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

The combined corporation will exist strong above the way toward becoming a corporation with the inherent scale and wealth ought invest at and deliver the most mission-critical solutions ought our global aerospace and defense customers. The occur ought build a new A&D corporation is an exciting and engaging challenge, one that Bill and I and the crude leadership team are ready ought recognize on. And at the many visits with our L3 and Harris employees at the field, this excitement is broadly shared throughout. during announcing this merger of force final 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 rate at the slightest, and we experience ought hammer out progress above streamlining and consolidating operations. because 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 brood into commercial aviation and are evaluating steps ought rationalize farther our instrument footprint.

Not virgin will the new organizational structure transfer overhead and redundant cost, besides during too improve align our capabilities with customer needs, sharpen concentrate above technique investments and enhance brood development efforts ought improve serve our customers. Improving brood deed across improve news collection and analytics is a key isolate of managing a more integrated company. final year, we rolled out a series of standard economical and operating metrics throughout the corporation because isolate of L365. Closer tracking of main efficiency metrics too because changes ought our incentive compensation plot ought emphasize money flow dine been helping ought motivate working main improvements.

Even with sales up 14%, our net working main virgin increased 4%, major ought a reduction at working main days compared ought the preceding year. Operating metrics that chase manufacturing estate and vendor deed is supporting our provide fasten and program management teams ought recognize and oration problems earlier, enabling the management team ought clearly visit the interdependencies at their operations. I experience ought compose customer pains a priority because the company, because myself and the crude leadership team. during the first quarter, we met with key members of Congress, the administration and the U.S.

military ought argue L3's virgin and disruptive capabilities and ought highlight our technique solutions. My team and I went out again ought encounter customers at the center East. because you are aware, international brood development relies upon protection long-term relationships and listening ought our customers ought know their challenges. We experience ought compose more and more inroads, seeing an improved tenor ought our meetings and dine received certain reception ought our merger with Harris from our international customers.

Bottom row is we are seeing a large need worldwide because an innovative, agile corporation who wants ought attach with their customers. little contemporary awards highlight our ability at delivering integrated mission solutions. at the recently announced $1 billion Peregrine give because the Royal Australian stand Force, L3 will deliver four next-gen EW airplane above a biz airplane platform. This includes a basis communications infrastructure that will integrate with the Commonwealth's joint pains fighting networks, providing a keen mingle between platforms, including the F-35, the Growler and maritime assets.

Our preference ought compete because the compose of FARA because the U.S. army is another demonstration of our capability ought employ customers with disruptive technique and ought attach above an significant platform, integrating various communications and mission systems. Many of our capabilities align with the Army's climax priorities, and we experience ought assign wealth ought encounter these needs. Our brood development activities are now more ambitious and focused and too improve integrated with order and proposal, engineering and R&D functions.

I visit many more instances of collaboration across divisions because we massacre upon our strategy. Leadership throughout the corporation is buying into the opinion that we can employ more and improve serve our customers if we occupation together. Next, I wish ought affect above the progress we are making above the capability front. Attracting, developing and retaining climax engineering and managerial capability is the lifeblood of the company.

We began leveraging our HR organization ought mature strategies ought become more effective at planning our capability needs, at recruiting and retention and at identifying and drill our emerging leaders ought recognize above larger roles at the company. We made significant progress at the past year engaging our workforce. Overall, the investments and changes we are making ought improve the brood are beginning ought generate tangible benefits ought growth and margin. Our employees are increasingly embracing the vary and the fabric of integration, collaboration and innovation is becoming woven deeper into the manner of our thinking.

Now let's become ought a journal of our division performance. Our tough quarterly deed was led by the ISR Systems division which grew funded orders 58% and sales 23%. Book ought bill was 1.38. Operating allowance increased 40%, generating a rim of 10.4%, up 120 basis points from the preceding period.

Growth was most impressive at our airplane procurement and ISR missionization brood because little key programs accelerated, including the U.S. stand force 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 crude grew double digits.

Given the broad-based growth at this segment, we experience ought expectation ISR Systems ought exist our fastest-growing brood with improved margin. Communications and Networked Systems returned ought growth with funded orders up 26% and sales up 11%. Book ought bill was a tough 1.19. Operating allowance 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 communication and ground-based SATCOM system shipments. Operating rim improvement was driven by program performance, sales mingle and fare reduction. Lastly, electric Systems sales grew 2% and operating allowance rose 3%. ES' segment-leading rim improved 20 basis points ought 14.7%.

The belt was impacted by a sales reject at the Defense drill Solutions brood owing ought final year's loss of the C-17 drill harmony ought the OEM. However, key highlights at electric Systems contain 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 during we experience ought expectation improved rim from ongoing fare takeout and favorable harmony performance. Given our tough deed at the first belt and improving bid momentum, we are increasing our 2019 guidance.

