be vis-à-vis this place? This is very, very difficult. You can't turn your back on this.

East Asia, the key I'd like to tell people in this area is Korea, Japan and Australia. They're essentially all in the same time zone. And if you looked at a large map, there's a relationship in terms of real-time data flowing back between the national command authorities in these 3 states. And that understanding is a hedge against China in this area. And China's strategic goal has been, will be, regardless of what they say in the media, is control in Northeast Asia, control in the Pacific and what follows after the Pacific.

So as we change and shift from our Eurocentric focus from the United States, are we prepared to take on China as a Pacific focus because that's what our leadership in Washington [ph] said. We're going to become an Asia nation, focused on Asia in the United States.

So as you look at this, it then becomes rather interesting. Nuclear state, North Korea; nuclear state in China; South Korea, not a nuclear state; Japan, not a nuclear state. So as you look at this dynamics, we can ill afford to do anything in lessening the troop population [ph] of Korea. So 30,000 you're going to buy there day in and day out in South Korea as that type of a hedge, plus the increase that we've just agreed to, to put Marines into Australia. So you're getting a footprint there, but it's a footprint that needs to be resourced and continually resourced in this region, a large troop population in Japan also.

China, I think we talked a little bit about this state. It becomes an enigma in some cases. You look at it, and you marvel how far they've come in such a short period of time. They do have a very good military, very well trained, and so we'll just have to watch this. And the point here is, you can ill afford not to resource whatever your geopolitical thoughts are to control their expansionism in this part of the world.

Then in the paper, if you look at the media today, Geithner in Frankfurt and then the bond deliberations both in Germany, we were talking before I got up here, what were we thinking of when we created the European Union, a United States of Europe? Because it isn’t working, and no matter how many Band-Aids you put on it, it needs a tourniquet, and that may not solve it.

So as you look at this and being a Eurocentric country for so long and shifting our focus to the Pacific or to Asia, we're going to leave this totally uncovered? And to underscore what I just said, NATO is not the NATO that you remember. NATO has lessened its troop population. Most of the states that contribute forces to the NATO establishment, if you will, are focused nationalistically, can be called upon, but they don't have a lot of wherewithal.

And just look at, although the Libyan operation came out okay, they came out okay from a flight standpoint, a tactical standpoint. But the strategic piece of that, the command and control and communications was provided by Mr. and Mrs. United States. Are we prepared to underwrite that going forward based on the TOA that's resident in the defense budget today and going forward? This is a big issue on how we treat Europe going forward, and it's not only economic.

Russia, as we talked about, Putin will, in fact, attempt to cobble the stands back into and others, Belorussia, et cetera and Georgia back into a greater Soviet Union over time. And I use it as an example on the cunningness on how well he has orchestrated some things. Just look at what he did in Georgia. Under the guise of deception, under the guise of using old equipment, he went in, took over Georgia, established what he wanted to.

The international community raised all hell for a 1.5 days and then they went away. He got everything he wanted with little or no emphasis on the centerline Soviet or centerline Russian armed forces. Secondly, the pipeline is a big issue with him and is a big source of wealth. And the missile field, and you see how he's playing us back and forth, and of course, in the paper the other day was a total number of nuclear weapons that he wants to keep in the inventory versus what we have predicated under the redo of the start treaty.

And so that number is an issue, and the issue there with the nuclear weapons is the modernization and how many is enough. In fact, there are some people are talking about lessening the triad. In other words, give up one leg of the triad, in fact, to just focus on 2 legs. Absolutely stupid.

The dimension of deterrence in the United States from a nuclear capability is the dynamic that, that triad causes in terms of an adversary trying to attack you. You can take out one, you can't take out all 3.

So this is an issue to watch and are we focused properly in this region. This is an Asian nation also and a European nation and sets up a very, very interesting cross flow of how you're going to handle it.

Good news. South America is really doesn't have anything percolating right now in the tri-border area. As we reported last year, Al Qaeda is still present, dispersed somewhat in the -- that's in the Uruguay area, somewhat in a training environment, recruiting environment, I should say. But by and large, they seem to be pulling the State of South America and the states within the state in the right directions not to cause a big blip on the screen. Even the drug cartels are falling in line.

And so trends to watch, I think I'd like to go through these. I think if you were a person that -- what keeps you up at night, proliferation of weapons of mass destruction, two, relationships with China, probably the 2 mega issues to watch going forward. Everything else is enabler to the effervescence of that equation.

And thoughts, I just focus on one of them for you. If we have a war, and it's not a social science war and it's not a cyber war, and it gets into a no kidding war, we won't like the results. So the question is, are you going to underwrite a military establishment that can acquit itself so that the United States maintains its position in the world as the leader among nations?

I'll be followed by Dick Cody.

Richard A. Cody

Well, I feel better already. Unfortunately, General RisCassi has given us some wise counsel. What I'm going to try to do is walk through very quickly the DoD budget, but really kind of start off with discussing the '12 appropriations because that's sitting out there right now.

As you know, the Senate has already made their marks. The House made their marks earlier this year before August, and we're in the CR right now, continuing resolution, with 9 of the agencies. They did the minibus appropriations to cover 3 other agencies, and that FY '12 CR goes away on the 16th of December. So between the Senate and the House in conference now, they've got to sort out these 9 agencies, the largest being, of course, DoD.

Depending upon how that goes, we'll probably be looking at another continuing resolution through the January time frame, which, of course, for DoD means no new starts, and you can only spend up to the FY '11 appropriations. Well, the good news there is that's what the FY '12 appropriations is because of the Budget Control Act.

In years past, when you had a CR, you were limited because your next budget was much higher than the year before. In this case, for FY '12, everybody knew for the last 1.5 years and made plans all the program managers industry, we all knew what the FY '12 was going to come in at. And it's probably going to come in at, and I'll show you in a minute about $526 billion when it's all said and done.

Now the FY '13 budget has to be submitted. The President's budget has to be submitted over to OMB and over to the White House and Congress here in February. And because the joint select committee failed to do what they're supposed to do by Thanksgiving and because Congress will most likely fail to do what they're supposed to do by the Budget Control Act on the 23rd of December, everybody's been assuming that the DoD is now planning their FY '13 submission based upon the worst-case scenario they sequestered, the $600 billion of cuts that was put in the Budget Control Act. They can't do that.

The budget, unfortunately, is about 40,000 pages of line items. And most of the big programs were already taken out, and they had 3-year money, if you will, that ran into '12 and '13 when Secretary Gates cut the 24 big programs before the Budget Control Act. So what's going over the OMB has not come back to the department said your new guidance because the joint select committee failed is this. And so they're going off of the FY '12 guidance that OMB gave them, and we just got word that the submission that's going over by DoD is going to be $523.4 billion, basically flat line between '11, '12 and '13.

Now what does that mean? It means Congress will fail to do something on the 23rd of December, sequestered by law kicks in, and then Jack Lew over at OMB, the White House and Congress are going to have to sort out what they want to pass back to that budget in terms of the cuts because those cuts are based upon the $260 billion over the 5-year defense plan, '12 out to '16.

Obviously, with the sequester, those numbers don't match. Now they'll sweep up some of those savings through some of these unperforming programs, as well as some of that unobligated money from '10, '11 and '12 from those programs that were already cut. But that is where the gamesmanship and the real deep dive of doing an analysis of the DoD '13 budget. And all of that with a backdrop of what General RisCassi just laid out for you.

The realities on the ground don't match the realities of a $600 billion sequester. And so how they go through that is going to be pretty interesting. Now having been in that situation for over 6 years, I will tell you exactly what the PMs are going to do as soon as they get a budget, the program managers.

Knowing full well that some of the pass backs are going to come from obligated funds, they're going to obligate everything they've got and get it on contract as fast as they can because they do not want to be the ones that have unobligated funds. And unfortunately, that's what's been happening in the last 5 or 6 years under these continuing resolutions.

But OMB and OSD are going to have to take a look at this. Most of the savings they're going to grab are unobligated, underperforming programs, as well as the tail of programs that were already cut in FY '10, '11 and '12.

Now something that's been missing in the debates and the discussions and laws doing all of this is the fact that we have a debt ceiling problem. If you remember when this all came about, the Budget Control Act was set, and they set the numbers in OMB, as well as the Congressional Budget Office, and that was to get $11.2 trillion over -- out to 2021. You divide that up, and you come up with this number of $1.2 trillion cuts. If you can do that, then when the next debt ceiling came in, it was an equal raise of $1.2 trillion for the debt ceiling. Because this whole process has fallen out and they have not delivered while they're working the '12 budget, which is there and the '13 budget, they've got the debt ceiling that probably is going to come about in either April, May or June of this coming year that they're going to have to address.

That's why everybody's going to be forced back to the table to deal with this. But a lot of people who have forgotten the fact that, that's what caused this in the first place. And we do have a debt ceiling because these savings have not been pulled in.

Okay, so let me just move away from that for a second, and let me talk to you about what I see is the reality on the ground of the U.S. global posture. And it dovetails quite a bit to what General RisCassi has already laid out. Iraq is still problematic. In fact, that chart that Bob put up there, which shows Iran, I would tell you, all roads to the Middle East and all problems, someplace you can always go back not 6 degrees, but 2 degrees to Iran.

The Shia leadership has strong ties to Iran, the militia, the Saudis Militia is funded by Iran just like Iran funds the Lebanese Hezbollah like he funds Hamas, like he used to fund the Muslim brotherhood. That is a problem. The transition from DoD that's going to happen on the 31st of December to Department of the State, a lot of consulates over 13,000 to 14,000 U.S. citizens that no longer have the blanket of coverage and safety that were provided by all the soldiers we had in there to include the helicopters, to include all of the other ISR assets that have been pulled out.

So there's a real challenge there for us as we watch this. So what are we doing? We're pulling back brigades that are crossing into Kuwait, and we're going to maintain presence in Kuwait right on the border just in case something happens. I'm less sanguine about Iraq as they go forward. I think there's great potential for a Civil War only because of the strength of the Shia.

Afghanistan's far from secure. You've been watching it. We are going to pull 10,000 troops out. Remember, we've had a surge in there, but everything we've seen and everything we've seen in the budget right now, shy of what's in the contingency budget, 68,000 to 70,000 troops are going to be in there past 2014.

Part of it is because of what General RisCassi showed you, NATO's contributions. A lot of those NATO nations are going to provide certain amount of capability, but not a lot of combat forces as they go forward, a lot of PRTs and other things. But in terms of boots on the ground, the surge that freed up the Helmand province, we could go south next year, by the way, because we pulled troops out depending upon how well the Afghani Army performs, we're still going to maintain 68,000 to 70,000 troops in Afghanistan. And it cost per troop twice as much as it did in Iraq to sustain them for year because it's a landlocked nation, because of the long logistics and the fact that they don't have a power grid.

Everything in Afghanistan is twice as hard in terms of sustaining the troops. You know about the U.S. Paki relationships extremely strained. The fallout of the Apache, the AC-130 attack that was on the border that killed 24 Pakistani army members on that attack. The demand now for C3ISR across that border so we can look in. The demand also because of the drone on the other side, because Iran is on the other side of the border of Afghanistan, we're seeing increases already in discussions of more C3ISR. Especially as troops come out, your footprint is more spread out over these countries. In the countryside, you're going to have to have more intelligence, persistent surveillance to fill the gaps where the troops weren't, as well as to not completely, but to try to eliminate any type of blue-on-blue U.S. Pakistani or civilian collateral damage. So that's kind of the reality.

Now I wanted to show you is also the Middle East, I've talked about it, Arab spring going into Arab fall. That chart that the General RisCassi told you, by the way, those are Sunni monarchies. And if you're a Sunni monarchy in the Middle East, you do worry about Iran having a nuclear weapon, but you worry more about a Shia crescent in an Arab fall than you worry about a nuclear weapon. And that's what these guys are worried about.

And then, of course, North Korea, Bob covered that. The bottom line is, we're going to have a large global presence in spite of the budget. One thing I learned in the building years ago, budgets have no memories. And I'm going to show you something here in a minute that kind of reinforces that. The bottom line is our global footprint, our military footprint and the sustainment of that footprint, even with Department of State, is required because no one else in the world's going to do it.

So with that, here's what it looks like today. You can't move this thing in the FY defense plan, the 5-year defense plan that they're coming up with from FY '13 to '17. You can only do so much with this footprint. We've got 345,000 American men and women in uniform in over 80 countries today, and you just heard that we're going to put more in Australia. We've got rotations that have been going on for years. We're still in the Sinai. Sinai now becomes more important because of the Muslim brotherhood taking over Egypt. We still got troops in Bosnia. You can start pulling these out, but you can't do it as fast as you want. And in many cases, we didn't put these people over there on vacations. We put them in there because these are borders or nations that are on strategic crossroads, and they're in our interest.

Every 90 seconds, the United States Air Force airplane takes off from some foreign base, every 90 seconds. And we've got over 140 ships deployed for a global presence, not just boots on the ground. So this is the footprint, and this is the size of your military.

Now the military will go down in force [ph] structure doing these budget drills, and most likely, they should. But you're still going to have this footprint, and this footprint comes with quite a cost, and they're going to have to budget for it.

Okay, also what gets lost in all of this $11.2 trillion that we've got to be able to cut out from FY '12 out to '21 is you can't fix it with DoD. You can do as you best bet -- if you just took DoD off the map, it still doesn't do it, and here's why. DoD is about 16% using then [ph] your dollars FY '10 actuals, and here's Social Security, Medicare and all your welfare programs and here's the interest on the debt, and they're 43% of the federal budget.

When you fast-forward, and this is what drove OMB and the Congressional Budget Office with their projections about 2 years ago, when you fast-forward, the way we're spending and everything else, this is the problem. The interest rate on our debt is bigger than the DoD budget, and you can see how fast they grow. Even with the 5-year plan that was built before the BCA back in FY '11, even then, the defense was only going to be about 12% of the entire budget. It actually went down. So the problem with our budget is not going to be solved by defense. In fact, I could make the case if you take defense down too much, you're going to pay for it in other ways that are much more harmful, not just to our economy, but to the global stability.

So that's the issue that they're dealing with. Now let me drill into the DoD budget for FY '12. It was flat, you can see. This is the sack position. The House was higher, 513. The House was about 535 or 540, depending upon -- if you add MILCON and some other things. This will settle out as about $523 billion this year when they go to conference.

And when you take a look at the so what of it for the defense industrial base, what's the so what of these budgets, C3ISR, still big winners because they're needed, especially as you start spreading and pulling back certain amount of your combat forces. You need to cover these areas still with something. Aircraft, helicopters have become -- they're fully funded in every program we've looked at. Because of China and now, us looking as a nation towards the Southeast Asia and Southwest Asia, ships, we have a 30-year ship plan. You've got a 5-year defense plan, but you got a 30-year ship plant. You have a 30-year tactical and strategic bomber plan. All those are going to fare well. The real takeaway is missile defense and SOCOM are still going to grow, as well as, as we go through '12 through '14 to '17, the budgets inside the services are going to go back to the pre-9/11 norms, where during the last 10 years the Army was up to about 29% of the overall budget, most of it in the contingency operations funds, not in the base. What you're going to see in the out-years is about 25%, 29% for the Navy, 27% for the Air Force and then Defense-wide, 18%. And then that covers everything from NRO, DIA and other agencies, as well as MDA.

So when Gates made his cuts early on to get ahead of this thing, most of us knew that this was happening, and we saw the programs and what platforms. Now here's what it looks like for the operational contingency funds. It's going to be about the SEC mark is $117 billion, this thing is going to come in at about $118 billion when all is said and done in the conference. So you're going to end up with a total DoD budget of well over $600 billion this year. Procurement in the out-years has always come out of -- there's been a movement the last 4 years to move the procurement dollars that were so rich in the OCO accounts. They're now moving back into the base, moving into a base that has less platforms, which just reinforces that those platforms are still going to be okay.

So you've seen many charts. It's about 6 or 7 different variations of these charts that people have put out. What we did was we said, let's take a look at the total buying power of DoD over time and take a look at it. This line here was the OMB guidance line prior to the Budget Control Act, and this line right here is what they're operating on now. That was the FY '12 guidance, and this is the sequester line. And so if you take a look here, let's say $524 billion plus $118 billion, that can get you that $600-plus billion for FY '12. What you're going to see in '13 is going to be up here, about $90 billion of contingency funds and the base budget's going to be about, oh, $530 billion, and then there's going to be some pass backs.

