Q3 2020 L3harris Technologies Inc Earnings Call
Greetings welcome to the L. Three Harris technologies third quarter calendar year 2020 earnings call.
At this time, all participants are in listen only mode.
A brief question and answer session will follow the formal presentation.
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As a reminder, this conference call is being recorded.
It's now my pleasure to introduce your host Rajiv Lalwani Vice President Investor Relations. Thank you you may now begin.
Thank you Rob good morning, and welcome to our third quarter 2020 earnings call on the call with me today are Bill Brown, our CEO Cookie based type of course, he Oh, Jamie a lot a of course here. So first a few words on forward looking statements and non-GAAP measures are forward looking statements involve risks assumptions and uncertainties that could cause pack.
Actual results to differ materially for more information. Please see our press release presentation catastrophe filings.
Reconciliation of non-GAAP financial measures to comparable GAAP measures is included in the Investor Relations section of our web cast, which adultery Harris Dot com, where a replay of this call will also be available.
I'd say with year over year compatibility following yelp reverse merger the first half of prior year results will be on a pro forma basis with that Bill I'll turn it over to you.
Thank you regime and good morning, everyone. So two years ago. This month, we announced the merger of L. Three and Harris and thanks to the hard work and perseverance of our employees, we've been able to deliver results consistent with or better than expectations, despite market volatility and unforeseen obstacles white coated.
Their efforts have led to another strong quarter and put us in a position to raise our 2020 guidance.
The mitigation plans, we implemented earlier in the year to manage Koby 19 have proven effective in keeping our employees safe and our facilities open and will remain in place for the foreseeable future.
We also continue to support our supply chain through accelerated payments totaling over $200 million in the quarter and nearly half a billion dollars year to date and we expect these advances will continue in the fourth quarter.
Earlier today, we reported third quarter results with non-GAAP earnings per share of $2, an 84 cents up a solid 10%.
Company margins expanded 60 basis points to 17.9% on organic revenue growth of 4.5%.
And adjusted free cash flow was $726 million.
Our core U.S. and international government businesses were up over 7%, including double digit growth internationally.
Partially offset by cold weather related impacts on our commercial businesses that were down largely in line with expectations.
With another quarter of strong execution on our under our belt, we're improving our outlook for the year and increasing margins earnings per share and free cash flow to the upper end of the prior range, while narrowing organic revenue growth to the prior midpoint of approximately 4%.
It's worth noting that despite a pandemic headwinds we're back to the mid point of our initial 2020 earnings per share guide a testament to the benefits of the merger and our earnings power.
Integration activity continued to progress well and then in the quarter, we delivered net cost synergies of $50 million, bringing year to date savings to $165 million and well on track to meet or one or even 5 million dollar target this year.
At this rate will exit the year with 250 million, the net cumulative savings, which positions us to deliver at least $300 million net in 21, a year ahead of schedule.
Our E. Three operational excellence program continues to mature and become institutionalized and alongside cost synergies was a key driver of the 60 basis points of margin expansion in the quarter and 130 basis points year to date.
With our strong performance to date, we're increasing our margin guidance to approximately 17.75% for the year, a 100 basis point improvement from 2019, and a solid base to build on over the medium term.
As we look beyond 2020, we see three primary building block supporting mid single digit topline growth.
First we have a portfolio that is well aligned with national security priorities irrespective of the outcome of the elections.
Our broad C five ice our capabilities, our central elements in countering the near peer threats identified in the National Defense strategy resists.
Resilient Communications open architecture command and control offensive and defensive cyber and I saw it across all spectrums electro optical infrared Hyperspectral RF sonar and all forms of intelligence signals columns electronic and image.
We have leadership positions in many of these areas and operate in all domains and we realigned our R&D efforts to extend our position to investments and open architecture multi function software define technologies.
The security threats are real and we anticipate that future defense budgets will continue to prioritize spending in these areas, we are well positioned and we're investing.
Second we uniquely benefit from the revenue synergy opportunities created in a merger of two complimentary companies that expanded our addressable market.
This quarter, we received an additional 12 revenue synergy awards, bringing the total down select to proposals to 25 out of 37 for a cumulative value of over $300 million in initial down payment on our multi billion dollar pipeline.
Two recent wins worth highlighting or the space development agencies tracking layer, which leveraged legacy Harris has strengthened space payloads in integration with L. Three's onboard space avionics solutions.
The other is safe send a DARPA program to simulate and training for future multi domain battle that addresses the challenge of secured data sharing of highly classified sensors.
And third we see upside in international which had about 20% of revenue is underrepresented versus peers.
With that now larger for international footprint, we can better leverage our scale and extensive sales channels and capitalize on our domestic position to support global modernization efforts and extend our I guess, our leadership in the airborne land and maritime domains.
And as seen with recent awards this quarter to deliver Missionize aircraft, both Canada and the Royal Australian Air Force, we're making progress.
Our topline and margin opportunities along with our discipline around working capital and Capex support our free cash flow potential as well as our ability to return capital to shareholders.
We're off to a good start to date and now expect to deliver free cash flow of approximately $2.65 billion to $2.7 billion for the year at the top end of our prior guidance.
This performance coupled with the divestiture proceeds has enabled us to return over $1.3 billion of capital to shareholders in the third quarter, which puts share repurchases to date at $1.85 billion ahead of our full year 2020 commitment of $1.7 billion for the.
