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

The combined company will exist healthy above the highway toward becoming a company with the indispensable scale and estate to invest at and deliver the most mission-critical solutions to our global aerospace and defense customers. The opportunity to found a new A&D company is an exciting and engaging challenge, one that Bill and I and the sum leadership team are ready to acknowledge 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 country bear October, our L3 and Harris teams dine been deep at integration planning.

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

Not only will the new organizational structure transfer overhead and redundant cost, besides though healthy improve align our capabilities with passenger needs, sharpen concentrate above technique investments and heighten affair development efforts to improve serve our customers. Improving affair operation across improve information collection and analytics is a key divide of managing a more integrated company. bear year, we rolled out a sequence of standard economical and operating metrics throughout the company though divide of L365. Closer tracking of leading efficiency metrics too though changes to our incentive compensation project to emphasize money flow dine been helping to drive working leading improvements.

Even with sales up 14%, our net working leading only increased 4%, leading to a reduction at working leading days compared to the foregoing year. Operating metrics that explore manufacturing quality and vendor operation is supporting our equip safe and program management teams to recognize and salute problems earlier, enabling the management team to clearly watch the interdependencies at their operations. I bear to compose passenger campaign a priority because the company, because myself and the sum leadership team. during the first quarter, we met with key members of Congress, the administration and the U.S.

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

Bottom row is we are seeing a large need worldwide because an innovative, agile company who wants to colleague with their customers. few contemporary awards highlight our ability at delivering integrated mission solutions. at the recently announced $1 billion Peregrine harmony because the Royal Australian stand Force, L3 will deliver four next-gen EW airplane above a biz airplane platform. This includes a base communications infrastructure that will integrate with the Commonwealth's mutual campaign fighting networks, providing a critical unite among platforms, including the F-35, the Growler and maritime assets.

Our option to contend because the create of FARA because the U.S. army is another demonstration of our capacity to hire customers with disruptive technique and to colleague above an significant platform, integrating different communications and mission systems. Many of our capabilities align with the Army's peak priorities, and we bear to assign estate to encounter these needs. Our affair development activities are now more ambitious and focused and though healthy improve integrated with order and proposal, engineering and R&D functions.

I watch many more instances of collaboration across divisions though we slaughter upon our strategy. Leadership throughout the company is buying into the concept that we can become more and improve serve our customers if we career together. Next, I expect to affect above the further we are making above the genius front. Attracting, developing and retaining peak engineering and managerial genius is the lifeblood of the company.

We began leveraging our HR organization to mature strategies to grow more effective can planning our genius needs, can recruiting and retention and can identifying and drill our emerging leaders to acknowledge above larger roles at the company. We made significant further at the past year engaging our workforce. Overall, the investments and changes we are making to improve the affair are beginning to generate tangible benefits to growth and margin. Our employees are increasingly embracing the alter and the fabric of integration, collaboration and innovation is becoming woven deeper into the mode of our thinking.

Now let's grow to a publication of our part performance. Our noise quarterly operation was led by the ISR Systems part which grew funded orders 58% and sales 23%. Book to bill was 1.38. Operating earnings increased 40%, generating a verge of 10.4%, up 120 base points from the foregoing period.

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

Given the broad-based growth at this segment, we bear to wish ISR Systems to exist our fastest-growing affair with improved margin. Communications and Networked Systems returned to growth with funded orders up 26% and sales up 11%. Book to bill was a noise 1.19. Operating earnings rose 31% and margins improved 160 base points to 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 verge improvement was driven by program performance, sales mix and fare reduction. Lastly, electrical Systems sales grew 2% and operating earnings rose 3%. ES' segment-leading verge improved 20 base points to 14.7%.

The district was impacted by a sales decline at the Defense drill Solutions affair because of bear year's loss of the C-17 drill commerce to the OEM. However, key highlights can electrical Systems include double-digit growth at precision weapons which grew sales 18% at the quarter. because of the headwinds from the C-17 loss, we wish modest sales growth at 2019, besides we bear to wish improved verge from ongoing fare takeout and favorable commerce performance. Given our noise operation at the first district and improving order momentum, we are increasing our 2019 guidance.

Now I will grow it above to Ralph to publication our financials and equip details of our updated guidance.

Ralph D'Ambrosio -- Senior Vice headmaster and leading economical Officer

Thanks, Chris. I'll publication some details almost the first district and then our 2019 guidance update. Reviewing the first quarter, though Chris explained, we had a identical noise go to the year and we exceeded our plan. Orders increased 28% and sales grew 14%, entire of which was organic.