Where it goes as they work through '12 and figure out exactly how they're going to deal with this sequester, they could actually rewrite the law. I remind you, in 2001, we were operating on a budget of about $75 billion in the base going to $80 billion in '03 like that. You go back now and see what we executed, it is much higher. Why? Something happened. So we think it's going to be -- it's not certainly not going to be this DoD case, but it's probably going to be somewhere right in here. It's flat growth in the out-years when you include inflation. How are they going to control it? They're flatlining their personnel budgets. They're taking troops out, which won't help them until about here because you can't take them out fast enough. So the procurement accounts are being hit here. But they were hit back here already, and so you're just seeing the residuals of it. So and they're also freezing some of the Tricare and making some adjustments there because the investment accounts are about 24%. The personnel accounts are 23%. And so they're going to take troops out and they're going to freeze their pay raises for a couple of years as well as the DoD civilians.

Now here's what I wanted to show you. That's why I showed you both the base and the OCO. Here's what the projections are based upon -- just remember what Bob RisCassi told you about the world, and here's the projections for contingency funding out to 20. No one has that good of a crystal ball, okay? I will tell you here because I was running this budget back then. This was not $67 billion when we put the budget in because we're going to be down to 6 brigades in Iraq, and we weren't going to do anything in Afghanistan other than what we're doing. This one here was below $100 billion when it was submitted. This was not -- This is about $100 billion. These started getting there, but every one of these -- this is what they actually executed but every one of these in the projections in the pie back then, we're 25% less than what was executed. And how do they make it up? On the major supplementals. If you remember, we had 2 supplementals. We had the bridge supplemental and the major supplementals. I'm not sure these numbers here are real. Certainly, they are hedged. This is where they hope to be. This is where we all hope to be if peace breaks out all over the place. I think what you're going to see is more like this.

Now this does not score against the DoD budget, as you know. And that's why they take care of it near of execution. This is not something you want to plan on if you are working things. But I'm just telling history has taught us that it's going to be not this small, especially with the footprint and so that's kind of the takeaway of the DoD budget as we go forward.

In summary, we know there's going to be force reduction. It's a smart thing to do. The most costly thing we have is the long and tendered people. But the reshaping of the force by taking some of the force structure out is going to be reshape with a lot more special ops. Special operations forces cost more in terms of equipment, as well as we're going to plus up on C3ISR. Modernization programs are going to continue, some will get pushed out a little bit, but we can't cut any more platforms. We've only got one bomber on the table. We only got one tanker. We're not building new tanks. We're not building new Bradleys. We've got to build new refurb, the Apaches, the Chinooks [ph]. All that equipment is going to have to be reset and brought up to higher standards. So we see new technology programs at higher risk, but quite frankly, that will change if something happens in the world.

DHS, we're seeing moderate or flat growth there and in Cyber, especially in DoD, and again, this kind of ties to C3ISR. We're seeing a large growth in the classified and unclassified portion of the DotMil Cyber programs.

So with that, I'd like to turn this all to put it all in perspective, our Chairman and CEO and President of L-3, Mike Strianese.

Michael T. Strianese

Good morning, everybody. Thanks both Bob and Dick for seeing this up. So as you can surmise, it's a rather challenging running a defense company in this environment. Nevertheless, there's challenges but there's also opportunities here for us. So we'll try to give you a balanced view of what we're doing at L-3 to address this environment. Budget numbers are still well north of $0.5 trillion, and we think we're positioned as good as we can be in addressing the national security challenges that the U.S. is going to face the next several years.

Obviously, changing dynamics, and changing dynamics require changing strategy. So we're facing the budget headwinds. As you've just heard, there's competitive turbulence, companies are competing more and more for everything just to fill the holes. Some of the actions that we've been taking involve: one, building upon our core strengths, which is in the ISR area and our electronics systems as well as streamlining our services and refocusing on the cyber growth area and winning more market share in our AM&M businesses. Reducing drag, we're almost halfway complete now more than halfway complete with the spinoff of Engility and also consolidating other operations to just increase our forward momentum here. Taking a lot of overhead out and addressing our core structures. Fortunately, we have the good fortune of being very scalable in terms of the way business is structured. We don't have major assembly plants, mostly electronic assembly and test. They're easy to consolidate where we have to, so we believe given that operating flexibility we're going to be able to move as quickly as we need to keep the company operating profitably and streamlined. And where we can, we will be focusing on adding growth engines.

I said last year, and it's always been our philosophy that we do like to grow through M&A, but we were going to be patient on valuations. I think that patience is paying off because valuations have started to moderate. To say it another way, given this budget environment, I think there's going to be a lot of wreckage to go over in the next couple of years and good assets to be had at good prices. And I know this because we've done this twice. We've done this in the mid-'90s at Loral, and we did it back when we started L-3 later in the '90s. That was a downturn environment and some of the best assets we bought were in that depressed period at great prices. So I have full confidence that, that history will repeat itself and there will be plenty of things to add to L-3, and I think our patience will pay off in the end.

Our strategy and priorities are, first and foremost, to expand our strong positions in the C3ISR, electronics systems and aircraft monetization and maintenance areas. When you look at the company, I have a pie chart that will show you the contributions, but really a lot of what's -- a good piece of electronic systems are systems that work in the C3ISR area as well as the service element now that's going through -- the ongoing service piece is going to be Intel and Cyber. A lot of that is applicable to the ISR area. And that is a space that is going to continue to be well funded and grow, and that's where we're focusing. It allows us to leverage our relationship with customers if they are the same customer sets but also to pursue adjacent market opportunities.

We gain market share through disruptive cost-effective solutions, demonstrated performance and collaboration, of course, L-3. Our performance has been, I'd like to call it, legendary really to our 15-year history as L-3. We've had no major program problems. We are the go-to company when the DoD needs it and absolutely needs it now and fast, and those are going to get done, our phone rings.

We're going to continue to work on shifting the business portfolio to emphasize products systems and proprietary service offerings and stay away from the more commodity type areas where there are a significant price pressures going on. We are trying to stay away from eroding margin business areas, and we've been doing a pretty good job of doing that as you'll see in our margins. We get into the financials, proactively managing our cost and rightsizing businesses, getting out in front of problems before they happen and not doing cleanup work afterwards. The capital allocation will continue to be as disciplined as it has been. And the objective is to grow EPS and cash flow. That's always been our objective, thereby increasing shareholder value. While this year, it'll be not quite as good as we'd like it to be, we still think that given our capital and the cash generation and the M&A opportunities, we'll find out there that we will be able to continue to grow.

So our positioning and our assessment of it is as follows for the segment. So electronics systems, as you know, is a leading merchant supplier. It's an attractive markets with competitive differentiation. When Jim -- John follows me, you'll get a flavor for what's there but there's about 10 or 11 business areas. All of them, virtually all of them are leaders, #1 and #2 in their respective business areas, all with a critical mass. We've put these together over the last 4 or 5 years, all these businesses people used to write about the cats and dogs. It's quite a highly honed portfolio of operations now with critical mass in the $0.5 billion and op area. Microwave is well over $1 billion. Marine and Power Systems is $1.2 billion. Our EO/IR and soldier systems that share that technology, again about $800 million, $900 million. They're all very, very well capitalized in terms of being able to share marketing, R&D, customer contacts and that's going to pay off as well.

Jim has been taking a lot of actions. As you know, we consolidated the Products Group earlier this year and created the electronics systems sector, which Jim runs. There's a number of actions going on across the company, probably a dozen of them putting together various pieces and consolidating both facilities, back-office operations, technology centers and the like.

C3ISR core capability of the company, we are #1 in this space in many of the airborne platforms where we are incumbent. We have now been able to demonstrate, we have the pull-through capability to pull our electronics systems products, whether it's EO/IR, cameras, antennas, data links, you name it, and put them on these platforms. In addition, we're also able to capture the tail on that business by providing contract logistic services. Liberty is a perfect model of how that happens where, with the integrator on the airplane. Its L-3 sensors and comms equipment and we have the tail on the AM&M as well. We've captured the whole end to end on that program. We're working harder now to get the remaining element of our services, our national security systems business more integrated into that part of our company because they handle a lot of the processing, and that goes on from sensor to Intel analyst and trying to develop what we call making sense of the data or sense-making solutions. Things that take some of the workload off the war fighter when you're dealing with all these Intel data that's coming through the pipes now.

AM&M has had a great year. And given the environment in terms of gaining market share and growing, they basically won just about every competitive competition they've been on this year. They've done an outstanding job in really honing the business model and trimming the cost to get competitive solutions to customers. The OpTempo decline will generate opportunities for reset work. There's a lot of equipment that's not in good shape. I think the Pentagon is starting to finally realize the serious problem we have with readiness. And if you take that readiness model versus the backdrop of the geopolitical situation, that is a dangerous model. And of course, we always continue the rightsizing actions to improve our margins.

Services, we've said a lot about it this year. It's continuing to see pricing and margin pressures due to a number of factors. First of all, you have multiple award IDIQ contracts that are breaking things up and making it more competitive, and of course, reimbursable type contracts have been replacing the T&M contracts, taking margins that used to be 7, 8, 9 and even 10 and dropping them to 4s and 5s. There's an increase ever-increasing number of competitors. We have competition. It's not unusual to have 10 or 1 dozen different companies coming in. That's not what we see, we're in a proprietary product area where we may see one very different type of model with significant OpTempo exposure concentrated in training and our operational support business and the SETA business and OCI rules will continue to impact our opportunities.

In Cyber and Intel, however, they are attractive growth areas with competitive strengths and we're developing more competitive strengths and focusing more on proprietary solution sets that make us different and move us out of the commodity space. The Engility spinoff addresses this whole area, and the OCI and the course-competitiveness issues, the OCI constraints will be eliminated in the spinoff. We can streamline this business units further. And we can restructure them under the new company as a low-cost provider focused on competitive takeaways. Basically, they need to drop their overhead structure and they'll be able to do a lot easier when they're outside of some of our corporate benefit plans and all the other things they have to do as part of L-3. Basically, that's happening at core services, you're having this second-tier of companies that are in $1 billion-plus service areas being re-created because of the reality of the change.

2011 was a good year for us in terms of our program execution. We continue to be excellent. ISR continue to grow. AM&M, as I said grew through market share and protecting its base. We've had numerous product introductions. Business unit consolidations continued. The spinoff was announced, and the cash flow and capital allocation were good.

Cash deployment for the year, we're generating about $1.3 billion, investing about $300 million in R&D another $200 million in CapEx, dividends of about $190 million for the year. It's been our seventh annual increase. As you know, we have a process with our board every year and around the February meeting, we address the annual dividend. We've increased it 7 consecutive years. I accept that trend to continue, and we also are repurchasing $1 billion this year in stock, taking advantage of some of the lower prices this year. And that's all been driving our earnings. Very strong cash and cash deployment.

M&A, just a few things to say about it. One, there's a lot of activity at the supplier base. Those companies are starting to get squeezed between -- we're dependent on a few programs and those programs are getting hit. They're getting disproportionately hit, which is, again, driving the valuations lower. We haven't really moved much on anything yet, but there's a couple of them that are very attractive and very nice fits for L-3 that we're considering. Price is everything right now, given where our prices. But I'll tell you the public market prices versus the private sale valuation disparities are moderating. And when you start to consider synergies and patch structures, we have a 338 type transaction. You can really do very well right now in this environment if you pick your place, and we're patient and we will pick our place.

Several of the recent LBOs are under stress. I think everybody knows that. I'm just pointing out that we have been -- I have been personally been a little critical of some of the multiple state of the last couple of years of some of these private equity deals and saying what are they thinking putting 6 or 7 turns of debt in a declining environment. And that's starting to show its face now, and that will be part of the wreckage that we'll be picking over in the next few years. I'm confident of it.

Portfolio reshaping at the primes, well a lot of the pieces that are being spun off, whether it was the services business that came out of Lockheed, the author of L-3 spinoff, Huntington Ingalls and everything. That second tier of defense is starting to grow. That's repopulating with the new companies that are being spun off and sold, and that will be a further consolidation opportunity in the future as those companies develop their strategies and become more established players. And the portfolio is shaping at the primes will probably continue, although I think you've seen most of what's going to happen in the short run right now.

Cash return to shareholders. This year again, it was a slow year on the M&A side. So we basically returned 92% of our cash to shareholders through dividends and repurchases. The money's going back to its rightful owners, our shareholders, as I would say. So that may moderate next year if we have a couple of acquisitions. But again, our focus will be to keeping modest cash balances, but keeping the cash deployed and working to increase value.

2012, it's going to be, of course, a more challenging environment for us as you saw from Bob and from Dick. The industry dynamics are changing. DoD rules are changing. Priorities are changing, but the geopolitical environment is still volatile. And what's different here than in the past cycles that we've seen, whether it was in the '60s or whether it was in the '90s, is that there was an occasion for a peace dividend. You can't possibly believe that this is an occasion for a peace dividend. It's just not happening. So there's a lot of tension between defense spending, geopolitical. It's just the fact of life. It's going to have to get addressed. Eventually something will happen that will tilt it one way or another. Iraq, Afghanistan drawdowns, well they're happening. But as Dick said, the view is that we're probably going to be in Afghanistan for a very long time. And I don't think they put a number on troops. You're talking 50,000 and up in terms of troops, 50,000 to 75,000 I wouldn't put words in your mouth, but I guess. So it's not insignificant. And of course, you have this Budget Control Act effect on the DoD budgets, which is right now anybody's guess because there's so been so much rhetoric in Congress about well, we still have a whole year to fix it, but nobody knows really what they're going to do, they've been ineffective in agreeing on anything right now. So it's kind of who knows.

Dick had this chart up, and again, I don't want to go over it for the same purpose, other than saying that we said we'll probably going to end up somewhere in this track. The Pentagon has planned at these numbers, and the secretary to that are in a meeting with industry CEOs that this is our plan. Now they're probably going to have to give up some more, but I think they're going to hold closer to this yellow line to drop it all the way down to here. And even if this were to happen, I mean it's another $50 million, we're still hanging in at above $0.5 trillion. I mean it will be painful but completely manageable. I like managing it, but it is manageable.

So for the company, 74% of our 2011 sales are in that DoD space. And as I said, it's a threat environment versus the fiscal environment, and that tension will play out over the next couple of years as to where this is going to end up. The drawdowns, a 25% drop, '11 to '12 in the OCO funding. Likely. The efficiency and the affordability initiatives they've been causing problems in terms of margin and cash flow, and especially in the services business. Nobody in the industry has been happy about it. Some of the things really can't be done. Even on the acquisition side of the armed services, they're having problems implementing it. So this is starting to lose some of its steam. There were some good thoughts in there with good intentions on saving money. Some of it's doable. Everything in there is not doable though.

And the 12 to 21 base budget cuts, well, the size of the timing and scope, what was the TBD. What's Supposed to happen is there's supposed to be the military Roles and Missions Review to determine how to do these cuts. The sad part will be, it will probably we have this much money, so what can we afford for national security, which is, of course, the backwards way to do this. We have another continuing res this year, which is going to give us volatile, the potential for some volatility in the guidance, but Rob will cover that and tell you how we're dealing with it. The Senate services committee versus the fiscal '11 budget is down 6% that we know, and it's likely to be where we end up. And it's a super committee failure outcome again is anybody's guess.

The other 26% of L-3, the non-DoD side, well, whereas U.S. government agencies that are non-DoD, think of state, Intel, Homeland Security, et cetera, where we do business. They're going to have the same fiscal pressures and BCA uncertainties as DoD, but they will be smaller bill payers, so we don't expect to see this issue in such a large form at those customers. The Intel agencies, they seem to be well funded and there are several competitive opportunities for us going into 2012. Security and detection looks like it's going to continue to do well in terms of modest growth. Several competitive opportunities internationally and new products are driving that. Foreign military opportunities exist across the company. However, I'm not going to hype it too much because, again, it's a long sales cycle, as you know. But there is activity internationally, especially in airborne ISR, clearly. And, as you know, John McNellis will talk about a new product we've introduced, which was our export version of Liberty known as SPDR. It was unveiled at the Dubai Air Show back at the end of November and before that in the U.K. At Riyadh, it's gotten a lot of interest, and we're in a lot of discussions on it. So it’s going to take a while for it to hit the sales line, but we're making forward progress, which is important.

