Q3 2019 Earnings Call

Greetings and welcome to the L. Three Harris technologies third quarter calendar year 2019 earnings call.

At this time all participants are in listen only mode. A brief question answer session will follow the formal presentation. If anyone should require operator systems. During the conference. Please press star zero on your telephone keypad.

This conference is being recorded and it's now my pleasure to introduce your host entourage <unk> Vice President Investor Relations. Thank you you may begin.

Thank you Michelle good morning, everyone and welcome to our third quarter calendar year 2019 earnings call.

Well the Cold me today as Bill Brown CEO , Chris Your basic CEO Jay lobby CFO .

Just a few words on forward looking statements discussions today will include forward looking statements and non-GAAP financial measures.

Forward looking statements involve assumptions risks and uncertainties that could cause actual results could differ materially from the statements.

For more information please see the press release, the presentation and <unk> SEC filings a reconciliation of non-GAAP financial measures to comparable GAAP measures is included in the quarterly materials on the Investor Relations section of our website, where a replay of this call. It also would be available.

To aid with year over year compatibility following the Oaktree Harris merger discussions also will be on a combined basis with prior results as well as year to date in first half 2019 results, reflecting combined <unk> and Harris historical operating results as of the businesses I'd been operating together during prior period under the.

For segment structure.

With that Bill I'll turn it over to you.

Okay. Thank you on Earth and good morning, everyone.

Earlier today, we reported strong third quarter results with non-GAAP earnings per share of $2 at 58 cents up 26% on 10% revenue growth.

Overall company margin increased 210 basis points, a 17.4% and free cash flow more than doubled over Q3 of last year.

These results extend our strong COVID-19 performance with non-GAAP earnings per share with the first three quarters up 27% on 10% revenue growth and free cash froch flow up 73% to $1.6 billion.

Funded book to Bill was 1.13 for the quarter and 1.10 year to date.

Writing funded backlog growth of 10% versus last year, setting us up for a strong finish to the year.

So we're off to a great start as a new combined company, we're executing well against our strategic priorities.

I'll begin with an update on our progress on slide four and then Christian Jay will provide details on segment results in guidance.

First we remain laser focused on integration and capturing cost synergies and we're tracking well toward achieving $80 million gross in your savings and $20 million in gross run rate savings as we exit COVID-19, both higher than previous expectations, and giving us confidence in exceeding our 500.

And our target in calendar 22.

In addition to cost synergy projects. We're also making good progress on our second priority of developing and institutionalizing, a new enterprise wide operational excellence program called E. Three.

Building this muscle will be essential to driving near term organic margin expansion and set us up to sustain the benefits of productivity well beyond the three year integration period, including approach program execution, R&D efficiency and working capital management.

Third we're building what we're calling a new performance culture as we pivot towards an operating company model leveraging the power of the enterprise to shared services shared resources and shared best practices.

At the end of September we held our first technology summit convening more than 200 top engineering leaders to cross pollinate ideas rollout our company wide stage gate development process and detail our plan to manage R&D investments on a portfolio basis.

We've also begun to institute enterprise wide business metrics and a review cadence aim that still in greater rigor and accountability and our decision making.

Fourth we are investing smartly and aggressively in technology to grow revenue, an increase share add content and expanded to adjacent sees.

And while it's still early I'm encouraged by our progress and recent success in capturing potential revenue synergies.

In just 120 days since the merger we've already submitted 14 revenue synergy type proposals, primarily in electronic warfare and space sensing domains with a potential lifetime value of about $3 billion.

One proposal is for the U.S. Air Force F 16, electronic warfare modernization program supporting a fleet wide 15 year upgrade cycle.

Our offering combined proven E.W. capabilities from legacy Harris with an innovative digital signal receiver from L. Three to provide the customer a high performing low risk solution that we could not have created separately.

In September we were one of two companies down selected for the initial development phase and if we ultimately prevail, we would double our addressable market and add the domestic F 16 fleet to our established international position.

From another bid we were awarded in early study project for space sensing technologies that combine space optics and electronic solutions from the legacy companies with the potential to grow to over $250 million in value.

So if you are encouraging early wins and a growing pipeline of opportunities validating the strategic growth potential other newly merged company.

Our first priority is to maximize free cash flow with shareholder friendly capital deployment.

In the quarter, we generated $618 million in free cash flow up 123% over prior year through higher earnings tight management of capital spending and a two day sequential improvement in working capital.

We've also improved the linearity of cash generation with about 70% of free cash flow guidance delivered in the first three quarters of the year compared to less than 50% for the same period last year.

And in the third quarter, we returned $922 million to shareholders, including $750 million and share repurchases, which keeps us on track to buyback $1.5 billion. The shares in the second half a COVID-19.

And finally.

Reshaping our portfolio to focus on high margin high growth technology differentiated businesses, where we can win and generate attractive returns.

While this is an ongoing process, we've begun marketing several businesses that we've assessed as noncore and our plan is to announce transactions as they occur and use the net proceeds to repurchase shares to offset dilution.

So in summary on the back the successful execution against our strategic priorities strong third quarter performance in a solid backlog, we're increasing our second have guidance for non-GAAP earnings per share to $5 at 35 cents with revenue growth of 10% and free cash flow of approximately $1.35 billion.

The higher end of the previous guidance range.

As we go into 2020, but assuming appropriations or enact it in line with the recent budget agreement. We continue to expect mid single digit plus revenue growth and expanding margins off a higher 2019 base than we anticipated in S for driving double digit cash and earnings per share growth.

So with that let me turn it over to Chris to provide an update on operational and segment financial performance or do you Chris Okay. Thank you Bill and good morning, everyone.

We are performing very well right out of the gate due in large part a month so pre merger work accomplished by the joint integration team.

Expanding on Bill's comments in addition to eat three and other enterprise wide initiatives. We're also driving a common business development capture process, we're incorporating best practices from across the company and we're focusing on a bottoms up effort to improve working capital performance.