Segment operating earnings and adjusted diluted EPS each grew 24%, and part verge increased 90 base points to 11.5%. We though healthy generated certain free money flow which is meaningful though we usually 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 enlarge of $0.55 or 24% above the 2018 first district driven greatly by operating earnings growth stemming from our 14% sales growth and our 90 base points of verge expansion. Adjusted diluted EPS excludes integration and transaction expenses related to the L3 Harris merger and a $2 million affair divestiture loss.

Sales increased 14% to $2.7 billion driven by noise growth at our DoD and international markets. can the part level, sales grew 23% can ISR Systems, 11% can 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 district growth rates. can Electronics, sales were negatively impacted by bear summer's C-17 drill commerce loss which lowered growth by 440 base points at that segment.

Operating verge operation was identical good. complete part operating verge increased to 11.5%, 90 base points higher than the 2018 first quarter. Lower pension price increased verge 50 base points. And favorable commerce performance, which includes productivity and fare reductions, accounted because most of the other 40 base points of verge expansion.

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

Other contributors to verge expansion greatly included sales growth, a lower G&A worthy and affair divestitures can ISR and favorable commerce operation and reduced G&A expenses can Communications and Electronics. The impose worthy increased to 14.7% from 11.1% because the first district of bear year and that was greatly because of lower stock-based compensation price deductions. We though healthy generated certain free money flow of $146 million, compared to a money outflow of $85 million because the 2018 first district and that improvement was due greatly to improve working leading operation and growth at earnings. though healthy compared to the 2018 first quarter, we reduced our working leading days by 10 to 82.

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

And I'll add that given our contemporary noise orders and noise backlog, we to exist able to drive more upside to this year's sales. can the segments, we wish sales to fetch 9% at ISR, 6% at Communications and 3% Electronics. Our planned 2019 verge expansion of 120 base points to 12% is unchanged and firmly above track. recolect that above our January 29 earnings call, we explained the three drivers of our 2019 verge expansion: L365 productivity fare savings, lower pension price and lower losses at the Traveling wave underground business.

Each of these will promote almost 40 base points of verge expansion. With reckon to the Traveling wave underground affair improvements, we bear to wish those to greatly happen at the second half of 2019. Our combined sales growth and verge expansion this year will originate at part operating earnings growth of 18% above 2018. We held our part verge guidance midpoints can 11.2% because ISR, 11.1% because Communications and 14.4% because Electronics with the segments expanding verge 110 base points, 200 base points and 70 base points, respectively, compared to 2018.

We lowered our impose worthy to 19% from 20%, greatly because of lower expected foreign earnings taxes. And because free money flow, we increased it to $1.055 billion, which is almost 13% higher than 2018 with a money conversion worthy of 113%. money eventually of March was $1.1 billion. And regarding leading allocation, at February, we increased our quarterly money dividend by $0.05 to $0.85 per share.

We cabin wish no debt repayments. And though we previously explained, we suspended portion purchases until the L3 Harris merger is completed. Looking can the second quarter, we wish sales among $2.6 billion and $2.7 billion with growth of almost 3%, operating verge at the high 11% range, with verge expanding more than 100 base points above the 2018 second quarter, and free money flow among $100 million and $200 million. Finally, to intimate my economical review, we had a identical good go to the year with our first-quarter results.

The company is growing can a noise pace, becoming more effective and advantageous and though healthy expanding margin. because 2019, we wish to fetch orders, sales, operating earnings and free money flow, and we're though healthy firmly tracking to our 12% operating verge objective. Thank you. And I'll now grow it uphold to Chris.

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

Thanks, Ralph. though you saw above April 4, both L3 and Harris received shareholder approvals because the merger, and Harris though healthy recently announced the sale of their evening vision business, both significant steps to consummating the deal. We bear to career with entire regulatory authorities to become the indispensable approvals. And though you heard above the Harris earnings cry this morning, everything is tracking to project and there's no alter to our expected midyear merger close.

The 50-plus members of the mutual integration team are working diligently and integration planning is going well. The integration management office recently held a worthy arrest offsite can the ISR facility at Texas. though L3 and Harris teams obtain more exposure to each other's operations and people, the more we grow grateful of the technique and genius of the combined company and the latent because what we can conduct together. I've been working closely with Bill above the integration, and we will equip details above the board, organizational structure and management near commerce close.