Full year, we now expect share repurchases to be about $2.2 billion a pace, we plan to sustain through next year.
Our portfolio reshaping, where about a third of the way through our bottoms up target of divesting, 8% to 10% of revenues and activity continues to be robust.
Criteria in strategy haven't changed as a result, the recent events, we continue to be patient and persistent as we look to maximize value and as previously stated we will announce divestitures as they occur with proceeds primarily used for capital returns.
So overall, we're executing well despite the uncertain times and with our unique revenue margin and cash opportunities. We remain focused on delivering double digit earnings and free cash flow per share.
So with that I'll turn it over to Chris to discuss segment results Chris.
Okay. Thank you Bill and good morning, everyone, Let's go to slide five.
Integrated mission systems revenue increased 6.2% primarily from growth in our maritime business as recently awarded Mandan classified programs begin to ramp up along.
Along with growth from our I guess, our business driven by strength in aircraft mission as Asian sales.
The modest decline in our electro optical business was due to timing of deliveries.
Operating income was up 21% and margins expanded 190 basis points to 15.5% from operational excellence and integration benefits, partially offset by higher R&D investments.
Order momentum at I am EPS was broad based with particular strength in maritime resulting in a segment funded book to Bill of 1.8 for the quarter and 1.22 year to date.
Our maritime business continued to build out its pipeline of opportunities following the medium unmanned surface vehicle Award a.
Additionally, the team finalized its position on the largest has the largest subcontractor on the U.S. Navy is frigate program.
We're playing a key role has a mission solutions provider for electrical propulsion and navigation systems.
The current 10 ship contract could exceed 300 million if all options are exercised.
In addition, the department of Defense recently reported its long range plan to significantly expand the U.S. navies manned and unmanned ship count to over 500 with.
With the greatest increase planned for unmanned vessels with our experience and capabilities in both platform types, we are well position to support the Navy's growth.
Turning to space and airborne systems organic revenue increased 6.8%.
Growth in our avionics business was driven by the production and modernization ramp on the F 35, and increased classified work at Intel and cyber.
These were somewhat offset by program timing in the space in electronic warfare businesses, which based on recent awards, including the F 18, I dekom contract position us for growth in the coming quarters.
Segment operating income was flat and margins contracted 110 basis points to 18.5% as integration benefits and operational excellence were more than offset by program mix from recent wins.
Overall funded book to Bill was 1.04 for the quarter and 1.05 year to date with key awards received in our space avionics and electronic warfare businesses.
As Bill highlighted our space business was one of two awardees for contract with the space development agency to develop and integrate and end to end system of four satellites, where we are providing both the boss and mission payload validating our space strategy to become a mission solutions platform.
This system will provide warning and tracking of advanced threats, including hypersonic missiles.
The initial satellites will be launched within the next 24 months and support the tracking layer of the D.O. These missile defense network in space.
Once fully operational there could be a demand for many more satellites, but the value well into the billions leading to the next space based franchise for our company.
We expect to build on these opportunities in the near to medium term with the space pipeline of over $10 billion and opportunities.
Next communication systems organic revenue was up 6.7% for the quarter driven by tactical growth in the mid teens, which included international growth of about 20%.
The Middle East Europe, and Asia Pacific provided most of that growth.
Both the tactical and integrated vision systems benefited from continued modernisation demand.
This strength was partially offset by our public safety business due to COVID-19, which was down consistent with expectations in the mid teens.
Segment operating income was up 17% and margins expanded 230 basis points to 25% from operational excellence integration benefits and cost management.
Funded book to Bill was about one out for the quarter and 0.94 year to date and was particularly strong in tactical communications at over 1.1 for the quarter.
This was driven by an initial full rate production award on the U.S.. So comps multichannel Manpack program as part of the $255 million sole source aidid IDI Q, an important milestone for this multiyear modernization strategy.
We also saw healthy activity on the international front, including customers in the Middle East, where we continue to build out our installed base and identify new opportunities.
Lastly, aviation systems organic revenue decreased 4.1% as the anticipated COVID-19 related impacts in commercial aviation were partially offset by consistent strong performance and defense aviation products, which was up high teens and mission networks, which was up.
Mid single digits.
Operating income was down 919% with most of the decline, resulting from divestitures, while margins contracted 40 basis points to 13% as integration benefits operational efficiencies and cost management were more than offset by COVID-19 related market headwinds in commercial aviation.
Third quarter funded book to Bill was 0.94 following strong first half orders, resulting in a year to date funded book to Bill of 1.08.
Award activity was notable on several ground vehicle programs from the deal D. and international customers for our power and propulsion systems, which total approximately $150 million.
In addition, we recently announced that we're a partner with Northrop on the U.S. Air Force's GBSD program for operations and maintenance training systems, highlighting continued progress with next generation programs and platforms.
Now over to Jay who will discuss the financials in more detail as well as our guidance. Thank you, Chris and good morning, everyone.
I'll begin with a quick recap of third quarter results and that shift over to our updated outlook.
In the quarter organic revenue was up 4.4% and margins expanded 60 basis points to 17.9% as the benefit from synergies more than offset higher R&D investment.