All of these enterprise wide initiatives are gaining momentum and expected to contribute to our future growth profitability and cash generation.

Let me now turn to operating results by segment.

On slide five integrated mission systems revenue grew by 10% for the quarter and 11% calendar year to date from strengthen is our mission is nation and increased global demand for WESCAM turret systems orders were strong as we continue to solidify our position on big Safari programs.

Increase share and electro optical and enhance our unmanned maritime franchise.

This resulted in a book to Bill <unk> 0.99 for the quarter and 1.11 year to date.

Segment operating income was up 24% and margin expanded 160 basis points to 13.8% for the quarter, resulting in a year to date margin of 12.7%.

This solid performance was driven by increased volume integration savings pension income and operational excellence slightly offset by program mix.

In space and airborne systems on slide six revenue increased 20% for the quarter and was up 18% calendar year to date from increased content wins and production ramp on long term platforms, including F 35, F 18 and that the 16.

In addition to sustained growth in classified space as we expand into a full mission solution provider.

Order momentum was broad based resulting in a book to bill of 1.05 for the quarter and 1.1 year to date.

Segment operating income was up 38% and margins expanded 250 basis points to 19.4% for the quarter, resulting in a year to date margin of 18.6%.

This robust performance was driven by higher volume operational efficiencies and integration savings, partially offset by higher investments and open systems architecture and advanced space technology.

Moving to slide seven and communication systems revenue growth was up 11% for the quarter and the year driven by solid growth in tactical communications and public safety.

Tactical grew 19% with DLD up 33% on increased modernization revenue and international was up 9% from ongoing border security supporting Eastern Europe and early adoption of the multichannel radios in Western Europe .

Revenue was once again up double digits and PSPC as the business continued to gain share with utilities and state local and federal agencies.

Order momentum was even stronger with segment book to Bill of 1.36 for the quarter 1.09 year to date as each sector is successfully executing on its strategy.

Tactical is ramping up modernization and de Odeon International broadband is maintaining incumbency on legacy platforms public safety is increasing share and utilities and integrated vision systems received NBG be test certification and made initial deliveries in August results.

And then a significant follow on for.

Additionally, last week, we achieved an important milestone on the SOCOM handheld program with the award of a full rate production order for $86 million. Following a successful field test in early August .

Not only is this a significant step into 390 million dollar sole source program, but the core architecture of the SOCOM handheld radio is also shared by the $250 million SOCOM Manpack program.

The SOCOM handheld radio is also the foundational radio for the Army two channel and several international modernization programs.

The investment in common architecture facilitates our customers desire for interoperability and future capability.

Segment operating income was up 18% and margin expanded 140 basis points to 22.7% for the quarter, resulting in a year to date margin of 21.9%. This strong performance derived from higher volume and operational excellence more than offset that mix impact from the ramp in tact.

The whole radio modernization program.

Lastly on slide eight in aviation systems, we grew in defense, while declining and commercial aviation for a net flat quarter and nine months.

Decline in commercial aviation as the result of lower volume and commercial training solutions as orders for full flight simulators continue to slip to the right.

We received three simulator awards in the first half and we're expecting 12 in the second half.

And although our pipeline remains strong due to uncertain timing of bookings we have now lowered our award expectation to lower single digits for the second half, which is reflected in our revised segment guidance.

Aside from simulators order strength was good resulting in a segment book to Bill of 1.16 for the quarter and 1.05 year to date segment operating income was up 32% and margin expanded 330 basis points to 13.4% for the quarter, resulting in the year to date margin of 11.5.

5%.

This performance was driven by integration savings and improved operational performance, primarily in our traveling wave tube business, partially offset by mix.

I'm very pleased with our first quarter as L. Three Harris with three of the four segments outperforming and more than making up for the shortfall in A.S., our customers remain supportive of the merger both domestically and internationally and as we build a mission focused.

Mission solution focused company and I'm increasingly encouraged by our company outlook with that I'll turn it over to Jay.

Thank you, Chris and good morning, everyone.

Recapping third quarter results on slide nine successful execution against our strategic priorities drove strong results for the quarter with revenue growing 10% in NPS, increasing 26% or 54 cents.

This growth 49 cents came from higher volume.

Flood program execution, and integration synergies and 15 cents from pension and elimination of L. Three intangibles offset by a net 10 cents headwind from taxes share count and interest.

On the back of this performance we are revising our outlook for the second half as noted on slide 10.

Starting with the topline we're tightening second half revenue to be up approximately 10% at the midpoint of the previous range of nine and a half tenant a half percent from strength and say, yes, and see us offsetting lower volume yes.

Second half total company EBIT margin is expected to be 17.1% 40 basis points improvement from the previous guidance of 16.7%.

Driven by higher cost synergies and pension income.

This combined with lower interest and tax expense results in the second half EPS expectation to approximately $5.35 up 35 cents from the prior midpoint of guidance to $4, a 95 cents to $5.05.

This EPS guidance also reflects one and a half billion dollars and share repurchase for the server purchases for the second half, bringing the second half share count to around 224 million shares and effective tax rate to 17% versus our prior expectation of 18%.

In the second half, we expect to generate free cash flow of approximately $1.35 billion at the high end of our port prior range of 1.32 $1.35 billion driven by increased earnings in a two to three day working capital reduction from June .

Capital expenditures are unchanged and expected to be $190 million or 2% of revenue.

As noted on slide 11 for the full year revenue is expected to be up around 10% with EBIT margin of approximately 16.4%.

EPS of about $10 per share.

Full year free cash flow is expected to be approximately $2.35 billion or about $420 million higher than last year for the combined company.

Turning to the EPS bridge on slide 12 expected full year EPS of approximately $10 per share reflects a total increase of $2, an eight cents with $1.74 from volume operational improvements and cost synergies as well as 29 cents from the elimination of L. Three intangibles and higher pension income.

