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

The combined company will exist sound above the highway toward becoming a company with the inherent scale and wealth ought invest at and ship the most mission-critical solutions ought our global aerospace and defense customers. The happen ought found a new A&D company is an exciting and engaging challenge, one that Bill and I and the total leadership team are ready ought receive 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 last October, our L3 and Harris teams eat been deep at integration planning.

While merger integration activities are occurring throughout the company, our section teams eat no altered the speed at the slightest, and we summary ought hammer out further 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 electrical Systems segment, we combined our Security & Detection affair into commercial aviation and are evaluating steps ought rationalize farther our device footprint.

Not only will the new organizational structure shift overhead and redundant cost, besides though sound improve align our capabilities with passenger needs, sharpen concentrate above technique investments and enhance affair development efforts ought improve serve our customers. Improving affair deed across improve news collection and analytics is a key isolate of managing a more integrated company. last year, we rolled out a sequence of standard economical and operating metrics throughout the company though isolate of L365. Closer tracking of main efficiency metrics though sound though changes ought our incentive compensation design ought emphasize cash river eat 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 explore manufacturing wealth and vendor deed is supporting our supply tie and program management teams ought identify and hail problems earlier, enabling the management team ought clearly shout on the interdependencies at their operations. I summary ought invent passenger fight 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 dispute L3's virgin and disruptive capabilities and ought highlight our technique solutions. My team and I went out again ought confront customers at the middle East. though you are aware, international affair development relies upon habitation long-term relationships and listening ought our customers ought comprehend their challenges. We summary ought invent more and more inroads, seeing an improved tenor ought our meetings and eat received sure reception ought our merger with Harris from our international customers.

Bottom queue is we are seeing a large demand worldwide because an innovative, agile company who wants ought colleague with their customers. few modern awards highlight our capability at delivering integrated mission solutions. at the recently announced $1 billion Peregrine award because the Royal Australian stand Force, L3 will ship four next-gen EW aeroplane above a biz plane platform. This includes a foundation communications infrastructure that will integrate with the Commonwealth's common fight fighting networks, providing a critical link among platforms, including the F-35, the Growler and maritime assets.

Our alternative ought compete because the rgeister of FARA because the U.S. army is another demonstration of our ability ought hire customers with disruptive technique and ought colleague above an significant platform, integrating different communications and mission systems. Many of our capabilities align with the Army's climax priorities, and we summary ought part wealth ought confront these needs. Our affair development activities are now more ambitious and focused and though sound improve integrated with order and proposal, engineering and R&D functions.

I shout on many more instances of collaboration across divisions though we assassinate upon our strategy. Leadership throughout the company is buying into the thought that we can change more and improve serve our customers if we profession together. Next, I expectation ought impress above the further 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 age strategies ought change more effective can planning our genius needs, can recruiting and retention and can identifying and habit our emerging leaders ought receive 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 ought improve 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 change ought a newspaper of our section performance. Our sound quarterly deed 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 margin of 10.4%, up 120 foundation points from the previous period.

Growth was most impressive at our aeroplane 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 total grew double digits.

Given the broad-based growth at this segment, we summary ought expectation 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 sound 1.19. Operating earnings rose 31% and margins improved 160 foundation 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 mingle and price reduction. Lastly, electrical Systems sales grew 2% and operating earnings rose 3%. ES' segment-leading margin improved 20 foundation points ought 14.7%.

The region was impacted by a sales refuse at the Defense habit Solutions affair owing ought last year's loss of the C-17 habit condense ought the OEM. However, key highlights can electrical 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 we summary ought expectation improved margin from ongoing price takeout and favorable condense performance. Given our sound deed at the first region and improving order momentum, we are increasing our 2019 guidance.

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

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

Thanks, Chris. I'll newspaper some details nearly the first region and then our 2019 guidance update. Reviewing the first quarter, though Chris explained, we had a identical sound go ought the year and we exceeded our plan. Orders increased 28% and sales grew 14%, total of which was organic.

Segment operating earnings and adjusted diluted EPS each grew 24%, and section margin increased 90 foundation points ought 11.5%. We though sound generated sure liberate cash river which is meaningful though we repeatedly eat negative cash river at our first quarters.Next, I'll comment above some details nearly the 2019 first quarter. Adjusted diluted EPS was $2.89, an expand of $0.55 or 24% above the 2018 first region driven mainly by operating earnings growth stemming from our 14% sales growth and our 90 foundation 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 sound growth at 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 region growth rates. can Electronics, sales were negatively impacted by last summer's C-17 habit condense loss which lowered growth by 440 foundation points at that segment.

Operating margin deed was identical good. sum section operating margin increased ought 11.5%, 90 foundation points higher than the 2018 first quarter. Lower pension charge increased margin 50 foundation points. And favorable condense performance, which includes productivity and price reductions, accounted because most of the other 40 foundation points of margin expansion.

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

Other contributors ought margin expansion mainly included sales growth, a lower G&A worthy and affair divestitures can ISR and favorable condense deed and reduced G&A expenses can Communications and Electronics. The impose worthy increased ought 14.7% from 11.1% because the first region of last year and that was mainly owing ought lower stock-based compensation charge deductions. We though sound generated sure liberate cash river of $146 million, compared ought a cash outflow of $85 million because the 2018 first region and that improvement was due mainly ought improve working main deed and growth at earnings. though sound compared ought the 2018 first quarter, we reduced our working main days by 10 ought 82.

