Q4 2019 Earnings Call
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Brian Healy B R Y and H E U line.
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I'd like to turn the conference over to your host for today and are at a much worry vice president of Investor Relations. Thank you you may begin.
Thank you Dana good morning, everyone and welcome to our fourth quarter fiscal 2019 earnings call.
On the call with me today is bill Brown, CEO , Chris Cubics, CEO and Jim Alavi CFO .
First a few words on forward looking statements discussions today will include forward looking statements and non-GAAP financial measures.
Forward looking statements involve assumptions risks and uncertainties that could cause actual results to differ materially from the statements for more information. Please see the press release, the presentation and our SEC filings.
A reconciliation of non-GAAP financial measures to comparable GAAP measures is included in the quarterly materials on the Investor Relations section of our web site, where a replay of this call also will be available.
Our supplemental information for investors discussions also will include selected L. Three and Harris combined financial information, which combines the historical operating results as of the businesses I'd been operated together on the basis of a newly announced four segments structure during prior periods, but excluding the operating results of viruses night vision business nail threes divested businesses.
With that Bill I'll turn it over to you.
So thank you Andrea good morning, everybody.
I am excited to welcome you to our first ever L. Three Harris technologies earnings call.
I'm also pleased to welcome our new Chief Financial Officer, Jay Malave, who joined US on July Onest from United Technologies, where he most recently was CFO of carrier.
Prior to that Jay spent more than 20 years in the aerospace businesses, including as CFO of United Technologies Aerospace systems and working the integration of the Goodrich acquisition.
Many of you know Jay from his time, leading the Investor relations function at United Technologies, and I'm thrilled to have him on board and confident he will be a strong business partner to me, Chris and the rest of the management team.
As you are aware on June 29th in fact in minutes. After we ended Harris's fiscal 19, we successfully completed the transformative merger establishing L. Three Harris technologies, and we really hit the ground running.
On the first working day after closing we consolidated headquarters activities between Harris and L. Three and announced our new organizational model, creating for mission focused segments that combine the top talent of both companies.
In the first week, we completed 115 town halls, with senior leadership touching 80% of all employees.
And then in the second week, we held a multi day leadership meeting, where Chris and I shared our joint vision values and operating philosophy with nearly 100 executives and then set our initial game plan and I had to say that the level of energy and excitement across the company is extraordinary.
So we're off to a good start as a combined company will talk more about that in a few minutes, but let me first begin by providing an update on Harris is fourth quarter and fiscal 19 results followed by Chris with L. Three's Q2, and first half results and then Jay with combined L three and Harris financials and guidance.
So starting with Harris on slide three we ended fiscal 19 on a high note with fourth quarter non-GAAP earnings per share up 39% on revenue growth of 12%.
The highest topline growth we've seen in eight years.
Overall company margin in the fourth quarter expanded 80 basis points to a record 20.2%.
These results capped an exceptional year in which we accelerated revenue growth and had margin expansion in all three segments. We outperformed on all guidance metrics and we delivered a record earnings per share of $8.29 up 30% and free cash flow of $1.055 billion.
Total company book to Bill was 1.1, driving funded backlog growth of 12%.
And setting us up for continued topline growth.
All three segments contributed to our strong performance driven by their topline growth, which continued to exceed expectations.
Let me take a few minutes to recap some of the highlights on slide of the year on slide four and five with additional segment detail in the appendix.
Communication systems had a terrific year with revenue up 14% from solid growth in duty tactical and public safety.
Duty tactical ended the year with revenue up 31% from last year and up 80% from fiscal 17.
This strong growth was driven by nearly $300 million of modernization demand from the Army Marine Corps and SOCOM as they embark on a multi year upgrade cycle.
Modernization order momentum continued in the quarter with the army awarding us a second HMS Manpack L. reporter followed in July with the release of the two channel leader Radio RFP.
We also continue to execute well on our strategy to penetrate adjacent airborne markets and were awarded the initial prototype phase of the Air Force's Airborne high frequency radio modernization program, expanding our leadership and HF from ground to airborne.
International Tactical performed as expected and revenue was up 3% for the year driven by the ramp of the a strong Australia modernization program early adoption of multichannel products in Canada, and Western Europe , and ongoing counterterrorism support in Africa.
This combined with a well supported deal the budget request, increasing international demand for two channel radios and executing on expansion into adjacent see gives us confidence in the continued growth trajectory and tactical for the second half of the year and the medium term.
In electronic systems revenue increased 14% the ninth consecutive quarter of revenue growth ending the year up 9%.
This strong performance was driven by sustained growth in long term platforms F. 35 F 18, F 16, and more recently by growth on B 52, and SOCOM rotary aircraft.
All of which collectively grew double digits as we leverage technology upgrades and ramp production.
Orders were strong NDS ending the year at nearly $3 billion in bookings.
With two thirds from the avionics and electronic warfare franchises as we continued to leverage our longstanding customer relationships to solidify our position on new and long term platforms.
Which means all of our F 35 production content across avionics and release systems is now under multiyear contracts, which increases medium term visibility.
This order momentum along with our investments in innovation increased content on existing platforms and expansion on the next Gen platforms will drive a multiyear growth cycle in avionics and electronic warfare.
In space and Intel revenue was up 8% for the quarter and the year well above our initial expectation of 4% to 5%.
Driven by mid teens growth in our classified business.
Im also pleased with our relentless focus on operational excellence, which drove the margin expansion across each of our segments. Despite the mixed challenges that come with new program starts.
Our operational excellence program called Hps has driven net productivity savings that are more than offset the dilutive margin impact of duty tactical modernization and revenue growth on long term platforms and classified space, resulting in total company margin of 20.2% for the fourth quarter and 19.8% for the year 90 basis points of margin expansion.
Similarly, our multiyear focus on working capital as delivered terrific results. We ended the year with working capital of 41 days, a four day improvement over last year, and a 37 day improvement since the Axcelis acquisition.
Our working capital reduction combined with earnings growth resulted in record free cash flow of $1.055 billion exceeding the post Axcelis acquisition goal of 1 billion by 2019.
Overall, we had an outstanding year of accelerating revenue growth margin expansion and record EPS and free cash flow exceeding the targets we set for ourselves.
