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

The combined corporation will exist sound above the way toward becoming a corporation with the inherent scale and estate ought invest at and send the most mission-critical solutions ought our global aerospace and defense customers. The happen ought found a new A&D corporation is an exciting and engaging challenge, one that Bill and I and the total leadership team are ready ought identify on. And at the many visits with our L3 and Harris employees at the field, this excitement is broadly shared throughout. because announcing this merger of energy final October, our L3 and Harris teams dine been deep at integration planning.

While merger integration activities are occurring throughout the company, our segment teams dine no altered the velocity at the slightest, and we last ought hammer out contribute 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 affair into commercial aviation and are evaluating steps ought rationalize farther our tool footprint.

Not only will the new organizational structure shift overhead and redundant cost, cottage during too better align our capabilities with customer needs, sharpen concentrate above technique investments and heighten affair development efforts ought better serve our customers. Improving affair action along better news collection and analytics is a key segment of managing a more integrated company. final year, we rolled out a progression of standard economical and operating metrics throughout the corporation though segment of L365. Closer tracking of main efficiency metrics too though changes ought our incentive compensation scheme ought emphasize money jog dine been helping ought motivate working main improvements.

Even with sales up 14%, our net working main only increased 4%, chief ought a reduction at working main days compared ought the preceding year. Operating metrics that explore manufacturing characteristic and vendor action is supporting our supply bind and program management teams ought identify and hail problems earlier, enabling the management team ought clearly shout on the interdependencies at their operations. I last ought compose customer battle a priority because the company, because myself and the total leadership team. during the first quarter, we met with key members of Congress, the administration and the U.S.

military ought argue 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 know their challenges. We last ought compose more and more inroads, seeing an improved tenor ought our meetings and dine received sure reception ought our merger with Harris from our international customers.

Bottom row is we are seeing a large ask worldwide because an innovative, agile corporation who wants ought fellow with their customers. little contemporary awards highlight our capacity at delivering integrated mission solutions. at the recently announced $1 billion Peregrine concord because the Royal Australian stand Force, L3 will send four next-gen EW airplane above a biz airplane platform. This includes a foundation communications infrastructure that will integrate with the Commonwealth's mutual battle fighting networks, providing a critical link among 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 capacity ought hire customers with disruptive technique and ought fellow above an significant platform, integrating various communications and mission systems. Many of our capabilities align with the Army's sumit priorities, and we last ought segment estate ought encounter these needs. Our affair development activities are now more ambitious and focused and too better integrated with order and proposal, engineering and R&D functions.

I shout on many more instances of collaboration across divisions though we slaughter upon our strategy. Leadership throughout the corporation is buying into the thought that we can become more and better serve our customers if we task together. Next, I outlook ought affect above the contribute we are making above the capacity front. Attracting, developing and retaining sumit engineering and managerial capacity is the lifeblood of the company.

We began leveraging our HR organization ought mature strategies ought become more effective at planning our capacity needs, at recruiting and retention and at identifying and exercise our emerging leaders ought identify above larger roles at the company. We made significant contribute at the past year engaging our workforce. Overall, the investments and changes we are making ought better 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 method of our thinking.

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

Growth was most impressive at our airplane procurement and ISR missionization affair though little 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 universe and sensor businesses coarse grew double digits.

Given the broad-based growth at this segment, we last ought desire ISR Systems ought exist 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 robust 1.19. Operating allowance rose 31% and margins improved 160 base 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 margin improvement was driven by program performance, sales mix and salary reduction. Lastly, electric Systems sales grew 2% and operating allowance rose 3%. ES' segment-leading margin improved 20 base points ought 14.7%.

The segment was impacted by a sales decline at the Defense exercise Solutions affair due ought final year's loss of the C-17 exercise conference ought the OEM. However, key highlights at electric Systems contain double-digit growth at precision weapons which grew sales 18% at the quarter. due ought the headwinds from the C-17 loss, we desire modest sales growth at 2019, cottage during we last ought desire improved margin from ongoing salary takeout and favorable conference performance. Given our robust action at the first segment and improving bid momentum, we are increasing our 2019 guidance.

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

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

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

Segment operating allowance and adjusted diluted EPS each grew 24%, and segment margin increased 90 base points ought 11.5%. We too generated sure free money jog which is meaningful though we repeatedly dine negative money jog at our first quarters.Next, I'll comment above some details almost the 2019 first quarter. Adjusted diluted EPS was $2.89, an increase of $0.55 or 24% above the 2018 first segment driven chiefly by operating allowance growth stemming from our 14% sales growth and our 90 base points of margin 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 robust growth at our DoD and international markets. at the segment 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 segment growth rates. at Electronics, sales were negatively impacted by final summer's C-17 exercise conference loss which lowered growth by 440 base points at that segment.

Operating margin action was same good. full segment operating margin increased ought 11.5%, 90 base points higher than the 2018 first quarter. Lower pension charge increased margin 50 base points. And favorable conference performance, which includes productivity and salary reductions, accounted because most of the other 40 base points of margin expansion.

