Q2 2020 L3harris Technologies Inc Earnings Call
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Greetings and welcome to the L. Three Harris technologies second quarter calendar year 2020 earnings call.
Hi.
Arnie listen only mode I.
Great question and answer session will all the formal presentation. If anyone should require operated systems. During the conference. They sets are zero on your telephone keypad.
I know this conference is being recorded it is now my pleasure.
Produce your whole, where he was vice President Investor Relations. Thank you you maybe yet.
Thank you Michel good morning.
Welcome to our second quarter 2020, <unk> earnings call all Mccall with me today.
Bill Brown, our CEO Christy basic horse here.
Jerry law. They of course here. So first a few words on forward looking statements and non-GAAP measures.
Looking statements involve risks assumptions and uncertainties that could cause actual results could differ materially for more information. Please see our press release presentation and I see filings reconciliation of non-GAAP financial measures to comparable GAAP measures is included in the Investor Relations section of our website, which has L. Three Harris.
Sarcom well replay of this call will also be available.
That's the end with year over year comparability of Poland Me all three hours merger partner results would be on a pro forma basis without bill I'll turn it over to you.
Okay, well, thank you regime and good morning, everyone I want to start by thanking L. Three Harris employees for their hard work and dedication over the last several months.
The pandemic is challenges fall to find new ways of working effectively and her team responded well to ensure we continued to meet the mission critical needs of our customers even as the virus spreads across southern states, where we have a large presence.
And as the environment evolves, the health and safety of our employees will remain our top priority.
All of our facilities are up and running at adhering to well established protocols such as daily health screenings faced coverings, social distancing and adjusted work schedules.
Our work from home policy remains in place for about half our workforce and we are prepared to operate under these conditions over the coming quarters.
We continue to pay close attention to our supply base and monitor our risk position daily and we've successfully implemented mitigation plans where needed including developing alternative sourcing providing on site assistance and working with local authorities to secure a closure exemptions.
In addition, we accelerated nearly $250 million in supplier payments within the quarter, we plan to continue that support through year end.
We're also doing our fair share to support our communities healthcare workers and first responders through the pandemic and we continue to higher aggressively to meet our growth needs, adding about 303000 employees through June and bringing onboard our largest cohort of interns and new college grads ever.
Chris and Jay will walk through the details at a minute, but as you saw earlier today, we reported second quarter results with non-GAAP earnings per share of $2 at 83 cents up a solid 13% against a tough backdrop.
Company margins increased 150 basis points, 18.2% and adjusted free cash flow was $785 million all above expectations.
Reported revenue was flat, but adjusted for divestitures was up about 2.5% as strong 8% growth in our core U.S. government related businesses more than offset a modest decline on the international side and a 35% drop in our small commercial businesses consistent with what we anticipated.
Total company funded book to Bill was 1.09 with funded backlog growing about 5% since the beginning of the year when adjusted for divestitures.
Our strategic priorities have remained the same since we closed on the merger a year ago and we're proud that our nearly 50000 employees quickly aligned as one operating company.
And we're pleased with how well the team is executing and avoiding operational missteps. Despite the many moving parts.
Integration continues to progress well with the net synergy savings of $60 million in the quarter and $115 million year to date.
We have not seen a slowdown in activity due to coated and now believe we can deliver $185 million a net savings this year up $20 million from prior estimate largely due to a steady ramp in savings from the supply chain shared services and benefits.
Our integration road map is very methodical and rigorous with a weekly cadence of top down reviews, and we continue to expect to achieve $300 million in cumulative net savings in calendar 21, one year ahead of original plan.
We're making good progress in driving a culture of operational excellence deep into the company and through the quarter. We continue to hold training sessions and conduct lean assessments quality clinics and value engineering events. Despite the inability to travel.
As we've said before Eathree savings are additive dis synergies and were a key part of the margin expansion, we achieved in the quarter and year to date, but more importantly are essential to expanding margins beyond the integration window.
Investments in technology and innovation remain at the top of our agenda and our key to long term revenue growth.
Since the closing we fully implemented a rigorous stage gate process called checkpoint and cut 30% of right red projects to sharpen our focus on key strategic themes around spectrum superiority actionable intelligence and warfighter effectiveness, while positioning for the shift to an integrated.
Art battlefield.
We are investing heavily in multi function software defined open architecture systems that allow us to deliver mission solutions independent of the platform.
These have these investments are evident in our increasing traction on revenue synergies. We've now been down selected on 13 out of 23 proposals and continued to build on our multibillion dollar pipeline.
Well, we're still in the early innings. The collaboration we are seeing across segments is really impressive with the process to identify new revenue synergy opportunities nearly self sustaining.
On portfolio shaping reshaping, we're set to close today on the divestiture of Eotech, a small consumer facing business, bringing total transactions the data for with proceeds exceeding $1 billion.
We're now about one third of the way toward our bottoms up estimate of divesting, 8% to 10% of revenue with more progress expected in the coming quarters as we increase our focus on businesses, where we're best positioned to win.
And on maximizing cash generation, we delivered $75 million of free cash flow in the quarter at about $2.7 billion on or on an LTM basis growth of over 20% on a per share basis.