And we'll continue building on this momentum as we go forward as L. Three heres to drive continued above market growth margin expansion and cash generation, creating long term value for our shareholders.
Let me now turn it over to Chris to discuss L. Three results for the quarter and the first half Chris Okay. Thank you Bill and good morning, everyone.
Let me take a moment to thank and congratulate the L. Three and Harris teams for their hard work this past quarter.
Today's results from both companies are due to everyone's focus and the uncertain times, leading up to the close of this historic merger.
As Bill mentioned day, one was seamless we rolled out new email addresses to all L. Three Harris employees launched a new website and portal the connected to 50000 employees across the globe and installed new signage at our 50 largest sites.
On the operational side in the first week, we issued nearly 40 RF piece to our supplier base totaling $900 million in annual spend to start leveraging the purchasing power of the combined enterprise and to work towards our cost synergies goal.
Shifting now to L. Three result, we had a solid second quarter highlighted by our consolidated margin and free cash flow.
Both outperforming the second quarter guidance, we discussed on our May earnings call.
Margins expanded 160 basis points to 12.2% and free cash flow was up 38% to $220 million.
non-GAAP EPS was up 18% to $2 or 91 cents on 2% revenue growth.
These results capped a strong first half with EPS up 21% on 8% revenue growth.
Total company margins expanded 130 basis points to 11.9% and free cash flow was $365 million or five times last year's first half as we executed on working capital improvements that resulted in a 12 day reduction over the past 12 months.
Orders were up 8%, resulting in a book to Bill of 1.11 and funded backlog increased 16%.
Turning to the segments on slide six is our revenue grew 2% driven by a ramp up in WESCAM turrets systems and the strength of our is our mission as Asian business.
Several key programs accelerated including the Australian para Grand and the presidential Aircat aircraft recapitalization programs.
This growth was partially offset by lower deliveries of night vision products due to export timing.
And operating income was up 50%, resulting in margin expansion of 460 basis points to 14.3%.
In the communications segment revenue was flat in the quarter with higher production volume for UAE, the communication systems offset by lower volume in the integrated maritime and microwave product sectors.
Margins declined by 130 basis points to 7.9% from the dilutive mix impact of the maritime developmental programs and the continued investment in unmanned undersea vehicles.
For the first half segment revenue was up 5% with margin expansion of 20 basis points to 9.3%.
Lastly, the electronics segment second quarter revenue was up 3%.
With strong growth in precision engagement systems, which includes the fusing an ordinance business.
F 35 display systems and airport security equipment.
More than offsetting the expected headwind and the defense training solutions due to last year's competitive loss of the C 17 training contract and lower volume from commercial flight simulator sales.
And in the first half segment revenue was up 3% with margin expansion of 10 basis points to 14.1.
Overall L. Three had a strong first half tracking above the guidance set at the beginning of the year and ahead of the amounts disclosed in the us for.
Looking forward as we announced on July one and detailed in the appendix to the webcast slides, we have organized L. Three Harris into four segments that group technologies and capabilities to allow us to compete across multiple missions and domains.
Cutting across these segments, we have business development operations and program excellence functions to drive further growth, while achieving greater cost and operational and programmatic efficiencies.
We have worked on the structure since we announced the merger in October and have assembled an outstanding seasoned and collaborative team to lead the new organization.
I'm excited to be part of it and look forward to the work ahead.
With that I will turn it over to Jay.
Thank you, Chris and good morning, everyone. It's an honor to join the L. Three Harris team I look forward to working with the analysts and Investor community once again.
In a moment I will discuss L. Three pairs guidance for the second half of calendar year 2019, and as a reminder, we have transitioned to calendar year reporting.
But before hand in order to provide context and support for the guidance I will walk through the L. Three and Harris combined financials for the first half of calendar year 2019, which we prepared on the basis. After I've described at the start of the call.
And I will also know various drivers and year over year comparisons in those results. Similarly, all comparisons included in the guidance discussion are to the comparable prior year period L. Three and Harris combined financials, Okay, starting with results in the second quarter revenue was up 7% and EBIT increased 16% on higher volume and operational efficiencies, resulting in margin expansion of 140 basis points to 16.3%.
EPS grew by 27% to $2.42 and free cash flow was $487 million for the quarter.
For the first half revenue was up 10% and EBIT increased 17% also on higher volume and operational efficiencies, resulting in margin expansion of 90 basis points to 15.8%.
EPS grew 27% to $4.65 and free cash flow was slightly above $1 billion up more than 50% from last year.
First half book to Bill was 1.07.
Turning to our new segment structure on slide eight.
Integrated mission systems revenue for the quarter was $1.25 billion up 3% driven by strong growth in electro optical airborne imaging systems and continued strength in the highest SAR aircraft mission position business, including the Australian Peregrine program.
Operating income for the segment was up 14% to $158 million from higher volume and improved program performance.
Operating margin expanded 110 basis points to 12.6%.
For the first half segment revenue was up 12% in operating income increased 17% with margin expansion of 50 basis points to 12.1% first half book to Bill was 1.16.
Next in space and airborne systems on slide nine.
Revenue for the quarter was $1.2 billion up 17% driven by double digit growth in avionics and electronic warfare from a production ramp and new content on long term aircraft platforms as well as continued strength in classified space.
Segment operating income increased 25% to $225 million and margin expanded 120 basis points to 18.8% from higher volume strong program performance and operational efficiencies for the first half segment revenue was up 16% and operating income increased 19% with margin of 18.2% first half book to Bill was 1.13.
Switching to communication systems on slide 10.
Revenue for the quarter was up 6% from strong growth and deal with the tactical and public safety.
Partially offset by lower deliveries of L. Three night vision products due to timing and a transitional impact to full operational capability of the UAE land tactical system program.
Segment operating income was up 10% in margin expanded 80 basis points to 21.6% a strong program execution offset the mix impact from the ramp and tactical radio modernization programs.
For the first half segment revenue was up 12% and operating income increased 18% with margin expansion of 100 basis points to 21.5%.
First half book to Bill was 0.96, and Thats coming off a book to Bill of 1.27 in the last six months of 2018.
Revenue for the quarter was up 2% as growth in precision engagement Airport security equipment and FHA programs was partially offset by the expected headwind in defense training solutions due to last year's loss of the C 17 training current contracts.