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

Ralph D'Ambrosio -- Senior Vice principal and head economical Officer

Thanks, Chris. I'll journal some details almost the first belt and then our 2019 guidance update. Reviewing the first quarter, because Chris explained, we had a too tough initiate ought the year and we exceeded our plan. Orders increased 28% and sales grew 14%, crude of which was organic.

Segment operating allowance and adjusted diluted EPS each grew 24%, and division rim increased 90 basis points ought 11.5%. We too generated certain free money flow which is meaningful because we frequently dine negative money flow at our first quarters.Next, I'll comment above some details almost the 2019 first quarter. Adjusted diluted EPS was $2.89, an amplify of $0.55 or 24% above the 2018 first belt driven largely by operating allowance growth stemming from our 14% sales growth and our 90 basis points of rim expansion. Adjusted diluted EPS excludes integration and transaction expenses related ought the L3 Harris merger and a $2 million brood divestiture loss.

Sales increased 14% ought $2.7 billion driven by tough 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 because ISR and Communications included some favorable quarterly timing items which will lower their second belt growth rates. at Electronics, sales were negatively impacted by final summer's C-17 drill harmony loss which lowered growth by 440 basis points at that segment.

Operating rim deed was too good. sum division operating rim increased ought 11.5%, 90 basis points higher than the 2018 first quarter. Lower pension price increased rim 50 basis points. And favorable harmony performance, which includes productivity and fare reductions, accounted because most of the other 40 basis points of rim expansion.

As a reminder, most of our productivity improvements and fare reduction actions display at favorable harmony performance. each division had double-digit rim compared ought the 2018 first quarter. ISR rim 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 price stemming from the service faith accrual freeze that we implemented effective January 1.

Other contributors ought rim expansion largely included sales growth, a lower G&A worth and brood divestitures at ISR and favorable harmony deed and reduced G&A expenses at Communications and Electronics. The impose worth increased ought 14.7% from 11.1% because the first belt of final year and that was largely owing ought lower stock-based compensation price deductions. We too generated certain free money flow of $146 million, compared ought a money outflow of $85 million because the 2018 first belt and that improvement was due largely ought improve working main deed and growth at earnings. too 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 flow earlier at the year, and we're seeing benefits from these actions. Now moving ought our 2019 guidance update. We raised our midpoint sales worth by $150 million ought $10.9 billion, which is expected growth of almost 6.5% above 2018. Most of the guidance amplify is at ISR Systems.

And I'll add that given our contemporary tough orders and tough backlog, we ought exist able ought motivate more upside ought this year's sales. at the segments, we expectation sales ought become 9% at ISR, 6% at Communications and 3% Electronics. Our planned 2019 rim expansion of 120 basis points ought 12% is unchanged and firmly above track. remember that above our January 29 wage call, we explained the three drivers of our 2019 rim expansion: L365 productivity fare savings, lower pension price and lower losses at the Traveling ripple underground business.

Each of these will promote almost 40 basis points of rim expansion. With count ought the Traveling ripple underground brood improvements, we experience ought expectation those ought greatly occur at the second half of 2019. Our combined sales growth and rim expansion this year will originate at division operating allowance growth of 18% above 2018. We held our division rim guidance midpoints at 11.2% because ISR, 11.1% because Communications and 14.4% because Electronics with the segments expanding rim 110 basis points, 200 basis points and 70 basis points, respectively, compared ought 2018.

We lowered our impose worth ought 19% from 20%, largely owing ought lower expected foreign allowance taxes. And because free money flow, we increased it ought $1.055 billion, which is almost 13% higher than 2018 with a money conversion worth 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 quiet expectation no debt repayments. And because we previously explained, we suspended division purchases until the L3 Harris merger is completed. Looking at the second quarter, we expectation sales between $2.6 billion and $2.7 billion with growth of almost 3%, operating rim at the tall 11% range, with rim expanding more than 100 basis points above the 2018 second quarter, and free money flow between $100 million and $200 million. Finally, ought end my economical review, we had a too good initiate ought the year with our first-quarter results.

The corporation is growing at a tough pace, becoming more effective and advantageous and too expanding margin. because 2019, we expectation ought become orders, sales, operating allowance and free money flow, and we're too firmly tracking ought our 12% operating rim objective. Thank you. And I'll now become it backward ought Chris.

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

Thanks, Ralph. because you saw above April 4, both L3 and Harris received shareholder approvals because the merger, and Harris too recently announced the sale of their evening eyesight business, both significant steps ought consummating the deal. We experience ought occupation with crude regulatory authorities ought become the inherent approvals. And because you heard above the Harris wage summon this morning, everything is tracking ought plot and there's no vary ought our expected midyear merger close.

The 50-plus members of the joint integration team are working diligently and integration planning is going well. The integration management office recently held a impose arrest offsite at the ISR facility at Texas. because L3 and Harris teams employ more exposure ought each other's operations and people, the more we become grateful of the technique and capability of the combined corporation and the latent because what we can perform together. I've been working closely with Bill above the integration, and we will supply details above the board, organizational structure and management end business close.