Earnings per share grew 10% or 26 cents as shown on slide nine.
While this growth synergies and operations contributed 24 cents, along with a lower share count for 13 cents, which more than offset headwinds from divestitures and pandemic impacted end markets.
Free cash flow for the quarter was $726 million and we ended the quarter with 55 working capital base holding the strong first half improvement of seven days.
With year to date organic revenue growth, just over 4% and margins of 17.9% along with 5% higher backlog Oethree Harris is set up well to close the year. So.
So, let's turn to slide 10 to cover our updated outlook.
Organic revenue is now anticipated to be approximately up 4% or at the midpoint of our prior range with the topline trending largely as expected.
Our core U.S. government businesses continue to perform well up about 7% year to date and to provide you with the tactical radios Maritime mission avionics and classified growth at Intel and cyber and defense aviation products.
On the international side, the business returned to growth in the third quarter up double digits, which sets up for for flattish year or better supported by a SAR and international tactical radios.
And finally this guidance reflects about a two point impact from our commercial businesses due to the pandemic in the range of our initial assessment.
Shifting to margins.
We have revised our outlook to approximately 17.75% a 25 basis point increase versus our prior expectation from better cost performance and mitigation of coated impacts.
EPS, we are raising our full year to approximately $11.55 at the top end of our previous range and consistent with the midpoint set at the beginning of the year.
As shown on slide 11, the increase of 20 cents from the prior midpoint is primarily driven by 13 cents of improvement in operations, including our mitigation efforts plus seven cents between a lower share count and other items.
Moving to free cash flow, we now plan to deliver approximately $2.65 billion to $2.7 billion or the upper end of our prior guidance driven by higher net income and Capex discipline.
This keeps us on track to deliver our 2022 free cash flow target of $3 billion in double digit annual growth on a per share basis.
I capital returns, we returned over $1.3 billion to shareholders in the third quarter with 1.15 billion of share repurchases and $175 million to $179 million in dividends.
Year to date total buybacks were 1.85 billion well ahead of our prior target of 1.7 billion for the year.
With an elevated cash position and solid cash generation anticipated in the fourth quarter, we now expect share buybacks for the year to be around $2.2 billion.
And we expect to continue our shareholder friendly capital framework into 2021, as we normalize our cash balance generate healthy cash flow and continue shaping our portfolio.
Now switching to our segment outlook.
In integrated mission systems, we now anticipate revenues up approximately 6% for the year.
In the prior range of a 5.5% to 7% driven.
Driven by growth in SAR and maritime.
Segment margin is now expected to be about 15% up a 150 basis points versus the prior guidance driven by solid program performance and cost management.
At space and Airborne systems, we know, we're now guiding to organic revenue growth of approximately 7% within the previous range of up 6% to 7.5% as higher F. 35 revenues continue to drive mission avionics second.
Segment margin guidance remains unchanged at approximately 18.75%.
In communication systems organic revenue growth is expected to be approximately 4% and within the prior range of up 3.5% to 5%, mainly driven by modernization strength in DLD tactical radios.
Segment margins are now expected to be about 24%, a 25 basis point increase from our prior guidance, primarily from richer mix related to our tactical business and cost management.
And lastly in aviation systems, we now anticipate revenues to be down approximately 3% on an organic basis versus our prior range of down 1% to 5% consistent with our prior estimates in the commercial Aero business, partially offset by double digit growth on the defense side from classified in other programs.
Segment margin guidance remains unchanged at 13.25%, reflecting the timely and decisive actions to mitigate commercial aero headwinds.
So overall, we delivered solid performance in the quarter and year to date and now expect to deliver results consistent with our original EPS and free cash flow guidance set back in February.
Before wrapping up I would like to briefly touch on our outlook post 2020, we will provide 2021 guidance as we typically do with fourth quarter results don't know we remain confident in our framework of annual double digit growth in earnings and free cash flow per share as the building blocks remain the same missing.
Mid single digit topline growth steady to rising margins working capital and Capex discipline, and returning our free cash flow to shareholders through buybacks and dividends.
With that I'll ask the operator to open up the line for questions.
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One moment, please while we poll for questions.
Thank you and our first question is from Mike Walton with EUV. Yes. Please proceed with your question.
Thanks.
Good morning, everybody you increased the repurchase effort by a half billion directionally closer to sort of your pre covert capital return level of 3.5 billion, but but not quite there yet im just curious is there anything that would hold you back from going that much higher and then more philosophically.
Phil or Chris as you look at capital returns through dividends and repurchase do you have more headroom here to maybe push the dividends a little bit harder and do you think that would be more appealing to investors. Thanks.
So Myles I'll start on the second one and maybe I'll ask Jay to come back on the first one on the on the buyback look on capital returns we.
Philosophy really is a 100% of our free cash flow coming back to owners and in purchase repurchases or dividends and we see that through next year, we've been leading pretty heavily into share buybacks and jail talk and then about our philosophy there.
Based on our share price, we think that that's a good good value, we do see our our dividend with some room to move up we have been up about 25% and our dividend rate since close we raised it twice once at close and once at the beginning of a beginning of this year, but at about 20% of our of free cash flow being paid out it's below the bottom end of our.