And lower volume for commercial flight simulators segment operating income was up 11% and margin expanded 90 basis points from better cost management.
Okay now turning to guidance for the second half on slide 12.
The strong year to date performance gives us confidence that we will continue to outperform markets in the back half of the year.
Starting with the topline we expect second half revenue to be up in the range of 9.5% to 10.5% with strong gross growth across segment. All segments. This supported by high visibility sales coverage from our backlog and high probability follow on opportunities.
Second half total company EBIT margin is expected to be approximately 170 basis points to 16.7% from higher volume operational efficiencies and cost synergies.
EPS is expected to be in the range of $4.95 to $5.05, which reflects higher profit and share repurchases, which we will initiate over the next few days.
As announced on July 1st the Board has approved a 10% dividend increase and a $4 billion dollar share repurchase authorization program of which we will utilize to $1.5 billion over the next 12 months.
In the second half, we expect to generate free cash flow in a range of $1.3 billion to $1.35 billion, reflecting higher earnings in a one to two day reduction in working capital from June 2019.
Capital expenditures expenditures are expected to be $190 million or 2% of revenue in the second half.
For the full year revenue is expected to be up in the range of nine and a half to tenant at 5% with EBIT margin of approximately 16.2%.
And EPS in the range of $9.60 to $9.70 full year cash flow free cash flow is expected to be in the range of $2.3 billion to $2.35 billion.
Turning to the EPS bridges on slides 14 and 15.
Expected second half EPS at the midpoint of $5 reflects an increase of 94 cents driven by volume, but higher volume across the four segments operational efficiencies and cost synergies, partially offset by the impact of a higher tax rate of about 18%.
Expected full year EPS at the midpoint of $9.65 reflects a total increase of one dollar and 65 cents with $1.70 driven by operational improvement and cost synergies and additional 17 cents coming from the elimination of L. Three intangible and pension amortization and lower interest and share count.
Partially offset by a 22 cents tax headwind.
Switching to the segment outlook in integrated mission systems, we expect revenue to be up approximately 10.5% in the second half driven by continued strength in airborne imaging systems and growth in ice our aircraft mission position and maritime platforms with operating margin of approximately 12.5%.
Percent with operating margin of approximately 12.3%.
Space and airborne systems revenue is expected to be up approximately 11.5% in the second half driven by continued double digit growth in avionics and electronic warfare and strong growth in classified space segment operating margin is expected to be approximately 18.7%.
Full year segment revenue is expected to grow approximately 13.9% with operating margin of approximately 18.4%.
Communication systems revenue is expected to be up approximately 9.5% in the second half.
Driven by strong growth across all sectors with operating margin in the range of 22.1% full year segment revenue is expected to be up approximately 10.7% with operating margin of approximately 21.8%.
Lastly, aviation systems revenue is expected to be up approximately 7% in the second half driven largely by continued double digit growth in precision engagement.
Operating margin is expected to be up from sorry expected to be approximately 14% from improvements in MDD and productivity initiatives across the segment.
Full year segment revenue is expected to grow approximately 4% with operating margin of about 12.3%.
In regard to the budget I'm very encouraged by the recent bipartisan deal raising the VCA caps over the next two years and removing the threat of sequestration.
We continue to believe the house and Senate will support increased funding to me in National security demands, which are well aligned with our core franchises.
And with budget outlays, continuing to lag a budget appropriations, we expect growth momentum to continue in the medium term.
A few weeks ago, Chris and I are aligned with our leadership team on our top strategic priorities first and foremost being integration and accelerating the capture of cost synergies.
We now expect to hit our gross run rate a $150 million by the end of COVID-19, putting us on track to meet or exceed 40% or $200 million of gross savings in calendar 2020.
We're off to a great start on segment and headquarter consolidations and supply chain activities and we are growing increasingly confident of exceeding $500 million gross cost synergies in calendar 2002.
Other priorities include driving operational excellence to our new program called E. Three excellent everywhere every day.
Establishing a new performance culture building on the strengths of both companies investing smartly and aggressively in technology to grow revenue and increase share reshaping our portfolio to focus on high margin high growth technology differentiated businesses and maximizing cash flow that will be returned to shareholders through repurchases and dividends.
Overall, the progress and alignment in the first 30 days has exceeded our expectations and we feel even more confident in this strategic combination and our ability to deliver shareowner value. So with that let me turn to the operator to open the line for questions.
Thank you at this time, we will be conducting a question and answer session. If you would like to ask a question. Please press star one on your telephone keypad a confirmation Tom let indicate your line is in the question queue.
You May press Star two if you would like to move your questions on the queue for participants using speaker equipment and may be necessary to pick up your handset before pressing the star key.
Our first question comes from Robert Stallard of vertical research partners color you May proceed.
Thanks, Josh good morning.
Hey, one Rob.
Maybe a quick first question for Bill there was some commentary at the Paris Air show that the combined company might be looking at some post merger disposals and I Wonder if there been any further thought all development on that front.
Well, Rob Thanks for the question, yes, so it's definitely a key priorities I mentioned in my closing remarks in terms of the top priority for the management team.
Certainly as we've talked about before on this call in other venues.
A broader mix of businesses gives us an opportunity to take a fresh look at the combined company portfolio and and really think about what fits what doesn't fit certainly gives us some optionality to do some things with businesses that we no longer consider strategic.
We continue to look at this through a couple of different lenses. Certainly one is is does the business have technology that is required for differentiation can we deliver good returns can we grow and win green share et cetera, and we're going to evaluate what businesses were in based on those those did those metrics. We continue to have this dialogue christen are working very hard on this we're engaging our new board on this as well, we're not going to deliberate decisions in discussions in public, but it's really top of mind to as Rob.
Okay. Thanks, and then maybe as a follow on for Jay and welcome back.
In the free cash flow guidance as around them.
$400 million worth of adjustments and I was wondering how many of these one off items, a 2019 and won't be repeating themselves a 2020 beyond thanks.
I think you're talking in the back half.
Rob Yes, it's in.
In the release there was there is a reconciliation of the guidance.
We've got one a 75 to one nine to five and then a number of adjustments that gets you to 2.3 to 2.35 adjusted free cash flow for the year.
Right. So we will when you look at that.
There will be we will continue to expect some of the deals or integration costs.