Our strong performance along with divestiture proceeds drove a cash balance of $2 billion at quarter end and supports our prior commitment to return capital to shareholders in the third quarter.
Longer term, we see a clear path to achieving $3 billion free cash flow in calendar 2002, driven in part by continued improvement in working capital.
In the quarter, we achieved another two days sequential improvement with solid momentum toward a calendar 22 goal of sub 50 days from 68 at merger close adjusted for divestitures and accounting items.
Slide four illustrates the opportunity ahead of US 10 businesses account for about 75% of our working capital six of which have more than 75 days on hand.
Driving those six to current company average of 55 days would generate nearly half a billion dollars of cash flow with a largest opportunity tied to lower inventory.
Shorter cycle times, better forecasting product rationalization, and part communization vendor managed inventory and improved supplier delivery performance. The levers are clear we've done it before and the team is focused and motivated to get it done.
Finally, we're all watching carefully the progress towards a 21 defense budget and signals from Congress, the Biden campaign and the Trump administration on the budget trajectory in 22 and beyond.
Encouraged by the bipartisan support in advancing the fiscal 21 National Defense Authorization Act to the house and Senate.
We believe that the heightened threatened environment will drive the trajectory of us military spending regardless of the election.
And while we're conscious of the risks surrounding elevated deficits, we believe our technological capabilities and opportunity set position us well over the coming years.
Recent house and Senate marks support this as we saw ongoing strength in areas like tactical radio aircraft Eyesore F 35 in space and classified budgets are also set to be well supported.
So between budget positioning revenue synergies margin expansion potential and shareholder friendly capital deployment, we remain confident in our ability to sustain double digit earnings and free cash flow growth per share in the medium term and with that I'll now turn it over to Chris discussed segment results Chris Okay. Thank you.
Bill and good morning, everyone.
I'd like to highlight the quarterly segment results starting on slide six.
Integrated mission systems increased revenue, 7% from growth in our electro optical and maritime businesses with I guess are relatively flat in the quarter, but expected to pick up in the back half of the year.
Operating income was up 38% and margin expanded 370 basis points to 16.8% from integration benefits operational excellence and cost management.
Order momentum at Imus was broad based with a funded book to Bill above 1.0 in each business, resulting in an overall segment book to Bill of 1.19 for the quarter and 1.12 since the merger.
I'll highlight in recent months has been the traction we've seen in our maritime business in the quarter. We received an order from a classified customer for unmanned surface vehicle.
And just this month, we were selected as the prime contractor for the medium unmanned surface vehicle for the Us Navy.
We're also in the process of finalizing our position on the U.S. navies frigate program as the system integrator.
This initial 10 ship contract has the potential value of over $300 million. So clearly we're seeing positive momentum in this business.
On slide seven space and airborne systems revenue increased 4% in the quarter.
Growth in avionics from the production and modernization ramp of the F 35, and increased classified work at Intel on cyber were partially offset by program transition timing and a tough compare in this space business.
Segment operating income was up 3% and margin contracted 20 basis points to 18.8% is operational excellence and integration benefits were offset by program mix from increased developmental work and investments in an earlier stage technologies.
Overall funded book to Bill was 0.94 for the quarter and just below one since the merger with particular strength in space, which delivered a book to bill over 1.0 in the quarter.
As a reminder, in our space business, we're transitioning from a legacy explicit payload provider to a full end to end systems provider for responsive satellite in ground systems.
A recent launch for the US Air Force demonstrated this capability, we designed developed and built satellites within a couple of years and are now providing the tasking and the command and control for these on Orbitz spacecraft.
This speed to market is a significant differentiator compared to legacy systems that take nearly a decade to become operational.
As war fighting capabilities accelerate in the space domain, we are well positioned to participate and capture new business and have a strong pipeline that exceeds $10 billion to support growth in the medium and long term.
On slide eight communication systems revenue was up about 2.5% for the quarter as deal the tactical and integrated vision systems benefited from modernization demand.
Both were up double digits.
This strength was partially offset by international tactical radio sales timing and headwinds that are public safety business, both of which were down in the mid teens consistent with prior expectations.
Segment operating income was up 11% and margin expanded 190 basis points to 23.9% from integration benefits and cost management.
Turning to orders DLD tactical modernization momentum continued with a 95 million dollar award for an additional low rate production contract on the U.S. armies HMS Manpack program.
After completion of the operational testing early next year, we anticipate a full rate production award against the previously announced I'd I Q of nearly $13 billion. This will support continued revenue growth.
Lastly on slide nine aviation systems organic revenue decreased 7% in the quarter with commercial aviation down about 50% due to the pandemic inline with our expectations.
This headwind was partially offset by continued growth within the classified areas at defense aviation products, which was up in the mid teens.
Operating income was down 8%, primarily due to the impact of divestitures, but would have grown 4% otherwise.
Margins expanded 120 basis points to 12.5% from operational efficiencies integration benefits and cost actions, partially offset by co good related headwinds.
Order is significantly outpaced sales leading to a funded segment book to Bill of 1.26 for the quarter and 1.13 since the merger.