Range and we expect to take a hard look at that early next year, and probably lead a little bit heavier into our into our dividend, but broadly all of our cash will come back to owners plus divestiture proceeds has through at least next year, Jay will talk about the buyback sure miles in the third quarter, we increased a little bit relative to the proceeds of about $150 million.
You just do the math that would say $350 million here in Q4, you can back into our free cash flow for the for the fourth quarter and Weve dividends were approaching kind of the framework that Bill just mentioned as far as returning to free cash flow.
To shareholders, yes, there could be a little bit more room. There I mean, our balance is elevated were $1.3 billion at the end of September.
Given where we are with the guidance. We just gave you we would expect the balance to continue to make remain elevated in December and so there could be opportunity. There. We're also evaluating other items, which include includes some pension contributions, but so we're leaving our optionality open a little bit, but if it doesn't happen in this quarter than it would carry over into next year.
Thank you our.
Our next question is from the line of Sheila Kahyaoglu with Jefferies. Please proceed with your question.
Yes, hi, guys have shines mutant hero live for question sorry about that.
Thank you. Thanks for the question and good morning, I wanted to ask about just integration activity clearly, it's been performing really well and EBIT was up 32 million in the quarter, but ex synergies. Your incrementals were about flat and then the implied incremental for 2021.
Ex energy that's 20%. So how are you thinking about maybe incremental going forward outside of synergies and what changes with mix going forward.
Thank you.
So Sheila it's a great question. If you if you think about it maybe in kind of a little bit bigger picture. We end the year. This year will be at 77 five for the year around that ballpark we.
We do have incremental synergies next year $50 million that equates to anywhere from 25 30 basis points of expansion. Our core Athree productivity is obviously going to be a driver for us, but we do have some mix headwinds that we'll be dealing with and we deal with that every year and so our intent always is to drive more than the mix headwinds.
But I think for now right now as we're continuing to go through the planning offsetting one for one is where we stand at the moment do thing I'll say is that we will see a little bit of a headwind in Q1 because of the just to roll through of the commercial the pandemic related impacts rolled through the four quarters and so that will put a little bit of pressure on Q1, which will also have an impact obviously on the full year.
But but having said that I think mix is something we just to keep an eye on but.
But our core Athree productivity is intended to offset that on a run rate basis and drive once we get beyond the synergy period in integration period. Our core three operating excellence program will continue to be a driver of margins for us.
Our next question is from the line of Kristine Liwag with Morgan Stanley. Please proceed with your question.
Thank you good morning, everyone on Bill and Chris what drove your narrower 2020 revenue outlook and I know, it's still too early to talk 2021, but how much of your expected 2021 revenue is already in the backlog versus what you need to go out and win.
So right now as you'll see in the queue are funded and unfunded backlog at the end of Q3 was about $20 billion and you'll note. They're about two thirds of its 65% rolls out through calendar 21. So we think that that part of our business is pretty pretty solid we've got a very good pipe.
Turning $69 billion, it's come up over the last quarter, it's come about.
Eight or 10% since the beginning of the beginning of the year. So it continues to continues to grow be very robust.
And as we look into next year and to Jays points about mid single digit growth, we see good solid growth in our core U.S government businesses, you've heard a couple of our peers talk about low to mid single digit growth. There we will add on top of that with revenue synergies that we've talked quite a bit about we see international.
Growing it's a growth business for us here in the back half.
Book to Bill was very good the pipeline is really strong internationally, we see that being a contributor into next year and certainly as Jay just mentioned about commercial it'll be a little bit of a headwind until we lap one year on coated but but the other dimensions will be pretty strong going into next year.
Thank you.
Our next question is from the line of Seth Seifman with Jpmorgan. Please proceed with your question.
Thanks, very much and good morning.
Maybe two areas following up there to talk about growth.
One is in space I know, Chris you mentioned a lot of the the opportunity is there.
Is there a point in which we should see the maybe the book to Bill step up even further and the backlog start to grow a little bit more on that.
And then you just mentioned the international opportunities are those principally.
On the tactical radio side or are they crossed.
Answer avionics or or other areas. Thanks.
Hey, good morning, Seth I'll take a take a first shot of both of those so in space, we are going to be seeing the the book to Bill increase.
We talked about some of the key wins, we had here in the third quarter, we talked about our strategy to be a mission solutions Prime and it's really taken traction here. The Sta win was a big one theres some opportunities coming down the pike.
In the fourth quarter, a fair amount of them are in the classified world, but you'll be able to see that in the quarters ahead as bill said on the international side, we do have a strong pipeline of good book to Bill.
The tactical radios are going to grow.
That represents about 20%, 25% of our international revenue, we're really seeing it across the board. The SAR platforms are doing well with the aircraft mission as Asian and of course, the maritime business. So, it's it's pretty well spread out across the portfolio and the domains.
Our next question comes from the line of caution Khanna with Cowen. Please proceed with your question.
Good morning, Thanks, and congrats on the Sta win.
Good morning.
Guys I was hoping you could elaborate on the revenue synergy opportunity.
If you.
The the Sta when it seems like that was a.
Kind of establishes a new franchise for you guys are there other kind of new franchise setting opportunities within that pipeline that you could maybe elaborate on so we could think about growth beyond 21, as well and would you be willing to opine on where you think.
The topline will shake out in terms of growth rate in 22.