Commercial Markets, there's modest growth driven by the aviation industry. Our avionics business has products that are 1 and 2 in their space and space communications as well, where we provide payload products and Microwave amplifiers, and traveling wave tube assemblies and the like.

Engility at one chart, just as a reminder for those that may have missed it. What this is, it's the spinoff of more than 1/2 of our Government Services business. The reason why is the SETA, the Systems Engineering and Technical Assistance work has OCI issues for us as it does for many of the other primes. And the training and operational service support businesses are seeing significant declines through this OCI -- OCO reductions. But we believe this will create value because we can create a new company that's going to be a lower cost operator. It will expand its markets so it can go after areas where we can't because of OCI and other constraints that we have, and we'll be able to lever it more so we give it a more efficient capital structure that it seems to being employed more and more at these $2 billion size service companies. You can lever in 3.5, 4x instead of the traditional leverage that's in a large-cap defense prime and boost the returns. And the way we're going to accomplish it is through a pro rata distribution of shares to L-3 shareholders. It should be -- it will be tax-free and it’s conditioned upon customary IRS and the SEC forms that we're well underway on. So I expect this will close mid-year. We're targeting June 30. We have no shareholder vote or anything, so this is moving along on track.

The piece of services that's staying with us will be referred to as L-3 National Security Solutions or our NSS business, which is retaining our Cyber, Intel, enterprise, IT and Security Solutions business, of our former Government Services segment. That aligns well with our core electronics, communications and surveillance systems businesses. And we're working together across the segments to integrate offerings to customers that pull through both ways the products into the services and services into the product and system areas, so that we can get more operating leverage. The same critical touch points with the DoD and Intel customer community, so we effectively have the distribution channels to the places where we need to do the business, and that was part of the rationale as to why this was staying with us. And diffusion and capabilities in the future network battlefield will drive this. They're not only do we have the sensors and the communications that boost the data but also the processing systems and sense-making systems that allow the war fighter to use this data efficiently and effectively and timely. And this is a space where differentiated capabilities and end-to-end solutions will win the day.

So sales mix, what do we look like? We have before the Engility spin and after, just highlight we'll be weighting much more now as the products over services and, therefore, more fixed-price versus cost and time and material. And the segments, Electronic System's now will grow off to be over 42. ISR is about 27 and AM&M 20. Now a good chunk of Electronic Systems the sensors are products that are ISR in the ISR space. So when you look at this, it's well over 1/3 and approaching 40% of the company is in the ISR space, which is a space that we expect to continue to grow, and actually the number is probably closer between 40% and 50%. If you start to take some of the work that we're doing in AM&M as well and then NSS.

So for strategy, in 2012 and out, the Roles and Missions Review hasn't been done so it makes it a little bit hard to target what their priorities are. But I think we have enough insight to know what they definitely will include, and it's the things that are more on the fringe that will get played out. We expect manpower related and new platform spending to be impacted disproportionately. Unfortunately, I think the new platforms are going to get hit more than manpower. It does create opportunities for L-3 to use our competitive strengths to grow our market share. We can continue our aggressive cost reductions and infrastructure consolidations faster than the competition, in my opinion, to get out with better rates, better offerings and we're much more agile in responding to emerging threats. And I think given the geopolitical backdrop, this going to be a world of emerging threats for as far as the eye can see.

We continue to evaluate acquisitions to strengthen the portfolio, expand the addressable market at products and technologies, and that will continue, but the low stock valuation is driving more share repurchases. So we could create value either way and we'll continue to do so.

I'm going to quickly cover the outlook for 2012 for the 4 segments, just very high level. Then each group president will go through it and detail with you. So Electronic Systems is looking like $5.4 billion to $5.5 billion in net sales next year. We have leading market positions in most areas. The product portfolio is diverse, so it has some counterbalances here. What we see growing or flat, because flat is almost as good as growing in this environment, the simulation and training security and detection, aviation, displays and space and propulsion areas; and declining, and this is modestly declining Warrior Systems, Marine and Power Systems, Microwave integrated sensors and precision engagement. The sales mix and declining sales volume are impacting margin again modestly

C3ISR, we're looking at $3.6 billion to $3.7 billion in net sales. Solid demand from manned and unmanned ISR and network communication capabilities. The international airborne ISR, as I said, is growing and look promising. Growth is going to come down a bit, a little bit flattening, but still it's going to be a growth area. AM&M, we're looking at $2.4 billion to $2.5 billion in net sales. The recent contract logistics services, competitive wins are driving that growth. Recompetition has comprised about 11% of the 2012 sales. That's primarily Fort Rucker and the contract field teams in Southeast Asia. Those will be mid-year events. So there is some volatility there because we have some re-competes coming up. That plan assumes no additional orders for the Joint Cargo Aircraft program, which is kind of on the fence as to whether it will be continued to canceled. We took the pessimistic view on the program. It's not an earnings driver to us, so I'm not saying I don't care either way, but it's not an earnings event no matter which way that does. The risk price competition and contract terms continue to pressure margins, but we think we've been holding up a very well in a very, very challenging space.

Services, in total, we're looking at $2.9 billion to $3 billion in net sales. So for national security systems, about $1.4 billion. We're focused on selective growth opportunities. We're picking up places where we have differentiated capabilities. And I think that given the dynamics in the Cyber budget and the fact that Cyber is starting to permeate basically everything we do, that there's some opportunity to lever this business in a more efficient form, and that's the rationale for retaining this piece of services.

Engility, which is if you haven't figured out already engineering and agility, that's how we got Engility, it's $1.6 billion in net sales next year. It's going to be transitioning to a low-cost model. There is intense competition in that environment. As you know. Everything is price-driven. Everything is ID/IQ. Everything is re-compete, constant re-compete and competitors throwing numbers and as low as 2s and 3s on margins, and it's just a very difficult market. But we can expand because now the aperture can open up to go after all SETA since there'll be no OCI issue with L-3. And we expect to complete this, as I said, by June 30.

So to tally it all up, and I only have one chart, Ralph's going to give you the details, but I didn't want you to make you wait any longer. This is what we're looking at for next year. I know we're one of the early companies to come up with guidance, so I will tell you that this is the way we see it. But as you know, it's a turbulent environment that could have changes, but we'll update you as those changes come about. I think we have a lot of confidence in these numbers and being able to deliver them, especially through the bottom line because of our cash.

Let me talk to them for a minute though. So what we put to is $14.4 billion to $14.6 billion in sales. The midpoint versus last year 2011 is down 5.5%. As you know, the budget's down $6 billion, and in the light blue box that's pro forma x Engility, so it looks like just under $13 billion x Engility and down 3%. So that's where the issue then once we complete the spinoff. Margins are down 60 bps to 10.1%. But if you look at the x Engility, it's about 10.5% or down 50 bps.

So operating margin before pension because we've now factored in higher pension costs. Again, Ralph will give you some of the sensitivity and assumptions there. We're looking at 10.4% operating margins consolidated, but the pro forma will be about 10.8% once the spinoff is completed, which is down 20 bps operationally from the prior year. So the mix, the actual operating mix issues and the ongoing business is about 20 bps down. We like to grow our earnings, but in this environment, I think we've been able to hold the line fairly well.

Diluted earnings looks like they'll be between $8.35 and $8.55, which is 2% off again at the midpoint from 2011, but that factor is in higher pension costs. If you take that out and you're apples to apples on it, again, we're looking at about 1% growth in earnings right now at the onset, $8.61 to $8.81 if you just took the pension out and said, all right, what is the pension account for? So again, you could digest that, but Ralph is going to give you everything you need to know in a few minutes.

So my concluding thoughts are on the year, it's going to be challenging, as you know, the 2012, I think we've gotten out a been as proactive as we can in positioning the company to continue to perform reasonably well given our current environment. We have a funded backlog of about $11 billion. We expect to have it at the end of the year. That gives us pretty good sales visibility, which is why we're willing to come out with guidance now. I think we can make a pretty educated call as to where we see the numbers. Obviously, we got to maintain customer focus and gain market share to keep the engine running. The acquisition strategy will support growth. But again, we're not going to lose the discipline. I think we've convinced you of that by now that we're not going to pay crazy multiples to do things that don't make sense.

Our success is going to require building upon our technical capabilities, maintaining a vigilant cost structure and our financial strength. As you know, we are committed to maintaining our investment grade rating and have done so. We've been taking out the senior sub-notes systematically over the last few years and have substantially taken the chunk out of our interest cost. So if at end of the day, I think that the company is and will be well positioned going into the future.

So with that, I'm going to turn over to Jim who's going to talk about Electronic Systems. And then we'll hear from Steve on services and then we're going to break. Thanks.

James W. Dunn

Good morning, everybody. Those budget talks make my head hurt. I want to talk to you a little bit about Electronic Systems group. What we're looking at here is something that comprises about 37% of the company, forecast to be something on the order of $5.5 billion going in to '12.

I'd like to draw your attention to it because a lot of you, I think, view L-3 as a kind of a potpourri of a lot of little companies. And quietly, over the last 3 to 4 years, we have basically been taking these companies and cementing them into operating entities. We've consolidated where we need to consolidate. That's an ongoing process. We're continuing to do it. What we've managed to do is put management in place, which is very focused around certain business areas. There's a lot of synergy in the way companies are cemented together, and we're driving forward in what are really 9 business base areas in electronic products, all focused together, all aimed at very precise targets. You can see the 9 there. They each operate I guess somewhere from $0.5 billion to well over $1 billion. And as I said, they're all quite focused on what they are trying to accomplish.

We do a lot of things. We make the ProVision scanner that you're starting to see in the airports. I think we've actually kind of hit a home run there because that product is the first one out there with automatic targeting so that you don't have privacy issues anymore. We've probably taken orders for 400 units and we're looking at a lot more of them. We make sophisticated electronic surveillance balls that are now flying on aerostats flying on aircraft, flying every place you can think of. And that marketplace continues to grow. If you look at the WESCAM ball kind of thing that we do, and by the way, we make the flares and the lasers and the pieces that go in it, I think people want that everywhere. Police forces are buying it. It's not just a military application. It's an application of a world, which, as you're all coming to grips with, is just filled with surveillance. Everybody's looking at everybody.

We make an -- we have a program of record in unmanned aircraft systems. It's been a program we've been in development with now for the last 3 years. It happens to be unmanned air vehicle that will fly 7 or 8 hours and carry 100 pounds. There's actually nothing in that class, and we're in the process of selling off the 9 vehicles to SOCOM now and expect it to go operational very near the end of the year, maybe early next year. We make aviation products for TCAS. We make SATCOM terminals. The technology is across the board in front of everybody or very near everybody who we compete with.

The march of the megacycles that we've all seen in the industries -- I mean your computers get smaller your cell phones get smaller, everything gets smaller. It happens in the military. It's just because they're very focused and targeted, it takes several generations. You can't move quite as fast as you can move in the commercial marketplaces. And you don't throw all your cell phones away every year. Somebody was telling me, Verizon, I think outsource is about a 1.5 million cell phones a year or months rather, so that they're constantly regenerating cell phone. And then it happened in our industry, but the pressure of the miniaturization does happen.

We're looking today at targeting systems for ground soldiers that could be man carried. Up until now, they're running in the back of a Humvee and they're probably 200 pounds, and they can't get them up a hill in Afghanistan. That's not what we're coming into now. We're coming to a world where the stuff is man packable and man portable. The market-leading technology has always been our solution. We've always been ahead of the game. How do we get there? Well, we get there down there, the agility, the smaller, lighter, less overhead structure. We move faster, we tend to invest in what we think is coming around the corner and we tend to get there ahead of most of our competitors.

We do have a system solution capability. We have a lot of products. Our potpourri of products allows us to put systems together very quickly because we got a very deep parts of it. There's a lot of things that we can configure in the systems. Look at the ISR plan, look at Liberty. They put airplanes together because we had M&A and we had airplane capability. We had ELINT capability from other systems. We had WESCAM ball capability. John will tell you a lot about it, but that kind of capability allows us to do things that a lot of companies can't do.

I'm going to walk through these 9 operations now because I'd like you to really see how focused they really are. Aviation products came out of what was the Products Group. They are aimed to displays, TCAS, aviation systems and they are very focused on a quasi-commercial marketplace. There's some military stuff in there, but they're aimed at satisfying the needs of largely a commercial marketplace both in the selling of backup instrument panels and instrument stuff as well as very sophisticated TCAS systems to protect you as you fly and collision avoidance.

Integrated sensor systems is -- centerpiece of it is WESCAM ball. We make balls from a 20-inch to 15-inch, to 12-inch to now a 10-inch. They're all as good, if not better, than our competitors. The reliability on the units is phenomenal. We're getting 2,000 and 3,000 and 4,000 hours of operating time per unit, and a lot of these things operate 24 hours a day. If you put them on a dirigible or an aerostat and tie it someplace, you put 2 of them on there at $1 million apiece and they're running 24 hours a day. That is a real demand for reliability, and frankly, we have the best reliability in the industry.

But beyond that, we also make satellite parts for ACSS high. We make a variety of devices, not the least of which is we're now taking a 4k by 4k integrated Indium Antimonide infrared array and put it in a package that allows it to fly on something the size of a shadow and do resolution well beyond anything that's available in the industry today. So we're moving forward continually with the risk. Do we have some risks in there? Yes, I guess. If somebody decides that we're not going to do ISR, there's some risk, but I think in any world that we look at, that's pretty unlikely.

Precision engagement. You saw that it was declining. The reason this forecast is declining is really because of the Fuse business. A big part of precision engagement is fuses and devices that are basically aimed at wholesale use of weapons. Those weapons -- the bins are full and the forecast for them buying as many is down a bit, but the precision part is where we stress ourselves. We are currently involved with a program called MUE, which is the next-generation GPS. It's a GPS that's supposed to be able to operate in GPS-denied areas. It ends up being as a very effective device, and will probably end up in every piece of ordinance in the next generation. As we move forward, those kinds of advanced programs are the things that are going to keep us moving in this arena.

We make a small medium U.S. -- we make several small ones. Actually, we have a program or record on a small classified UAV that I really can't tell you much about, but it's in production and is functioning very well. We also have UAS and we do a lot of force protection work in London and in England. TRL does force protection, anti-IED jamming and it's a pretty sizable business. Each one of these has a focused management. Each one of them has targets and each one of them is run as a cohesive business entity.

Similarly in security and detection, I think you know this part of the business pretty well. We've talked about it for years. What's changing, we've been saying this for a number of years, it's cargo. Cargo is coming but it really is coming. I mean, the need for looking at cargo, scanning cargo is getting stronger and stronger. The Border Patrol is looking at it. We're looking at it in harbors. We're putting a few vehicles together for cargo scanning. And by and large, we've been as successful as anybody in security detection business. Our competitors are out there, but I don't think there's anybody who gets -- generating margins or better performance than us.

Space and propulsion. This has come out a couple of things. In here, we make the COMINT targets, MDA programs. You're fundamentally dropping a rocket out of the back of the C-17, lighting it off and then using it as a target for a FAB or another ground-based missile system. We had some troubles there. you saw some reversals there a couple of years ago where Mike and I got some nasty letters and we got involved in fixing a problem. Well, we fixed it. We've had very successful launches since, and that company is basically looking forward to a better life.

Vehicle capitalization. There's 4,000 Bradleys or something like that, general, I believe. I think about 2,000 of them are parked. We don't need 4,000 Bradleys as a country anymore, but we need some Bradleys. The whole business of buying a new vehicle is very iffy, but the problem with the current vehicles is, number one, they need to be up armored. the IED world taught us that you need more armor and you got to be better prepare. When you up armor a vehicle, the first thing that happens is you need a transmission and you need a power pack. That's what we make. It's not rising right now as an industry, but as that movement comes forward and we start to deal with those vehicles, we're going to do very well in that industry.

