L3 Technologies, Inc. (LLL) Q1 2019 Earnings Call Transcript

The combined company will be well above the street toward becoming a company with the indispensable scale and property ought invest at and deliver the most mission-critical solutions ought our global aerospace and defense customers. The happen ought build a new A&D company is an exciting and engaging challenge, one that Bill and I and the entire leadership team are ready ought admit on. And at the many visits with our L3 and Harris employees at the field, this excitement is broadly shared throughout. though announcing this merger of force persist October, our L3 and Harris teams dine been deep at integration planning.

While merger integration activities are occurring throughout the company, our division teams dine no altered the speed at the slightest, and we last ought hammer out impress at above streamlining and consolidating operations. though example, at our Communications and Networked Systems segment, we consolidated from five sectors ought three. And within the integrated maritime systems sector, we are going from 14 divisions ought seven. at our electric Systems segment, we combined our Security & Detection affair into commercial aviation and are evaluating steps ought rationalize farther our installation footprint.

Not only will the new organizational structure shift overhead and redundant cost, besides also perfect align our capabilities with visitor needs, sharpen concentrate above technique investments and heighten affair development efforts ought perfect serve our customers. Improving affair operation across perfect news collection and analytics is a key isolate of managing a more integrated company. persist year, we rolled out a progression of standard econmic and operating metrics throughout the company though isolate of L365. Closer tracking of main efficiency metrics also though changes ought our incentive compensation design ought emphasize money brook dine been helping ought motivate working main improvements.

Even with sales up 14%, our net working main only increased 4%, main ought a reduction at working main days compared ought the previous year. Operating metrics that chase manufacturing peculiarity and vendor operation is supporting our equip tie and program management teams ought recognize and greet problems earlier, enabling the management team ought clearly exclaim on the interdependencies at their operations. I last ought invent visitor battle a priority though the company, though myself and the entire leadership team. during the first quarter, we met with key members of Congress, the administration and the U.S.

military ought controversy L3's only and disruptive capabilities and ought highlight our technique solutions. My team and I went out again ought encounter customers at the center East. though you are aware, international affair development relies upon dwelling long-term relationships and listening ought our customers ought learn their challenges. We last ought invent more and more inroads, seeing an improved tenor ought our meetings and dine received definite reception ought our merger with Harris from our international customers.

Bottom row is we are seeing a large ask worldwide though an innovative, agile company who wants ought comrade with their customers. little tendency awards highlight our talent at delivering integrated mission solutions. at the recently announced $1 billion Peregrine give though the Royal Australian stand Force, L3 will deliver four next-gen EW aircraft above a biz aircraft platform. This includes a basis communications infrastructure that will integrate with the Commonwealth's common campaign fighting networks, providing a critical blend among platforms, including the F-35, the Growler and maritime assets.

Our option ought compete though the create of FARA though the U.S. army is another demonstration of our ability ought hire customers with disruptive technique and ought comrade above an significant platform, integrating different communications and mission systems. Many of our capabilities align with the Army's peak priorities, and we last ought isolate property ought encounter these needs. Our affair development activities are now more ambitious and focused and also perfect integrated with order and proposal, engineering and R&D functions.

I exclaim on many more instances of collaboration across divisions though we massacre upon our strategy. Leadership throughout the company is buying into the scene that we can become more and perfect serve our customers if we occupation together. Next, I expect ought impress above the impress at we are making above the ability front. Attracting, developing and retaining peak engineering and managerial ability is the lifeblood of the company.

We began leveraging our HR organization ought mature strategies ought festival more effective at planning our ability needs, at recruiting and retention and at identifying and training our emerging leaders ought admit above larger roles at the company. We made significant impress at on the past year engaging our workforce. Overall, the investments and changes we are making ought perfect the affair are beginning ought generate tangible benefits ought growth and margin. Our employees are increasingly embracing the alter and the fabric of integration, collaboration and innovation is becoming woven deeper into the street of our thinking.

Now let's modify ought a journal of our division performance. Our healthy quarterly operation was led by the ISR Systems division which grew funded orders 58% and sales 23%. Book ought bill was 1.38. Operating earnings increased 40%, generating a edge of 10.4%, up 120 basis points from the previous period.