Well first of all on 22 is a little bit further out in the future, but I might have maybe.
Maybe ill answer the first part of the question as Chris thinks about if he wants to give any guidance on 22.
But we're making really good progress on the revenue synergies and I think this has been.
Pleasant surprise all of us in terms of the pace and magnitude of getting at revenue opportunity thinking points to the strategic rationale the combination in the complimentary nature of the technologies that we're working on so again were about 80 proposals that have been submitted.
It's come up from from Q3, we're winning quite a few of them 25 out of 37 is pretty healthy with $300 million of awards, we talked about a couple of these are some of the certainly the EPS. The win is one of the bigger ones, but generally speaking they're going to be in the space domain electronic warfare something.
Some in maritime and there's quite a lot is happening in the classified domain as we said over multiple calls.
One of the things that was unique here is as we put our companies together, we got a lot of input and feedback from our classified customers, who really see across our portfolio and across other missions across all the companies and we're really giving a strong guidance as to where there might be opportunities to combine capabilities within L. Three Harrison and the team is working.
Very hard to put together some compelling proposals and we continue to win so it's it's modest growth. This year. It will start to grow next year and be a good contributor in 21, and certainly more beyond that so it'll grow to hundreds of millions over the next year or two which I think is a very positive sign for not just winning.
In them, but actually seeing them come through in in revenue opportunity. So so so I am really really pleased here got them on on some of the revenue synergy intellect, Chris maybe answer the question on 22, if he wants to take a stab at that one absolutely no I agree with Bill we've really outperforming here on the revenue synergy and overtime and.
Probably by 2022, you know the business development pursuits, and as the business integrates these things are really going to be merging and part of our our overall strategy. So I'm I'm thinking by the time, we get the 22 23 I'm not sure we're going to be calling these out what it is going to do is give us higher confidence in our growth rate that we've already.
You talked about so.
I'm I'm looking for good opportunities and year over year growth improvement relative to revenue synergies, but over time, it's just going to be merged and part of our normal processes I think Jay Jay's comment about the mid single digit framework kind of expand spans more than one year.
Thank you got it.
Our next question comes from the line of David Strauss with Barclays. Please proceed with your question.
Thanks, Good morning.
Good morning.
Bill.
I get this question a lot from investors so thats.
Ill.
There is this perception that.
Your portfolio is a shorter cycle than your than your peer group I guess.
How much of your portfolio is short cycle converting from.
Backlog into sales just within 12 to 18 months and in June you know your portfolio, a shorter cycle and I guess more risk than your peer group to.
To lower budgets. Thanks.
So David Thanks for the question look as I mentioned earlier about two thirds of our backlog coming out of Q3, what you'll see in the Q is around 20 over $20 billion funded and unfunded rolls out over the next year.
And what I've seen over time is it's hard to compare our portfolio sort of short long cycle versus peers, but certainly it has lengthened over the last several years as some of the programs that we worked on specifically in tactical radios have moved from sort of a book and ship.
Turn to replenish spares were or radios in in EPS.
Rack in Afghanistan to now being fundamental long term programs of record, which a lot more longer visibility in terms of the buying pattern. The the spending outlook. So so we certainly see our portfolio being longer term than we were several years ago and certainly we are combining with L. Three I think puts us in that position as well so.
Again, I think our portfolio is very is very sound its robust, we're well positioned and we will be well positioned to grow into next year.
Thank you.
Our next question is from the line of Pete Skibitski with Alembic Global. Please proceed with your question.
Hey, good morning, guys.
Bill could you maybe talk at a high level about these these new concepts as Amy Madison Jed C to I think you have some bids in there and they seem pretty well.
Well supported in DMD.
I just wonder if you could maybe size the opportunity set for you. There is still a little nebulous and maybe talk about timing just just maybe level set us on your expectations.
So it's a good very good question looking and I took some pains of my comments to talk about the broad set of Cfive eyesore capabilities added across the company and when you break down see bias in the highest saar into its components in domains different sensing technology, we've got a very strong position across all of them all of which.
Each are essential in enabling this jed C or joint all demand commanding control vision of the future. We are we were a strong player. There I think the BMS weve lots of players on on the Q, but we are across all seven business areas, which is somewhat unique we had content on project convergence, which.
This is sort of the army version of that and in partnership with the Air Force, We had a lot of content there and we hope to see more as it gets into the next version of it next year, we're very strong in maritime and distributor Maritime operations. So we believe this is a a strength of ours. We've guide very strong capabilities in Com Brazilian communique.
Regions, which is developing very strong resilient waveforms L. Three was had a strength there we had a certainly a strength. They are very strong I as far so to me you will right in the middle of this and I think its fundamental that huge ATSI to that vision that concept is going to be required in the near peer competition is going to be more.
About the capabilities on platforms and how they interact operate as opposed to the platforms themselves and when I think about this powerhouse that we've created here at L. Three areas. Pete I think will revenue rate can be in the middle of it it will grow over time. This funding there and we are confident thats going to be a driver for the company over overtime, it's hard to size. It today, but we believe is.
And to be pretty important.
Thank you the.
The next question is from the line of Richard Safran with Seaport Global. Please proceed with your question.
Good good morning, everybody how are you doing.
Good morning, Richard.
Just a very quick question here on R&D.