Training and simulation. There's not a lot of new platforms. The tanker is an opportunity, there's a TX trainer that's an opportunity. We basically own the F-16 program at this point in time. We're going operational with the F-16 MTC in Nevada as we speak. That is probably the most sophisticated trainer that's ever been built. We also own the underlying F-16 program. We just won a major recompete on the F-16 UTD and lower-level program. So that piece of our business has been incredibly successful. The opportunities are somewhat limited. We're looking at some things that maybe take us into a commercial world or someplace where we could expand and use our skill sets in a bigger manner. But we're also taking technology and inserting it in there. If we can take manpower and bodies out and replace them with avatars and computers, we're well on our way to taking the cost out and revolutionizing the training business. We're about to go online with that in a few instances here this coming year.

Warrior Systems. Well, Warrior Systems is where the hit has come. We've taken a pretty sizable hit. Two years ago, the army told us they would buy every night vision tube we could make. We took our yields on those tube from 50% to probably close to 70% now. We can make them very efficiently, but the army doesn't want anymore. They basically said their build -- bins are full and until somebody wakes up and [ph] a lot of the stuff that's coming back, it's not going to be all that usable. That business is depressed. It was a sizable piece of Warrior Systems. The other part of Warrior Systems, it's a development set of a whole new set of products. I mean, we're talking about handheld lasers, complex night vision goggles, complex systems, which are in development and getting ready to go into production. So 2011, 2012 is a tough year for Warrior Systems. We don't know where the budgets are going, but we know those new products are going forward and they'll be online in 2013, and we expect to see some good gains there. But to our credit, I believe, is we got ahead of this problem. We took some 250 people out and reduced the cost and size of the Warrior Systems operation before we got hit. So in the 2011 year, we took a pretty good whack, but we've absorbed most of those reductions going into '12, and that hit, I think, is kind of behind us.

Microwave. Everything gets smaller, but John has managed to put together a series of satellite terminals that run from manpack to really big devices. He fills the gamut, and again, you're dealing with an equipment set where the customer is delighted and very happy with what they're buying. He's done a great job in terms of putting that customer situation together. The business is a little bit flat as we look at it now. But going forward, it has some real potential, and it's certainly has strong market. It's not going away.

Marine & Power is run by Bob Leskow. That business is heavily levered by the commercial ship building enders [ph]. We make some great products in there. We make hell rises, probably the best local area sonar you can buy. We make our whole series of devices like that, but they're not rapidly growing market places. The commercial ship building does drive the business. The commercial ship building started to rebound. And now, with all the euro stuff and things that are going on, I think, there's a lot of nervousness and where that's going isn't quite clear. But we expect it to be a good business. We expect it to reset and move forward. When this economy ever gets going again, we think it's going to be pretty healthy.

Mine operations. That's what we're talking about and everyone of them is focused. Leveraging technology, here's a few. I've talked about enhanced night vision goggle. That's the combination of an infrared camera and a night vision camera put together in an overlay. It's a new product. It's in the development. We're 1 of 4 or 5 competitors, but we actually have the lightest, smallest and probably the best design. We've also got a product like this operating with SOCOM. So going forward, I think we're very well established here. ONR is the product I talked about before where you take a very wide area surveillance capability and build it into small package, smaller UASs, the ProVision device, SafeScout [ph] is an interesting example. The Kiowa Warrior is out there. It's supposed to be replaced Comanche, then it was going to be replaced by ARH. And it turns out, there's nobody replacing it, and everybody's using it. And since its inception, it's never had a simulator. So all of the training was done by somebody flying an airplane. It led to some serious issues with landing, some safety issues, some problems associated with it. We took it upon ourselves based on our experience at Flight School XXI to build a simulator for the Kiowa Warrior. We called it semiscath [ph]. We put it on to display last year. It's currently going up to one of the bases to be used for active training. We expect to get some real sales and in a position where there's nobody else making it. So either [ph] we go forward as a fee-for-service device or a direct sale, but it's innovation, it's investment and it's in a place where the market was waiting for us.

I could keep going here forever. We're working on a 1,500 horsepower air cooled diesel. The power packs and the warmed [ph] systems will need it. We have an M60 tank that we've reconfigured and looking for FMS sales associated with it. So there's a lot of things going on. There's a lot of advanced technology, and we are constantly moving forward in all those market places.

Consolidations. We've done a lot. We consolidated Warrior Systems. We consolidate a bunch of the product stuff in the security and detection. We've closed actually one facility. In general, what we're doing is consolidating, attempting to keep the engineering so we can save the engineering, and doing a lot of back office work to take cost out. That process has allowed us to keep our agility, keep our engineering teams. But at the same time, take advantage of the synergies and all the organizational debts.

Execution focus. These are the things we got to do. We got a contract for some 400 engines for the Israelis. Those tank engines are sold at an aggressive price, and we got a lot of work to do. But it's something we've been making for a long time. And we expect it to be a product that will make a fair amount of money on. WIN-T in John's area. The MX-10 is a new product coming out of WESCAM that's aimed to lower cost customers and lower cost sales.

I told you the ICE2 tubes. We're now having yields better than we've ever seen on ICE2 tubes. The C-17 program we won last year, I think this time last year we were talking about getting ready to win it, and we did win it. Executing it and making some serious money on it and following through with the new operations and the margin changes is kind of where we expect to go with it. The F-16 training system is out there. UAS is out there and we do a lot of pieces on JSF. We make the display for JSF. We make the display for JSF. We make the infrared focal planes for JSF, so there's a lot of piece parts on the JSF program that represent execution challenges, but also serious opportunities.

Major awards: Tank engine, the training systems, C-17, OMNIxi, more turrets for aerostats. Things we're chasing: the tanker for the Training and Simulation business. We're chasing a PMATS, which is a program we kind of -- this is basically the trainer for all of the General Atomics Predator family. We train the pilots who have to fly them. The OEM M60 [ph] modernized GPS, a whole potpourri of things that are on the list for next year which kind of bodes well. I think we're well positioned for it. I think we feel very strongly in the game. These are speeches we've made before. We have a very diversified product base. That product base tends not to make us any really sensitive to any one platform or any one budget cut. There's a lot of demand for ISR. I mean, it's driving a lot of things in the company, and it's beyond just what's happening in Afghanistan. It's kind of a pseudo-ISR and police forces, and helicopters and people who want video and intelligence information. The vehicle reset is still there. We're waiting for it. I think something has to happen, and we're close to our war fighters. We're very close to our customers. The customer relationship has boded very well in the microwave area. It's done very well in the simulation area. It was done very well in the UAS. We are very, very close to our customers.

And I think that's the time for Mr. Kantor.

Steven Kantor

Good morning. I'm pleased to be here and brief you on government services today, and I'm very proud to be representing the more than 15,000 people we have that are deployed globally to protect our national security interests. As Mike talked to you earlier, the Services business represents today about 24% of L-3. You can see on this chart the split between NSS and Engility.

We got 4 major business units that has consolidated over the last 1.5 from about 6, so a more efficient and consolidated the operations further to take cost down. We still have the bulk of our business with DoD and Federal Services, 60 -- about 80% frankly in the DoD, but we see some growth these other federal services businesses and selective foreign opportunities for the Global Security systems. Our guidance is about $3 billion for next year based on the current budget situation.

Before I go into the details in services relative to where we stand today and our future strategic plans, I'd like to show a little video that I think will help give you a good picture without the products that Jim's talked about and how some of the integrated systems and communications you'll see later in the next briefings come together to give L-3 a particularly unique capability to provide total systems solutions to our customers. These solutions will be lower cost, more effective and they go to the point Mike was making about how we can leverage across L-3 to provide lower cost, more capable systems to our customers.


Well, I'll take you now through some of the specifics related to the Services business, but I hope that video allows you to see how we connect the pieces. At Services, we have the 2 primary business models, the national security work, which is cyber, intelligence and IT, providing solutions to our customers; and Global Security Solutions where we take these systems and provide local security to ports and facilities. And on these systems engineering and technical services side, we provide engineering, support systems engineering, program management, technical support to our customers who have operating areas. We do this across DoD and across the various agencies like Department of Homeland Security, Department of Justice, Department of State and all of the 3-letter agencies. For the Services, the key is performance. Our people are our greatest asset. Our past performance is key to winning new business, and while it's managing -- it's a challenge to manage the people as they are dispersed around the globe, what we have is really a marketing for us that's embedded with the customer. So we get a lot of very good information as what are the customer's challenges, how we can help them solve them, and then we come back to into the organization and create solutions.

We are dispersed, as I said. We're in 24 countries around the world. We got more than 15,000 people, 55%, in fact larger than 55%, are basically embedded with the customers.

You've heard a lot about the market from General RisCassi and General Cody and Mike talked about. I'll give you a slightly different take on it. While we see the pressures on the OpTempo and the decline in Iraq, I think, we also see that with this decline, there's a huge opportunity to be able to bring solutions to our customers that will allow them to do their job, meet their mission requirements and do it more cost effectively. That's a unique position that L-3 has in my opinion. And so we are working hard to develop the distinguishing capabilities and technology discriminators that bring those solutions to our customers.

The OCI issue continues and be an issue as we are -- spinning off Engility will clearly solve that problem. There's been in-sourcing in the past that's really basically completed. Most of the in-sourcing activities that the government has had last year and the year before are done. So we don't see a lot of impacts from that, but the OCI issue remains.

As you've heard, cyber, intel and IT, along with communications and that convergence to solve problems is where we really see the growth. And as you've heard with the various budget constraint issues, those areas see growth. So while it fills some of the hole, we also think in the future we can really exploit this market. So I'm pretty excited about being in that space.

We see international markets emerging, particularly in the global security area. We're pretty careful about doing those programs, make sure they're funded. A lot of these countries, as General RisCossi talked about, have budget problems as well and some government issues. So we're careful with that. We've got some really good programs around the world.

Competition is severe, but we're frankly not afraid of that. L-3 has got a history of competing with technology discriminators and being agile and meeting customer demands. So we're able to compete. Fund some unique things in terms of challenging market for highly cleared people. This is an area where it's very difficult to find and clear people working in the intelligence community. We've got some special programs that we've created that helps get people cleared. We've got the customer working with us in that area, and we've been told that some of these programs are really benchmark for the industry. As a result, we've been able to meet our fill rates.

So our growth strategies. I've separated by NSS and Engility. They're very different. We talk here, and you've heard Mike refer to sense making, what that really is, is if you think about it, what you try to do in the Internet yourselves. There's a huge amount of data available from all these sensors and they come from space assets, so UAVs or ground-based information. The amount of data that's accumulating increases exponentially every year, so there's mass amount of data available, as you know, as you've searched the Internet. The real problem here is how do you find that data. The real problem is how do you analyze that data, how do you do it in realtime, how do you communicate it to those who need it and how do you do it securely. That's the key to what we call sense making or connecting the dots and making solutions for the customer from this vast disparate database. We're working -- we have discriminators in this that we are currently providing to customers. We're continuously developing new ones. So part of our R&D investments are to develop and continue to develop these new technologies. This market moves quickly, so whatever you create today to solve the problem, you need a new technology tomorrow, very exciting area.

We're looking at acquisitions as part of the strategy, I'll talk more about that. Customer satisfaction is key. We've got to service them. They've got to have what they need when they need it and we have to be able to then give them better solutions at lower costs. We want to grow our programs as we have them. I'll give you an example where we had a program. It was designed to consolidate and lower cost. We signed up for that. And in fact, in the first year, we reduced the number of people we had assigned to the business to meet the cost-reduction objectives. That sounds like we're designing reductions in place, and it is. But what happened was, they took that money and gave us back a new scope to further enhance and consolidate additional programs. So the net is that the program itself went up by $200 million in content. So this whole process of reducing cost, being more efficient can lead to more business. And we're looking at strategic partnerships both commercially and with universities to help us grow, and I'll talk some more about that.

Engility. It's a little bit different model, but clearly, we believe that we can grow the seed of business. They can expand where we haven't been able to, and that's really the key to that. And we want to be as cost efficient as we can be, and that's the strategy there. We are absolutely sure that we can expand that portfolio to areas that we haven't even been able to bid, and we've seen customers come to us now and tell us about projects they have that we were not able to bid on before because of the conflict with our products companies.

So simply stated, our NSS strategic initiatives, they're threefold. We need to develop technology discriminators, we need to do acquisitions where they make sense and we need to average the capability of L-3. And the third one, I think, has huge potential for the future.

In terms of developing differentiators. I've got 3 areas there, cyber, intel and IT. I'll talk a little bit about active defense as a technology defense system that allows the Internet -- this is the network that the government operates on. As they're doing a mission, the active defense wants to be able to keep the system running even when there's a cyber attack. So you can understand that as the military operates, they can't shut down if some kind of virus comes into their system or somebody tries to collect the data. L-3 is pretty unique and now we have a very high-speed backbone that we can bring to play here. And we can actually test the system, monitor itself, detect threats and take action against those threats while the system is running. And there's no -- it's invisible to the operators. So this all goes on in the background, very unique capability taking on our products work in the communications area and migrating it to the intelligence area.

Customers are, as we all are, moving to mobile computing. And so they all want to move to mobile computing as their people are more dispersed, be able to touch the databases both classified and unclassified remotely. To do that, we need cloud computing. We need to do this both with crypto and cybersecurity. We're developing unique technologies and waveforms that allow that to happen, and the government's moving to that. Those technology discriminators are required for them to accomplish that need. There's just too much data, there's too much computing to carry it all around so they are moving to the cloud, and they can't afford all the distributed systems. I talked about sense making. Here again, it's tools that bring the data to the analysts. A huge portion of the intelligence analyst work is finding the data that he needs or she needs amongst the vast databases. We are developing technologies and are using some of them today. And we actually assist the analyst in pulling the data out of their systems, it's called knowledge base, and providing to them somewhat automatically. And then we're working on algorithms that help them to analyze that data and have actionable intelligence that then gets securely communicated to the users. This is a great step forward because it's reducing their workload so that they're not operating the system and out searching, they're doing what we need them to do, which is analyzing the data.

And ultimately, the enterprise IT work is all the operating system that allows the sensors and the systems to provide data into the system, the people to access them, keep that IT system operating in a secure way. And again, because of the large data centers, consolidations of data and cloud computing is coming simply driven by the budget situation. So what I see there is great opportunity for us to exploit this market with our technologies.

Partnerships are key as well. We've recently announced a partnership with Virginia Tech, developing a cyber lab, taking their cyber people into our space, putting some of our people with them. The result is a joint cyber development lab right next to the customer. So we're developing products. Customers can come in and see them. And as a result, we've gotten some of our R&D programs moving, and now the customers are starting to give us customer-funded R&D to help jointly develop these things. So we're very excited about that, and we're going to expand that to other universities in the same way. And we're also working on commercial partners who have big data in handling that. And that's a 2-way street, bring some of their capabilities to handle big data in data centers to play in the military and for us to bring some of our cybersecurity capabilities to them. So we're working on those as we speak.

So again, in summary, I think these technology discriminators are really going to be key to our future growth. Acquisitions, I think, you heard Mike talk about discipline. We're very disciplined in it. We don't bring anything forward that we don't believe has got a real strategic benefit, 1 plus 1 has to equal 3. We look at the valuations and we're both patient and careful to make sure that what we're looking at, will meet all the criteria. And we'll continue to do that as these opportunities come up, but I would totally agree that overtime, we'll see more opportunities at better prices.

In terms of the leverage, I think the video explained it pretty well, but the whole point here is that from L-3, we're able to take from the centers to the gathering systems, to the intelligence analyst, to the IT systems, produce the cybersecurity communications and put that end-to-end solution from basically gathering the data to the user seamlessly, and that's a total systems solution. And if you look at L-3 and you couple this with the rest of the products, as Mike said, we're more than 40% in this ISR space.

Major awards in 2011. Pretty proud of these. The SOCOM, there's 2 awards there on SOCOM. Those are special forces, which again will continue to be funded going forward, much more emphasis on special forces going forward. So those are programs that give distributed computing and support for all of the SOCOM support services in IT. JDISS is a program, DoD-wide, intelligence infrastructure that we set up and we manage and keep running. Farsee [ph] services is IT and communications program. It's a new area we went after. We're in sub. We decided we to prime, to recompete, we won it. And in the specialized communications and engineering, this again is areas that we provide special services to specific customers.