And five cents of net five cents net of interest and taxes.

Switching to the segment outlook.

Yes revenue guidance is unchanged at approximately 10.5% for the second half.

Driven by strength in airborne imaging systems and growth in Iowa, SAR aircraft mission as a nation.

Segment operating margin is now expected to be approximately 13.3% versus previous guidance of 12.5%.

And by higher cost synergies and pension income.

This implies full year segment revenue up approximately 11.2% with operating margin of approximately 12.7%.

I'd say, yes revenue is now expected to be up approximately 15.5% in the second half versus up 11.5% previously.

And by strong stronger growth on long term aircraft platforms and classified space.

Segment operating margin is expect to be approximately 18.8%.

Implies full year segment revenue growth of approximately 16% with operating margin of approximately 18.5%.

So yes revenue is now expected to be approximately 10% in second half versus previous guidance of 9.5%, resulting from better than expected modernization orders and deal de tactical.

Operating margin is now expected to be approximately 22.5% versus previous guidance of 22.1% driven by higher volume cost synergies and operational excellence. This implies for your segment revenue growth of approximately 10.8% would operating margin of approximately 22.1%.

Finally, with yes, we are lowering revenue guidance for the business, which second half revenue now expected to be up approximately 3% versus previous guidance up 7% driven by slower simulator sales.

At this guidance, we believed that we have sufficiently de risked the uncertainty related to simulator sales segment operating margin is unchanged that 14%.

This implies full year segment revenue growth of approximately 2% with operating margin of about 12.3%.

So in summary, and improved outlook, reflecting a strong start for the combined company with that I'll ask the operator to open the lineup for questions.

Thank you we will now be conducting a question and answer session and the interest of time. We ask you. Please limit yourself to one question and one follow up if he would like to ask a question. Please press star one on your telephone keypad a confirmation Tony will indicate your line is another question Q.

First start to if you'd like to move your question from the Q for participants using speaker equipment, maybe necessary to pick up your hands at the for profit aim is dark is one moment. Please we pull for questions.

Our first question comes from the line as Sheila Kahyaoglu with Jefferies. Please proceed with your question.

Morning.

Chris Jay Thank you for the time.

Phil in your prepared.

And your prepared remarks, you mentioned 14 revenue synergy proposals that total about 3 billion and lifetime value.

As you guys have combined that your portfolio is how do you think about the potential wins, how do they changed the growth profile of the business over maybe this coming year or two and where are you seeing the most opportunity. Thank you.

Thanks, That's a great question. So we have 14 proposals that are in its very early days, but we're pretty encouraged especially given the fact that we've been down selected on two of them. So this is I think good news. So we talked about $3 billion in value that's lifetime value. So read that over the next 10 years I.

I think the way these things will work there is a bit of an incubation period, the studies or the small award you to receive upfront that eventually lead into bigger opportunities over time. So I think in 20, probably minimal impact and getting the 21, maybe a little bit more and I think it should ramp up that beyond that so I went out I went through the 14, but there is about 80 total ideas that were trade.

Tracking year, so hopefully we will we see some some of the good news coming over the next over the next number of months they broadly really come into mostly right now electronic warfare and stay sensing domains, mostly relative to leveraging complimentary technologies.

But but what's an encouraging start and we hope to see more over time.

Thank you.

Thank you. Our next question comes from the line of Carter Copeland with Melius Research. Please proceed with your question.

Okay.

Good morning, gentlemen.

Morning.

Hi, just a couple of quick ones one I wondered if you could just give us some color on the slippage in the simulator sales. It just seems strange given all the we'll talk about pilot training out there and I wondered whether that's in a particular customer behavior for one reason or another on a commercial realm I just wonder if you talk a little bit about that.

As a secondary one I'm just kind of curious on that the efforts on E. Three.

How does that differ from what youre, each individually trying to accomplish with with H JAKKS or L 365, and what's unique to the to the opportunity set that you think you have together thanks.

So maybe Chris will take on the piece on the simulators, let me hit quickly on the E. Three of the Opex program. So both are both L. Three at Harris had operational excellence programs, we called ours H.B. acts. There's was L 365, and Eathree really is a combination of the best across both programs and the objective really as I mentioned in my remarks is to do.

All of that operational excellence of muscle to go after labor reductions go after supply chain savings watch improving quality performance on time delivery program execution all of those things, we do to keep winning overtime. So we know that there's going to be inorganic margin expansion opportunity separate from cost synergies. It go.

Side by side with what we're doing on integration, but really over the next couple of three years they'll start to merge together and what we want to make sure as we build that muscle. So that once we get beyond integration, we continue to see that regular cost takeout, improving quality well beyond the integration period, and that's really what we're trying to do I think we're off to a great start weve.

Core people work in this we have a new hire driving this across the company doing a great job and I think we're off to a really good start so let Chris comment on that on the simulators.

Yes, good morning, Carter as I said in my prepared remarks, we had three in the first half of the year, we only had one in the or the third quarter and while we have a lot of letters of intent find and such we get to secure those in the fourth quarter and I think what we're really seeing is that the airlines and.

Training companies.

Our slowing down their discretionary spend.

Probably as a result of the.

Depending on issues with the Max aircraft as you know Thats, what our financial pressures on the airlines themselves and there's still some uncertainty surrounding that so we.

Weve actually speaking of Eathree, we've had a lot of progress on the simulators, we've been able to reduce the cost in the cycle time, a building them. We're just now need to go ahead and sell them. So still a good business still optimistic just a little lumpy here in dealing with market trend somewhat outside our control in discards another comment there that the pipeline is pretty soon.

Well. It is just to that took orders are lumpy and at the timing is difficult to predict and so we thought as prudent with one quarter left to just push it to the writing ticket out of the year, we'll revisit that for 2020, but the pipeline is pretty solid.

Great. Thanks for the color and good numbers guys.

Thank you.