We saw considerable traction on the defense side for airborne radars ground vehicle systems and training solutions as well as within the classified arena.
One of the key wins in the quarter was a 900 million single award IDI Q to develop and manage simulator requirements and standards across the air Force's training portfolio.
This solution will leverage open systems architecture, and set common standards for the Air Force and aligns with the DLD moved towards multi domain operations and ties to the program direction of Jab C.
It will also position us well for future military training offerings.
So before handing it over to Jay I'd like to Echo Bill's comments and thank our employees for their dedication focus and hard work during the pandemic, we'll continue to prioritize your health and safety as we move forward with that over to you Jay Thank you, Chris and good morning, everyone.
I'll begin with a recap of second quarter results, then provide an update on the impact of co bid and then wrap up with guidance.
In the quarter organic revenue was up nearly 2.5%.
As a percent growth in our us government business more than offset the commercial decline.
EBIT increased 9%, an 18.2% margins, resulting in EPS growth of 13% or 32 cents as shown on slide 10.
Oh this growth 22 cents came from synergies 15 cents from operations, including cost management.
And 13 cents from share count pension and other items, including divestitures, partially offset by pandemic related headwinds of 18 cents, mainly from our commercial businesses.
Free cash flow for the quarter was $785 million and we ended the period with 55 working capital days or two days better sequentially after adjusting for divestitures and purchase accounting adjustments.
Versus the prior year and our expectations, we benefited from accelerated customer collections and ongoing inventory management, while continuing to support our suppliers.
Margins in the quarter came in at 18.2% or 150 basis points higher than last year and ahead of our internal views.
Most of the expansion or 140 basis points came from the $60 million synergies drop through.
We also saw benefits from our cost management efforts and Tailwinds from reduced expenses, such as for travel and trade shows along with operational efficiencies, which more than offset 60 basis points of cobot headwind.
While some of the expense tailwinds are temporary.
Our margin performance highlights the portfolios resiliency during a tough environment and our future earnings potential.
Next let's turn to slide 11 for details on the guidance outlook.
Organic revenue is unchanged at up 3% to 5% with topline trending as expected and overall cobot impacts sales still size within our prior range.
For our core U.S. government business, representing about 75% of sales, we expect the 8% first half growth to carry over to the backup as well.
Our commercial aerospace businesses, which was down about 50% in the quarter, it's generally tracking to our previous forecast for the year and in line with broader industry forecasts.
In public safety the business was down in the mid teens in the quarter that we now expect that business to decline around 15% from 10% previously, reflecting the slow pace of New awards.
On international we're holding our flattish view for the year based on our second have visibility with upside opportunity and I have SAR.
So overall relatively minor changes with a clear line of sight to our sales outlook.
Which is supported by a funded book to Bill of 1.1 in the first half.
Shifting to margins, we've increased our outlook to 17.5% plus with the plus indicating potential upside of 10 to 20 basis points versus the prior guidance of 17.5%.
Due to performance to date cost synergies Eathree progress and expense management.
Margin step back in the second half versus the second quarter due to higher R&D investment as well as a place holder for higher co bid related mitigation costs or disruptions, but.
But still continued margin expansion progress on the full year of nearly 100 basis points.
On EPS were holding the full year guidance range of $11 at 15 cents to $11, a 55 cents with a contingency at the midpoint for the margin upside to account for the uncertain map uncertain backdrop amid the pandemics progression.
Our capital allocation weren't as strong cash position and should remain so after completing our committed repurchases with divestiture proceeds here in the third quarter.
Beyond that we'll continue to monitor market conditions for deployment opportunities such as capital returns and employee pension plan contributions.
Moving to free cash flow, our guide to our guide of $2.6 billion to $2.7 billion remains intact with similar upward pressure from earnings upside working capital traction and lighter capex.
Finally in briefly on the segment outlook, we've maintained our guidance for all items line items, but for margins it Imus, where we see likely upside.
The improvement is coming from synergy dropped through an operational excellence via Eathree productivity.
Both year to date and going forward. So great example of the merger the merger benefits.
So to put it all together a solid growth outlook supported by our year to date performance in forward visibility with an upside bias, assuming a stabilizing environment.
And with that I'll ask the operator to open the lines for questions.
Thank you we will now be conducting a question and answer session and the and just the timely assay. Please limit yourself to one single part question.
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Our first question.
Seth Seifman with JP Morgan. Please proceed with your question.
Hey, thanks, very much and good morning, everyone.
Bill you to talk in the slides about potential for cash flow growth beyond 2002, and you mentioned.
Working capital just wanted to confirm a is that the is that the chief source of.
Cash flow growth in those out years number one and b.
Are there others and if so kind of.
What are they and if you could speak a little bit that maybe qualitatively to the the magnitude and relative importance of those other drivers.
Yes. So thanks for the question so between now and 22 timeframe mid single digit plus type of revenue growth that we expect because we're seeing.
Good visibility into 21 budget, which we think is going to get pass sometime in the next six months or so our programs are very well supported there lot of and spend dollars from prior years good opportunities on revenue synergies growth opportunities international. So we see the topline continued to improve margins coming up we are doing very well have more.