Engility awards. Missile defenses programs into the launched services, we've been here for 20 years. We won that recompete. The DLITE is a linguist program where all the services have put all the linguist needs together under one umbrella. That was a competition this year. We won one of the positions for the ID/IQ multiple award, and now we're bidding on the various task orders. The first task order will be linguist for Afghanistan for next year and that's underway now.

You'll see CTAP and CJPS a criminal justice programs and police training and support programs, Department of Justice, Department of State who will provide special capabilities for training, support to these agencies around the world. And the ROTC is a program, also a new program for us. We went after support to ROTC in terms of recruiting, retention and support to the cadets. That's a new program that just started.

For 2012, we've got a nice cadre of programs pretty well split between NSS and Engility. Both top and bottom are over $1 billion dollars each of new programs in terms of contract value. At the NSS side, the first 2 talk to intelligence support report work that we're proceeding with along the lines I talked before. This is how to restructure, how to support, how to make more efficient the analyst work and also the engineering support and management of all of that product. GTax [ph] is a program we're very excited about. This again represents the government's view of how to put everything together and buy solutions. This is a tactical communications system that's basically buying products in the communications area, as well as services. So within this umbrella, they buy everything they need for tactical communications. There are 16 L-3 divisions on the team that supports this. And everyone of them has a unique capability in this space. So we're very excited about this because it really positions us well to couple together all of our communications work. And the IT and cyber support make all of these systems work, and we're bidding that as we speak.

EPM is a program with NSA and items as a geospatial program where we're doing IT and intelligence work as well. So these are the big hitters for 2012.

On the Engility side, similar programs that we've had in the past, SSES next gen is our system engineering support to the army. This is a program we've had for many years. This is a recompete. We're expecting that out early this year. We continue to operate today before that on the old contracts. Counter narco [ph] is program well funded. If you look at the budgets, that's going forward. That's to prevent not only narcotics but small arms and explosives coming into the country. We support that through training and logistics support. DBMS [ph] is a program that we're providing support to the veterans administration as they consolidate all their systems and pool the electronic data records together, so we have engineering support to help them do that. And TAWS is a recompete of a program we've had again for the navy communication support. This is engineering services SEDAR [ph] work, and that's up for recompete.

So in summary, I think we've got a good understanding of our market, and why the budgets are under pressure, it's a bit unknown. I think we know where we fit. I think we're well positioned to grow in that area over time. I think 2012 will be an area of transition. Are going to be some challenges in terms of timing, but I think we've factored that in as best as we can to our plan. I think we do have a good strategy in terms of how to grow in this environment, and that's got to be better solutions at lower cost to meet our customer's needs.

And I think in terms of support and sustainment, as Mike said, we need to be agile. We need to have a low-cost solution in terms of Engility business, and be able to go pursue other work. It's interesting to see there that there are many programs that we have been unable to bid, as I mentioned earlier. Examples of those are some of the IV&V programs where we verify and validate the work that contractors are doing. Well, obviously, we can do that for our own products, now that's opened up.

Defining requirements. We can assist the government in defining requirements for new programs because we were going to bid on the products, and that's opened up. So the OCI issue being solved really opens the door for Engility to go after programs that they haven't previously had. They can also expand through acquisitions into things like logistics and base support, which we haven't had. So their structure will allow them to grow. And NSS structure focused on the intel community and bringing the products across from L-3 really allows that to grow.

And so to accelerate it further, if we can find acquisitions that make sense, we'll do them. If they don't make sense financially and strategically, we'll defer them. But they can accelerate it if we can find them and if it's 2012, that's great, if not, we'll do them when they make sense. So the bottom line of all of that is I think we're well positioned. We understand the market. We really understand our customers' dilemmas. I think we have solutions in this environment that others don't. And so I think this is still an attractive market at $500 billion or more, and so we look forward to exploiting that. And with that, I'd turn it over to Curtis.

Unknown Executive

Thanks, We'll break until 10:40, 10:45.


John C. McNellis

My name is John McNellis, and I'll be providing an overview of the Aircraft Modernization and Maintenance segment and also the ISR systems component of the C3ISR segment.

I'll begin with Aircraft Modernization and Maintenance, or AM&M. AM&M comprises 16% of the projected sales for 2011 within L-3. We're organized into 2 major business areas. Platform systems, which comprises 40% of the AM&M sales and is focused on the modification and enhancement of various aircraft platforms. And Contractor Logistic Supports is the other 40% -- or 60%, I should say, which is responsible for sustaining aircraft in the field. Sales in terms of funding course predominantly good sources in DoD, with foreign governments being the next component split between foreign military as well as direct commercial sale. And we're projecting as guidance for 2012 sales between $2.4 billion and $2.5 billion.

From an overall marketing environment perspective, we believe that with the current defense budget situation, it presents both opportunity and some element of risk. And the outlook that I cited on the prior slide, we believe represents a prudent balance between that opportunity in that risk. From an opportunity perspective, we expect relatively few, if any, new additional platforms to be coming on the scene in any large numbers in the next several years. That gives us the opportunity from an aircraft sustainment perspective to continue to maintain a large number of fielded aircraft. From a risk perspective, depending on where the budget falls and how deep it goes and what kinds of programs, we may find that even some of those fielded platforms find themselves retired early. But we believe on average that we balance that risk and opportunity well in the outlook.

We see the market shape by a continued high OpTempo. Notwithstanding the fact, there's been a draw down in Iraq. We're seeing continued sustained OpTempo in Afghanistan that will continue to require legacy systems sustainment.

This market space in Contractor Logistics Support continues to be a very competitive one. The contract vehicles the government uses in terms of multiple award contracts continue to remain the norm. Those tend to drive large number of competitors, making it a very cost-sensitive marketplace. On the other hand, as I commented last year in this session, we are continuing to see a move from just pure cost as the only deciding parameter to what we call best value where the government makes a trade between cost and the capability that the contractor brings to the table. And we've been able to actually be very successful this year in winning some key competitions based on that best value premise.

So overall, L-3's advantage lies in our ability to rapidly be able to turn aircraft back to operational use out of the sustainment of modification mode to do that more cheaply and cost effectively than OEMs, and we do that through a variety of targeted investments that focus on improving our overall productivity.

What I'd like to do now is I'll talk briefly about what the market offering is of each of those business areas platform systems and then Contractor Logistics Support services, and in particular, focus on the growth strategies for each of those business areas. Within platform systems, we provide this menu of various aircraft enhancements from putting mission equipment onboard aircraft to extending the service life of those aircraft through a variety of structural design and engineering capabilities, avionics and other kinds of upgrades. We have a nice Aerostructures Fabrications business that continues to grow well in this marketplace, and we have capability to modify a variety of aircraft for use by VIPs as well as heads of state.

Our customers are as indicated here and we distinguish ourselves by our ability to rapidly turn fleets through maintenance and modification back to users, variety of technology investments that help our users be more cost efficient in their operation in their fleets. So a good example of this is a partnership we have with one of our customers in producing integrated avionics suite that we're going to be introducing the C-130 aircraft in the very near term. And overall [Audio Gap] alternative to OEMs.

From a growth strategies perspective, one of the key themes, and you've heard it in a number of the earlier speakers, is we do collaborate very extensively across, in this case, the business units that comprised platform systems. There are 5 of those, and we do that in a very interesting way.

Those business units in capability run the range from very intense structural engineering kind of business units to those that do a relatively simple installations onboard aircraft. And what we do, and in particular we're looking to grow on the C-130 market, is depending on what kind of a modification or enhancement the customer wants. We optimize the mix of those particular business units to achieve not only the technical capability of product that's desired, but to do so with the most cost-efficient price point.

Within our VIP head of state aircraft business, we see that as a growing marketplace for us. We were very fortunate to, just slightly up to the timing of this event last year, we won the very first modification contract for a 747-8 cargo aircraft, Boeing's biggest into a VIP head of state aircraft. That is going to be a platform for the future. We're seeing a lot of demand for that. And we believe being the first to modify such a thing, gives us a substantial advantage in the market in terms of nonrecurring investment.

Our aerostructures business, as I commented, continues to do well. We see a number of new OEM relationships and platforms, not only in the military market space, but also within the commercial aerospace marketplace as that market continues to recover.

Another area of collaboration we have is between platform systems and another business area that I'll talk about in a subsequent section of this presentation ISR systems. There's a very long-standing relationship between platform systems and the special missions area of the United States Navy. The Navy is looking to evolve that signals intelligence capability over time. That signals intelligence turns out to be a very special capability of our ISR systems group. And so we have a partnering between those 2 business areas to produce a modular signal intelligence capability that we can install on board a whole variety of different platforms, and we'll be working with our navy customer very closely to help them evolve their system on a going forward basis.

And last but not least, we have a long-standing position with P-3, maritime aircraft surveillance. And again with a relatively few new aircraft being introduced, we look forward to being able to continue to grow in that market space, both domestically and internationally.

So overall, we are looking in this area from a growth strategy perspective to continue to improve our competitive position by leveraging the combined strengths and collaboration across our business units, and through a variety of targeted investments that make us very competitive.

CLS services, we basically provide here a menu of capabilities. But in the large, it's everything from managing a supply chain of parts through the actual performance of maintenance on aircraft in the field to repair of a variety of components and subsystems. And depending on what a customer wants, we can mix and match within that menu of capabilities to deliver just the capability that they need.

Our markets and customers are as indicated here. The distinguishing feature in this particular space is the long-standing and extensive knowledge that we have of a variety of a deployed legacy platforms. And we use a variety of data models for those platforms that help us optimize the service that we provide against those, and we continue to invest in a variety of analysis tools that allow us to minimize the overall lifecycle costs associated with maintaining the aircraft.

And in addition, we streamline our processes to continue to make our overall approach very cost effective. In terms of growing the business, first off, and we've talked a lot about how we structure the organization across L-3. Within this market space, because different customers have different kinds of business models that they're looking for, we've restructured our own organization, such that we can deliver the most cost-effective approach to a particular customer set.

In some cases, all our customer is looking for is for us to deliver any fed bodies that they direct to do sustainment, that demands a very thin infrastructure from us to manage those people. On the other hand, if they want to full soup to nuts supply chain management, delivery of sustainment to the aircraft and also component repair, that integrator role demands a more robust infrastructure. And we've aligned ourselves to be able to offer that, rightsize infrastructure to each customer as they require it.

One of the key competitions of this year, Mike made reference to it, is our Fort Rucker contractor logistic support contract. Our proposal has been submitted in October. We expect award in August of this coming year. I will tell you that we have been getting ready for this for well over 2 years in terms of variety of strategies. And we believe we are well positioned for that and we'll be watching that competition very closely.

One of the areas that we look forward -- we talked a bit earlier in our discussion today, is in terms of pull-through from other parts of L-3. As we have people sustain aircraft in the field, very often they identify ways in which we can improve those aircraft and their capabilities by pulling products from other parts of L-3. And we're able to sell those capabilities into those programs.

I mentioned there's a variety of different service models that we support. Some of those that are more full service, if you will, tend to be fixed price, tend to offer the opportunity for more robust margins. As we pick and choose, those things we're going to go target competitively, we're biasing ourselves more towards the high-margin end and we've been very successful to date in executing that strategy.

In terms of collaboration, again, there's a great collaboration between the contractor logistics and support services part of the business, and the activities in ISR systems, as well as within platform systems to be able to offer integrated offerings. And again, Mike's site at Project Liberty is a great case in point. And we've been very successful in doing that.

And we continue to enhance our overall competitive position through a variety of improvement initiatives that streamline our maintenance approach and make us, overall, more competitive. So in this market space, we're really focused on continuing to improve our cost performance. Again, it's a very cost sensitive market space. But by the same token, we recognize that it's moving towards best value. And so again, we're looking to make sure we make the maximum impact possible in terms of meeting customer expectations.

In terms of major awards within AM&M in 2011, I've provided 3 of the top of the page that were major platform system wins. P-3 sustainment is a long-term business of ours. It used to be aircraft were split up between ourselves and the OEM, Lockheed. There was a winner take all competition that we are able to beat Lockheed. And so now, we are the sole sustainer of those aircraft going forward.

Airborne Sensor is a 10-year program. It was a recompete of a missile defense agency contract, wherein we provide both the aircraft, the people that operate them, the sensors on board and the overall sustainment that track missile intercepts associated with the missile defense test program.

And finally in our Canadian F-18 business, we were able to capture a total system integrator role that gives us a 7-year base program with 3 option years. And we think that positions us very well for the long term, not only in the F-18 world, but also as Canada ultimately moves towards JSF. We really are the leader in that fighter enterprise in Canada.

The bottom 4 contracts represent our -- some of our wins, key wins in the CLS services area. The first 2, Air Force Navy C-12 and Corpus Christi Army Depot, are programs that we have been performing on for a number of years and we were able to retain those through recompetition.

The bottom 2, the Regional Aviation Sustainment Management East, which is a management of a variety of aircraft deployed in 3 bases -- Army bases on the East Coast and the T-34, 44, T-6, which is the Navy trainer enterprise aircraft sustainment program. We were able to take those away through competition. And so again, we had a very successful year from our recompete, as well as a take away competition perspective.

And looking forward into 2012 and beyond, I think we've covered most of these things. We see C-130 modernization as a real opportunity, as do we see VIP/Head of State continuing to be a growth area for us, both rotary as well as fixed wing aerostructures is a growing market space that we intend to continue to drive forward on. We're very focused on the recompete at Fort Rucker. And again, we believe we're in good position on that. But we're not leaving anything to chance as we work our way through that competition.

There is an army, aviation field maintenance program, a task order contract that we need to make sure that we have a ticket to that dance. And so we'll be competing for that task order program in the -- I would say, the middle of this coming year. The Air Force's Contract Field Teams, Mike mentioned one of the key recompetes on the task order that provides people in Southwest Asia. We're looking for an award in that program in the April of 2012 time frame.

And finally, more towards the third quarter of 2012, we expect the award of the recompete of our current incumbent program on the T-6 joined fixed wing trainer. So a variety of both recompetes, as well as new opportunities to take us forward in the AM&M market space.

I'll now shift to the C3ISR segment. As indicated on this slide, the C3ISR is broken down into 2 major business components. ISR systems, which I'll talk about and Communication Systems, which Susan Opp, who will be following me, we'll address. Together that represents some 23% of 2011 projected sales.

Broken out a little differently, ISR systems is about 56% of overall sales within the segment and the Communication systems components is 44%. Again, predominantly in this sector, this is DoD funded. But there is a significant international component, again, a mix of forward military, as well as direct commercial sales.

Here, we're looking from a guidance perspective that sales in 2012, in the range between $3.6 billion and $3.7 billion. From a market environment perspective, and I think it's been hit in a number of different ways by some of the earlier speakers, we basically don't think that ISR is immune from the Defense budget constraints that are going to happen, but we see this as more a reduced rate of growth as opposed to a decrease in overall budget associated with it.

And so we're projecting conservatively, some amount of growth in this segment going forward. You should have gotten from General RisCassis' as well as General Cody's presentations, it's very much driven by the international situation and it's going to continue to be so. The threats that are out there adapt continuously that demands ISR enhancements and that plays to our strength.

In addition, we see the areas of most significant growth being large, as well as smaller aircraft based ISR solutions, which is our real stock in trade within this segment. We do expect, and are seeing more competition, from a variety of other players. But we think our leadership position is being held in good stead. It really lies in what Mike was talking about earlier in our speed to market with absolute minimum development time, as well as low-cost. And we do that through some very focused technology investments to make sure that as the threat evolves, we're positioned to be there with our customers to address it and address it quickly.

In terms of ISR systems at a glance, I find and whenever I talk about Intelligence, Surveillance, Reconnaissance it helps to give just a little bit of a perspective on what that's about. And if you focus on the upper right here, this is really the overall mission cycle, if you will, or circle that it is how Intelligence, Surveillance and Reconnaissance works.

First is identifying the threats that are out there or finding them. Second is locating or fixing them. Once we've done that, we track those depending on what comes out of the tracking, we may decide to target it, order up an engagement, deal with the threat and then do an after action assessment.