Given that this is likely L3's final conference summon because a divide public company, I wish ought personally thank crude of the men and women of L3 Technologies because the difficult occupation and dedication throughout the years because making L3 a large lay ought work. And a especial owing ought my executive leadership team because their leadership and deed during the past mingle of years, specially with the rate of change. because this chapter at the company's history comes ought an end, a new and exciting chapter begins. I dine ought recognize the two CEOs preceding me, frank Lanza and Mike Strianese, because their eyesight and difficult occupation ought acquire L3 ought this stage.

By combining what makes L3 such a especial corporation with the best of what Harris has ought offer, I dine no doubt we can create a corporation that is even more agile, innovative and customer-centric, a best-of-breed aerospace and defense technique corporation that delivers superior impose because employees, because customers and because the shareholders.

Ralph D'Ambrosio -- Senior Vice principal and head economical Officer

Yes, Chris. I was thinking almost this yesterday. And I counted that it's been 52 consecutive quarterly wage calls because me. consequently it's been a immense experience and I'm too grateful because it.

So I too wish ought thank everyone above the summon today because their past and continued employ at L3 and instantly ought exist L3 Harris, specially the analysts above the summon too because the analysts who previously covered L3.

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

Outstanding. crude right. Kerry, why don't we blank the lines because questions.

Questions & Answers:

Operator

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

Gautam Khanna -- Cowen and corporation -- Analyst

Yes. It's Gautam indeed above because Cai. Congratulations above a large flow obviously at L3. I wish ought impartial need above the free money flow improvement at the belt and some of the working main initiatives more broadly, if you could impartial explain kind of how much low-hanging fruit you perceive there ought be? And then impartial because a follow-up, while you impartial recognize the LTM free money flow of both Harris and L3, we're at impartial below $2.4 billion.

I'm impartial odd how you view, Chris, the longer term $3 billion free money purpose given we've already chopped a convict of lumber here. Thanks.

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

Gautam, thank you too much because the riddle and the compliment. We're fairly excited almost the first quarter, besides during a expect manner ought promote because 2019 obviously. I count the concentrate above working main and money generation was something that we setting together at late December. We even changed the incentive comp plot ought highlight the importance of generating free cash.

And Bill and I oration a convict almost the $500 million of synergies and the $3 billion of money flow at year three. And I used to state we dine more faith at achieving those numbers today than we did while we first announced this business above October 14. I'll allow Ralph oration almost some of the improvements we made here at the first quarter.

Ralph D'Ambrosio -- Senior Vice principal and head economical Officer

Sure. consequently because I commented, we had a dramatic reduction at our working main days quarter-over-quarter. And if you can recall, the first belt of 2018 was our high-water sign at condition of working main and money custom and that's why there's a dramatic reduction compared ought this year's first quarter. besides during certainly what we're doing is placing more attention above basic blocking and tackling, trying ought accumulate our receivables sooner, continuing ought become the corporation and become inventory at a slower rate and taking actions ought change our unbilled receivables into billed receivables sooner.

So it's a concerted trouble across crude those fronts. because the crude year, we're expecting working main days reduction because well, and we count that's going ought exist at least two ought three days year above year. consequently we ought visit more improvement the remains of this year because well. And obviously, we're going ought attempt ought perform better.

Gautam Khanna -- Cowen and corporation -- Analyst

Appreciate it.

Operator

The next riddle will become from Carter Copeland of Melius Research.

Carter Copeland -- Melius investigation -- Analyst

Hey, good morning, Chris. I wondered if you could comment above the book ought bill. I intend obviously too tough at the belt even despite the tough 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 drag anything send or is the pipeline a small division improve than you were originally thinking?

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

That's a large question. I'll talk you, we've indeed tried ought reinvigorate the BD organization and function. We've made investments that you've heard me oration almost at the past at systems and standardizing policies and procedures. There were a mingle of ISR accelerations.

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

and an international customer. And we possibly dine three ought four extra bids remarkable that could exist worth $100 million each. consequently there could exist $300 million ought $500 million of more orders of F-16 because an example. C-130 AMP, hopefully we'll hear above that.

As I mentioned, the team and I dine been spending time at the center East. I count we dine some interesting strategies and partnerships there that could direct ought significant growth. And the classified world is indeed picking up. That's an district 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 because the entire year, I used to wish book ought bill ought exist at least 1.1 at each and each segment. And perhaps $12 billion of orders overall is what our extend aim is. besides during that's what we're working toward.

Carter Copeland -- Melius investigation -- Analyst

Great, that's great. Thanks. And impartial a swift clarification above the org structure and leadership announcements you said end ought close. ought we assume that's impartial an 8-K disclosure too near, meaning impartial ago your intended close?

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

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