Okay and progression this year, Jay just talked about some of the upside drivers here in calendar 20, we see continued momentum on margins over the next couple of years, it's certainly not going to end as we get to 22, there's going to be opportunities, even certainly beyond that working capital is a driver we've made great progress down 13 days since the close to 50.
Five we see getting to about 50 days below 50 by the time get calendar 2002.
But is that the way we look at this from a bottoms up perspective Harris was at 41, we can see our ability getting down into that 40 41 days. So even as we had 50 days in 22, an extra 10 beyond that's about $350 million worth of cash which has great opportunity to deploy it.
The near term certainly next year or so towards share buyback that will reduce our share count. So overall you put all those pieces together, we continue to see double digit growth in free cash per share.
Thank you. Our next question comes from the line of Robert salary with vertical Research partners. Please proceed with your question.
Thanks, so much good morning.
Rob.
I think is a question for both Bill and Chris I mean hosting a lot of talk out there about what the trajectory of the budget could be over the next few years, but I'm wondering if you could maybe frame have different the merged company is today versus what you saw in the last defense dance and had high things could play out.
Well I mean, I'll start and all that maybe Chris jump in here Rob. So it's it's a great question look I think part of the reason why almost two years ago now, Chris and I contemplating put into accompanied together was really to build a more scaled mission solutions Prime and Chris talked a lot about become a six prime.
When we sit there in fact, we talked about our merger back in October of 2018, we talked about our presence connecting across all domains.
C is our power House Company Mission solutions Prime company and you can see based on the progression and we've seen to date clearly moving in that direction.
Certainly as the as DLD moves towards connecting all of their platforms. All sensors, all shooters across all domain I see us be really being in the in the sweet spot of that we won seven idea accuse any BMS with lot of players on the team, but I think is testament to the capability that this organization has.
As overall in spectrum superiority spectrum dominance cross what we do electronic warfare Waveforms communications eyesore, all those pieces come together to help realize that vision of where the deal the needs to move to in order to fight. The next next slide you can see really cross all domains of progress.
Space the progress in unmanned both airborne maritime So we're really I think realizing that vision and I think we're much more resilient organization today, we would have been several years ago with a tremendous opportunity to gain share in a market that may flatten or come down over time. So I think we're just a fundamentally differ.
Composition today, we were a number of years ago. If you want to add on to that Chris maybe I'll, just add a little bit Rob.
We talked a lot about leveraging the scale of the enterprise and I think in this industry scale matters and you look at this new company with.
Close to 700 million of R&D that positions us well for these new markets and then next gen opportunities. So we're starting with the clean sheet I believe we're pretty agile and responsive.
The National Defense strategy talks about this aggregation bill mentioned autonomy and some of the capabilities we have their fit in nicely.
These large platforms and then the ability to connect them and.
You look at our ability to attract and the higher college grads, others Theres a lot of excitement with this new company people see that we're growing 8% from the government business and.
I think we're ahead of schedule I'm going better than I would've expected after 13 months.
Thank you. Our next question comes from the line of Carter Copeland with Milia Research. Please proceed with your question.
Hey, good morning, gentlemen, thanks to the time I hope everybody as well.
Hi, good credit or Phil.
No I wonder.
Or Chris I.
I wondered if you might tell us a little bit more about this.
The comment from crummy, erad pipeline or narrowing the focus of that I read pipeline to.
Help us think through the end of the private prioritization of that thought process are you looking to prioritize capabilities or ROI is or customers that any granularity you can give us on how you're thinking through that process. Thanks.
Hey, Carter is a great question I know it really im glad you asked because it gets a fundamental part of the value creation story that we have in front of US we've been talking about this for a couple of years of taking you as Chris mentioned $700 million worth of I read that previously was distributed very deeply and broadly across the company no.
Not centrally coordinated.
No clear business rationale across the individual investments in through the work that that the CTO Ross as done here too to really get AD and categorize. We're all that money is going we looked at it weve saw 30% of the projects that were didn't have a business case or more.
Overlapping were duplicate so we've provided to investors. Some examples of that so allows us the focus that fire power, that's pretty potent on a smaller set of opportunities really around the areas around multi function open systems architecture software defined everything that really is the heart of what we're trying to do in spectrums.
Peer yardi.
Sensing solutions delivering actionable intelligence natural were really we're really focused and as I think about this that's that is going to enable us to continue to invest in these new opportunities that we're seeing coming through in revenue synergies. We've won quite a few year, they're small today in terms of revenue impact will grow over.
Her time, but the pipeline is largest getting bigger and really positions us and I think in a fundamentally different ways. So when you think about value creation a potential into the future for a technology company, we call L. Three Eric this is fundamental to the value creation story.
Ill just Tom Carter I mean, this is what we've been talking about four for almost a year and internally and externally. This is about optimizing.
The enterprise the greater good of L. Three Harris versus optimizing the divisions and this is part of the transition from more of a holding company to an operating company and when we look at things Holistically from the top down we're able to prioritize those to get the greater growth in the greater returns same process applies to capex and everything.
Else that build Jay and I look at on a regular basis. So that's the origin of the 30% that bill referenced.
Thank you. Our next question comes from the line of Noah Poponak with Goldman Sachs. Please proceed with your question.
