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

The combined company will exist vigorous above the way toward becoming a company with the inherent scale and assets ought invest can and dispatch the most mission-critical solutions ought our global aerospace and defense customers. The opportunity ought perpendicular a new A&D company is an exciting and engaging challenge, one that Bill and I and the sum leadership team are ready ought acknowledge on. And can the many visits with our L3 and Harris employees can the field, this excitement is broadly shared throughout. during announcing this merger of energy persist October, our L3 and Harris teams dine been deep can integration planning.

While merger integration activities are occurring throughout the company, our section teams dine no altered the speed can the slightest, and we abstract ought hammer out advance above streamlining and consolidating operations. because example, can 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. can our electric Systems segment, we combined our Security & Detection worry into commercial aviation and are evaluating steps ought rationalize farther our appliance footprint.

Not only will the new organizational structure transfer overhead and redundant cost, cottage during also perfect align our capabilities with passenger needs, sharpen concentrate above technique investments and enhance worry development efforts ought perfect serve our customers. Improving worry code across perfect news collection and analytics is a key divide of managing a more integrated company. persist year, we rolled out a sequence of measure economical and operating metrics throughout the company during divide of L365. Closer tracking of leading efficiency metrics also during changes ought our incentive compensation plot ought emphasize cash flow dine been helping ought motivate working leading improvements.

Even with sales up 14%, our net working leading only increased 4%, chief ought a reduction can working leading days compared ought the previous year. Operating metrics that explore manufacturing characteristic and vendor code is supporting our equip fasten and program management teams ought identify and greet problems earlier, enabling the management team ought clearly visit the interdependencies can their operations. I abstract ought list passenger effort 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 ought debate L3's sole and disruptive capabilities and ought highlight our technique solutions. My team and I went out again ought encounter customers can the core East. during you are aware, international worry development relies upon building long-term relationships and listening ought our customers ought appreciate their challenges. We abstract ought list 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 great demand worldwide because an innovative, agile company who wants ought companion with their customers. little modern awards highlight our competence can delivering integrated mission solutions. can the recently announced $1 billion Peregrine give because the Royal Australian stand Force, L3 will dispatch four next-gen EW aircraft above a biz aeroplane platform. This includes a base communications infrastructure that will integrate with the Commonwealth's mutual battle fighting networks, providing a critical unite among platforms, including the F-35, the Growler and maritime assets.

Our option ought contend because the create of FARA because the U.S. troops is another parade of our capacity ought use customers with disruptive technique and ought companion above an significant platform, integrating various communications and mission systems. Many of our capabilities align with the Army's climax priorities, and we abstract ought segregate assets ought encounter these needs. Our worry development activities are now more ambitious and focused and also perfect integrated with order and proposal, engineering and R&D functions.

I visit many more instances of collaboration across divisions during we kill upon our strategy. Leadership throughout the company is buying into the sentiment that we can acquire more and perfect serve our customers if we occupation together. Next, I expect ought impress above the advance we are making above the genius front. Attracting, developing and retaining climax engineering and managerial genius is the lifeblood of the company.

We began leveraging our HR organization ought ripen strategies ought grow more effective can planning our genius needs, can recruiting and retention and can identifying and exercise our emerging leaders ought acknowledge above larger roles can the company. We made significant advance can the past year engaging our workforce. Overall, the investments and changes we are making ought perfect the worry 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 grow ought a journal of our section performance. Our vigorous quarterly code was led by the ISR Systems section which grew funded orders 58% and sales 23%. Book ought bill was 1.38. Operating earnings increased 40%, generating a verge of 10.4%, up 120 base points from the previous period.

Growth was most impressive can our aircraft procurement and ISR missionization worry during little key programs accelerated, including the U.S. stand energy Compass Call, Australian Peregrine and the U.S. Missile Defense Agency HALO program. can addition, EO/IR sensors, soldier systems and space and sensor businesses sum grew double digits.

Given the broad-based growth can this segment, we abstract ought desire ISR Systems ought exist our fastest-growing worry with improved margin. Communications and Networked Systems returned ought growth with funded orders up 26% and sales up 11%. Book ought bill was a vigorous 1.19. Operating earnings 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 traffic and ground-based SATCOM system shipments. Operating verge improvement was driven by program performance, sales mix and fare reduction. Lastly, electric Systems sales grew 2% and operating earnings rose 3%. ES' segment-leading verge improved 20 base points ought 14.7%.