We'll see we'll still see going into next year from a cash basis.
But let me just take you back to the second half of of free cash flow.
Because we expect an uptick in net income.
There will be a little bit of an outflow related to our working capital with the one to two days improvement, but we're going to try to hold that flat and we'll see a little bit of a better fit in and cash taxes.
So feel good about the second half as specific to your question in terms of what we see going next year as I mentioned, there will be some continued costs on related to the integration restructuring type level costs and those type of items, but beyond that I don't expect there to be other significant items that will repeat going forward. Mr suggested in a nutshell I think for the year, Rob $260 million of free cash impact from deal and integration costs, we had about $25 million or so in the first half. The 235 will be in the back half about 100 million that 95 or getting the deal cost thats going to be behind us by Q3, the balances integration costs will cease a little drag forward into into calendar 2000 and integration costs as well.
That's very helpful. Thank you.
Around.
Our next question comes from Sheila Kahyaoglu of Jefferies Caller, you May proceed.
Thanks, Good morning, Don Christian welcome Jay.
On the deal closing you guys increased share repurchases and your dividend. How are you may be thinking about your overall free cash flow target and targeting returns to shareholders.
Well I think it's as Jay was alluding to we feel good about this year in terms of cash generation. We are still targeting $3 billion three years out as calendar 22 will certainly ramp to that.
So I think we're off to a really good start on terms of the cash we generate in the first half.
LTM cash what we're going to do this year. So all that is looking pretty good. We ended June with it on a pro forma basis with $1.7 billion on the balance sheet.
We are going to generate about seek to another $1 billion more or less in the next 12 months. So that puts is about 4.2 billion more or less of cash available for deployment or dividends about $700 million Sixeighty, that's including a 10% increase we did that we announced on July onest that will be enacted here in August we'll talk we'll reevaluate that in January by $7 million dividend you, we have about $300 million worth a deal and integration costs. We just spoke about that over the next 12 months, we had to fund the serp and deferred compensation.
Programs, but what that means that leaves you about $3 billion over that period of time.
For for things to do to another $1 billion on buyback and about a half a billion dollars Sheila that is going to be held on the balance sheet, just because it's what we require for normal working capital needs.
Okay. Thanks, and then.
Maybe just on the margins the pro forma margin guidance for the total company implies second half margins are up 80 basis points over the first half.
That's a decent acceleration can you maybe talk about the moving pieces, how much of that is coming from synergies versus the underlying business profitability.
Yes, so you're right Sheila the first half on a pro forma base of 90 basis points to second half up 170, So it's up sequentially as well as 16 seven for the year about 130 basis points of margin expansion. So was 16 to a little bit better than we thought when we put the deal together in the S. Four so we feel good about that trajectory you mentioned on the call about $40 million in the back half is coming from net cost synergies.
Theres a roadmap in the back on her as a bridge, which indicates the absence of L. Three intangibles and pension amortization. It's about another 40 $43 million, we see an operational improvement year over year in a couple of businesses from L. Three including SDDC operational excellence savings, which offsets some some mix gross of investment into back half all of which gives us to about a 170 in the back half and we feel is pretty well calibrated.
Thanks, very precise affiliate thank you Ben.
Our next question comes from Carter Copeland of millions research color you May proceed.
Hey, good morning, gentlemen.
Morning.
Just.
A couple of quick ones, one I realize it's hard because we didnt have a Harris guide for the next fiscal year out there, but it looks like on a pro forma basis.
The topline.
That youve.
Good for us for the second half is a little bit ahead of where we may have been on a pro forma basis coming in can you just verify that and maybe help us size it.
And then as a follow on and I wondered as.
Part of the many decisions you made and.
Getting the deal closed or whatnot, where you shook out on.
Things like incentive compensation not necessarily for the executive team, but as you go a layer down in terms of driving this sort of behavior that you want and if there was anything.
Useful or notable to speak about there that that will help us understand where your points of emphasis our thanks guys.
Yeah sure Carter. Thanks, So really the first point on the combined first of all Harris's trailing a little bit backtracking a bit better on a COVID-19 in terms of versus the S. Four on a combined company basis.
For COVID-19 were about a half a billion dollars better so let's say, it's quite a bit stronger than we envisioned late last year, we put out the S. Four but again as we mentioned at that time. The S. Four was related to strategic plans, which were put together earlier in the year over the summer in the market is guided better we want some strategic opportunities. So we feel good about where we're at in COVID-19, a bit better than we started 20 is looking pretty good as well certainly with the budget backdrop strong funded backlog at the beginning at the midpoint of the year is up 15%. So lot of its tracking I think for for really good topline progress on on the comp program. We're still in discussions with our board in terms of what we do going forward, but Chris and I. Obviously, there is a short term plan in the in a longer term plan on the short term basis. It will be some combination of revenue op income and free cash.
And since we all know the importance of cash generation important to drive working capital improvements.
There's probably a slight tilt towards towards free cash much like we did a number of years ago add that Harris, you'll know Chris mentioned about the big step up in the first half and free cash generation up fivex over the first over the first half half of last year, I think 50% of the short term comp for the L. Three executives came on free cash and we all know when you incentivize for something to get results. So that's kind of we're thinking on a short term basis longer term. It will be performance based equity that'd be tied to the targets were discussing with with shareowners.
Okay, great. Thanks.
You bet Carter.
Our next question comes from Peter Arment of Baird color you May proceed.
Yeah. Thanks.
Good morning, Bill Chris Jay.
And a question Ajay I guess on on Capex, you mentioned $190 million for the second half of the year about 2% of revenues just thinking about longer term as we think over the forecast period and thinking about your integration period is that still a good number to go off of about 2% of sales.
Yes, I believe it is Peter 32% this year on a full year basis Thats $380 million when 90 in the first half when 92nd half I think going forward.
It feels like that's the right place to be to fund and pre prepared for the growth.
And yes, I think too.
Nothing nothing material Peter there'll be additional non-GAAP charges in Q3, because some of the deal and integration expenses, but on a non-GAAP reported earnings per share revenue growth should all look pretty pretty stable Q3 versus Q4.
Thank you for the color.
You bet.
Our next question comes from David Strauss of Barclays.
Color you May proceed.
Thanks, Good morning, Thanks for all the information and welcome Jay.
Thank you David.