I wanted to ask you about your opening remarks on on on research and development given.
Given the number of wins.
The fact that your win rate has been increasing and your remarks I want to know how you're thinking about R&D longer term if.
If you think it could be ratcheted back a bit do you need to spend more R&D to support the increase increasing win rate on programs or are you really just about the right level right now.
Hey, Richard Thanks for the question, because I think you're hitting on a very important topic and that is the power of the I read that we spend in the work that's happened over the last five quarters, we're spending in a 3.63, 0.8% of our revenue in that in that range, we think you'd sized well and I think more importantly, what what the team has done is worth.
Very hard over the last five quarters to make sure. It's spent on the best highest value highest return opportunities and focusing that spear recall, we call erad.
We've reduced the number of projects by about 30%, we moved about 10% of the dollars around to really be placed on the on the technologies. The areas that we think we have the best returns are aligned to revenue opportunities revenue synergies.
The second element of it is making not just putting the money we're spending on the right project, but also doing it efficiently. So we've got good opportunities to drive operational excellence skills into the way. We developed products you were pushing hard on digital engineering on Dev ops in with a lot of work is software development, there's lots of ways to improve.
Prove the effectiveness of our R&D spend and to me. This is going to be a very powerful driver of growth in the future I don't see stepping up materially from where we're at I think it's a good amount it will come up with revenue and in terms of a dollar perspective, but but I think we're spending a healthy amount on on R&D.
Thank you. Our next question is from the line of Doug Harned with Bernstein. Please proceed with your question.
Good morning.
I want to I want to go back really to the budget here with when you look across the portfolio.
Trying to understand how your businesses are affected by end strength in forward deployed and strengthened.
Change is really aren't in the plans right now it's in terms of lease basic number if let's say army troops, but.
We're about to have an election so.
If we were to see military personnel reduced in the coming years, how would that affect you and I'd add.
The same thing.
For changes in forward deployed troops such as moving troops out of there.
Afghanistan, Iraq or elsewhere, when you look across the businesses.
How are you tied to those levels.
So Doug I'll start here, maybe going to ask Chris to jump in I don't think.
We're going to be much affected by redeployment of overseas trips back on shore I don't think it's going to I don't think that's going to be a big driver of growth either top headwind or tailwind on end strength. It would come back to things like businesses like night vision goggles or radios, where those are just.
Attributed out to individual soldiers, but frankly, we're on the front end of a modernization ramp even through the next five years, we're not even 40% through the monetization ramp in that with radio so even the bench strength comes down as I expect it likely will I don't think it's going to affect the growth rate in our.
In our radio business I think you were so far underpenetrated with new technology, both night vision as well as radios that we still see good good growth opportunities. There. So if anything we do stand string might actually free up some dollars to be put on to modernization investments that will really affect the broad part of our business, Chris you want to.
Yes, and if there is a reduction in the forward deployed troops I mean, you look at the rest of the portfolio Dugan situational awareness is going to be critical. So you look at the IR SAR assets that we have both in space and air and and the need as bill talked about for the multi domain comps it strengthens the.
Rest of the portfolio. So I'd look at it as kind of a net net push or may be a slight positive. When you look across all four segments and the same theory applies internap.
Internationally, there's just a lot of need for communications and situational awareness. So our I guess our capabilities both in space Air land and maritime are well positioned.
Thank you.
Our next question is from the line of Noah Poponak with Goldman Sachs. Please proceed with your question.
Hey, good morning, everyone.
All right now.
Hey, guys, so kind of every quarter since the merger, we sort of all get on these earnings calls him quite.
A question you on the sustainability of your growth rate and ask about short cycle and the OEM exposure.
And I think those are sensible questions on and you guys provide no decent answers to those that have some conservatism, but are mostly qualitative in nature.
And you know after every one of those conversations the stock just de rates.
Moving sideways lot, while you are performing well and the numbers are going up and so.
I guess I wonder how much are you all talking about that internally in terms of.
So a different way to start from scratch and re frame. This for for investors. I mean, you you talk about the.
Handful of franchise as you have you know the defense budget is broken down into a handful of franchises is there a way to sort of.
While while still giving detail like Super simplify this so that people can see auto legit three to five year basis, you really can keep growing mid single digits, because otherwise it just feels like.
We're just sort of circling back to the same things every quarter I don't know I mean, maybe there is no good answer to that and you just have to keep performing and the stock eventually matches to the numbers, but I was pretty curious if you guys talk about that or think about that internally. If you could share any any thoughts with us.
Well, yes.
No I think could comment on some of the New awards that we talked about is just I think it demonstrates is illustrative of our positioning for the modernization trends that we're seeing going forward and so while people may want to focus on an open end budgets and historical tactical radios.
The New awards that were winning are really positioning us well for the trends that we're seeing in terms of defense priority spending and so I think you should lead as Bill mentioned think about our our portfolio and our revenue potential more in that broader context.
And that's what gives us confidence in our mid single digit growth over and we're seeing this in our New awards right now.
Our next question is from the line of Robert Stallard with vertical Research partners. Please proceed with your question.
Thanks, so much good morning.
Hey, good morning, Rob.
You've mentioned defense export side, a couple of times. This morning, and I think early this year you were suggesting this area could be a bit slower but that doesn't seem to have happened sooner. If you could comment on what changed there and also looking forward and maybe to follow on on Noah's question, how big could defense exports be as a percentage of sales going forward.