The area was impacted by a sales refuse can the Defense exercise Solutions worry owing ought persist year's loss of the C-17 exercise understanding ought the OEM. However, key highlights can electric Systems involve double-digit growth can precision weapons which grew sales 18% can the quarter. owing ought the headwinds from the C-17 loss, we desire modest sales growth can 2019, cottage during we abstract ought desire improved verge from ongoing fare takeout and favorable understanding performance. Given our vigorous code can the first area and improving order momentum, we are increasing our 2019 guidance.

Now I will grow it above ought Ralph ought journal our financials and equip 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 area and then our 2019 guidance update. Reviewing the first quarter, during Chris explained, we had a too vigorous go ought the year and we exceeded our plan. Orders increased 28% and sales grew 14%, sum of which was organic.

Segment operating earnings and adjusted diluted EPS each grew 24%, and section verge increased 90 base points ought 11.5%. We also generated sure free cash flow which is meaningful during we usually dine negative cash flow can our first quarters.Next, I'll comment above some details almost the 2019 first quarter. Adjusted diluted EPS was $2.89, an expand of $0.55 or 24% above the 2018 first area driven largely 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 ought the L3 Harris merger and a $2 million worry divestiture loss.

Sales increased 14% ought $2.7 billion driven by vigorous growth can our DoD and international markets. can the section 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 area growth rates. can Electronics, sales were negatively impacted by persist summer's C-17 exercise understanding loss which lowered growth by 440 base points can that segment.

Operating verge code was too good. full section operating verge increased ought 11.5%, 90 base points higher than the 2018 first quarter. Lower pension fare increased verge 50 base points. And favorable understanding 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 can favorable understanding performance. each section had double-digit verge compared ought the 2018 first quarter. ISR verge 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 fare stemming from the service belief accrual freeze that we implemented effective January 1.

Other contributors ought verge expansion largely included sales growth, a lower G&A worthy and worry divestitures can ISR and favorable understanding code and reduced G&A expenses can Communications and Electronics. The impose worthy increased ought 14.7% from 11.1% because the first area of persist year and that was largely owing ought lower stock-based compensation fare deductions. We also generated sure free cash flow of $146 million, compared ought a cash outflow of $85 million because the 2018 first area and that improvement was due largely ought perfect working leading code and growth can earnings. also compared ought the 2018 first quarter, we reduced our working leading days by 10 ought 82.

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

And I'll add that given our modern vigorous orders and noise backlog, we ought exist able ought motivate more upside ought this year's sales. can the segments, we desire sales ought grow 9% can ISR, 6% can Communications and 3% Electronics. Our planned 2019 verge expansion of 120 base points ought 12% is unchanged and firmly above track. memorize that above our January 29 earnings call, we explained the three drivers of our 2019 verge expansion: L365 productivity fare savings, lower pension fare and lower losses can the Traveling wave subway business.

Each of these will further almost 40 base points of verge expansion. With admire ought the Traveling wave subway worry improvements, we abstract ought desire those ought greatly happen can the second half of 2019. Our combined sales growth and verge expansion this year will originate can section operating earnings growth of 18% above 2018. We held our section 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 ought 2018.

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

We cottage desire no debt repayments. And during we previously explained, we suspended division purchases until the L3 Harris merger is completed. Looking can the second quarter, we desire sales among $2.6 billion and $2.7 billion with growth of almost 3%, operating verge can the high 11% range, with verge expanding more than 100 base points above the 2018 second quarter, and free cash flow among $100 million and $200 million. Finally, ought familiar my economical review, we had a too good go ought the year with our first-quarter results.

The company is growing can a noise pace, becoming more effective and advantageous and also expanding margin. because 2019, we desire ought grow orders, sales, operating earnings and free cash flow, and we're also firmly tracking ought our 12% operating verge objective. Thank you. And I'll now grow it help ought Chris.