Thank you. Our next question comes from the line of Noah Poponak with Goldman Sachs. Please proceed with your question.

Hey, good morning, everyone.

No.

I was hoping to just get your updated thoughts on.

Where you think you can take the total operating margin of the business long term.

Because you're going to exit the year at this kind of 17 or a little better than 17.

And then the incremental cost synergies you still have yet to achieve alone.

At least 100 basis points, if not more higher than that and then bill you just spoke to continuing the drumbeat.

Of operational improvement beyond the synergies and I know each legacy business had a couple.

Sort of temporarily depressed pieces that looked like there were going to improve so I mean is this a 20% sustainable starting four to five years out, but then sustainable operating margin business.

No look we're very optimistic about what we've seen so far in the back half of the areas. We raised our guidance on margins here in the second half is better than we thought some of this coming from some pension good news, but the reality is they get team is coming together very well.

Chris what I've been working for a number of months here on integration. This goes back to from the time, we signed and we knew we can get out of the gates quickly, we're getting out of the gates little bit faster than we thought so some of the ideas. It did pull forward a little bit exiting the year at $200 million run rate lease puts us in.

Something north of $20 million gross savings next year. So we will see margin expansion next year I think it will continue to grow we saw more gas and the tanks certainly from integration savings.

Could it be the numbers youre, suggesting that's a little bit for out there our job is to keep driving its everyday and every year, we'll see margin expansion next year, we'll see it again going into into 21, and probably 22 to simply because of the tailwind behind us on on integration savings lot of it comes from growth in the mix of new.

Customers and development programs, so what the keep a close track well that what the key watching our investment in in business for in BNP activity as well as an eye Ratchet to fund some of the revenue growth ideas. So so no I think we'll keep updating you overtime, but we are more encouraged today about margin expansion.

I think we started out.

That's great.

But if I could just follow up really quickly on the on the aviation systems situation I just wanted to I think some people have the segment growth rates model somewhat.

What level next year and so.

Any help you can provide on on how the comparisons will shake out with a simulation and training piece and then also you have the FY 17 piece coming out just.

You know in an effort to kind of get ahead of a level setting everyone for the for the right order of magnitude changed in that business next year would be helpful.

So so yeah Cseventeen drive will go away, but overall, we my comments I talked about mid single digit plus so just based on where we are adding the yes for L. Three was at 5% were at six in assets in that range and it's coming off of a much higher base in 2019, so not a half a billion dollars above the S. Four so.

We're still expecting good growth going into next year I think we'll see communication system to be pretty good is more short cycle will CMS and space business sort of in the middle both doing pretty well and we'll see aviation systems, probably being a little bit less than the other three part of this some of the trend that Chris talked about will continue into next year I don't think.

I'll go into any more detail within this segment, but the reality those are the major drivers are at a pretty macro level across the four segments.

Okay. That's really helpful. Thank you yes.

Thank you. Our next question comes from the line of David Strauss with Barclays. Please proceed with your question.

Thanks, Good morning, everyone.

One at a two part question first on the on the margins there implied in the fourth quarter lower than lower than what you did in Q3, despite having more in the way synergies coming through can you just explain what what exactly is going on there and then on the on the working capital side Jay.

Looks like you were relatively flat overall in terms on working capital in the quarter can you just.

Maybe update us how you're thinking about this target I think longer term target you have out there to reduce working capital days from 75 down to 50 to 60 days.

Thanks.

So I mean at the first one and I'll pass it on to Jay. So, yes, we did see really good performance in Q3.

Steps down sequentially in Q4 still up year over year, and it's really coming from higher higher cost synergies going from Q3 to Q4 offset by some additional investment quite as quite a big chunk of investment coming in Q4, both in R&D as well as it BNP, so theres a little bit of sloppiness here in our Q3, but we see good opportunities too.

Invest investing in some of the ideas that are coming out as we're really busy on BNP activity and really it's just a measure of additional step up in investment in Q4 from Q3, So Ajay hit the word another quick one I'm on margins David It. We did 210 basis points in Q3 were almost 200 basis points in Q4, some expansion is fairly similar.

Just starting off a little bit of a lower base in Q4 as far as working capital.

We've got a couple of days that we achieved in the third quarter. We're as I mentioned were being flat to maybe a day in the fourth quarter over the longer term, we're still kind of holding onto the 678 days of reduction to get us $2 billion to $3 billion. In 2022, So really nothing has changed from our prior communication. There obviously the internal objective is to.

To better than that natural we continue to do and drive our working capital.

Initiatives across our businesses in our sectors, but right now we're just holding it to where we were before.

I'll just comment I'd say, the working capital improvement really begins and ends with the operations and we have 1200 program managers and we are pushing down specific goals and education at the program management level. In addition to the general managers and through the finance organization. So it's part of a top down.

Bottom up effort to focus on an improved working capital.

And Bill just a quick follow up the investments that you're talking about look it would look like from them from the margin guidance. These are mostly in IMAX and so yes is that the right way to think about.

Yes that will be that's primarily in two places, yes, correct little bit to see us, but mostly of the other too right.

Thank you.

Matt.

Thank you. Our next question comes from the line of Richard Safran with Buckingham Research Group. Please proceed with your question.

Bill, Chris Jay and a rock good morning, how are you.

Good morning.

Oh.

Another philosophical district or strategic question to open up here could you elaborate on era building, a new performance culture and grow revenue remarks on slide four no you're constantly using the word innovation and it's clear theres been a substantial benefit from innovation, but you know what works against that is size and I. Thank you.

We're all aware the rule of thumb that a bigger company gets less nimble on the less they are able to what to innovate.

So you're saying you're going to invest in innovation, but I thought you Mike discuss a bit more on how you're going to incentivize in foster innovation at a much bigger or L. Three Harris.

So Richard Thats, a good question and I won't be a long winded on it but this is fundamentally what Chris and I and the rest of the senior team are focusing quite a bit of time on its is building the culture that we want to see in the organization.