Given that this is responsible L3's bear council cry though a isolate public company, I expect to personally thank entire of the men and women of L3 Technologies because the difficult career and dedication throughout the years because making L3 a large lay to work. And a exceptional because of my executive leadership team because 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 to an end, a new and exciting chapter begins. I dine to acknowledge the two CEOs foregoing me, blunt Lanza and Mike Strianese, because their vision and difficult career to obtain L3 to this stage.

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

Ralph D'Ambrosio -- Senior Vice headmaster and leading economical Officer

Yes, Chris. I was thinking almost this yesterday. And I counted that it's been 52 consecutive quarterly earnings calls because me. hence it's been a gigantic undergo and I'm identical grateful because it.

So I though healthy expect to thank everyone above the cry today because their past and continued apply at L3 and presently to exist L3 Harris, specially the analysts above the cry too though the analysts who previously covered L3.

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

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

Questions & Answers:

Operator

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

Gautam Khanna -- Cowen and company -- Analyst

Yes. It's Gautam indeed above because Cai. Congratulations above a large flow obviously can L3. I expect to fair demand above the free money flow improvement at the district and some of the working leading initiatives more broadly, if you could fair explain category of how much low-hanging fruit you perceive there to be? And then fair though a follow-up, when you fair acknowledge the LTM free money flow of both Harris and L3, we're can fair beneath $2.4 billion.

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

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

Gautam, thank you identical much because the question and the compliment. We're fairly excited almost the first quarter, besides a expect mode to proceed because 2019 obviously. I count the concentrate above working leading and money generation was something that we spot together at late December. We even changed the incentive comp project to highlight the importance of generating free cash.

And Bill and I oration a destiny almost the $500 million of synergies and the $3 billion of money flow at year three. And I used to say we dine more confidence at achieving those numbers today than we did when we first announced this commerce above October 14. I'll lease Ralph oration almost some of the improvements we made here at the first quarter.

Ralph D'Ambrosio -- Senior Vice headmaster and leading economical Officer

Sure. hence though I commented, we had a dramatic reduction at our working leading days quarter-over-quarter. And if you can recall, the first district of 2018 was our high-water badge at condition of working leading and money habit and that's why there's a dramatic reduction compared to this year's first quarter. besides naturally what we're doing is placing more attention above basic blocking and tackling, trying to deduce our receivables sooner, continuing to fetch the company and fetch inventory can a slower speed and taking actions to alter our unbilled receivables into billed receivables sooner.

So it's a concerted effort across entire those fronts. because the complete year, we're expecting working leading days reduction though well, and we count that's going to exist can least two to three days year above year. hence we to watch more improvement the rest of this year though well. And obviously, we're going to experiment to conduct better.

Gautam Khanna -- Cowen and company -- Analyst

Appreciate it.

Operator

The next question will grow from Carter Copeland of Melius Research.

Carter Copeland -- Melius investigation -- Analyst

Hey, good morning, Chris. I wondered if you could comment above the book to bill. I intend obviously identical noise at the district even despite the noise 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 moment slice improve than you were originally thinking?

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

That's a large question. I'll state you, we've indeed tried to 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 unite of ISR accelerations.

We're talking possibly second district to first quarter, which is why we came at a moment higher no only above the orders, besides the sales. besides I'm equally excited almost what we cabin dine looking ahead. There are clearly F-16 drill opportunities. We won a U.S.

and an international customer. And we possibly dine three to four additional bids eminent that could exist worthy $100 million each. hence there could exist $300 million to $500 million of more orders of F-16 though 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 to significant growth. And the classified earth 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 wish more wins there.

So because the complete year, I used to expect book to bill to exist can least 1.1 at each and each segment. And possibly $12 billion of orders overall is what our extend deduce is. besides that's what we're working toward.

Carter Copeland -- Melius investigation -- Analyst

Great, that's great. Thanks. And fair a rapid clarification above the org structure and leadership announcements you said near to close. to we suppose that's fair an 8-K disclosure identical near, meaning fair ago your intended close?

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

Yes. I mean, I count that's fair. Bill and I cabin dine to career out the details. It depends when we're going to near above the timing and such.

But yes, it used to exist a math at that commonplace time frame. We'll conduct what makes feeling because entire the nation involved, interior and external. hence I'll exist seeing Bill next week and we'll bear to career above a plan. besides I count both he said and I said we're ahead of the interior project that we've laid out above a destiny of the various milestones we're going for.