Exelis Earnings Call Nuggets: Services Margin and Outstanding Proposals

Exelis (NYSE:XLS) recently reported its first quarter earnings and discussed the following topics in its earnings conference call.

Services Margin

Robert Stallard – RBC Capital Markets: I was wondering if we can kick off with the services margin in the quarter, which you noted was down to good productivity. I was wondering your thoughts on how sustainable you think this margin could be going forward given the funding environment and also the competitive environment?

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Peter J. Milligan – SVP and CFO: Yeah, sure. You’re right in that the first quarter was stronger than the last couple of quarters as a result of some program improvements, contract performance improvements. But I think as we go throughout the year and we probably, I would assume that we should stay in that mid-to-high single digits for that business. As you know even though with services we do have probably about 30% of that statement maybe a little bit less 25% or so. It’s fixed price work and obviously that’s the place where we’ve historically done well as we’ve taken some risks out of programs. So clearly the price pressure is there it’s the short cycle nature of the business is also pressure is obviously the topline, but I do expect the margins to trend down a little bit, but I would hope for the year they are still in that again mid to upper single-digits range.

Robert Stallard – RBC Capital Markets: And then secondly on the pension front it doesn’t look like you’ve changed your FAS assumptions for the year. I was wondering if there have been any changes on the CAS side or in any of the metrics we might look at.

Peter J. Milligan – SVP and CFO: No, I mean normally those things would only be changed if there was some sort of remeasurement requirement which of course there has been none at this point. So no our expected return is the same. We moved it down from 9% to 8.5 as you know, and everything else is in line with our original assumptions…

Robert Stallard – RBC Capital Markets: Then Dave just one for you on the restructuring side of things. Things have moved on extremely from where we were three months ago. Do you think the restructuring amount that you are expecting to spend is sufficient or could you see it increasing from here?

David F. Melcher – CEO and President: It’s one of those things where as you dig in and you really take a critical look at all your systems and layers of management, expenses and control you find that there are other opportunities that crop up. We’re actually trying to take on a number of things that I think are going to be important to us as shared services organization, more global sourcing of some of the things that are important to us, and I think we’re going to be able to take out, not only the back-office that we talked about, but perhaps a little bit more. So we’re going to look for targets of opportunity, that might require a little bit extra restructuring and into 2014, but I think that that is appropriate given the environment we’re in.

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Peter J. Milligan – SVP and CFO: And I think also Rob, if I can add – this is Peter. As we look now, obviously, if the volume changes are going to be very different than what we’re expecting, then obviously the costs have to come out and restructuring charges are part of that. But without giving our specific view of the next couple of years, I do expect that the $70 million if we’re at that range this year and that’s where we expect to be, it’s probably the highpoint as I look out the next couple of years. So, there will be restructuring next year. As Dave mentioned, we’re continuing to take out footprint. That alone obviously requires some lease termination costs and whatnot in many cases. So there will be restructuring cost next year, I don’t know specifically what they’ll be, but I do expect them to be lower than this year. So, as you move into 2014, there are a couple of things that are really creating some tailwinds for us, because as you know, we don’t normalize our numbers at all, everything is on a GAAP basis. So we’ll have a couple of positive things moving into next year. One, I would certainly expect to be lower restructuring, and then the other, of course, would be lower pension expense as we said 2013 on a FAS basis is the highpoint.

Outstanding Proposals

Greg Konrad – Jefferies: I was hoping if you could talk a little bit about the dollar value of outstanding proposals and kind of the areas of focus where you are seeing the most strength in terms of upcoming order opportunities?

David F. Melcher – CEO and President: Yeah, Greg, great question. I think we talked about this a little bit on the last call and I’ll repeat it. We’ve got over $6 billion worth of proposals that are in evaluation now across the Company, and all the range of things that we do. Some of the things that are probably more notable that are on the horizon are some contracts for different agencies, for example, Deep Space Network is one that we’ve been the incumbent on, it’s a joint propulsion lab contract for NASA. That one is coming up for a recompete announcement sometime in the May timeframe. We also are the incumbent on a contract called TAC-SWACAA that has changed its name to OMDAC-SWACA, but essentially it’s the theater communications contract directly. That also is coming up for a recompete in the May timeframe. We’re partnered, as I said, with Northrop Grumman on the next-generation jammer, and we could have a decision, I think sometime this summer on how that might go. We’re also participating in some other FAA programs, and we have a number of international capture opportunities that are out there from satellite payloads to radars to other things, night vision, airborne countermeasures that have the opportunity to come in later this year. Then I guess the last big one on the server side is, we have the space ground range contract for the Air Force that supports NASA, and that is morphing into a larger contract called LISC, which has Launched Integrated Support Contract. That one could come forward here at the end of this year or perhaps in ’14. It’s been delayed a few times, but we’re – we got a good team for that one as well. So, there are a number of big opportunities for us here in 2013.

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Greg Konrad – Jefferies: And just a quick follow-up. I think in the past you said the big three was about $300 million last year and you expected that maybe in the $200 million range this year, and when I look at the numbers for this year, there was over $100 million of declines for those three products in the quarter. Does that kind of allude to the fact that it may be flat and for the remaining three quarters are there any other pressures on that part of the business…

Peter J. Milligan – SVP and CFO: You are right $300 million was the number last year, we would assume that I think we said at the end of the year when we gave our guidance that we expected that number to be sort of at or below $200 million and obviously that depends on lot of different things. At this point it’s going to be below $200 million I mean I think that’s pretty clear to us. But the declines in Q1 obviously just mathematically can’t repeat. So that is a big driver to the Q1 numbers, whether sustainment rate ends up at $150 million or a little bit less, we’ll see. But certainly we factored some, when you look at the guidance range like we have, that factors in some of that variability, but that’s sort of the update. I think that I need to give you on that one.

David F. Melcher – CEO and President: I would just add that we’ve classically defined longer-term to big three as the SINCGARS orders, the domestic night vision orders and jammer orders. You can’t forget that beyond that strict definition we’re in the enhanced night vision goggle program and we are I think the only company that is fully certified and producing that capability for the government and it’s going to be an important one going forward, that’s not counted in those kind of numbers.

Peter J. Milligan – SVP and CFO: In fact we received an award on that SENVG contract that Dave was mentioning that came in very, very early in the second quarter, but was almost $50 million. So to Dave’s point clearly that those declines that we talked about in that legacy type equipment does not mean that those businesses don’t have very strong opportunities going forward and also again as Dave said internationally we have a number of things in the pipeline that we’re optimistic about.