Going back eight years ago Harris went from a holding company to an operating company. This is the path that Chris has been on that is a clear statement of intent within the organization is moving towards an operating company you will that means more centralized coordination of the things I talked about my remarks, I shared services resources technology.

Talent across the organization to leverage the power of the enterprise and there's lots of things that still off of that that's driving a lot of change with the organization, that's fundamentally where we're heading and I think that speaks to the culture. We're trying to create that also flows into R&D at how we're thinking about R&D development.

Again back to where Harris was a number of years ago. We are developing R&D plans by each segment very side load Thats. What L. Three is been doing we're moving towards more of an integrated model, where we're sharing ideas across the company.

We had our technologies together at the end of September starting to share different ideas. So how we remain innovative in agile look at it comes through multiple dimensions part of it is structural in how we set up the organization with tools for us to be able to share ideas across the enterprise on things like cyber or AI away.

Formed capabilities that really embed across all that we do you part of it is in process season going to a common stage gate process for developing programs, making sure. There is good business cases, managing things on a portfolio. So you trading off investments across the organization and then a lot of it is going to come from just beat but just culturally.

Part of that is Jay Chris and I being willing to step forward and invest ahead of the curve on innovation ahead of need we've been demonstrating a willingness to do that and then of course, you mentioned and part of it is the type of people were selecting how we incentivize them look Richard it's a long winded answer and I would only longer than I wanted to but the reality. This is fundamental to our create.

Adding a different organizational recalling L. Three harris to remain agile fast moving especially in the world. When today with do you de where it's not just innovation, we're affordable innovation, it's affordable innovation now it's moving quickly in delivering solutions and that's why I think we'll geared toward.

Okay that was terrific just quickly here are a space and airborne on the F. 16 modernization program you went down selected for because this is a potential revenue revenue synergy and because it sounds like a pretty large opportunity here. Just wondering if you could size that and give us a sense of timing.

Yes look it's going to take several years couple of years. So the final selection occurs I mean, the fact is we got in a little bit late but we were one of two down selected for the program in which as you know we Harris legacy Harris has the.

The W. platform for International F. Sixteens, we are not on the domestic F. 16 that opened up that market. We think over time that could be cumulatively, something like a $1 billion, but depends on how many aircraft and the cost per shipset, but it's a pretty substantial opportunity we're working at a pretty aggressively and we're encouraged by.

Within just a few months being down selected to be one of the two thanks very much.

Thank you. Our next question comes from the line of Gautam Khanna with Cowen and company. Please proceed with your question.

Yes. Thank you guys appreciate it.

Couple of questions first I was wondering can you give us any sense of the size of the divestments that you guys have identified.

No I don't think we're going to be prepared to do that today Gotham what what im very encouraged about is the fact that when a relatively short period of time I think we've aligned across the management team and with the board on how we're thinking about the portfolio.

We're moving quickly on a number of different businesses, we'll announce the transactions as we go forward and as we do then I'll size them for for investors, but I think you will be premature to give you any sort of a target at this point.

Okay. Secondly, just wondering you guys are running ahead of the cost targets.

When will you formally address those again.

Yeah, we'll talk about that every earnings release got them I think you will probably give you a as we get into 20, an update on what the 20 numbers are given where we're tracking again exiting this year at a $20 million gross run rate makes 20 look pretty good and probably at that time, we'll give you a sense as to.

The magnitude of the opportunities, we're seeing longer term and a and if we were coming up above 500 million dog gross and if so how much so we'll probably shape that little bit more early next year.

Okay and I was hoping you could also just walk through the.

Legacy RF tactical pipeline, and what you're saying their domestic international.

So what's your expectations for bookings are over the next 12 months.

Thank you.

Yes, So let me hit on that one pretty quickly so on the tactical side.

We're seeing the for the second half for the legacy are a tactical business.

Up low double digits, which is still pretty pretty good growth. It was up mid teens in the front end the year or so so as we get through COVID-19. The overall tactical business will be up sort of low to mid teens and that in that range. You deal has been very very strong. This year. We started off in the mid forties in the first half it will be sort of in the mid twentys percent.

Growth in the back half so very good trajectory was up 33% as Chris mentioned in in Q3. So so so very good numbers, but you know we're starting to get into some more tougher compares here as we get into the fourth quarter, which is why the year over year is not quite as good as it wasn't in the past, but still very healthy we're seeing a great shift towards modernization the base.

Revenue deal deal has been relatively stable modernization is coming up pretty dramatically, it's up about two and half times over last year. So it's moving quickly you only replacing some of the readiness spend that we saw last year. So overall deal the looks pretty good the pipeline is about $1.7 billion, that's pretty solid on the international side.

This year for COVID-19 will be up low single digits were flat in the first half will be up sort of on three 4% in the back half of the year, Chris mentioned were up nine in the quarter. So it was quite good.

There will be down in Q4, but when you look at Q3 versus Q4 for the on a on a dollar magnitude will be fairly fairly similar in size. We just had better linearity. This year on our calenderization than we did last year. So all that's really good trends. The pipeline is about $2.5 billion. It's right in line with where we were.

Before it's pretty resilient. This year. The story has been largely around Europe Europe had a really good back half both western and eastern Europe , but we also some middle east to be up quite a bit. This year, we saw Asia pretty pretty nicely as well. So we're seeing I think generally good trends as we expected you can't it will be down we know.

Capital would be down a little bit.

So so generally thats kind of where we're heading but overall I think things are hanging in pretty well on both the and international for I think a very good year on tactical.

Thank you.

That.

Thank you. Our next question comes from the line of Robert Spingarn with Credit Suisse. Please proceed with your question.

Hey, good morning.

I wanted to Jay asking about the free cash flow guide and if the pension pre funding in Q3 is flatter and your Cas recoveries. This year at all and therefore the driver of the.

The boosted free cash flow guide and then how do you plan to report Cas recoveries going forward.