Phil you staff.
In the Harris deck, you had a slide that showed the medium term outlook by segment I wanted to see if you might offer since were.
We're in we're new to the combined company segments I wanted to see if you would offer your thoughts on kind of how the growth rates relative to each other or among the segments might look going forward and also from a margin opportunity.
Beyond what we're looking at for the second half a 19.
Well, David I mean, it's still a bit early I mean, we're obviously, we just put the company together, we took a enormous work to put together pro forma guidance for the back half. So it's a little bit premature to get out beyond that but maybe just some high level comments that without getting into the segment by segment looks here.
For us I mean, looking at 10% growth in a calendar year in the industry that happened to be in is pretty special you follow US you follow them into space looking at 10% a back half feels feels pretty good as well so.
I mentioned the S. Four is a little date it were doing a lot better than yes for about half a billion dollars stronger this year. So we're coming off a stronger starting point.
In the S. Four think L. Three's numbers were growing at 556% in that range, we were a bit a little bit higher than that.
I see us continuing to grow in that mid to high single digit range into 20, and maybe a little bit beyond that comes from me a good bipartisan budget deal the topline budgets not growing that much 3% and basically flat the year after but the certainty that provides the funding lines that we see tactical F. 35. Other plays that affect the business look very very good and very positive I think is $122 billion worth of with of appropriations that are out there that are exceeding the outlays. So those at least have to catch up there's a lot of dry powder in a system that should keep.
All of that bodes moving in the in the water and we feel pretty good about.
The medium term outlook on the margin side looking at 16 to this year would be a great result, we're at the front end of our ramp on synergies only 40 million. This year getting to 300 billion. Several years out. That's another 170 280 basis points. So you can kind of run the math and get to 18% pretty quickly a few years out and we'll we'll ramp to that as quickly as we can so.
As we look out in the back end of the year, we feel great and I think that that looking to bring in calendar 20 also looks pretty good too.
Okay. That's helpful.
As a follow up on to ask about the the free cash flow.
Cadence beyond this year, so you're guiding to the full year adjusted free cash flow number around two three you've got this 3 billion our target.
For 2022, I guess calendar 2022.
It implies like blow less than 10% CAGR between here and there, which just seems a little light given what you're talking about from a working capital upside opportunity and and and synergies can you just help help square that why it's not a higher growth rate between here and there.
Well look we we feel really good about where we ended in on an LTM basis and cash and just just for.
Okay referencing a couple of data points I mean areas over the last 12 months was better than by four days of working capital. So going from 45 to 41, a day or two better than we thought a couple of months ago L. Three's results were 12 days better year over year in the June ending quarter. So we're making good progress over the balance of the year. We're only looking at another day or two between June and the back ended the year.
But we're starting from about 75 days pro forma at the end of June .
Ours is sitting at 41, I think we got a lot of opportunity ahead of us let's get through the next couple of quarters, We'll give you guidance on calendar 20, and certainly as we look at Chris and Jay We're all over trying to figure out a way to make sure. The cash gets accelerated that's certainly what we're trying to do.
Keep in mind in working capital is going to want to grow with increasing volumes. So our challenge is going to be that take out for the productivity and working capital hold it flat over that period of time.
Yes timing that we were clearly focused on this Dave Youve seem to progress as Bill mentioned the 12 days of the good news is a lot of that's coming out of inventory a little bit out of.
Days sales outstanding So we haven't even really focused on the on the payable lever. So the teams are working at hard and we're allocating.
Targets right down to the program manager level, everybody knows what they need to do to achieve these targets.
Great. Thanks, everyone.
Our next question comes from Adam Khanna of Cowen color you May proceed.
Yes. Thank you.
I may have missed this but bill could you talk about maybe some sort of ballpark.
Spec divestments.
Now that the deals closed in terms of size.
Maybe by sales then I have a follow up.
No I don't think that we're going to sort of cited today only because of decisions aren't yet need.
And we're at the front end of the process, it's going to take some time to get alignment work the process and what all do got him as I've done before I know Chris has done before is rather than talking about something that we are going to do I'll talk about what we have done when that when that is done. So we don't have at a predetermined target, but we're trying to do again, what we're looking at is is we want to make sure. The management team is focused on the business that are strategic ones that are technology, driven have great returns and we can win and Chris and I spend a lot of time in the last few months on this we've we've worked with our boards. We've got a meeting coming up in a couple of weeks on this so we're on it.
But I'm not going to size, how much the divestiture might be until we really get around to making some decisions around that.
I appreciate that just a quick follow up tactical comps book to Bill look pretty strong.
I was wondering if you could give us some flavor.
Yeah. The 12 to 18 month outlook pipeline international domestic and just any commentary you can give around.
Not that Im a profit.
Yes look I mean, the international pipeline remains pretty good at about 2.5 billion in the shape of its not not changed a lot. So we had a good finish on international good.
Basically flattish on in Q4, but we had a good year about 3%.
Deep pipeline is around 1.7 billion. So it's up a little bit what's interesting is the mix. It's about 50 50 now between base in monetization as we would have expected monetization to start to grow we see that over the course of fiscal 19. It basically tripled in size in terms of modernization that pipeline is now half monetization is fund thats backstopped by what is a pretty good budget outlook.
So I got to tell you got in it we had a good year in tactical the guys did a great job.
We were up about 13% this year in COVID-19, it's going to be.
About 10%, 12% or so low double digit in the back half deal. These going to continue to grow pretty well, we see international in low to mid single digit range. So we see continued momentum in this business and it goes beyond the back end of the year based on what I'm seeing in the budget. So the tactical business is performing and performing very well as expected.
And last one for me any major Rick if we should be monitoring over the next 12 months. Thank you.
Any major recompetes.
Any recompetes that was the question.
Okay, I think I if I if it was a major recompetes, we really don't see a lot over the next 12 months I mean, there's always places that we're bidding it theres opportunities out there, but there is.
There is nothing that is really significant the one that that's really come into mind is what we call. Our sensor program is what we do.
Maintenance for ground based.
Telescopes IL 12 sites around the world to legacy Axcelis program to 150 $102 million a year of revenue, it's under a recompete, but but it's one of those programs I feel very strong about.