So yes, as we talked earlier this year right. After I think it was Q1, maybe Q2 as we looked at the international business, we saw being more flattish for the year, we saw the first half being down a little bit the back half growing.
And being about flat for the year.
Q3 came in strong like we had expected it would a little bit better than we had thought so it could be up a little bit to a flat to up low single digits internationally. So a little better than we saw a couple of months ago International Tactical has come in almost exactly as we had expected to see the numbers of 21% in the third quarter, we expect the fourth quarter up the Sims.
Lower amount so we see good recovery in that business in a lot of its middle East Europe Asia Pacific, mostly Australia, New Zealand. So there's there's pretty good growth in tactical and we've got a nice pipeline of opportunities I think the numbers about $20 billion of international opportunities. The book to Bill year to date over one, but 1.06 or so.
We see the fourth quarter looking shaping up to be pretty sizeable in terms of book to bill looks pretty good.
About $3 billion of of those proposals that are out there. Our pipeline is in proposal. So it's actually getting to be more near term. So it's looking a little bit more encouraging than we thought just a couple of months ago, I think Chris and the team are putting a lot of focus on this we have resources in place going after 10 focus countries and we're starting to turn the corner. So.
So we're at 20% roughly in terms of our revenue we expect it's going to grow.
Several points over the next number of years on a Chris if you want to state.
Stated goal, there, but but it's going to it's going to come up from where we are because it's under represented in our portfolio today, Yeah. I think ultimately the next target would be closer to the 25% of revenue over the several several years and you know what I like about our.
Our company is the portfolio and the demand for our products and when you export there is always a focus on offensive versus defensive products, especially as administrations look at approving these exports and when you look at our IR capabilities the maritime capabilities the radio to comps those are generally.
Easier to export and approved.
Regardless of which administration is running the country. So I think that that gives us a lot of confidence and we've been able to stay in touch with our customers. We have executives forward deployed full time in the focus countries and all of us have been using new technology to called zoom and stay in touch with our customers really on a.
On a weekly basis, and that's that's working well, we're negotiating contracts for the of zoom and continuing to keep the business running so very optimistic on international.
Thank you. Our next question is from the line of Peter Arment with Baird. Please proceed with your question.
Hey, Good morning, Bill Chris Jay.
Nice results.
Bill I guess on the working capital you've given us a lot of details I just kind of a clarification that is a seven day improvement year to date.
The number in the <unk> is that a good kind of I guess pacing item as we think about your goal to get to the low fortys as we think about next year and into 2002 to hit that kind of $3 billion free cash flow target. Thanks.
Yes. Thanks, Peter you know seven days year to date, it's about 30 days operationally since the close of the product divestitures and and purchase accounting, we will see towards the back ended the year, we'll probably stay right on 55 days. So you won't see seven days improvement over three quarters as they continue pace into the future we see the 55 dropping below below.
50 over the next couple of years three to four days per year that gets us to the $3 billion goal in in calendar 2002, we still see an opportunity to get down to the low fortys or about 40 days certainly.
Certainly that's where legacy Harris was we've seen our peers at that point. So so even after calendar 20 to 47 48 days, we see opportunities continue to prove working capital beyond that as I said last time and we've talked about this a number of times a lot of its going to be on inventory that we've got a lot of opportunity here, we know where its at we've got.
10 businesses that were really focused on that drive 75% of our working capital six with more than 75 days. So we so we know we're focused we're driving it hard we review. These every single week and you can see the progress and trajectory that we happened to be on so again about three to four days a year beyond beyond calendar 2000.
Thank you. Our next question is from the line of Jon Raviv with Citi. Please proceed with your question.
Good morning, Thank you.
I know talked a lot about margin going above 18% with the synergy drop through offsetting the next but there's been some conversation over the last month or so about a long term opportunity for 20% margin. What's your perspective on how you get there is it all on your control or do you need some customer behavior to change and then also if we're going to get there is it linear.
Or could there is something could something big pop up in a given year such that you have to make a big investment margin could step back for a year or two and then kind of kind of getting that margin expansion growth trajectory again, so more of a long term question there around margin. Thank you.
Hey, John look it's a good question I think we are really performing better than we had expected on margins even through this year keep in mind. We started the year I think guiding to 17 to 17.5 and now today. It's 17.75, so in an era of Cobra, which actually dinged us about 40 basis points. This year. So we perform.
I mean, very very well it comes through the synergy dropped through comes through operational excellence, which is maturing at it at a fast fast clip Jason.
James talked about 18% or so next year. He gave you some of the drivers will go up beyond that it will likely move up I don't know if when it will hit 20% I think the key thing to be thinking about is we got to make sure that we're we're leaning into two to go after and drive revenue growth capturing them opportunities, which might have a near term.
Short term impact on margins, but long term be good businesses for the overall enterprise, we got to make sure. We continued to invest at the level required to grow the business on a long term basis anyone could easily pull back investment like I read and drive margin up in the near term, but be detrimental on long term value for the owners and they get there.
Work to pedals here and I think we do this very very effectively so we can't commit to something beyond next year, but will contribute we will commit to continuing to work the agenda to drive hard on on technology investments, we've tried differentiation and good cost management lean productivity across the whole company.