Other pension line items, which would be.

Giving us detail as per the industry, just now that they seem to be a little bit more material.

Okay, well for for this year and the cash there's really no recoveries related to this pension.

Funding, what's what's driving the improvement was just a little bit better earnings and just a little bit in terms of balance sheet position than what we were looking out before as far as going forward on there.

But we can take a look at it just another disclosure looking first to provide there. We can certainly take a look at that and give it to you I think going forward I would just I'm not entirely clear exactly what what the.

With the go forward recovery is so I'll just have to get back to on that Rob.

Okay and that just another question.

On SCS growth you called out classified space.

Earlier in the call.

Can you provide any detail on how quickly this areas growing either in percentage terms or or versus the segment as a whole.

Yes growing in line with the overall segment Rod vivid.

It's been very strong it's been strong for multiple quarters.

When we say classified space, there's a space, where the big gas, meaning things in space Theres, meaning the domain. So lot of we do in that area is classified it could be ground programs could be space programs and what we're finding is really good growth growth trends in both both areas in space with a capital last as well as on ground domain.

In the and really what's driving this is a shift again, we talked about this before from components assist subsystems to full and admissions solutions is starting to move into various adjacent markets. So that the trend has been very good. The funding has been very strong in this area and it's been growing sort of inline with the overall overall segment so sort of mid.

Mid teens.

That's helpful. Thank you guys.

You bet.

Thank you. Our next question comes from the line of Jon Raviv with Citi. Please proceed with your question.

Thanks, and good morning on the free cash flow, finishing this year at the high end of the range and then you also mentioned on your prepared remarks double digit growth over the next couple of years Im just trying to tease that out gets gets us above 3.1 billion in 2022. So what are your thoughts on that 3 billion dollar target in 2020 chilling when could we maybe repairs.

With that I've been talking about percent, that's potentially some upside there.

So John Thanks for the question, we'll probably talk more about that I would imagine next year as we close this year routed settle down the balance sheets and get ourselves organized we'll talk more about the longer term goal right. Now we're still saying is 3 billion in calendar 2002. So we've added goodstart. So we hit the guidance your 2.35 billion for the year getting the three is another.

Other $650 million over the next over the next three years broadly speaking, it's about a 30 each between earnings growth. The after tax cost synergies beyond the 50, we're delivering this year and then working capital Jay mentioned six seven days of working capital is still about $35 million a day so thats.

Generally the math and and we'll reassess where we happened to be once we get a little more comfort what's happening to cost synergies was going up from where the growth trajectory and really as we start to see real traction on working capital. We had a good quarter, we are down year over year on working capital by about 19 days about 10 days.

His inventory that's pretty good work so to really accelerate 3 billion will require us to do a fast and job on inventory takeout that just takes some time to go and do you Chris mentioned about some of the metrics being pushed down to the pro a program manager that's exactly right is driving accountability for that deep in the organization across all our.

Cities, So I think it's going to and about a lot on how quickly can we take out inventory that's what we're working on.

Okay. Thank you and then you talked about investments a lot on this on this call have talked about a lot over the past months and quarters.

Has that investing calculus changed at all in for instance, the customer wanted to allow you higher return if you if you take on more risk.

Are you investing ahead of need more often today that in the past, perhaps and what what could that mean for long term profitability.

Well I think.

We're running just shy of 4% of revenue. This year, that's what we've been guiding investors to on on an overall basis I think we'll still be in that range over the next couple of years I think the you know the mix of where the dollars happened to go will likely shifted move around as we move from running things locally to more as a portfolio will start to.

The shifted spend between programs you may see more shift towards revenue opportunities to backstop those.

Only about 10% or so of our Iran is in support of OTI A's I mean has certainly been a trend, but thats not going to be a big driver here as I mentioned culturally we had been willing to step up and invest ahead of the need and we're going to continue to be able to do that our job is to drive operational excellence drive cost synergies and make sure that we can invest in great.

Turn programs for shareowners, and that's something that Chris and I adjacent you're looking each other committed to go and do John .

Thank you.

Yet.

Thank you. Our next question comes from the line of Seth Seifman with Jpmorgan. Please proceed with your question.

Hi, Thanks, very much had a good morning.

Wanted to maybe at the divestiture question in a different way, we shouldnt think of the divestitures at all as being.

Potentially standing in the way of.

The 3 billion dollar cash flow target for for 2022 correct.

Thats correct data that are not that doesn't stand in the way that each business, we have or most of them that we're thinking about generates free cash but.

We think with some of the levers we can pull we'll be able to offset any any cash loss from divestitures.

Right Okay.

And then maybe as a quick follow up the Deo de radios in terms of the order flow and kind of what's needed from a fiscal 20 budget.

How does that shakeout in terms of your visibility into your calendar slash fiscal 20 based on where things stand with the CR and at a budget.

No I think we're so we're assuming a CR through the balance of this year through December the gets deeper into 2020.

Could have some impact on the deal the business, mainly because it's more of a short cycle business, but we've talked about this before the visibilities become a lot better we've got a good backlog the order trends have been very good.

At least the G. if white 20 budget is up again for tactical radios to about 1.1 billion from I don't 900 million or so in NGL flight 19, there's still some unspent funds. If you out over the flight of the next five years I think the number grows the 1.6 1.7 billion in that range. So there's a lot of momentum here still remaining in the tactical.

Radio business I think we're at the front end of the curve and from the way we see it there is funding support Theres program momentum, there's operational execution by our team up in Rochester, That's still leaves us confidence will they have a $1 billion business here in calendar 2002 and deal the tactical.

Great. Thank you very much event.

Thank you. Our next question comes from the line of Michael Thermally with Suntrust. Please proceed with your question.

Hey, good morning, guys. Thanks for taking the questions here.