The key thing in here to notice is, L-3 is in virtually every one of these key elements of the ISR circle. We have the ISR systems segment that's very focused on the sensors and platforms, as well as the processing of data into information to get that data and adjust the right person at the right time. The Communications Systems organization is very focused on all the infrastructure, communications wise, as well as data fusion wise that supports all of this.

And then as Steve was talking, within the National Security Systems organization, the ability to assess and be able to take that huge amount of data and be able to make sense out of it, is absolutely what the capability is we're getting out of the NSS organization. And throughout all of this, we have tremendous contribution from the Electronic Systems part of the organization. This really is an L-3 strong suit across the entire enterprise of ISR. And that's really what goes into allowing us to provide these capabilities.

The way that we distinguish ourselves is through our absolute agility, responsiveness and low-costs. That's what customers look for. As Mike said earlier, when they've got a hard problem, they pick up the phone and call us. We pride ourselves on the ability to rapidly mature technologies from concept all the way through to operational system. That's shown on the lower right down here, Project Liberty being a very good example of that. And we continue to invest in the technologies that would make for data being converted into actionable information.

On terms of growth strategies, clearly the technology investment is a key part of this. We also look to evolve the currently deployed ISR solutions so they're usable by other customers and other applications. And in particular, make sure that those technologies, to the greatest extent possible, are capable of being exported. We're continuing to advance our networking technologies to allow us to fuse data from a variety of different kinds of sources and be able to turn that data into actionable information that can be disseminated out to users when they need it.

We're very focused in the past and continue to be in the future on ensuring we're very cost competitive. And in this budget constrained market, that's absolutely key. And we continue to drive on that cause cycle or activity by reducing our cycle times through a variety of initiatives, as well as operational automation that allows our customers to produce their overall cost profile.

And so overall from a growth perspective, we're looking to continue to keep our leadership position in place and grow it with low costs, first to market solutions and products that we demonstrate to our customers and that comes to a key element of strategy that Mike mentioned earlier, is being able to take technology and solutions to our potential customers. I call your attention to the lower right on this chart, the spider aircraft is a significant L-3 investment -- have no doubt you read about it in the trade press. And what we've done is we purchased a King Air 350 aircraft, the same kind that is used on Project Liberty in a variety of other ISR application aircraft. But we fitted it up with a very generalized infrastructure that allows us to plug-and-play, if you will, different kinds of sensors, different kinds of communication gear negation year, different kinds of self protect systems. So that a particular customer, whether it be domestic or international, depending on what their requirements are, we can quickly configure this platform, fly it to their location and they can try before they buy. And we've had tremendous interest in this capability both domestically, as well as internationally, and we see this as a key marketing tool moving forward.

In terms of major awards in the small ISR aircraft arena, we added 15 new aircraft for a variety of customers over the last year, significant upgrades to over 46 aircraft currently fielded. And the contractor logistics support for both Project Liberty, as well as other platform we're fielding continues to grow. And so a very nice market space to be in, and we believe it's going to continue with the help of the spider aircraft initiative to continue to grow.

Similarly in the large ISR aircraft arena, we've had some very nice performance this year. The Cobra Ball is a fleet of aircraft that L-3 historically has been responsible for the platform. This last year, we were able to take responsibility for both the platform and the sensor, and now we are the total system integrator for that program. So a very nice take away and growth of our role, that's very similar to what we do on other major large aircraft platforms.

In the United Kingdom, you're aware that we've had the U.K. Rivet Joint or Air Seeker program that continues to be an incrementally funded program. This year was a very strong mode of support within the U.K. government and we had significant orders this year in terms of continuing incremental funding and we expect that going forward. And then we've had a variety of proprietary or classified customers in this arena that have brought in some orders for this year.

And then finally, the third category is what I refer to as the ISR enterprise. You'll recall on the ISR processing circle, I talked about taking data that's collected and converting it to just the right information that gets to just the right user at the right time. The ISR enterprise is what does that conversion. We've had some very strong inroads and the Air Force's distributed common ground station, which is their standard architecture for this, as well as the award of a couple of very key technology programs that we believe will allow us to expand further out into this ISR enterprise domain.

SmartLink, which is associated with managing bandwidth very smartly so we can get the highest priority information to the right user at the right time. And in electronic warfare planning demonstration that will allow us to be able to ensure that we test electronic warfare assets in just the optimal way based on the information that's been gleaned from the prior-intelligence collection. So very solid 2011 from an awards point of view.

We're looking to leverage in those same 3 areas, those awards going forward. Within small ISR aircraft, Liberty, as well as other U.S. government agency platforms, we delivered, continued the need to evolve and we'll be there with them to do that. We believe through the spider initiative, we'll be able to exploit a variety of international customer demands for small ISR aircraft. I've indicated 2, South Africa and Australia, off a very long list of opportunities we see coming into 2012 and beyond.

Within the large ISR arena, we see, besides Air Seeker, a variety of other opportunities in large aircraft ISR. South Korea has a couple of opportunities coming and again, some proprietary or classified customers have some coming.

And finally, we're continuing to look to expand our ISR enterprise presence both within the Air Force's distributed common ground station taking on an ever broader role. And also on the small, there is a desire within the military to be able to have a very localized processing of data to be able to take all that data coming down in a very small domain, and be able to get just the right information to those folks in their particular part of the battle space. And we think we're well positioned to pursue that.

So in summary for both AM&M and the ISR systems components of C3ISR, 2011 was a very strong year in terms of capture of awards, retention of business. We see us very strongly footed going forward towards 2012. We see that we're well positioned to achieve sales growth even within this budgeted environment.

In the ISR domain going back to what General RisCassi and Cody spoke with us about, we see the international situation demanding the continued enhancements of this type. And within the contractor logistics support services domain and as well as overall AM&M, the overall high OpTempo was going to continue to demand that legacy systems must be sustained. That, notwithstanding the drawdown in Iraq, the demands continue a pace in other parts of the world to include Afghanistan.

Overall, in both these areas, the proven differentiators align extremely well with our customer expectations and needs and that's agility, responsiveness, as well as cost effectiveness. And finally, the technology investments I mentioned, we'll continue to ensure that L-3's continued market leadership is maintained and move forward.

And with that, I'll turn it over to Susan Opp, who will now talk with us about the Communications systems. Thank you.

Susan D. Opp

Thanks, John. I'm the last of the group president briefings, and then we'll get on with the finances. So I'm representing the C3ISR network and secure comms segment. I've got the orange part, the 10% of the C3ISR sector, and the themes of my briefing very much match what John McNellis just briefed us on.

We're coming off the best year we've ever had. We're well positioned for continued growth. Just dependent on the budgets and of course, what happens with the world politics. We have seen some drawdown from Iraq but what we've noticed is that our systems are just being moved to other theaters of interest. Some that you see on the news and some that you don't see on the news.

So from a sales perspective, the 44% in the blue there is what we're talking about in my particular briefing, and that's nested into John McNellis' 56% for the rest of the segment. And again, that segment is estimated to be between $3.6 billion and $3.7 billion for 2012. My particular business is nearly 100% DoD. We do have a small foreign military sales market. Mostly predicated by foreign military sales. Some limited export opportunities but usually to countries that are aligned with the U.S., the U.S.'s goals.

As is evident, we build Communication products, they range through everything from very small handheld devices, much like your BlackBerry, all the way up to very large 5-link systems that are over $2 million apiece, and wind up having 5 or 6 integrated links all at once. They all have a variety of waveforms, technical capabilities and what we really are providing is the infrastructure that the network rides on. So if you will, it's a lot like the cellphone infrastructure that you use every day. We guarantee interoperability. We build our products to a set of standards that ensure that everybody can talk to everybody, and we're using IP-based networks in order for people to transfer the right information. These things all need to be encrypted. And so encryption winds up being very important and that has to be, not only at low-data rates like telephone speeds but also at high-data rates like for full-motion video.

As is normal, in this particular customer said, it's a pretty -- it's a well-integrated set of clients, and so customer relationships are very important. And especially, lately, it's all been about program execution. Meeting customer's schedules with products that work, the way they intend them to work. We spend some fair amount of internal research and development money to develop new products ahead of our competition and we are #1 in our particular segment. So we often enjoy the advantage of knowing what our customers are going to need ahead of most everyone else.

So we often have a set of demonstration assets that we're able to loan out to critical customer sets. Some of those assets even wind up deploying and then those users then come back and tell us maybe what needs to be improved, or come back with an order for more of those systems. And so we combined our internal research and development, our knowledge of the customer set, our talent within our segment and then our loaner assets to really create a competitive advantage.

As you've heard today, it's an interesting market dynamic. ISR programs of record are the strongest they've ever been. Many of the upticks in the 2012 and 2013 budgets are in the ISR program set and yet, we don't we do know exactly how the budget problems are going to shakeout. So as far as my particular portfolio, almost everything is funded with program of record funding. We're not highly dependent on supplemental funding, and so I'm expecting 2012 to be roughly the same volume as 2011.

Our franchise for wideband communications is very robust. We provide the communications for name-recognized platforms like the Predator, the Global Hawk, the U-2, P-3s, P8, the Broad Area Maritime Surveillance UAV in the Navy, Shadow, ScanEagle, basically if it flies in theater and has sensor information, we are probably the communications package on it.

We're seeing demand for higher amounts of data rate for persistent surveillance missions, and those sorts of missions allow many, many sensors on board a platform to be keeping track of a particular area. And the new mission for that is to provide forensic information. So perhaps if an event happens, you can rewind the tape, if you will, and take a look at who did what maybe the 12 hours before. And in order to do that, that takes terabytes of information. And that's where then the fusion and the Intelligence making of that information is so critical.

Bandwidth of course is quite cluttered in theater, and so making the use of the bandwidth available is another strength of ours. And then as we see some of our low-rate initial production programs transitioning to full-rate production, we see some growth possibilities there, especially in Army ISR. The manned, unmanned teaming between helicopters and UAVs, as well as outfitting all Army UAVs with these wideband links is something we're looking forward in the next 3 years.

I talked a little bit about our growth strategy. This is part of, I think, what makes our particular niche so strong. We take advantage of years and years and years of customer knowledge and intimacy. I have some 350 field service people who are forward deployed, intense with troops, some of them are at basis, they see firsthand how our equipment is used. We're able to scramble a quick reaction capability if the mission changes either overnight or over the weekend. And then of course, we use our internal research and development funding to fill niches or to ring the risk out of certain key development items ahead of time. So that when our products are out in the field, they work the way we expect them to work.

One of the nice kind of outgrowth of our continued investment in our software programmable modem technology is a market opportunity in electronic warfare. This is a market that has been under invested over the last 20 or so years. And the Navy and Marine Corps are now taking the lead to do some advanced technology development. This particular opportunity, we have 4 or so targets in 2012, and each of them are really kind of small seedling programs that allow us to show our capability adapted to the customer community and then ultimately, there should be play here for the next jam jammer [ph] program, which is coming up for down select in the next 3 or 4 years.

Some major awards, we were quite fortunate in 2011. We didn't have any major recompetes in our segment. We had a lot of ongoing awards. These are recognizable programs of record as you can see [Audio Gap] our largest order for the year was on the Predator program. You can see Apaches, Great Eagle is the Army UAV system, ROVER 6. There are some 10,000 of those going to be fielded, and we're building over 400 a month right now in full production. And then we were selected by Boeing to provide a very complicated comps suite for their EMARSS platform, which also connects them into the Army DCGS network.

Coming up in 2012 and beyond, I alluded to the need for gigabit per second communications terminals, mostly for persistent surveillance. We're also looking at the next generation of handheld transceivers. So not only receive and transmit but also encryption, and the apps that go on a handheld radio in the field. And then cognition, which allows the radio to self select the waveform that's in its best interest in a cluttered bandwidth environment.

We're putting wideband communications and encryptors on the F-22 and F-35 fleet. That's an order to connect that large fleet of aircraft into the ISR network. There's a few unmanned air vehicles and ground vehicles being developed, some in the white world, like UCLASS, some in the classified world. So there's some new exciting opportunities with respect to peer and near-peer combat, where it could be long-range strike or other types of opportunities, where I have our engineers working on covert waveforms and other types of advanced communications programs to position us for a procurement in 2016 and beyond.

FAB-T, it's an AEHF protected communications program. It's been delayed as far as delivery and so there's a few opportunities to do a reduced subset capability for AEHF in 2012. And then some international shipboard and naval programs mostly with Australia and other countries who are trying to beef up their naval capability.

And so in summary, the demand that we see in our segment is very steady, very strong. For us, program execution is extremely critical. We've talked about security and networking, applications and bandwidth management that's kind of what's new and what's next in the ISR marketplace.

Classified opportunities are as strong as I've seen them over the last 10 years. There's a lot of funding and a lot of the traditional white world missions are now being done in the classified world. And then I talked just a little bit about an adaptation of our existing technology to electronic warfare capabilities and a large program of record that's coming up in the next few years.

So that is the end of my briefing. At this point, I would like to introduce you to our Chief Financial Officer, Ralph D'Ambrosio.

Ralph G. D'Ambrosio

Thank you, Susan. So hello, everybody. I guess, good and late morning, it's almost lunchtime. We heard today from our Washington operation folks on the undue political situation and the DoD budget, and then Mike on the whole company, and then from each of our group presidents on the operating segments.

So generally, financial comments by CFOs tend to be more conservative and guarded. And I think you're going to hear some of that right now. So the forward-looking statements, I'm not going to read all those, there are lot there. A few comments about the financial overview of L-3. So first of all, our backlog and our follow-on business provides good feasibility into our sales, operating income, earnings and cash flow for next year. And that's why, as Mike said earlier, we're comfortable in giving guidance for next year, despite all the uncertainties about the defense budget.

So if you look at our sales composition specifically, next year we expect about 51% of our sales to come from funded backlog at the end of 2011. Another 40% will come from follow-on business to that funded backlog, and that's where we're not competing for the business. And then the remaining 9% is a combination of contract recompetitions, which is 6% and 3% for new business. So that's why we're comfortable in giving you guidance on sales in particular, for next year.

Also, when you consider that 50% of our sales comes from funded backlog, it explains to you why L-3's business is largely short cycle in nature. And I've talked about that the past year or so. And it means that each year, we have to book and ship at the same year about 50% of our sales and therefore, we tend to see changes in the environment faster and sooner than longer cycle platforms, prime systems, integrated-type companies and you've been seeing that in results of L-3 for the past couple of years.

We talked this morning a lot about how our customers are experiencing physical constraints. The Department of Defense, which is our largest customer, is experiencing declining budgets. Same thing is happening in the other U.S. government agencies and even in some foreign government customers. And on top of that, we have the continuing resolution for FY '12, which began on October 1, and still not resolved and there's a big question marks about the outcome of the BCA sequestration items, those are largely going to impact the end of next year and 2013.

Generally, you'll see that our services businesses are under greater pressure than our products businesses. And that's generally because those businesses structurally and fundamentally are more competitive in nature, they're a few discriminators and that all translates into more price competition, margin pressure and more contract turnover. Additionally, more of our sales exposure to Iraq and Afghanistan is in the Government Services segment compared to the other 3 segments. And that's one of the reasons why we're doing spinoff of Engility.

The company continues to be very aggressive and proactive about managing its cost structures. We always have had a lot of focus on reducing our overheads and rightsizing the businesses to their expected volumes both on the direct side and on the overhead side. And we're also focused on giving our customers more affordable products with better performance, and you heard that this morning especially from Jim when he talked about Electronic Systems, where we are developing and introducing smaller size, lower weight, better performance type products that are disruptive in nature. And we think that's going to enable us to capture market share in this environment in the next few years.

The company continues to generate excellent robust free cash flow. It's going to be about $1.3 billion for this year and about $1.2 billion for next year. And as usual, we're continuing to be very disciplined and balanced about how we allocate and deploy that capital and that cash flow.

I have one chart on the defense budget, it kind of repeat some of the same things that you heard this morning. So we start on the top left-hand side of the chart here, this shows you where we've been in the last few years. The budgets peaked in FY '10. They fattened in FY '11 and they're going to begin to decline in FY '12. Also, I'm showing here the base budget and the OCO together, which is the total. I think it's important to talk about the defense budget in total not just looking at the base budget.