From way back when we bought Axcelis. It was over 30, 530% on time delivery were closed the quarter at around 94, 95% very very good reputation with the customer. So that's the only way is jumping off my mind is as as a recompete that certainly I got my eye on but but nothing more than that got them. So thanks for the question. Thank you.
You bet.
Our next question comes from Michael.
CR Molly of Suntrust color you May proceed.
Hey, good morning, guys. Thanks for taking my questions and nice results.
Just on the on the second half margins.
Specifically the aviation segment I think you've got.
Pretty strong margin expansion in the second half of the year. They are looking at 14% versus.
10, and a half you gave some initial comments on whats driving that but can you be a little bit more specific there on the sharp margin expansion in that segment.
Yes. This is Chris we see an up ramp from from a couple our main drivers. If you recall, we have the HDD business in there which of course is very.
Tough compare fourq for 18 compared to 19, so we talked earlier in January .
About a significant improvement 40 basis points from not having the same issues that DDD, which we don't expect to have in 19 that we had an 18, we have some athree savings.
That are pretty significant in the $40 million range and we have a pretty good road path to execute upon those and.
We have some growth opportunities in the commercial aviation sector, specifically avionics that has higher margins. In addition to some fusing an ordinance opportunities all that contributes to the guidance we gave.
Got it and then just bigger picture on on the defense budget I know, we've got the two year budget deal, but any thoughts on sort of whats taking place now with with the expansion of of this night court process that Marcus for looks to be implementing you guys see this as a risk or opportunity as you look at the potential pipeline of business versus modernization legacy I know funding lines look good now, but it seems like.
What we saw take place at the army could be expanding now into the Navy and the Air Force and just just wondering how you guys are for you in that process.
Well look I think it's still very early it was only confirmed very recently, but through.
What he did when he was army secretary was actually very positive very productive I think it's.
It is notable that that he with with Ryan Mccarthy with achieve got together and really prioritized, where they wanted to spend limited army dollars and focused on key priorities and start to move away from things that weren't.
All that critical the fact is I think between what we do at L. Three does on a combined basis.
The fact is we're working on important programs and I think we ended up.
Being doing very well through the army process I Didnt vision, the same thing overcrowding over the cross deal de what what is now going to work on so.
The discipline of looking at where they want to spend dollars is important and I think based on the things that we're working on we're going to be I think we're going into being pretty pretty strong year.
Sounds good thanks, guys.
You bet.
Our next question comes from George Shapiro of Shapiro Research color you May proceed.
Hi, good morning.
Hi, George.
I was wondering bill if you could provide a breakdown of your revenues between the OEM budget any investment budget.
'cause L. Three had a high percentage from the open end budget.
Yes, no one on the deal the size. So we're about 55, 60% deal D. It about it's about 50 50 OEM versus procurement.
Okay, and then with some of the shorter cycle businesses that that you're in and the flattening of the the budget is there any concern that your growth rate can slow somewhat quickly more quickly than others with longer cycle businesses might have or you think that you gain enough share that we keep going on with better than industry growth rates.
I mean, the short cycle business that we really have talked about in the past towards really around the tactical radio business and that that has become when we when we merged with Axcelis. It became a smaller piece of the overall company certainly as we improved in the other segments.
So it was like 30, 536% of the legacy Harris companies now even smaller as part of L. Three hairs, but the fact is it is a it is a relatively quick turn business, but it's a little bit different today. It would have been a few years ago would today lot more the business is driven by modernization and modernization is a lot more visibility into it then these quick turn open end fund it.
Orders that we would have gotten in the past. So you know I'm not I'm not terribly concerned we had a very very strong count of fiscal 19, we had a really extraordinary first half of COVID-19 in DMD tactical move that and that will naturally mitigate itself or slow down a little bit in the back half, but is still very healthy growth north of 20%. So look it's it's a great business were across all of the different platforms different contract vehicles. All the services that weren't on the front end of what we believe is a multiyear ramp here George.
Okay very good thanks very much.
You bet.
Our next question comes from Rob Spingarn of Credit Suisse color you May proceed.
Hi, good morning.
On run.
Congrats on.
On the deal.
I just wanted to go back to the guidance and this really could be for anybody but Jay. This is the guidance you gave.
If I look at the second half revenues, it looks like and everything but yes, we have a slight decrease in growth is that just comps or is there anything else going on there.
Yeah, Rob some of it is as comps we had up in the last half of last year, some pretty significant growth rates, but you're you're talking you're kind of splitting hairs and in Indian integration mission systems business. It was 12% growth in the first half we're expecting around 10, and a half growth so a real slight reduction there.
In communication systems, where nearly 12% were going to be conducted a half they're close to 10, and so yes, I'd say more compares up than anything else, but the growth rates are still pretty substantial and pretty significant support to 10% in the back half as I said in my comments high visibility with the backlog, we have 90% visibility in the backlog to the back half and so we feel really good about going into this next six months.
And then I guess for the the increase in growth and asked does this go back to the comments that Chris just made about some new programs are there things ramping there.
We're seeing we're seeing what Chris called the precision engagement systems business ramps a bit more in the back half in the front half a grew really nicely in the first half will be even stronger the back and it's just a lot of classified work that Chris and his team have have solidified themselves on plus lot of fusing business for munitions that and that OPTEMPO. There is pretty high we're also getting a little bit better comps on the commercial training business. The defense training business looks a little bit better. The C 17 carriers for the full year, but Theres F 16 wins that have happened thats going to help mitigate the C 17 loss in the back half so really across the across all the pieces of a as it just gets better and Thats what were seeing better growth in the back half in the front half.
Okay, and then just a clarification just on the proceeds from the night vision sale.
Just the the L. Three pension pre funding that I think youre going to direct those proceeds toward has that happened is that in the op cash flow guidance for this year.
What's going to happen is so we're still on track for that the net proceeds will be about 325 million, we expect to get through the process in in Q3, its deepened the sippy his review.
And that will be used to prefund. The pension that are basically mitigates any cash contributions on the all three sides of the pensions for the next couple of years into calendar into calendar 2002.
So thats like a 70 80 million dollar improvement if you will in cash, but remember in night vision generated some cash. So there is a bit of an offset on an annualized basis, that's sort of a 50 $60 million net benefit to us on a free cash side and that is in our guidance.
The timing is in the guidance for this year.