Growth was most impressive at our aircraft procurement and ISR missionization affair though little key programs accelerated, including the U.S. stand strength Compass Call, Australian Peregrine and the U.S. Missile Defense Agency HALO program. at addition, EO/IR sensors, soldier systems and universe and sensor businesses coarse grew double digits.

Given the broad-based growth at this segment, we last ought expectation ISR Systems ought be our fastest-growing affair with improved margin. Communications and Networked Systems returned ought growth with funded orders up 26% and sales up 11%. Book ought bill was a healthy 1.19. Operating earnings rose 31% and margins improved 160 basis points ought 10.7%.

Sales growth was led by the broadband sector which rose 15% driven by higher UAV traffic and ground-based SATCOM system shipments. Operating edge improvement was driven by program performance, sales blend and price reduction. Lastly, electric Systems sales grew 2% and operating earnings rose 3%. ES' segment-leading edge improved 20 basis points ought 14.7%.

The area was impacted by a sales decline at the Defense training Solutions affair owing ought persist year's loss of the C-17 training session ought the OEM. However, key highlights at electric Systems embrace double-digit growth at precision weapons which grew sales 18% at the quarter. owing ought the headwinds from the C-17 loss, we expectation modest sales growth at 2019, besides we last ought expectation improved edge from ongoing price takeout and favorable session performance. Given our healthy operation at the first area and improving bid momentum, we are increasing our 2019 guidance.

Now I will modify it above ought Ralph ought journal our financials and equip details of our updated guidance.

Ralph D'Ambrosio -- Senior Vice headmaster and chief econmic Officer

Thanks, Chris. I'll journal some details around the first area and then our 2019 guidance update. Reviewing the first quarter, though Chris explained, we had a same healthy commence ought the year and we exceeded our plan. Orders increased 28% and sales grew 14%, coarse of which was organic.

Segment operating earnings and adjusted diluted EPS each grew 24%, and division edge increased 90 basis points ought 11.5%. We also generated definite free money brook which is meaningful though we usually dine negative money brook at our first quarters.Next, I'll comment above some details around the 2019 first quarter. Adjusted diluted EPS was $2.89, an multiply of $0.55 or 24% above the 2018 first area driven greatly by operating earnings growth stemming from our 14% sales growth and our 90 basis points of edge expansion. Adjusted diluted EPS excludes integration and transaction expenses related ought the L3 Harris merger and a $2 million affair divestiture loss.

Sales increased 14% ought $2.7 billion driven by healthy growth at our DoD and international markets. at the division level, sales grew 23% at ISR Systems, 11% at Communications and Networked Systems and 2% Electronics. The growth rates though ISR and Communications included some favorable quarterly timing items which will lower their second area growth rates. at Electronics, sales were negatively impacted by persist summer's C-17 training session loss which lowered growth by 440 basis points at that segment.

Operating edge operation was same good. complete division operating edge increased ought 11.5%, 90 basis points higher than the 2018 first quarter. Lower pension charge increased edge 50 basis points. And favorable session performance, which includes productivity and price reductions, accounted though most of the other 40 basis points of edge expansion.

As a reminder, most of our productivity improvements and price reduction actions display at favorable session performance. each division had double-digit edge compared ought the 2018 first quarter. ISR edge increased 120 basis points ought 10.4%, Communications increased 160 basis points ought 10.7% and Electronics increased 20 basis points ought 14.7%. Operating margins benefited from lower pension charge stemming from the service certainty accrual freeze that we implemented effective January 1.

Other contributors ought edge expansion greatly included sales growth, a lower G&A evaluate and affair divestitures at ISR and favorable session operation and reduced G&A expenses at Communications and Electronics. The impose evaluate increased ought 14.7% from 11.1% though the first area of persist year and that was greatly owing ought lower stock-based compensation charge deductions. We also generated definite free money brook of $146 million, compared ought a money outflow of $85 million though the 2018 first area and that improvement was due greatly ought perfect working main operation and growth at earnings. also compared ought the 2018 first quarter, we reduced our working main days by 10 ought 82.

As Chris explained, we dine placed more attention above improving working main and generating free money brook earlier at the year, and we're seeing benefits from these actions. Now moving ought our 2019 guidance update. We raised our midpoint sales impose by $150 million ought $10.9 billion, which is expected growth of around 6.5% above 2018. Most of the guidance multiply is at ISR Systems.