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

Other contributors ought margin expansion chiefly included sales growth, a lower G&A evaluate and affair divestitures at ISR and favorable conference action and reduced G&A expenses at Communications and Electronics. The tax evaluate increased ought 14.7% from 11.1% because the first segment of final year and that was chiefly due ought lower stock-based compensation charge deductions. We too generated sure free money jog of $146 million, compared ought a money outflow of $85 million because the 2018 first segment and that improvement was due chiefly ought better working main action 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 jog earlier at the year, and we're seeing benefits from these actions. Now moving ought our 2019 guidance update. We raised our midpoint sales evaluate by $150 million ought $10.9 billion, which is expected growth of almost 6.5% above 2018. Most of the guidance increase is at ISR Systems.

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

Each of these will contribute almost 40 base points of margin expansion. With esteem ought the Traveling wave subway affair improvements, we last ought desire those ought largely happen at the second half of 2019. Our combined sales growth and margin expansion this year will arise at segment operating allowance growth of 18% above 2018. We held our segment margin guidance midpoints at 11.2% because ISR, 11.1% because Communications and 14.4% because Electronics with the segments expanding margin 110 base points, 200 base points and 70 base points, respectively, compared ought 2018.

We lowered our tax evaluate ought 19% from 20%, chiefly due 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 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 cottage desire no debt repayments. And though we previously explained, we suspended segment purchases until the L3 Harris merger is completed. Looking at the second quarter, we desire sales among $2.6 billion and $2.7 billion with growth of almost 3%, operating margin at the high 11% range, with margin expanding more than 100 base points above the 2018 second quarter, and free money jog among $100 million and $200 million. Finally, ought total my economical review, we had a same good commence 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 desire ought become orders, sales, operating allowance and free money flow, and we're too firmly tracking ought our 12% operating margin objective. Thank you. And I'll now become it backward ought Chris.

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

Thanks, Ralph. though 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 last ought task with coarse regulatory authorities ought acquire the inherent approvals. And though you heard above the Harris salary shout this morning, everything is tracking ought scheme and there's no alter ought 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 evaluate arrest offsite at the ISR facility at Texas. though L3 and Harris teams acquire more exposure ought each other's operations and people, the more we become grateful of the technique and capacity 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 equip details above the board, organizational structure and management total business close.

Given that this is apt L3's final conference shout though a segment public company, I outlook ought personally thank coarse of the men and women of L3 Technologies because the difficult task and dedication throughout the years because making L3 a large post ought work. And a specific because of my executive leadership team because their leadership and action during the past unite of years, specially with the velocity of change. though this chapter at the company's history comes ought an end, a new and exciting chapter begins. I dine ought identify the two CEOs preceding me, frank Lanza and Mike Strianese, because their eyesight and difficult task ought acquire L3 ought this stage.

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

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

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

So I too outlook ought thank everyone above the shout today because their past and continued advantage at L3 and presently ought exist L3 Harris, specially the analysts above the shout too though the analysts who previously covered L3.

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

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

Questions & Answers:

Operator

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

Gautam Khanna -- Cowen and corporation -- Analyst

Yes. It's Gautam truly above because Cai. Congratulations above a large flow obviously at L3. I outlook ought fair ask above the free money jog improvement at the segment and some of the working main initiatives more broadly, if you could fair illustrate type of how much low-hanging fruit you perceive there ought be? And then fair though a follow-up, when you fair identify the LTM free money jog of both Harris and L3, we're at fair below $2.4 billion.

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

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

Gautam, thank you same much because the puzzle and the compliment. We're pretty excited almost the first quarter, cottage during a wish method ought impress can because 2019 obviously. I deem the concentrate above working main and money generation was something that we post together at late December. We even changed the incentive comp scheme ought highlight the importance of generating free cash.

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

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

Sure. consequently though I commented, we had a dramatic reduction at our working main days quarter-over-quarter. And if you can recall, the first segment 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. cottage during of lecture 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 velocity and taking actions ought vary our unbilled receivables into billed receivables sooner.

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

Gautam Khanna -- Cowen and corporation -- Analyst

Appreciate it.

Operator

The next puzzle will become 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 robust at the segment even in spite of the robust 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 draw anything dispatch or is the pipeline a small sheet better than you were originally thinking?

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

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

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

and an international customer. And we perhaps dine three ought four additional bids notorious that could exist worth $100 million each. consequently there could exist $300 million ought $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 deem we dine some interesting strategies and partnerships there that could guide ought significant growth. And the classified dust is truly picking up. That's an segment we've been focused above and dine seen some growth, and given some of the next generation capabilities we have, I desire more wins there.

So because the full year, I used to outlook 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. cottage during that's what we're working toward.

Carter Copeland -- Melius inquiry -- Analyst

Great, that's great. Thanks. And fair a swift clarification above the org structure and leadership announcements you said total ought close. ought we presume that's fair an 8-K disclosure same near, implication fair ago your intended close?

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

Yes. I mean, I deem that's fair. Bill and I cottage dine ought task out the details. It depends when we're going ought total above the timing and such.