So based upon the Presidents' FY '12 request that he submitted this past February, this is what we are looking at, base budget and OCO. So before the BCA was introduced, we're already looking at declining budgets when you factor in the rapidly declining OCO, which is going down about 25% FY '12 versus FY '11. Well, this has all been obsoleted by the Budget Control Act. And we're now firmly in the yellow part over here, and here we've modeled our interpretation of the DoD case where they're targeting about $450 billion of cuts over the next 10 years.

And here's what we think, it looks like, incidentally, the $645 billion of FY '12 is consistent with the Senate Appropriation Committee recommendation for FY '12, which had adhered to the first phase of the BCA legislation. But all in, the budget is going to decline by about 6% next year FY '12, based upon what we know today. And we'll see what happens over the next year or so with sequestration on mechanism. But all told, it looks like we could have another 2 or 3 years of declining budgets when you factor in the OCO continuing to decline in accordance with the Jordan and Iraq and Afghanistan. We'll see how it shakes out, but we're very confident that we can manage effectively in this environment.

So moving on to the consolidated financial guidance. We expect our sales to be at about $14.5 billion at the midpoint versus $15,350,000,000 for 2011, which is a 5.5% reduction or about $850 million. Most of that reduction is coming from 2 items: One, the Jordan, Iraq and Afghanistan is going to cause a reduction of a little more than $500 million, '12 versus '11, and the rest of it is largely in Government Services. And I'll talk more about that when I get to the segments on the next chart.

Operating margins have declined 60 basis points, half of it is the higher pension expense, the other 30 basis points is the pricing pressure -- volume pressures and OST initiatives that we're seeing mostly in Government Services, and some mix changes in Electronic Systems that Jim talked about. Interest expense and the debt retirement charges are both going to decline in 2012 versus this year, because of the debt refinancings that we undertook in the first quarter and a few weeks ago.

The tax rate is going to increase significantly by 230 basis points. 80 basis points of that is the fact that we're not assuming that there's going to be a federal army credit in 2012. It expires on December 31 and the BCA committee failure are also failed in amending or extending the R&E credit. That's worth about $0.10 of EPS for 2012. And then the rest of the tax rate decline is the fact that we've had some gains in 2011 due to closing out some IRS audits late the past couple of years or so.

The diluted share count is going to decline by 9%, that's driven by our share repurchases, which are going to be $1 billion in 2012. And we're predicting -- or not predicting, we're guiding to $800 million for next year. And that all boils down to a 2% reduction in EPS at the midpoint.

As Mike talked about it, if you stripped away the higher pension, it's a 1% increase in EPS. And if we look at the moving parts over here, essentially what's happening is that the lower sales and margins x pension are being offset by the lower share count. And then the combination of the lower interest and absence of debt refinancing costs offset by higher tax rate gives you the 1% growth in EPS x pension.

Free cash flow, $1.3 billion in 2011, almost $1.2 billion in 2012, and I'll have more to say about that in some charts. Here are the segments. So to go through sales first, C3ISR, we're guiding to flat at the midpoint versus 2011. On the third quarter call, I talked about that we expected to be at the low end of guidance in 2011. So this suggest that this 0% is likely to be 1% or 2% growth in C3ISR for next year. And what's happening there is, we're growing International Airborne ISR, the U.K. Air Seeker is one of programs. There are some others, and that growth is being offset by lower volume on Fab T and Phoenix ground terminals, Small Aircraft ISR is going to be largely flat year-over-year at about $700 million, and those are the major trends in C3ISR sales.

Government Services is declining 19% or $700 million at the midpoint year-over-year guidance. 200 [Audio Gap] and drawdowns is another $200 million or so related to the OSD initiatives changing from a single award to multiple award contracts, and we're losing some share because of that trend happening. And then there's about $150 million or so related to budget cuts in the different service areas across our customer base and about $100 million or so due to some recomputations that we lost earlier this year.

Aircraft Modernization and Maintenance, we're showing a flat year-over-year. What's going on there? The drawdown in Iraq and Afghanistan is causing about a $75 million decline, most of it is on that CFT Southwest Asia task order. That decline is being is also -- so that's one decline. Another decline is the JCA program, which is down $50 million, and those 2 declines are being offset by growth that we've had elsewhere in the CLS business, on CFT, in particular, and on the T34, 44 program and our Head of State VIP customization aircraft model work is also growing. And despite the recomputations on Fort Rucker and on CFT Southwest Asia, we have some conservatism in here. So we're very comfortable with that guidance range.

Lastly, Electronics Systems is down $200 million year-over-year at the midpoint. It's due mostly to the drawdown in Iraq and Afghanistan, which is about $200 million. And then there's growth in a couple of [indiscernible] areas that are offsetting the declines in the night vision tubes that Jim talked about.

If you move over to operating margins, these are the decline in margins with the higher pension expense, which are 30 basis points. At C3ISR, they strip away the high pension, which is 70 bps. We're actually expanding margins here 10 basis points. Government Services, there's no pension impact. The 8 basis points is a result of the lower volume, the OSD initiatives and the pricing pressure.

Aircraft modernization expansion is down 30 basis points, what's happening there is the CLS business is growing. It has its pricing pressures as well, and that's what generally affecting the margins, lowering in Aircraft Modernization and Maintenance. And in Electronics Systems expansion, the margins are down 60 basis points, and that's due to a change in sales mix.

Here's a look at L-3 Consolidated to midpoint, stripping away Engility with we expect to spin off by the middle of the year, and you see how our growth profile and our margin profile improves x Engility. The margins improved by 40 basis points and the growth rate improves by about 2.5 percentage points. We also believe that spinning off Engility is going to improve Engility's prospects, enable them to grow at a faster rate because they can go after more OCI, I mean, go after more CEDA unencumbered by L-3's OCI constraints.

Here's one chart on our cost structure. I try to give you some data here, without giving away any competitive data. The points here that I wanted to show you very broadly how our cost structure is comprised. So the labor aspects of it, both direct and the labor-related overhead is about 43% of our cost. The material subcontract cost and ODCs, which is other direct contract cost, plus of the variable nonlabor overhead is about 52%. So these 2 categories ultimately are variable in nature, and we can attack them aggressively as we deal with our cost structures. And we do that today, and we continue to do that in the future. And then we have about 5% of our overhead that is fixed and nonlabor-related, which is stickier and more difficult to reduce. But the takeaway here is we're very flexible and adaptable cost structure to manage in this budget-constrained environment, and that's what we're doing and what we will continue to do.

Looking at our cash flow. The company is continuing to convert a substantial portion. In fact, about 130% of its net income converts to free cash flow each year. So we continue to have robust cash flow. While our free cash flow is declining, if you look at it on a per-share basis, it's approximately $12 per share in 2011 and in 2012 due to the lower share count. So very strong cash flow, especially on a per-share basis. And we do recognize that our 401(k) match, which is done in common stock plus the stock-based compensation programs create share creep.

But even if you factor those out, we're still generating $10 per share in free cash flow in both of these years, and that's roughly 15% yield on our stock price. We think it's very attractive, and we're hoping for the yield to go lower with a higher stock price. But we're going to continue to have very strong cash flow.

Here's a look at our cash sources and uses. I already talked about the free cash flow. Mike talked about the deployment of the cash to dividends and the share repurchases. We haven't done much M&A this year. We don't predict future M&A until it happens. So that's why you see nothing, essentially nothing there for next year. And then we're probably going to do some debt reduction next year, so that we can maintain our investment grade credit ratings, and that's being caused by the reduction that we're going to experience in operating income. But overall, very strong cash balances and we're deploying the cash in a disciplined and balanced fashion.

Here's a look at our capitalization and leverage. Same key themes that we've had the past few years. Serving the cash balances, ample available revolver and a strong balance sheet now with the investment grade credit ratings. And overall, the company continues to have a solid balance sheet, which brings me to my summary.

I would -- we know we have an uncertain environment with the Department of Defense, and we'll see how it unfolds. We think we will be able to achieve our guidance despite all these uncertainties. We talked about the declines in sales. It's being driven by the lower defense budget and the Iraq and Afghanistan drawdown, which is related to that lower defense budget. The margin pressure coming mostly from higher pension and then these items mostly in Government Services. We continue to proactively manage our businesses, size them properly. That is not going to change, and we think we have a flexible cost structure to be able to continue to do that. I showed you that the Engility spinoff will improve L-3's growth profile and margin profile. We continue to have strong liquidity and robust cash flow, and our capital allocation is bolstering our EPS. Bottom line, the company is stable, healthy and flexible. That concludes my commentary. Thank you.

Michael T. Strianese

Okay. Thanks, Ralph. So standing between you and lunch is Q&A. I know usually is candid and active session. So we're happy to answer any and all of your questions. The management team here, a couple of board members here as well. So with that, the ladies are available with mics and just go.

Unknown Analyst

This is probably more for Ralph, to start off with. 2012 midpoint guidance, $14.5 billion, midpoint 845, right? The x Engility though is $11.5 billion approximately, and EPS then of what?

Ralph G. D'Ambrosio

[indiscernible] x Engility sales are about $12.5 million at the midpoint. -- I'm sorry, $12.9 billion at the midpoint.

Unknown Analyst

Sorry, $12.9 billion at the midpoint.

Ralph G. D'Ambrosio

I showed you that in one of my charts. In terms of EPS, the EPS that we have at L-3 and Engility post the spinoff is going to be impacted meaningfully by the spinoff dividend back L-3 and how we were able to finance Engility's balance sheet. But all in all, we think that the spin-off is a value-creating activity. So that means that we expect the combined EPS on a pro forma basis from both entities to be higher than what I showed you for L-3 consolidated, which is 8.5 [ph] at the midpoint. It's not going to be somewhere between $0.10 and $0.20 higher on a pro forma basis, and we'll have more details for you on that as we get closer to spin-off at the middle of next year.

Unknown Analyst

Okay. Just to clarify, that $12.9 billion number was only -- that's including a half year...

Ralph G. D'Ambrosio


Unknown Analyst

That's including...

Ralph G. D'Ambrosio

No. Let me summarize it for you and this information is again contained in the charts. So the midpoint consolidated guidance is $14.5 billion for 2012. That includes Engility for a full year at approximately $1.6 billion. X Engility, its $12.9 billion.

Unknown Analyst

Could you give us a little more color on Engility? I mean, given that the numbers are going to be down, how much debt do you think they can take on? What that's the dividend to L-3 likely to be? And if you're on track, any chance you could get it done before the middle of the year?

Michael T. Strianese

Yes. I could handle all those, the kind of mechanics on the deal. We're looking at a certain targeted credit rating for Engility. And their EBITDA is lower, coming down faster than projected. So I think we had given a range roughly around...

Ralph G. D'Ambrosio

It was a range in Engility [ph] of around $500 million [indiscernible]

Michael T. Strianese

Probably, its less than that in terms of the dividend back. Assuming we can go up a little more in the leverage side. I don't want to go too much that hobbles the business, and it doesn't give them a fair chance to succeed. So we want to be consistent with not some of the highly levered transactions, but the other competitors in their space. If you look at the dividend back and the fact that we showed a debt reduction on the cash flows and uses, it’s likely that we'll do with that dividend back to reduce debt to maintain L-3's investment grade rating. But again, these moving parts will all reconcile at the time the transaction is done. It's going to -- a bunch of factors involved. In terms of the timetable, can we get it done before June? Yes. I mean, if everything goes exactly according to plan and we're in and out of the SEC in a reasonable time frame, we certainly can. I think we gave you our view of a likely date with some contingency in there for the typical round of comments that we would expect in the normal process with the SEC in terms of the revenue ruling that is going through the IRS, that's on track and it's looking like there are no issues there that I've been aware of yet or at all. And the SEC, the third year of financials as it underwrites will keep with 2011. Those have to get done. There's a Form 10 that is already drafted. Yes, we have a Form 10 that's already to go. We're going to drop those numbers and file. I think the filing will be made by end of February or early March. So 30 days through the SEC gets us out sometime in April, but surely one with 30 days. So...

Unknown Analyst


Michael T. Strianese

Well, and the answer is things go well. Okay? Great. Sure.

Unknown Analyst

Mike, sort of a big picture question for you on cost. Your cost structure has always been an advantage over three years, and you guys have talked a lot about the further leaning out cost structure, staying ahead of the curve in all the presentations today. But your peers have talked a lot about similar sort of strategies, taking costs out, and to your chart, Ralph, it has 90% of the cost is variable. It seems like some of the peers are actually going after that fixed component, if I think about talk around Boeing Wichita on aircraft modernization and stuff like that. How, as you look around at the peer group and your own efforts, how confident are you, you can stay ahead of the curve on cost when everybody is running to get to the same sort of goal?

Michael T. Strianese

Because I'm highly confident we could do that, because we were ahead of all to start with. So and we know this from, not that we know everybody else's rates, but we know this from competitive wins that we have. And generally when we're dealing with the prime community, our rates are much more competitive than the rates. You say they were attacking their elements of fixed costs, well, that's because they have more fixed costs to attack, where we don't. We don't have major plant facilities, imagine a tank plant or airplane plant or anything else, which would become redundant quickly. I don't think the C-17, for example, or the F22. Things that have been held down. It had massive infrastructure issues there that have to be consolidated, right? Or eliminated. We don't. Ours are very minimal. So I don't think it's a question of us falling behind. It's a question of them catching up, and do I think they'll ever catch up? And the answer is no. It's an aggressive statement, but I think I feel comfortable with it. Yes?

Unknown Analyst

Ralph, I think you said there's 6% recompete in the guidance for sales range. Of that $850-plus million, what's the success rate assumption that you have in there for the recompetes?

Ralph G. D'Ambrosio

It's probably 75%.

Unknown Analyst

And how does that stock up relative to the last couple of years?

Ralph G. D'Ambrosio


Unknown Analyst

Okay. And then also on pension funding, what is the current under our projected funded status at year end? And also, it looks like the funding that you're doing is coming down the last couple of years, and I'm just kind of surprised it's not ticking back up. So if you can give kind of a couple year trajectory of where that pension funding has to go?

Ralph G. D'Ambrosio

Okay. So[indiscernible] $780 million based upon the assumptions that we used to estimate 2012 as expense, we tried to end 2011 with contribution of roughly $970 million last year [indiscernible] We certainly decide to do, so we make more pension contribution [indiscernible] discretionary insurance, and that doesn't mean [indiscernible] we have to ramp up our pension contributions even though they've had lower asset market share [indiscernible] So almost always, the situation we have to [indiscernible] pension because obligations[indiscernible] on an absolute basis [indiscernible] other large [indiscernible]. So that's where we stand [indiscernible]

Unknown Analyst

Okay. Then the last one, the use of proceeds from the dividend of Engility, I think, Mike, you mentioned that it might be used for debt repurchase. But the debt repurchase is already in the guidance. So I'm just curious is there upside to the guidance from the use of the dividend from Engility?

Michael T. Strianese

It could be a modest upside there, depending on how it's going to be deployed. The debt reduction, again, it's going to depend on a number of factors, but we want to have a comfortable margin and maintaining the investment grade rating. So we're anticipating a portion of it. I mean, you can look at it another way, and since the rating agencies are generally accounting the pension liability in terms of overall indebtedness, that debt reduction could also be through taking out some more senior sub notes, taking out some of the codes or putting the money in the pension plan. I mean, we have a number of options as to how we accomplish a little bit of delevering to keep the rating agencies happy, and that could provide upside. Further, to the comment of the pension fund, let me add that we fund to the maximum of the cash allowable on it. So once you start going way beyond that and build it, they have these huge prepaids, you do get a short-term benefit boost. You made earnings on it, but you don't want to close the money issue there and you're not recovering it. So if you would take a view, unfortunately, you don't know how low is low is going to be with interest rates that you could get a balance at some point. And all of a sudden, that gap closes fast then you're rapidly in a prepaid position that you can't undo. So we are not leagues under the sea here on terms of the hole we have in pension. It's not really not quite that big. We were fully funded, I don't know, 7, 8 years ago almost, and the erosion here is almost been, I'd say, 3 quarters of this is probably discount rate, and the other 25% is probably asset return. And I think the discount rate couldn't catch up. So it's an option. We can do a number of things with those proceeds. And including shares, by the way. So...