And I'll add that given our tendency healthy orders and sturdy backlog, we to be able ought motivate more upside ought this year's sales. at the segments, we expectation sales ought festival 9% at ISR, 6% at Communications and 3% Electronics. Our planned 2019 edge expansion of 120 basis points ought 12% is unchanged and firmly above track. remember that above our January 29 pay call, we explained the three drivers of our 2019 edge expansion: L365 productivity price savings, lower pension charge and lower losses at the Traveling ripple subway business.

Each of these will further around 40 basis points of edge expansion. With glory ought the Traveling ripple subway affair improvements, we last ought expectation those ought greatly happen at the second half of 2019. Our combined sales growth and edge expansion this year will originate at division operating earnings growth of 18% above 2018. We held our division edge guidance midpoints at 11.2% though ISR, 11.1% though Communications and 14.4% though Electronics with the segments expanding edge 110 basis points, 200 basis points and 70 basis points, respectively, compared ought 2018.

We lowered our impose evaluate ought 19% from 20%, greatly owing ought lower expected foreign earnings taxes. And though free money flow, we increased it ought $1.055 billion, which is around 13% higher than 2018 with a money conversion evaluate of 113%. money at the aim of March was $1.1 billion. And regarding main allocation, at February, we increased our quarterly money dividend by $0.05 ought $0.85 per share.

We however expectation no debt repayments. And though we previously explained, we suspended portion purchases until the L3 Harris merger is completed. Looking at the second quarter, we expectation sales among $2.6 billion and $2.7 billion with growth of around 3%, operating edge at the high 11% range, with edge expanding more than 100 basis points above the 2018 second quarter, and free money brook among $100 million and $200 million. Finally, ought entire my econmic review, we had a same good commence ought the year with our first-quarter results.

The company is growing at a sturdy pace, becoming more effective and beneficial and also expanding margin. though 2019, we expectation ought festival orders, sales, operating earnings and free money flow, and we're also firmly tracking ought our 12% operating edge objective. Thank you. And I'll now modify it back ought Chris.

Chris Kubasik -- Chairman, chief Executive Officer, and President

Thanks, Ralph. though you saw above April 4, both L3 and Harris received shareholder approvals though the merger, and Harris also recently announced the sale of their evening eyesight business, both significant steps ought consummating the deal. We last ought occupation with coarse regulatory authorities ought obtain the indispensable approvals. And though you heard above the Harris pay exclaim this morning, everything is tracking ought design and there's no alter ought our expected midyear merger close.

The 50-plus members of the common integration team are working diligently and integration planning is going well. The integration management office recently held a impose catch offsite at the ISR facility at Texas. though L3 and Harris teams become more exposure ought each other's operations and people, the more we festival grateful of the technique and ability of the combined company and the latent though what we can perform together. I've been working closely with Bill above the integration, and we will equip details above the board, organizational structure and management shut bargain close.

Given that this is prone L3's persist meeting exclaim though a isolate public company, I expect ought personally thank coarse of the men and women of L3 Technologies though the difficult occupation and dedication throughout the years though making L3 a large lay ought work. And a particular owing ought my executive leadership team though their leadership and operation during the past unite of years, specially with the speed of change. though this chapter at the company's history comes ought an end, a new and exciting chapter begins. I dine ought acknowledge the two CEOs previous me, frank Lanza and Mike Strianese, though their eyesight and difficult occupation ought acquire L3 ought this stage.

By combining what makes L3 such a particular company with the best of what Harris has ought offer, I dine no supicion we can invent a company that is flat more agile, innovative and customer-centric, a best-of-breed aerospace and defense technique company that delivers superior impose though employees, though customers and though the shareholders.

Ralph D'Ambrosio -- Senior Vice headmaster and chief econmic Officer

Yes, Chris. I was thinking around this yesterday. And I counted that it's been 52 consecutive quarterly pay calls though me. hence it's been a immense undergo and I'm same grateful though it.

So I also expect ought thank everyone above the exclaim today though their past and continued advantage at L3 and immediately ought be L3 Harris, specially the analysts above the exclaim also though the analysts who previously covered L3.

Chris Kubasik -- Chairman, chief Executive Officer, and President

Outstanding. coarse right. Kerry, why don't we vacant the lines though questions.

Questions & Answers:

Operator

[Operator instructions] The first mystery will festival from Cai Von Rumohr of Cowen and Company.