Hey, good morning, everybody.
Hey, good morning, though.
Can you hear me okay.
Yes, yes.
Great Yeah, I'd love to get a little more specific on.
The the capital deployment plan and specifically the intent to buyback stock.
Just given the large cash balance at the end of the quarter and how much free cash you are set to generate moving forward here.
And if theres going to be even more proceeds from divestitures.
No one will your restarts.
In the third quarter on an underlying basis, even before the latest proceeds like are we just buying back stock again now or not.
And I want to add up all those pieces that looks like you can be buying back.
Several billion dollars a year going forward.
Is that a reasonable assumption.
Yes, so no it locally in Q3, we will use the proceeds we received from the sale of STS to Lydalls was a $1 billion. We closed that in Q2 will deploy that back to owners as we've always said we would.
In Q3, we sold an asset or buying back an acid habit would be our stock.
As we look to the back into the year with a 1 billion 3 billion Fourish in free cash generation in the second half will then the year with a pretty strong balance of cash in the 1718.
Q1 billion dollars range.
So still opportunities beyond that for for deployment as we've been talking a lot we see that growing a $3 billion by 22, there's there's no debt pay down requirements at all would refinance some debt, but at a one seven go into one five leverage ratio Weve Guide I think a good leverage basis, we don't see.
The any significant M&A on the near term horizon. So gives a lot of opportunity to employee, yes upwards of $3 billion of year in free cash generation back to owners as we said we would in that just to remind everybody is after significant investments in development internally here.
Irene people training people spending investment on capital driving erratic close to 4% as Chris mentioned, a couple of minutes ago significant investments inside the company, even with that gives us an opportunity deploying that cash effectively with shareowners.
Thank you. Our next question comes from the line item.
Cowen. Please proceed with your question.
Thanks, Good morning, guys Transco and.
Good morning.
Hey, I wanted to ask Bill maybe numerically express the revenue synergy opportunity in some reasonable timeframe, so whether it's 22 and 23.
What should we be anticipating.
So what you're going to get incrementally from some of these.
Captures you're pursuing the combined the capabilities of L. Three in Paris.
And how do you see that playing out over the next five or 10 years.
Yes, it could just give us quantification of it.
Yes. So so again, we won we won 13, it's into tens of millions of dollars in its and its actually growing it's we're seeing good good traction there.
It's you'll see a little bit in into 20 results will start to grow in 21, a little bit beyond that the pipeline itself is north of $5 billion in its and its growing every time, we meet with the team and it's pretty substantial the opportunities that we won or in the 1 billion $5 billion to $2 billion a lifetime revenue.
So so I would expect.
And with Chris Ajay to something here, so maybe I'll, let Chris jump in here, but I would expect that it will be something growing north of $100 million year, but Chris.
Maybe you can now no I'll I'll I'll sign up to at least 100 billion a year and.
Would you say 10 years from now [laughter] no. It as Bill said it is better than than we expected.
And we have a very strict definition of what we're calling revenue synergies either bid that neither company would have.
Submitted had we not merged together so we're getting the momentum a lot of these are the initial wins some from DARPA. Some from a rapid capability office and then we got to win from four to two two to one but we like the momentum and.
I would I would expect that this will contribute to our topline growth for the foreseeable future and will quantify at 40 as we as we start to move up.
And get some of these women.
Thank you. Our next question comes from the line, Doug Harned with a line Bernstein. Please proceed with your question.
Good morning, Thank you.
Hi, good morning.
If I, if I think back.
Chris to what L. Three look like.
Not that long ago, and you had to all of.
With an 80 or so businesses with overlapping overhead functions and.
In the sense and need to rationalize the supply chains and facilities.
And if we roll forward.
Where where does where do things stand today in terms of.
Addressing a lot of the opportunities on cost that you had before because I'm. Just you continue to find new cost synergies. So I'm trying to figure out what the pathway looks like terms the things you've gotten done the things that are still to go here and.
Where you can potentially be.
Yes, I know that's a great question, Doug and I'd say, we made really good progress in the last 13 months, but a lot of the progress. We made was a result of starting early even the pre pre merger I'd say, we're ahead of schedule on the synergies that we talked about but everything that we've looked at.
Shows continued margin upside and cost take out opportunities well beyond the initial three year period.
The facility consolidations are ongoing those will take the most time as you would expect I think we've made great progress on on the supply chain and.
That's just something we're going to continue to work on year after year and also not only on the value capture but improving the resiliency given some of the recent challenges and the coded environments. So.
Sure Baseball game, we're probably in the second or third any and as I as I see it holistically.
And.
Really hitting the ground running on day, one the benefits of the HR and all those initiatives. We're done on the first cycle, which was pretty impressive. So I think there's a lot more to go and we see this is part of our culture of operating excellence.
It's just kind of go year after year and I think there's a lot more to go.
Thank you. Our next question comes from the line.
Hello with Jefferies. Please proceed with your question.
Good morning, everyone and thank you.
Bill I think you mentioned six businesses with high working capital and you quantified the opportunity, which is quite big at 500 million.