Did not in the back half is in the outlook as we get into 2000 and beyond.
Okay. Thank you.
You bet.
Our next question comes from Richard Safran from Buckingham Research Group caller you May proceed.
Thanks, Bill Chris Trey Good morning, how are you.
Good morning.
First I had a bit of a top level kind of philosophy question here you know for lack of a better term you know commercial business model has really been at the core of Harris. So what I wanted to ask was how you how long you might think it might take to apply that model to the new combined company. How long do you think it might be before we see a tangible results just interested in any color you could provide there on how are you thinking about implementing that.
Well, it's a great question.
And it's a less philosophical more financial in sense of what we've tried to do in a really back to where we were three years ago with Axcelis excels manufactured radios in Fort Wayne It was under eight sort of normal model and with cost disclosures that we moved that up to Rochester took us some time, but that's now full commercial model business at all three west Cam the west Cam because they have a very profitable nice sized business growing very well great positions around the world. That's a commercial model business much like what we do in the tactical side. There is a possibility you take the satcom business at L. Three has been very strong and overtime migrate that to a commercial model. It's something that we'll work on it may not be a needle mover in the next couple of years is something that obviously, we're focused on but I wouldn't say that thats going to be the key driver to margin expansion is going to come through.
Operational excellence going to come from synergies going to come through basic better performance in our company. So.
We're certainly on it Richard.
Okay. Thanks for that and ill just quickly then on the F. 35 program just following up on your opening remarks, you know just generally we've seen a lot of changes among suppliers on the F. 35 program. So I just wanted to know.
Are there still incremental opportunities out there for you on that program and if possible and you're at your could you just discuss how your content on that platform has evolved.
Yes, sure we you know.
Now I'm going to quote a number to it. This is probably just legacy Harris I'm look to honor and Jay can from as we were $2.2 million per shipset. Today. So we do the common components. We do the model system. We do the release systems. So about 2.2 million that we know is going to grow to about 2.7 over the next several years. We won three different pieces of what they call Tech refresh three so so one is the the mission computer the called the ice CP those the aircraft memory system as well as the electronic unit the panoramic cockpit display PCD, you and all those things add together over time to give us another half a billion dollars of content per for F. 35, So so thats going to grow in terms of content per shipset.
And it's going to also grow with the ramp which is why it's an important one for us to keep talking about as the number of ships that continued to grow plus our content continues to grow it's going to continue to be a growth driver for the company.
And Richard on the legacy L. Three as you know we have the crypto we had the display so.
Think of another five or 600.
Per per Shipset, as well and when we put the merger together, we talked about the benefit of scale I think Lockheed Martin would acknowledge we're one of the top suppliers that gives you better access.
To the management team to be a part of the strategy and we would expect to bid on other components in the years ahead.
Given our scale and investments.
Thanks, very much I appreciate that.
You bet.
Our next question comes from Noah Poponak of Goldman Sachs color you May proceed.
Hey, good morning, everybody.
Good morning or no.
In the three the the 3 billion through your free cash flow target what is the.
Underlying organic business segment, so before putting aside anything below the line.
Putting aside the working capital opportunity in the synergies just the core newly combined business segment EBITDA growth rate.
On that three year basis that you are assuming in the 3 billion.
Yes, I think the topline is around five 6% little bit higher than on our EBITDA growth when we yields about half a billion dollars of incremental net income incremental cash coming from growth over that three year period.
Okay.
The 500, I guess 500 on.
The new should I be thinking about that relative to the two or three to two or three and a half so it'd be kind of 20% of add on it but over three years, so call it 6% CAGR.
Yes, it'll it was awful like a two to $2 billion to $2.1 billion free cash basis. So it's so it's going to be maybe a little bit less than that but yes in about that range six seven present.
Okay.
And then.
Just to make sure I have the.
The bridge correct working off of this year in the two three to 235.
How much.
How much working capital and synergy is in that it sounded like the one or two days of working capital is maybe 50 million Bucks.
And then I thought I saw a 40 million of synergy in the deck, but then I believe I heard you, saying 150 I didn't know if maybe that was a run rate number.
Can you just clarify those for me.
Yeah sure. So so theres $40 million of net synergies in the back half lets net synergies in the full year as well and that drops through into generating cash on a on an after tax basis that 150 is the run rate will be out in terms of cost synergy by the calendar year. So thats the run rate will be at which gives us confidence that we can be at $200 million in calendar 20 gross savings dropping through so so thats, how thats, how we talked about it over the course of the back end of the year. We were I think were around 75 days at on a pro forma basis in June and as Jay pointed out we're expecting one to two days of improvement sequentially through the back end of the on working capital so ending around 70 473 days.
Okay. So I should be kind of in the zone of maybe call. It a 100 million Bucks of the 500, but you had further in that free cash flow bridge of net after tax synergy plus capital efficiency, maybe a 100 of the 500 is happening in 2019.
I am not sure and we're looking at each other here not sure well.
40 to 50 of synergy and then one or two days of working capital.
I guess I wanted to ways that we weren't capital on a full year basis is probably on the order of 30 $60 million in that range. So it will be half that over the course of the back end of the year.
Okay.
And then just.
Bigger picture on the margins.
Clear clearly the margins will expand if you if you achieve the synergy plans, but should that should we be giving consideration for margin expansion in the underlying business before synergies Harris kind of had incremental margins from the partially commercial model legacy all three had plans to continue to improve the operations on the margins of the business before the deal.
Is it fair to assume the margins are expanding independent of the synergies and then synergies in addition to that.
It's fair to assume that you have both independent businesses had talked about margin expansion in both pieces. It was on the order of 100 basis points and certainly the synergies that we had talked about that would be incremental to that which is you know going back when we first talked about the deal on a pro forma basis. The margins EBIT margin was around 14, we said that we get around 17 through 100 basis points of organic growth and margins. Another 200 basis points on synergies you get to 17, obviously wiser coming here into into calendar 16 were doing a bit better than that as starting off here. So so yes. It is incremental to the benefits of synergies Noah.
Great. Thanks very much.
You bet.
Our next question comes from Seth Seifman of JP Morgan color you May proceed.
Thanks.
Thanks, very much and good morning, everyone.
I apologize.
If I missed it in the prepared remarks, I know there was a lot a lot going on.