Go back to the out to the revenue synergies I know you mentioned a couple the programs, but maybe talk a little bit more about some of the opportunities you might be seeing and in some of the unmanned surface for subsurface areas. I know, we've got a Navy has project overlord out there and maybe additionally on the revenue synergies I know it was already.

Bid on L. Three standalone, but but how does the future vertical lift program does does the combination.

Make that offering a bit stronger are there some synergies there is that if that a high priority program for you guys.

Hi, Good morning, Michael It's Chris.

First on the on the maritime you're absolutely right on on the unmanned.

Opportunities, we both have surface.

Opportunities the the Overlord program as you called it which I think it was renamed Black parole.

Submitted a proposal recently on the medium unmanned surface vehicle and we're going to team with.

Another contractor on the large.

Surface vehicle on the under C., we legacy L. Three had made some investments and those are actually up progressing quite well, we've been able to get some smaller awards and demonstration. So we're feeling pretty good about the investments and the opportunities in the unmanned.

Arena and also relatives to synergies and maritime there are capabilities.

That legacy Harris had that we're now incorporating on new programs like frigate, where there's four different shipbuilders and were on all four teams with more content than had we not done the merger and at future vertical lift which is a specifically the near term is the Farah.

Program, our focus there has to be one of the two down select for phase two were teamed with another company who's the prime they did the design we did the modular open system architecture and there is additional content.

From legacy Harris, mainly on the E W and avionics that we're able to pull together. So you know the synergy we're very excited about the revenue synergy Bill mentioned the 14, but again 120 days, then I think thats more than any of US would have predicted we have to go ahead and execute we've got to go ahead when these competitions or.

Both.

Very excited about where we are today.

Got it and then just if I may can you sort of give a general state of the union here on the continuing resolution should we think core or do you guys envision that there'll be any near term impact either revenues. Your bookings whether you know it doesn't look like this might get resolved by November 21st, but if this drags on for three to six months can you just.

Maybe articulate if you expect any headwinds there.

Well as I mentioned, you were calibrated through COVID-19, assuming as year goes through the ended the year. So like you were expecting that'll go beyond November Twentyth and go live longer that could good could go into early next year I don't want to add on to size. It yet because we really to see when it actually gets enacted in the appropriations bills or.

Natural we're hopeful that will happen by the end of this year, but we'll have enough time as we get into January to assess for AD and as we guide on 20 will incorporate the latest thinking at a DC on on budget and budget timing, but but the reality I think what's encouraging years. There is a topline to your agreement Theres a lot of alignment between how.

In the Senate bills on funding areas and as I look through that we feel pretty good about the budgets as they're starting to shape up.

And I'm optimistic that the overall budget will get approval get put in a timely basis a lot of pressure on that.

To that to that to happen. So right now it's not a concern for 19, we'll revisit this early early 20.

Sounds good thanks, guys you bet.

Thank you. Our next question comes from the line of George Shapiro with Shapiro Research. Please proceed with your question.

Yes, good morning.

Yeah.

Bill just wondering that you TX has got to sell their tolland's GTS business I would think that would be pretty attractive for it I was wondering if you comment on it.

I won't know George.

Not sure what you TX is going to do I'm not really.

Following detailed what's happening in the regulatory process. So.

I really can't comment on anything that they might have to divest I really don't have any inside knowledge on that.

Okay and then.

Just one for Jay they lowered operating cash flow guidance.

Is that just timing of all of the onetime items that caused that kind of the drop yes, yes. If you exist exactly right George if you look at it I.

I think if you take a look at the deal related costs. There were on a cash basis $300 million plus the good news with that is that's pretty much fundamentally behind us and so it's not something that we'll have to worry about going forward and what will have to tunica keep track of is the other cost to implement the synergies the integration costs going forward on it.

You know basis, where we will be through the year about 250 with 200 left to go to the fourfifty level and kind of the timing of that in a piano based about two thirds, one third on a cash flow.

A little bit slower about $375 million after tax there and we'll be around 200 wish I guess this year and again I would say probably 60 40 in terms of cash impact between 20 and 21 there.

And just your out if you're comparing into the guide from Los Angeles, We also prefunded the pension of transcriptome adult as we talked about of the operating cash flow.

Okay, and one quick one if I might squeeze it in.

You should benefit next year from the discount rate coming down for your with pension income going up.

Just give us any benchmark as to how much it might change per every 25 basis point drop in Drs, something along those lines, yes, 25 basis points up or down about $10 million, a piano impacted the balance sheet impacts about $300 million in a liability.

Okay. Thanks very much.

Thank you. Our next question comes from the line of Peter Arment with Baird. Please proceed with your question.

Hi, Good morning, Bill Chris Jay.

The questions already asked here, but I'll just ask a quick one here bill on on all the investing and then just kind of highlighting I think these great revenue synergy proposals that have been put out I guess, what do you. What are you hearing from the customer in terms of the feedback on your investing obviously it sounds very encouraging and then anything about just share gains that you're going to be looking at.

Thanks.

Well look I mean, I'll jump into within a and Chris can jump in as well and build on this so Peter look first of all we're very encouraged on the revenue synergies Chris mentioned about being early.

In the process and we are so there's a lot more to do we have to go in when some things. So it's all sort of good indications the feedback from the customers I think has been very good but they've seen us do what we've been trying to do individually and that step up invest in R&D invest ahead of the need will be proactive in providing or offering solutions.

Being agile moving things quickly. So so overall the feedback has been very good and I think the fact that these revenue synergies are moving like they're moving is an indication of the trust and confidence that the customer community puts in this new company called L. Three Harris, So I'll, let Chris me to build on that yeah, absolutely I mean, if I put the customers and.

In two buckets the end users the DRD we've had meetings.

As recently as a last month and they're very supportive of the merger they like the agility.

The significant investments that we are making and again the mission solutions.

Prime that mission solutions provider plays Im very well with the strategies that are that our customer has them whether its older platforms with new capabilities are new platforms with better capabilities.