Getting the size of these businesses might be fairly large but is there anything structurally different about them and how do we think about that working capital drive down contributing to intermediate results.
Yes, theres nothing structurally different about them.
The what's happening is we're getting into a lot of detail, which drive in working capital to be where it happens to be and as I mentioned a lot of it is inventory supply and inventories north of 100 days.
It's about just prudent management improving forecasting.
Improving the performance with suppliers because of lack of confidence in when a supplier is going to deliver a component drives management to increase buffer stock.
It's managing better the development of new product. So that you are leveraging components that exist across other products. So you reduce sort of both skews as well as the as the parts that go into the S.K.. So it's really across all of those fundamental pieces, Chris and I enjoy today.
Have a weekly institution right next to our integration meeting to focus on working capital we'd be doing this since day one.
We've got a dedicated teams focused on this is driven by the general managers themselves. The teams are incentivized to improve cash with incentivize them to drive working capital. So we expect to make a big achievement in those six businesses, but the reality is we had 19 different sectors all of which have opportunities to improve.
Working capital and we're going after every single one of them. That's what gives us confidence of taking the 55 to below 50, and hitting 40 over the next couple of years.
Thank you next question comes from the line of Richard Safran with Seaport Global. Please proceed with your question.
Hi, good morning, everybody I hope everybody as well.
Morning, Richard.
So.
Bill and Chris I thought I had another question on on your revenue synergies I thought you might try to explain the driver of the revenue synergies and if they continue why you know the potential is north of 5 billion and why they've come so much earlier than expected to me pentagons, giving awards to not to.
Additional players and major platform markets. You know you have Spacex with launchers, and you recently with maritime So is that the driver here, where you stand to benefit is the Pentagon looking for more competitors and bring again non traditional players and I guess as is there room now for moving la trucks to the next level as a six prime.
I think he is looking for more competition you know more companies suppliers that can bring unique mission solutions that can simplify what they're doing bring additional capability has driven through technology investment I think what we've proven is the ability to a.
That's the technology dollars, it and find ways of delivering new capability from those from those investments. So I think thats clearly the direction that that the deal do you happen to move moving into but I think we have just a great opportunity across our portfolio. We've had from day one piece.
Well getting together in classified space is an open space is sharing ideas and when you have a good sense of what the mission need is that you put technologists and a room to try to look at what we can do differently. There just lots of great opportunities that come from the capabilities that being brought by this this new new entity.
So we're still early days. This is only one year in is moving faster than we had expected there's been a lot of residents with the customer as you can see by the wins we've had so far we've got to follow through we've got a when some of the down selects move some of the studies that Chris mentioned that are with DARPA into actual programs of record but that happens.
Over time with continued focus and investment and it has anything to the opportunity set is getting bigger than than small lives coming the classified side as well let me keep in mind tool in the classified domain lot of these things are relatively stove pipe in the larger companies have a broader view across multiple different programs. So we're now doing is getting more vis.
The ability across multiple different types of of programs classified programs in its and we're bringing different mission solutions.
Thank you question comes from the line of George Shapiro with Shapiro Research. Please proceed with your question.
Yes. Good morning. This is probably front Jay I was curious as to how much incremental cash you got from the change in progress payments I noticed it accounts payable were down 328 million see obviously gave some of that back at the same time receivables inventories.
And contract assets were down 447 million so.
Maybe just expand on that and then what you would expect that to be for the year and is that the potential incremental to the cash flow guidance that you have thanks.
Okay, George So I'll just go to the quarter and then the year in the quarter. The the progress payment benefits were in the range of $100 million and that was a pretty much float down through through the suppliers separate from that we did have customer payment accelerations that also we benefited from in the quarter.
In the range of say $150 million or so.
The the flow through of that to the full years really dependent on what the customers do if the customers continue to on that type of prepayments schedule on the non progress payment types of payment schedule than we would see it potential upside in the year. If it's if not it may go back, we'll probably see a snapback and really.
I would just be a pull into second quarter.
So it could be upside.
We have to kind of just monitor the customer behavior over the back half for the year as far as these accelerated payments I mean, if the progress payments right now we're expecting those will continue.
With those could shift as well, but as I've just mentioned thats been basically flow down to the suppliers.
Thank you. Our next question comes from the line Peter Arment with Baird. Please proceed with your question.
Yes, good morning, Bill Chris Jay.
Bill I wanted to circle back on the on the budget.
On a topic, we get a lot from investors about maybe L. Three harris's exposure to kind of the OEM own m. side of the budget and I think it's reasonably high how should we think about that part of the budget if that if the overall budget starts to compress how that impacts you I know theres a lot of eyes are missions and activities that flow through there, but maybe just some color on housing.
How we should think about that.
Well, it's I think we size it in the 40 percentage range of our of our business is open end fund that I think of this year. They know the duty is under running the spending on own m. So it does create actually some additional opportunities for over $10 and you mentioned that exactly right. Some of that does fund some of the eyes are missions that we happen to have here. So.
So we think we're well positioned on that I don't think it's a major concerns we go into into 21.
I don't Chris or JV of any thought on that but no I think gives us good good diversity and various sources of colors of money I think is actually a strength. So yes, I Echo what bill says were.