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

Thanks, Ralph. during you saw above April 4, both L3 and Harris received shareholder approvals because the merger, and Harris also recently announced the sale of their evening vision business, both significant steps ought consummating the deal. We abstract ought occupation with sum regulatory authorities ought acquire the inherent approvals. And during you heard above the Harris earnings cry this morning, everything is tracking ought plot 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 estimate arrest offsite can the ISR facility can Texas. during L3 and Harris teams acquire more exposure ought 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 carry out together. I've been working closely with Bill above the integration, and we will equip details above the board, organizational structure and management end vocation close.

Given that this is apt L3's persist conference cry during a divide public company, I expect ought personally thank sum of the men and women of L3 Technologies because the difficult occupation and dedication throughout the years because making L3 a great put ought work. And a especial owing ought my executive leadership team because their leadership and code during the past unite of years, especially with the speed of change. during this chapter can the company's history comes ought an end, a new and exciting chapter begins. I dine ought acknowledge the two CEOs previous me, unfold Lanza and Mike Strianese, because their vision and difficult occupation ought acquire L3 ought this stage.

By combining what makes L3 such a especial company with the best of what Harris has ought 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 estimate 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 earnings calls because me. accordingly it's been a colossal experience and I'm too grateful because it.

So I also expect ought thank everyone above the cry today because their past and continued favour can L3 and shortly ought exist L3 Harris, especially the analysts above the cry also during the analysts who previously covered L3.

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

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

Questions & Answers:

Operator

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

Gautam Khanna -- Cowen and company -- Analyst

Yes. It's Gautam truly above because Cai. Congratulations above a great flow obviously can L3. I expect ought just demand above the free cash flow improvement can the area and some of the working leading initiatives more broadly, if you could just illustrate type of how much low-hanging fruit you perceive there ought be? And then just during a follow-up, when you just acknowledge the LTM free cash flow of both Harris and L3, we're can just below $2.4 billion.

I'm just crazy how you view, Chris, the longer language $3 billion free cash familiar given we've already chopped a fate of timber here. Thanks.

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

Gautam, thank you too much because the issue and the compliment. We're fairly excited almost the first quarter, cottage during a desire method ought advance because 2019 obviously. I fancy the concentrate above working leading and cash generation was something that we post together can late December. We even changed the incentive comp plot ought highlight the importance of generating free cash.

And Bill and I kind a fate almost the $500 million of synergies and the $3 billion of cash flow can year three. And I used to say we dine more belief can achieving those numbers today than we did when we first announced this vocation above October 14. I'll allow Ralph kind almost some of the improvements we made here can the first quarter.

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

Sure. accordingly during I commented, we had a dramatic reduction can our working leading days quarter-over-quarter. And if you can recall, the first area of 2018 was our high-water symbol can condition of working leading and cash manners and that's why there's a dramatic reduction compared ought this year's first quarter. cottage during certainly what we're doing is placing more attention above basic blocking and tackling, trying ought amass our receivables sooner, continuing ought grow the company and grow inventory can a slower speed and taking actions ought alter our unbilled receivables into billed receivables sooner.

So it's a concerted effort across sum those fronts. because the full year, we're expecting working leading days reduction during well, and we fancy that's going ought exist can least two ought three days year above year. accordingly we ought visit more improvement the surplus of this year during well. And obviously, we're going ought test ought carry out better.

Gautam Khanna -- Cowen and company -- Analyst

Appreciate it.

Operator

The next issue will grow 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 too vigorous can the area even in spite of the vigorous sales. Was there anything can 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 little sheet perfect than you were originally thinking?

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

That's a great 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 kind almost can the past can systems and standardizing policies and procedures. There were a unite of ISR accelerations.

We're talking possibly second area ought first quarter, which is why we came can a little 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 possibly dine three ought four additional bids famous that could exist worthy $100 million each. accordingly there could exist $300 million ought $500 million of more orders of F-16 during an example. C-130 AMP, hopefully we'll hear above that.

As I mentioned, the team and I dine been spending time can the core East. I fancy we dine some interesting strategies and partnerships there that could direct ought significant growth. And the classified clay is truly picking up. That's an area 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 expect book ought bill ought exist can least 1.1 can each and each segment. And possibly $12 billion of orders overall is what our extend goal is. cottage during 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 end ought close. ought we presume that's just an 8-K disclosure too near, implication just ago your intended close?

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

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

But yes, it used to exist a math can that commonplace time frame. We'll carry out what makes sensation because sum the people involved, inner and external. accordingly I'll e