Unknown Analyst

Okay. Ralph, I have a couple of questions for you. First one on OCO, there's a few numbers flying around there on 2012. I was wondering if you could tell us where you expect 2112 on OCO or you expect to end 2012 on OCO?

Ralph G. D'Ambrosio

Sure. So we're going to end 2011 with Iraq- and Afghanistan-related sales just slightly above $1,250,000,000. I think that's going to decline by about $530 million next year. So that brings you down to about $750 million for 2012, and that is not attributing any of the small aircraft ISO programs to Iraq and Afghanistan. And immediately, those platforms are being used in Iraq and Afghanistan, but we believe that those programs are going to have a long large and use in other missions. So that's where it stands.

Unknown Analyst

Okay. And then secondly, on Fort Rucker, what's your assumption regarding that contract recompete in '12?

Ralph G. D'Ambrosio

Sure. So Fort Rucker is currently our largest contract in terms of annual sales volume. It's about $450 million. The new contract is scheduled to begin October 1 of next year. So you have one quarter that pertains to the recompete, which is a little more than $100 million or so. And we factored some of that into the guidance, which is what I have said earlier year.

Unknown Analyst

And within that, I mean, to Mike's comment, the service contracts, seeing pricing pressure, margin pressure, are you assuming that the Fort Rucker follow-on contract is at a lower margin?

Michael T. Strianese

Well, we talked about the OSD initiatives and what's happened to margins, and that's happening there as well.

Unknown Analyst

Two things. First, just talk a little bit about kind of the timing of some of these big macro uncertainties that exist in 2012 and when do you think these might get resolved? Sequestration under the BCA, I mean, is this all stuff that happens after the election? And how does that affect how you think about capital deployment and maybe some of the other big strategic moves you could make?

Michael T. Strianese

Well, I think it's almost anybody's guess on what happens here because -- I'll ask Dick to comment as well. When Senator McCain got up, for example, on bomb services on this, they kind of just wrung their hands at this and they said, "The committee is likely to fail. We don't care." Well, we have all next year to fix it, but it doesn't start until '13. And then throw in the effect in election year and then throw in the effect that Congress hasn't been able to get anything really done without a real food fight. So I think there's a real possibility that this actually can happen by law. And in terms of our decision processes, well, one of the main things it's affecting is M&A and R&D, areas that we're -- where we're deploying our cash. And you could look, with some degree of certainty, on a select number of programs and areas, such as ISR and communications systems, et cetera, that we know good on any scenario that those will be the bottom of the list of things that are going to get cut, and we're kind of comfortable there. And then when you get a gray area where things that could get whacked and maybe not or, for example, if you look at M&A candidate that has a good chunk of content on a couple of major platforms, and those platforms in a bad environment are going to get reduced significantly, what you can't go forward with it, or we wouldn't necessarily go forward in that regard, because you couldn't effectively evaluate your returns, how much risk you're really taking. So it's slowing those decisions down, and it's making it a wait-and-see attitude. So we're trying to focus on the areas that we know are best insulated from these downturns. And Dick, do you want to spend a minute on just perspective? I don't know what you'll say, but I know you have a lot of perspective on Washington because I think worth hearing what you have to say on the budget.

Unknown Executive

I think, first off, I believe everybody in Washington, D.C. across the river believe that the BCA was so wrought between those who want a tax out of it, those who were looking at the welfare programs and those that came in and said that we got to cut defense. So with that as a backdrop. Remember a couple of things, and that's why I tried to and I did probably not a good job to talk to you about '12 and '13 being the same as '11, and what they're going to do with that debt ceiling -- its going to come up. That's going to force Congress to come back, and they will not -- let's just say that they come up with $800 billion, that's $0.4 trillion off of $1.2 trillion. Okay, if that scenario happens and they take some of it with unobligated funds out of Defense, they talk -- they do something with tax reform. They hit the nondiscretionary and Medicaid to come up with $800 billion. By the Budget Control Act, that's $400 billion that they were short, and the 60% -- the 50% of that is a $200 billion to Defense, and that's why I showed you the medium line. And so I think what you'll see is a kick the can down the road because an FY '12 election year. They'll come up with somewhere short of the $1.2 trillion, and the DoD's cut of that is only 50% of the difference. But you are going to see something on revenue side. You'll see something on Medicare and a lot of the Defense cuts is going to be, I don't want to say it's different, but it will be from unobligated programs already. And that they'll have a some of the low-hanging programs, and you've seen them in the trades. I don't want to mention them because our primes are also our customers. But some of those will get pushed to the right, some will get canceled, and then the net will be 50% of whatever they failed to come up within in FY '12. And the rest of it will get resolved in '13 after the elections. But they have to do something because of the debt ceiling coming up in May.

Unknown Analyst

Can I have a follow-up? The President's trip recently to Asia, there was this whole emphasis on this pivot to that part of the world, right? We're going to focus more in Asia-Pacific at the expense of some of the other things we've been doing. Does that change of the way you think about your business and some of the areas you should be in? You tend to be more army-focused our ground-forces-focused or just events are going to make that strategy current no matter what?

Michael T. Strianese

Right. The portfolio is fairly down among the 3 services. Probably more heavily weighted the 2 Air Force and a little bit less in Navy since that's a course projection issue, you think of long-range strike ISR course projection. Some of those things we don't do. It's not in the platform business. We do pieces of them. So yes, of course, we think about it, and we have a good relationship in Korea. I visited there, at least, 3x or 4x over the last 5 years directly with the MoD. And right now, I think that we are where we need to be in the region. I wouldn't -- I kept [ph] expanding anything in the environment. But we keep our eye on it every day. I think it will be more of a -- some rapid change that's going to happen or it was some type of issue than some gradual buildup here or there. That's just what we're seeing now.

Unknown Analyst

Mike, during the year, we saw -- if looked at the 50-odd defense companies that report segments, about half of the segments go down and about half of the segments show growth, which was consistent with what you and others have been saying about sort of a packets of growth to be found, and then other places were buckets of pressure with drawdown and so on. So I was struck by the guidance that we have that has sort of 0, as of the best that you could -- that you're expecting in the C3ISR area, which has been one of those pockets of growth that pretty much everybody has thought was going to grow, and I'm wondering, just as not just for your segment, but whether this is suggestive that 0 is a good number going forward or whether there's just something particular, perhaps, that's in C3ISR that leads to, I mean, perhaps because the deployed troop activity or something else where C3ISR was a very big component. And it's getting some drawdown or pace of activity hit, or whether there's something unique about your set of programs or just how you see when -- how do you explain the sort of 0 for the best of the group?

Michael T. Strianese

Yes. Well, I think it's a mix issue, and Ralph you can probably drill in some for details for us. But the long-term view is that area will continue to grow. I think one of them is you're going to have a big impact in there from Liberty going from last year to this year. Again, Ralph, we'll go through the pieces first, and we can talk about the strategy.

Ralph G. D'Ambrosio

When I talk about the segment guidance, Joe, I said depending where the actual sales fall within the guidance range is for this year and next year, we could have 1% to 2% points of growth in that segment. And what's happening in our business, I said the smaller-craft Q3ISR programs are potentially flat year-over-year. We haven the International airborne ISR growing, a couple of domestic programs like Fab T and Phoenix declining, and that's what's happening there. But I think, ultimately, you're going to look at what's happening with that defense budget. Really, for the entire industry, especially when you look at the larger, more diversified integrated companies. Like you said, everybody has pockets of weakness and strength, but that's the budget trend and we're going to -- we can't escape it in total, and we're trying to do what we can to better position the company. [Audio Gap] trend going on. It's a parting one and one that's going to be here. It looks for at least a couple of years.

Unknown Analyst

So it sounds like it's sort of, well, 0 is going to be a pretty good number in a declining budget.

Ralph G. D'Ambrosio

Joe, the budget declined 6% year-over-year for a few years. There is in no way for the industry to be down -- for the industry to be flat. It's mathematically impossible.

Unknown Analyst

Going to the topic of capital deployment again. Can you guys speak to your thoughts on the dividends versus buybacks? And what would it take for you guys to maybe switch towards paying higher dividend and kind of decreasing some of the buybacks?

Michael T. Strianese

We have a process we go through every year with our Board that's going to come up with the February meeting, while we evaluate based on the company's outlook, where our competitors are in terms of yield or where we are in deciding how much to increase that dividend. We've shown a willingness to increase the dividend for 7 consecutive years, and I said earlier I expect that trend to continue. So now we're into a question of degree of increase, which I think is the real question. And I think that's a valid area that we'll be evaluating in February. I think the yield -- we're close to most of the industry, except for one outlier that's up at about 5%, Mockley Morton [ph], as you know they had a real significant boost, I guess, at the end of last year, beginning of this year. And I think we're considering moving it up to get the yield meaningfully higher. I won't much say we're going to go to 5%, but that's certainly on the table. That's something we'll evaluate as we come up to the February time frame.

Unknown Analyst

I got a follow-up to Joe's question. So Ralph, when you look at '11, you basically overestimated sales partly due to continuing resolution for the full year. Now we've looked at '12, it's unclear what's happening on that front. But it's certainly clear to me that with the uncertainty with the sequestration, you're going to see delays in awards through all of '12. So how do you try to factor that into your sales guidance for '12 and what's the risk that the '12 revenues could turn out to be high like the '11 revenues did?

Ralph G. D'Ambrosio

Sure. So first of all, George, you had a couple of dynamics in 2011 surrounding the defense budgets. You mentioned one of them, which was the continuing resolution that lasted for 7.5 months. But the other dynamic was that once the budget was actually appropriated, it was 3% less than what was requested by the administration. So that was probably more of an impact on what you saw happening to industry revenues in the CR. So going into next year, we have a CR today. We expect that we're going to have CR continue for some length of time, and we've generally have factored that in to our guidance. That said, when you have a CR and a flat budget environment or a declining budget environment, it's less important than when you have one in the growing budget environment. So CRs tend to prevent new starts. There aren't many new starts. So take that away, for example. So that's how we think about it, George.

Unknown Analyst

And if you try to factor it all how you could forecast just general delays and awards in '12 because contracting officers aren't going to give out awards that might get canceled in the subsequent sequestration? Or is there any way to try and figure that out?

Ralph G. D'Ambrosio

Well, the way we figure it out, well, what I do personally is our operational folks put together their plans and then we apply some conservatism to it. That's the best way to do that, and that's what we've done in our guidance.

Unknown Analyst

And is that conservatism greater for '12 than it was for '11?

Ralph G. D'Ambrosio

Yes. Yes.

Unknown Analyst

Mike or Ralph, when you set up 2012 guidance, throughout the morning, you showed us several different charts with scenario analyses of the DOE budget, what would you define as L-3-based case in establishing the 2012 guidance range?

Michael T. Strianese

As it relates to the budget chart?

Unknown Analyst

Right. You showed us the DoD-based case and you showed us a sort of a worst-case and best-case scenario but what would L-3's best case [ph]?

Michael T. Strianese

We were slightly below the DoD case. So it wasn't all the way down to the life sequestration line, but it was a haircut, a modest haircut throughout the DoD line, which is consistent with what the senate mark is right now and which likely -- remember, that's a 10-year look. We're in the short 2012 now period, and we're basically right on top of the numbers we're based on is exactly where we are right now for the government in terms of their budget.

Unknown Analyst

And so should we assume that, if we see FY '13 DoD budget in the range of 472, that's not encapsulated in the current guidance?

Ralph G. D'Ambrosio

It wouldn't be but that's going to impact 2013. So the outcome of sequestration, whatever it is, is supposed to be implemented January -- beginning January 3, 2013. So it’s largely a calendar 2013 event. And so far as our guidance is pertained. Now you can argue whether or not it caused some more delays like we just talked about, and it can very well do that, but we'll factor some of that. So...

Unknown Analyst

When I look at your slide where you break out Engility and NSS, you made a comment before that the services revenues were deteriorating maybe a little bit worse than expected. With the 16% decline next year at the NSS and lower margins than Engility, is it possible you rescoped the spend?

Michael T. Strianese

I'm sorry that we've...

Unknown Analyst

In other words, is NSS what you thought it would be or perhaps should some of that, perhaps, be moved into the Engility?

Michael T. Strianese

No. We have no plans to change the strategy about what's staying and what's going. There's a much -- a bunch of different strategies in terms of how these businesses are going to operate. The growth prospects in the NSS area are certainly much brighter. It is a growth area. However, those programs are competitive and have been slow to develop, but there's clearly more funding in that cyber area, and the cyber area is becoming more pervasive throughout everything that's done in the DoD, the cyber element that is virtually everything. So those capabilities will be relevant, I think, in the future years. We could always a take another view in a couple of years, if it turns out that it did not pan out the way we had hoped. But where we are now, I think we're pretty much locked down on what's going and what's staying as part of Engility and NSS, because these are different businesses and that's -- you wouldn't -- you couldn't really mix them anyway. If they were going, they wouldn't be going that way. So...

Unknown Analyst

Okay. So that being the case, any census to when that growth decline stabilizes in that business in NSS?

Michael T. Strianese

Well, we have Mr. Kantor right here, let him answer an unpleasant question. We did it last night.

Steven Kantor

We were really focused on the solution-ing that I talked about and the discriminators in '12 is what we're looking as a year to bring that all forward. '13 is where we expect to see to start the growth and thereafter.

Unknown Analyst

A Question on guidance for 2012 related to margins. Can you give us any sense for how your margins assumption differs for fully funded versus follow-on versus the remaining 10%? How we should think about relative margin differentials?

Ralph G. D'Ambrosio

Generally, there will be lower margins new business category and the weaker peak category. So the reasons that we talked about.

Unknown Analyst

At that is scheduled to the environment, more or less?

Ralph G. D'Ambrosio

I believe it's due to the environment, particularly the OSD efficiency and the $40 billion initiatives where we see that in spades on recompetitions of the service contracts, both in Government Services and on CLS where we they're changing contract types from time in material to cost reimbursable, which by definition are lower margin, which is why they're doing it. So that's a going on and then, to the extent that we're trying to win new business, we may bid more aggressively, i.e. our lower margin to displace incumbent. So that's generally the dynamic that you would see on the operating margins across those different types of sales, and that's with the exception of the new OSD initiative pressure. That's the way it's always been.

Unknown Analyst

Can you offer any sense of magnitude and the difference between new business versus existing?

Ralph G. D'Ambrosio

Well, I said it's a different. It's lower. That's kind of all I want to say right now.

Michael T. Strianese

But not by large orders of magnitudes. I mean, they slipped with 0.001 point [ph] here and there...

Ralph G. D'Ambrosio

We're not bidding loss contracts there. Also, to get back at you, to give you that information so...

Michael T. Strianese

Okay. So just a couple of cleanup points. One, a question about the Engility dividend, by the way. I want to just point out that even though the dividend may be lower than we originally forecasted by somewhat, the offset to that is that because of the decline, there will be a reduction in working capital, as we go through the first half of the year. So the money that we pull out in terms of operation should offset, to some degree, what we're not getting in terms of the dividend. And then just in terms of the overall guidance, again, yes, I mean, we're flat in a couple of areas and ISR's somewhat surprising. However, it's what we see now. I don't think it's our view long term. We think it's still a very healthy business base long term, but as assets are being pulled out of Iraq. Some of them will be moved into Afghanistan, which is slowing the need for new equipment, Joe. So that's part of the answer is they have so many assets over there now that it's filling holes where, in the past, there will be new equipment being ordered. So I don't think it's the end state. I think that's a capability that we lead in, and that is going to be necessary and one can to take a view that as the troop drawdowns occur, there will be a need for more ISR to give your eye on things, and including places that you don't hear about all the time on TV and that's kind of underway. So with that, the concluding thought is that we are well-positioned. We are able to maintain our -- at least, maintain our EPS in this environment where the top line and budget is down 5.5%, and still manage to generate a lot of cash and hopefully do better on our EPS growth, which is, in this environment, I think is doing well. So with that, thanks for coming and we have lunch back there. I hope you join us, and we'll keep you updated. I guess we'll have our year-end discussion at the end of January. Thanks.

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