We're in good shape.
Thank you. Our next question comes from the line David Strauss with Barclays. Please proceed with your question.
Thanks, Good morning, everyone.
Morning.
Phil one the follow up you mentioned three.
Good maybe talk about what kind of organic.
Margin upside seen so far from the three how much further good it can go.
And then on that on the synergy side.
The launch on Theres upside to 300 million.
Any any sort of quantification of how much how much upside there beyond that thanks.
So this is David look, we're making really good progress on Eathree in fact a.
At L. Three Chris instituted a program called L 365, we had our own.
Program here at at Harris HP acts the combination of than I think has.
Yielded a process internal process, that's been driven deep in the organization. We typically would expect something like 2% to 3% net of inflation cost net of giving back to the customer as well of cost coming out and we're seeing eathree in that range over the course of years getting a little bit better.
We I think we would sustain that in 21 and 22, so that size. It a bit you as we get beyond the calendar 22 time period and integration. It starts to wind down in terms that focus process the drive to achieving cost savings will continue at all merge into what.
We've now call. It three so we do expect to hit $300 million net in 21, we do see opportunity beyond that some of the.
I think that Chris mentioned, a minute ago about facility rationalization, they do take a bit longer they will be fully complete in 21, so we'd see a little bit of step up in beyond 21 on justice consolidation of the facility. So we can't really size. It today was we get further down the path will continue to update investors on this but as you think about.
Where we been over the last six months, we started out the year guiding to about $115 million net we want to 165, an hour at 185 in an environment that is very uncertain with the cold and pandemic. So we continue to make great progress here great progress on Athree and all of this is going to drive us north of 18% margin next year with some.
Upside beyond that.
Thank you. Our next question comes from the line Pete Skibitski Lundbeck Global Advisors. Please proceed with your question.
Yes, good morning, guys.
Just on the really strong second quarter margin rate I imagine.
Was there any one off benefit and there and it looks like Guidances, assuming kind of a lower rate sequentially in the second half of the year kind of touched a little bit, but any color that you could add there.
Sure featured really strong synergy drop through overt over 200 basis points. They do have a benefit of pension running through because it's a predominantly legacy all three business, but they also had strong productivity eathree productivity dropping through which pretty much offset any mix headwinds and a little bit slower on on R&D, there and I.
As I meant as we expect R&D to step up in the back half for the year.
For the full year, they're just they're doing well.
We had originally had 13.5% it does step down as I said for.
For the R&D as well a little bit of a mix as we indicate some aircraft, but bottom line there you're going to see some solid margins the around 14% for the year.
Thank you. Our next question comes from the line of Michael Ciarmoli with Suntrust Robinson Humphrey. Please proceed with your question.
Hey, good morning, guys. Thanks for taking my question.
Maybe just to stay on that R&D, you look at the second half margins. They obviously come down a bit you talked about that.
Hi, good place holder. It did you called that out maybe as a contingency in there in the earnings bridge, So maybe thats 10 million or so, but you know how big how do we think about the R&D step up and I guess I'm thinking about a two in the context, you're talking about 30% of Iraq, but it sounds like cutting 30% that Iraq, but it sounds like some of that's just going to be.
Reinvested is that was that the right way to think about sort of the reprioritizing the Iraq kind of following it back into higher areas of opportunity.
Yes, one of the Reprioritization occurred as part of our planning process for the year, we were going to step up around 3% to 5% about 3.7 in the back half of the year and what we're talking about as part of the checkpoint process is really just a process for defining prioritizing those projects there might be some timing differences here in there.
We continue to monitor them as part of that process, but there's not been any type of effort to actually reduced R&D spend as we dealt with some of the headwinds with cold and Thats really been more other expense type of discretionary spend items that we've been not would be a we've been dealing with and so our goal has been to hold our R&D and protect the investment and draw.
All the items in revenue synergies fit that bill referenced before.
Ill just chime in with a 1.19 book to Bill and IMF, specifically you know a lot of these as you know started out as more developmental programs and then over the course or the life of a program you get into a low rate production and ultimately production to the margins or increase so a little bit of the second half pressure.
Is coming from some of these recent maritime wins, which are good margins, but dilutive.
In the near term.
But we will ramp up as we continue to deliver on them.
Thank you. Our next question comes from the line of Robert Finbar with Credit Suisse. Please proceed with your question.
Hi, good morning, everybody.
Good morning.
I'm wondering if we could disaggregate the space group space in airborne a little bit just the primes are having such strong growth there and I'm wondering if you are seeing higher growth in space and airborne. If you could talk about that a little bit and then if longer term on the space side, you think potentially outgrow the market just given the share gain.
Opportunities that you have in front of view.
Yes, so we feel very encouraged by the space business as a whole just in the quarter. We had a couple of programs that are transitioning in.
Just a year over year comp was it was particularly difficult in the second quarter last year end point in 2019, Q2, which as you recall was Q4 the last fiscal quarter of Harris now we had sort of 18, 19% growth in that space segment. So it was quite strong in the comp was that was kind of difficult just on a year, but.