It's really in the sweet spot of where the the challenges are in course, we work collaboratively with a lot of other prime contractors and again those relationships are going well and our capabilities that we bring to like getting that 35 or appreciated and noticed and we worked collaboratively to to provide those.

Capabilities, so pleasantly surprised with the feedback and we just have to continue to execute and deliver on time quality products.

Appreciate the color nice quarter.

Thank you.

Thank you. Our next question comes from the line of Josh Sullivan with Seaport Global. Please proceed with your question.

Hey, good morning.

Just a question on the classified budget exposure I know you provided some color there on the space exposure, but what about the rest of the classified budget how big of an opportunity is that outside of space and then maybe what percentage of the total portfolio. At this point is coming from the classified budgets.

Yes, we've got like I, probably come back to you on the piece of the portfolio, we knew where legacy Harris was I think we the commonize our definition, but.

It could be in the 20% range.

The reality is when you look at the combined military National Intelligence budgets is north of 80 billion 82 billion something like that.

So our piece of that or share that still is relatively small I think lots of opportunities to go into it but more importantly, the places where that Bud you are those by just shifting or more in line with the direction that we've moved clearly theres been a shift towards resiliency and how you define that with space.

Architecture, and I think we're ahead of the curve on that a little bit and we're enjoying some of the benefits of that.

I think it's a so I'd love to come back you on what piece of our overall company is now classic part of it is definitionally as well so.

I think we'll come back and maybe a different answer that.

Okay, that's fair enough.

And then just on the footprint consolidation efforts, where are you moving faster.

Are there any hurdles popping up and I'm not sure. If you mentioned, but any metrics on square footage or the number facilities, maybe targeted for the end of the year.

No we didn't mention at I mean, we think we've talked publicly that we have about 20 mill at 28 million square feet, a space and just over 400 facilities. So we've obviously move pretty quickly on a couple of different facilities headquarters facilities. We've moved pretty quickly on you a few others. There's a number of projects that are working itself through the process where.

Evaluating each one and turn the bigger ideas the ones, they're going to move the needle are the ones, where we actually do production those do take some time to to really think through to action to the put teams against and we're right in the middle of that.

When we step back we talk about sort of overall cost savings knew about half was coming from supply chain and facility rationalization in the facility part was on the order of 30 $40 million and that sort of overall magnitude and we're making good progress I think it's still early days on what will be a multiyear journey.

Okay. Appreciate the time.

You bet.

Thank you. Our final question comes from the line of Rajiv Lalwani with Morgan Stanley . Please proceed with your question.

Hi, good morning, gentlemen, thanks for squeezing in.

Hi, good morning.

Just a couple of quick wins on the international side can you talk about the traction you've been gaining their post the deal given the expanded scale and size of the company and maybe any color on the portion of revenues you think that could become.

As we look forward a couple of years.

It's a good question I'll start and maybe Chris can jump in here. So Rajiv. Good question, it's about 22% of our revenue today is coming out of international again, we're still working through making sure were harmonic harmonizing. The definition of the international So work in Napa is around 22%, we should expect that to come up over time.

So we're underpenetrated internationally combined we've got a great position in five or six different markets and to that combined strength in those markets. We do believe we can provide better offerings with something that we're working through and what the specific strategy is there a chris is leaving us with his team, but that should come up over time.

To sort of offset what might be a deal D. A flattening. If you will the next couple of years, So Chris maybe jump in and say a couple of things on Internet absolutely.

I'd put in three buckets, we have we have three countries, where we have a pretty big presence in Canada, UK in Australia, where we have engineers and business development actually delivering and building product in country exporting out of those countries and those three are looking very good and and we've had some combined synergies from both legs.

I see companies with those three countries, we have the a distribution systems. The legacy Harris has in place that we're looking at some legacy L. Three products going through those distributors and then of course, we have the business development footprint and about seven countries, mainly far east and mid east and we're very.

Optimistic about the growth opportunities again, bringing more capabilities to our customers and.

I agree we're at 22% now and there was an upward trajectory over the next couple of years and we'll give you more in future calls, but a good good opportunity and good progress so far.

That's great and then real quick on the technical side.

The DMD part of it has been incredibly strong is there any opportunity for the international side to maybe catch up to those sorts of growth rates over time effectively on a lag basis.

Well, the very different markets of the driven by different factors.

In the last is a shift towards modernization and upgrading legacy radios as well funded by government. So you've got different services moving a different rates, but you've got only a few services internationally. We're in a 100 different countries. So each one operates in different ways, but the reality what we see.

Is what's driving a lot of the growth right now is really coming from monetization and upgrading from what we're Falcon two to Falcon three and now Falcon for radios moving from single channel to two channel radios really lagging in following what we see happening in the U.S. domestic market. So typically the way. These things happen you moved from special ops.

Operations in the U.S. with things like that to channel radio with a Chris mentioned the two general Manpack, we're developing the Hfive radio that trickles into regular army in the U.S. It trickles into international special operations that eventually trickled into regular forces on international markets, that's sort of the trajectory here that we typically see.

And that gives us encouragement, we'll see continued growth into the future in international I don't think it's going to be the sort of growth rates. We've seen this year on deal D. Because the bump on run at different paces, but I do think that Thats, the general trajectory and with Backstops growth in the future International.

Great. Thanks to all thanks, Chris you bet. Thank you.

So so look just to wrap up here. Thank you very much for joining the call. The progress we've seen in our first 120 days has been terrific in our leadership team our employees remain focused on meeting customer expectations and delivering value to shareholders, while really executing extremely well in integration I want to thank them for their hard work and for their dedication.

We feel good about our increased guidance as we enter the final innings of what has really been a in an exceptional year relentless focus on our strategic priorities puts the company in a strong position to continue to outperform next year and beyond so thank you again for joining us today.

Thank you. This concludes today's teleconference. You may disconnect. Your lines at this time. Thank you for your participation and have a wonderful day.