Gautam Khanna -- Cowen and company -- Analyst

Yes. It's Gautam really above though Cai. Congratulations above a large flow obviously at L3. I expect ought just demand above the free money brook improvement at the area and some of the working main initiatives more broadly, if you could just explain kind of how much low-hanging fruit you perceive there ought be? And then just though a follow-up, while you just admit the LTM free money brook of both Harris and L3, we're at just under $2.4 billion.

I'm just odd how you view, Chris, the longer vocabulary $3 billion free money finish given we've already chopped a destiny of lumber here. Thanks.

Chris Kubasik -- Chairman, chief Executive Officer, and President

Gautam, thank you same much though the mystery and the compliment. We're pretty excited around the first quarter, besides a absence street ought impress at though 2019 obviously. I fancy the concentrate above working main and money generation was something that we location together at late December. We flat changed the incentive comp design ought highlight the importance of generating free cash.

And Bill and I class a destiny around the $500 million of synergies and the $3 billion of money brook at year three. And I used to say we dine more faith at achieving those numbers today than we did while we first announced this bargain above October 14. I'll allow Ralph class around some of the improvements we made here at the first quarter.

Ralph D'Ambrosio -- Senior Vice headmaster and chief econmic Officer

Sure. hence though I commented, we had a dramatic reduction at our working main days quarter-over-quarter. And if you can recall, the first area of 2018 was our high-water badge at condition of working main and money usage and that's why there's a dramatic reduction compared ought this year's first quarter. besides of class what we're doing is placing more attention above indispensable blocking and tackling, trying ought amass our receivables sooner, continuing ought festival the company and festival inventory at a slower speed and taking actions ought modify our unbilled receivables into billed receivables sooner.

So it's a concerted endeavour across coarse those fronts. though the entire year, we're expecting working main days reduction though well, and we fancy that's going ought be at least two ought three days year above year. hence we to exclaim on more improvement the remainder of this year though well. And obviously, we're going ought attempt ought perform better.

Gautam Khanna -- Cowen and company -- Analyst

Appreciate it.

Operator

The next mystery will festival from Carter Copeland of Melius Research.

Carter Copeland -- Melius inquiry -- Analyst

Hey, good morning, Chris. I wondered if you could comment above the book ought bill. I intend obviously same healthy at the area flat in spite of the healthy sales. Was there anything at there that surprised you from a timing perspective or magnitude perspective that we saw early above this year? Did we pull anything dispatch or is the pipeline a small sheet perfect than you were originally thinking?

Chris Kubasik -- Chairman, chief Executive Officer, and President

That's a large question. I'll say you, we've really tried ought reinvigorate the BD organization and function. We've made investments that you've heard me class around at the past at systems and standardizing policies and procedures. There were a unite of ISR accelerations.

We're talking perhaps second area ought first quarter, which is why we came at a small higher no only above the orders, besides the sales. besides I'm equally excited around what we however dine looking ahead. There are clearly F-16 training opportunities. We won a U.S.

and an international customer. And we perhaps dine three ought four additional bids noted that could be worth $100 million each. hence there could be $300 million ought $500 million of more orders of F-16 though an example. C-130 AMP, hopefully we'll listen above that.

As I mentioned, the team and I dine been spending time at the center East. I fancy we dine some interesting strategies and partnerships there that could perform ought significant growth. And the classified earth is really picking up. That's an region we've been focused above and dine seen some growth, and given some of the next generation capabilities we have, I expectation more wins there.

So though the complete year, I used to expect book ought bill ought be at least 1.1 at each and each segment. And perhaps $12 billion of orders overall is what our extend finish is. besides that's what we're working toward.

Carter Copeland -- Melius inquiry -- Analyst

Great, that's great. Thanks. And just a motivate clarification above the org structure and leadership announcements you said shut ought close. to we assume that's just an 8-K disclosure same near, implication just ago your intended close?

Chris Kubasik -- Chairman, chief Executive Officer, and President

Yes. I mean, I fancy that's fair. Bill and I however dine ought occupation out the details. It depends while we're going ought shut above the timing and such.

But yes, it used to be a math at that joint time frame. We'll perform what makes sensation though coarse the nation involved, interior and external. hence I'll be seeing Bill next week and we'll last ought occupation above a plan. besides I fancy both he