But the profitability in the in the communications business at L. Three in the quarter.
Just Nick nearly 8%.
And maybe if you can address that and kind of seemed like we were moving past last year's issues and kind of what kind of risks that presents gone far.
Okay. So yes, Seth this is Chris that was driven.
As we put it in the prepared comments, mainly by the maritime sector, we have a pretty strong international focus and maritime we have some steady our cornerstone programs as I cover him on as I call them focused on sensors and control systems, but there are some new developments going on.
One in the <unk>.
Unmanned arena, both surface and undersea and that requires investments and then we have some new programs for the Columbia and the destroyer and laser weapons Theres were slow during the quarter by some additional cost to get those development programs on track and those will have long term 10 to 20 year.
Ladies once we get going so there was focused on maritime development to answer your question.
Great. Thanks, and then on Bill for in legacy Harris, the space and intelligence segment seems like the book to Bill for fiscal 19 was probably around 1.0.
Which is pretty solid and obviously, there's some good growth there, but theres also a ton of growth in the space budgets. So maybe if you could talk a little bit about the visibility you have there and the you know the confidence you have that.
But you guys are taking your fair share on the on the space side.
Yes look as Seth I mean, we feel very good about the space business, It's you're right I mean in the in the year to book to Bill was little over one backlog came up a little bit. So so theres a good there is a good trend there and we've talked about that pretty consistently over the course.
Above fiscal 19 with the classified business being up mid teens orders looking pretty good that comes in a couple of different areas. We talk of our classified businesses not just space. So there's opportunities in spaces, both lease both exquisite as well as moving to small side and the team has just done a great job maintaining a strong position on exquisite components. While at the same time, taking the lead on full ended mission solutions with small sad, but our classified business in that area also relates to other domains and that business continues to go well again same philosophy moving from providing components to subsystems to now full mission solutions, whether they be terrestrial systems near shore systems deep water systems and that business has gone very well and is really this philosophy. There is the budgets are coming up and we're expanding our ability to compete a more full end to end mission solutions and you can see the trajectory happening in a back into the year, we continue to.
We see strong growth in a classified business.
I'll, just say that bill and I spend a fair amount of time last week reviewing the classified business and I was.
Thoroughly impressed with the technology and the opportunity. So we're excited about the.
Space business going forward and other classified work.
Great. Thanks, very much everyone.
You bet.
Our next question comes from Jon Raviv of Citi color you May proceed.
Hey, good morning, and thank you.
Okay got it now that we had some more time pass on any sort of additional perspective on industry M&A.
Would be appreciated by you guys as others talk about more scaled investments to increase the probability of wins and by definition, taking some market share what do you consider the impact to beyond on Elliott Jaques going forward.
Besides bagging ULA I CFO .
Was it the hit we measure.
Exactly so so let me start and without him.
He led with that.
No look I think we so Chris and I started this conversation quite a long time ago.
With that with the goal of creating a very large scaled mission solutions Prime and that's exactly what we've done.
We continue to access assess implications of what other people in this space do but from when I look at just the company that we have created and the opportunities ahead of us.
I think we're very well positioned when you talk about scale I think we are scale in places, where we need to be scale, where scale and tactical radios are becoming scale in this space business were skill in lots of different areas of the company and we feel we feel great. The company is a technology leader our strategy is to continue to invest significantly and aggressively in innovation, we've been running about 4% of our revenue in Iran. And we can see continue to see that continue to go up we've got great set of people, who are great technologies and business leaders to drive our business, what's going to require for us to win is continuing to accelerate the deployment of technologies into into the marketplace into the field to the war fighter and continue to execute well on our programs. That's what we can do and no matter what happens in the market and the changes in the structure, we're going to keep focused on what we do well the things that we can control and as the technology and the way we execute so I think we're in a good spot here John .
Great. Thanks, I'll keep it to one since I know overtime there.
Okay. Thank you.
Our final question comes from Josh Sullivan of Seaport Global Securities color you May proceed.
Hi, good morning, Thanks for taking the time for the last question here.
Just given the success with the Axcelis combination and maybe using that as a benchmark you can you talk about how the experience so far with L. Three has been maybe similar to that of integration and then maybe where it's been a little more dynamic.
Well certainly on it's a much bigger scale clearly and there is a lot of complexity within L. Three was a company built over 20 years to a lot of M&A and Chris has talked about the desire to move from a holding company to an operating company and we're sort of on that journey.
So getting information getting it consistently across businesses is a bit of a challenge, but the reality is we're out of the gates very very quickly we've got a great.
Seasoned integration team people that are very experienced they've done. This before there are lot of people from the accelerated integration.
We're getting data very quickly the enthusiasm and energy across the company is very good.
It's it's gone from my Vantage point, certainly better than we would have imagined in better than we did with Axcelis, we're going faster on supply chain that was an area that took us a little time to ramp up to one axcelis that were at that a lot faster. This time, obviously with the segments in headquarters we made those decisions we execute on that on day, one here, which is very important the revenue opportunities ahead of us are quite significant something that Chris is spending a lot of time on it and we're very encouraged so we're going to get on that probably a lot faster. This time than we do with Axcelis keep in mind, we're in a different market space were different sort of part of the cycle back with Axcelis, we're still coming out of sequestration the visibility to budgets were very strong. So we focused much more on cost side. This time is different and Chris and the team are really putting a lot of time and effort into making sure we understand where the revenue opportunities are and then making sure that we fund them. So.
I am optimistic about trajectory that we're on here and clearly want a great path to deliver half a billion of gross cost synergies and and hopefully a bit more than that over time Josh.
Appreciate that I'll keep it to one as well thank you.
Okay. So so that wraps up our call. So thank you very very much Chris and I are very excited about the company that we've created and getting to the closure of this historic merger on exactly the minute that we thought we would be in mid October of last year. There's a lot of precision in that as you'd expect from us and his team were very excited that we are confident create a lot of value for owners, but importantly, and Chris mentioned this in his in his comments. We have 50000 employees of this company. We are working very very hard to deliver results keep the focus on the customer and we want to thank them for all their efforts and we look forward to updating you again on the merger and the progress we're having at the end of October for our next earnings release. So thank you very much.
This concludes today's conference you may disconnect. Your lines at this time. Thank you for your participation and have a wonderful day.