Thank you.
Next question comes from the line of George Shapiro with Shapiro Research. Please proceed with your question.
Yes, I wanted to know.
What's the progress payment benefit you've gotten this year and then how much benefit from payroll.
Federal and is that inhibiting getting to the 3 billion of free cash flow next next year.
Im assuming capex, probably is no higher next year than what you're saying this year. Thanks.
Sure George Thanks, the the progress payment benefit to shares in the range of say around close to $100 million in that ballpark, maybe a little bit lower than that that when we basically have offset with some small supplier payments and so it's just one for one as its come in we really pushed.
Up supplier payments out on on the payroll tax benefit that's kind of a $150 million plus enough ballpark similar type of effort, we've kind of put a place holder there to support supply chain there as well that as you know will be paid back over two years 21 and 22.
But I would say is as it relates to kind of longer term targets in our $3 billion target there.
The number of puts and takes as risks and opportunities. We've got that factored in we feel good about our ability to generate continued working capital improvement and we don't see that getting in the way of us getting a $3 billion and 22.
Thank you. Our next question is from the line of Ron Epstein with Bank of America. Please proceed with your question.
Hey, guys good morning.
Ron.
Bill just filled up so following up on.
One of your your early comp earlier comments.
You gave us some color on the growth and classified and can you give us more detail on that and.
You mentioned that that's a big area for synergies and I realize it's it's classified right. So it's difficult, but can you give us some more fuel around that and then also.
How many more opportunities are there out there can you share the growth profile and what percentage of the overall business is classified today.
Okay. So let me hit on a couple of points there Ron.
But you're right. It's a lot of its classified terms of his natures, but it's about 20 by 20% of our total company revenue.
Is classified as you know the classified budgets, both military and National intelligence programs.
Those budgets have come up over the last five or six years, there at a very healthy level and that does offer some some cushion. If you will as you go into the next several years. If there is more pressure on the non classified deal de budget money tends to move and be well supported in the classified domain and even the elements of that what's in the classified.
Budget was around 85 billion plus or minus between military and national intelligence programs.
The elements are actually moving in a direction, which we believe supports a lot of the investments. We made so lot of we focus on is in this space domain various new technologies for optics RF systems.
Driving to larger constellations from prototypes running a full end admission solution. I think was an interesting element of this is is historically a lot of the space domain was was dominated by the intelligence community, but because of the lower cost faster time to market more onboard processing of our sales.
All satellite, it's opening up new markets within the deal D.. So the Ics the addressable base for us is actually expanding so thats, helping us quite a bit so it's really on the space domain, but there's plenty of other classified opportunities.
On the on the land in maritime domains as well, we've got a strong position you really across all of them. So its hard to shape them, but it gets back to the comment I made on the strength of Sci Fi bias Saar and a lot of the things that we do in the classified domain leverage off of that we hone technologies advanced technologies, and then you can leverage that.
That benefit into the non class environment, and that's been a strategy of the company for a number of years front and its worked pretty well.
Thank you.
Final question comes from Rob Spingarn with Credit Suisse. Please proceed with your question.
Hi, Good morning, Thanks for squeezing me Ed So bill just following up on that it seems like the competitive landscape for some of your work is changing a bit there is some public companies and government services that are increasingly moving into common DW and then you have some private companies, especially out on the west coast like Anderle annuity.
Ease and Spacex and small sats and the Air Force is also encouraging new contractor formation business formation. So.
Ultimately would you accept the premise the competitive landscape is changing how do you negotiate this into potentially flattening budget and how much will M&A factor in.
So it's a very very good question. So the landscape is changing we are seeing greater penetration of some of the.
Western companies Silicon Valley Company Space X., you mentioned as you know they were one of the award ease of the Sta tracking layer, we could follow what theyve done in commercial launch in which Starlink and other things. So they are they are playing more theres a number of the companies you mentioned a few of them.
There are some more typical government contractors, who are looking to expand what they do into from services to other components. So.
So the market is moving around at least we get it the way. We stay ahead is basically running our strategy winning our game, which is really strong investments in performance in in R&D and technology.
Moving quickly Theres really nobody that's put up a small sat with the capability. We had in the timeframe. We've done it and just in the last couple of years and I guess the way. We stay ahead, we continue to drive cost out drive operational excellence improve quality and meet our program objectives. I think if we do that and we continue to accelerate the pace at which we can.
Execute on our programs and technologies, we're going to stay ahead, and I think thats, what we need to do will M&A play a role in that maybe over time right. Now we're focused on integration on portfolio shaping but as you go out in time, there could be pieces of other companies or things on the market that could become a could become available to fill the gap in our port.
Folio, we will see that today, but that's very possible in fact, it's probably likely it's going to happen over time, but today, we're focused on running our game and I think thats been an effective effective strategy. So Ron thanks for the Rob. Thanks for the question was very good I really appreciate that.
So let me just let me just wrap up from here the I want to thank again the L. Three Harris team they've done a fantastic job of staying focused on meeting our customer commitments. They worked very very hard and that hard work has led to another quarter of very strong results were well positioned coming into next year into the year end and into the coming years.
And I look forward to our next update thank you very much everybody for joining us today. Thank you.
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.
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