Year basis, so little bit of impact on just Calenderization, we good book to Bill in the first half of the year just over just over one we were very confident about the about that business very strong pipeline of opportunities coming at us and space as we transition from an exquisite provider to a end and responsive.
Mission solutions Prime Chris talked about that in his remarks thats both ground both space capability in ground support for space capability.
The pipeline and add businesses is quite large it's about $10 billion, we have about a $1 billion or proposals outstanding net our pending awards. So lives with as we look at this we expect towards the back end of this year, we'll see some recovery, but but overall through the technology investments we've had some of the revenue.
Synergy opportunities that will come through in the space domain, we feel we feel very good about the opportunities in space. So that space segment also has airborne airborne has been quite strong for us.
Lot of the F 35 grow this monetization its production, it's some sustainment growth there as well so we see in our classified part of that space business is growing quite well. So look we feel very very confident about about space. It will come back towards the back into the year and be a driver getting into a 21.
Robin I was just chime in and you know one of the things that was very excited about this merger was space and of course pre merger you couldn't look at a due to clearances, but once we got all the clearances set up and I.
I got into the program several months back I got to say I'm, even more impressed now than than what I thought where suspected we had so.
I think we're in good good shape, we just got to continue to win and performance.
I think there's some long term growth here, that's going to be pretty pretty impressive.
Thank you. Our next question comes from the line of Myles Walton would you. Please proceed with your question.
Thanks, Good morning.
So I wanted to say other guys in this space and people in the space have size, the R&D tax amortization and 22 I'm curious if you can do the same.
And then secondarily on the.
On the segments I know that the pension.
Adjustment being made there was 98 million in the quarter.
Bill is there any.
Assumption about how much pension helps or hurts that you have to absorb going forward over the next couple of years and your comments about 18% margin next year and beyond.
So I.
Im taxes at the impact in 22 is north of $500 million. If the lost stays as it is as you know.
Others as well as us believe that that wasn't necessarily the intent of the legislation to penalize.
R&D investment and so that's something obviously, we're continuing to work, but just to answer your question specifically, it's what will be north of $500 million on pension. If you look at growth pension. This year, it's about $300 million will benefit.
Year over year is about $60 million is $100 million in the Fas pension benefit that's offset by about $50 million of lower Cas recovery. So net net youre talking about 50 60 right now.
We're not expecting any significant changes in pension benefits next year.
If we were strike it right now.
We'd be generally in line with data, maybe a little bit worse, obviously on the returns.
But but that gets amortized so right now we're pretty much holding holding the line there what I told you about $300 million Fas and $60 million of of cash.
Thank you final question comes from the line.
With Citigroup. Please proceed with your question.
Thank you very much for squeezing me in here.
Phil when you're talking our billing credits are talking about transition notes, which were operating company walled industry itself as it is in some transition we know what the NBS wants for capabilities can you talk about how it's acquired how those things are changing like investment requirement business models partnerships leveraging commercial you've got.
The prime out there with new leadership talking about new ways of doing business like Fiveg. Some of it sounds like stuff that you do so can you just expand on what the next generation of defense industry on me if it looks like here.
Well, John ill start and maybe Chris can jump in here, but the way I look at this without commenting on what other other players in this space happened to be doing we're we're very unique in a sense that we've got this opportunity that can only be created by this significant transformation driven by a merger you know it's a seminal event allows us to drive a clean sheet.
Okay and take a fresh approach about how you drive kind of activity cooperation collaboration across the enterprise and that's what we talk about we drive towards an operating company is from from from a technology perspective, and making sure all of the pieces are connected across across the enterprise.
We believe success in a future is going to come from driving our business as operating entities not as disconnected.
Pieces of an over an organization like a holding company would have so we have an opportunity to drive that is part of the DNA. That's been created in the organization that we're building we're not trying to start from from a from an existing large position but.
We've got good momentum that's built here and we feel pretty good about our ability to compete and win based on that particular model.
And I'd, just say from the customer perspective, and I will throw out the other customers have been.
Great here during the pandemic, I mean, bill and I pad.
Fettered access to them and there's been a lot of creativity, except in a lot of our products using the.
Video and virtual means and inspecting the products, but you know the customer talks a lot about a speed and you know they have rapid capability offices are using.
Either as an example, and I think we've been pretty good and responding and quick turns and winning some of these.
New business opportunities several of which our revenue synergies and again I think the mission systems are becoming more and more important and the customers are looking at maybe procure and those are directly from companies like us.
And Ah Theres several initiatives in that regard BMS and others. So I think we're well positioned and we can adjust to the customer they change their buying patterns and ER.
There's new business models, I think were more than capable to to support that so.
And then certainly theres not we're not beholden to a platform theres not a loss risk of loss of revenue from moving from proprietary to open systems. We're building the organization from the start with a focus on open systems architecture, which we believe is an opportunity for us and it's certainly what were geared to do.
So so I want to thank everybody for joining the call today and I'd like to close by again thanking our employees as well as a leadership team for their hard work for their dedication as we wrap up our first year as L. Three Harris infrequently meeting customer commitments during these very.
Challenging time, so thank you to everyone and be safe. Thank you.
Thank you. This concludes today's teleconference. You may disconnect your lines nine thank you.
We have a wonderful.
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