As Chris explained, we eat placed more attention above improving working main and generating liberate cash river earlier at the year, and we're seeing benefits from these actions. Now moving ought our 2019 guidance update. We raised our midpoint sales worthy by $150 million ought $10.9 billion, which is expected growth of nearly 6.5% above 2018. Most of the guidance expand is at ISR Systems.

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

Each of these will further nearly 40 foundation points of margin expansion. With reputation ought the Traveling wave subway affair improvements, we summary ought expectation those ought greatly happen at the second half of 2019. Our combined sales growth and margin expansion this year will arise at section operating earnings growth of 18% above 2018. We held our section margin guidance midpoints can 11.2% because ISR, 11.1% because Communications and 14.4% because Electronics with the segments expanding margin 110 foundation points, 200 foundation points and 70 foundation points, respectively, compared ought 2018.

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

We still expectation no debt repayments. And though we previously explained, we suspended segment purchases until the L3 Harris merger is completed. Looking can the second quarter, we expectation sales among $2.6 billion and $2.7 billion with growth of nearly 3%, operating margin at the high 11% range, with margin expanding more than 100 foundation points above the 2018 second quarter, and liberate cash river among $100 million and $200 million. Finally, ought end my economical review, we had a identical good go ought the year with our first-quarter results.

The company is growing can a vigorous pace, becoming more effective and advantageous and though sound expanding margin. because 2019, we expectation ought bring orders, sales, operating earnings and liberate cash flow, and we're though sound firmly tracking ought our 12% operating margin objective. Thank you. And I'll now change it hind ought Chris.

Chris Kubasik -- Chairman, main 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 sound recently announced the sale of their evening sight business, both significant steps ought consummating the deal. We summary ought profession with total regulatory authorities ought acquire the inherent approvals. And though you heard above the Harris earnings shout 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 evaluate arrest offsite can the ISR facility at Texas. though L3 and Harris teams acquire more exposure ought each other's operations and people, the more we change grateful of the technique and genius of the combined company and the latent because what we can do together. I've been working closely with Bill above the integration, and we will supply details above the board, organizational structure and management terminate business close.

Given that this is responsible L3's last council shout though a divide public company, I expectation ought personally thank total of the men and women of L3 Technologies because the difficult profession and dedication throughout the years because making L3 a large site ought work. And a special owing ought my executive leadership team because their leadership and deed during the past attach of years, especially with the speed of change. though this chapter at the company's history comes ought an end, a new and exciting chapter begins. I eat ought acknowledge the two CEOs previous me, frank Lanza and Mike Strianese, because their sight and difficult profession ought obtain L3 ought this stage.

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

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

Yes, Chris. I was thinking nearly this yesterday. And I counted that it's been 52 consecutive quarterly earnings calls because me. consequently it's been a vast sustain and I'm identical grateful because it.

So I though sound expectation ought thank everyone above the shout today because their past and continued benefit at L3 and soon ought exist L3 Harris, especially the analysts above the shout though sound though the analysts who previously covered L3.

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

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

Questions & Answers:

Operator

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

Gautam Khanna -- Cowen and company -- Analyst

Yes. It's Gautam really above because Cai. Congratulations above a large river obviously can L3. I expectation ought impartial request above the liberate cash river improvement at the region and some of the working main initiatives more broadly, if you could impartial illustrate type of how much low-hanging fruit you perceive there ought be? And then impartial though a follow-up, while you impartial receive the LTM liberate cash river of both Harris and L3, we're can impartial beneath $2.4 billion.

I'm impartial crazy how you view, Chris, the longer word $3 billion liberate cash aim given we've already chopped a fate of timber here. Thanks.

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

Gautam, thank you identical much because the question and the compliment. We're fairly excited nearly the first quarter, besides a expect method ought further because 2019 obviously. I fancy the concentrate above working main and cash generation was something that we site together at late December. We flat changed the incentive comp design ought highlight the importance of generating liberate cash.

And Bill and I address a fate nearly the $500 million of synergies and the $3 billion of cash river at year three. And I used to say we eat more credit at achieving those numbers today than we did while we first announced this business above October 14. I'll permit Ralph address nearly some of the improvements we made here at the first quarter.

Ralph D'Ambrosio -- Senior Vice principal and main 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 region of 2018 was our high-water badge at condition of working main and cash habit and that's why there's a dramatic reduction compared ought this year's first quarter. besides certainly what we're doing is placing more attention above basic blocking and tackling, trying ought accumulate our receivables sooner, continuing ought bring the company and bring inventory can a slower speed and taking actions ought alter our unbilled receivables into billed receivables sooner.

So it's a concerted pains across total those fronts. because the sum year, we're expecting working main days reduction though well, and we fancy that's going ought exist can least two ought three days year above year. consequently we ought shout on more improvement the remainder of this year though well. And obviously, we're going ought attempt ought do better.

Gautam Khanna -- Cowen and company -- Analyst

Appreciate it.

Operator

The next question will depart 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 identical sound at the region flat despite the sound 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 deliver or is the pipeline a few sheet improve than you were originally thinking?

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

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

We're talking maybe second region ought first quarter, which is why we came at a few higher no only above the orders, besides the sales. besides I'm equally excited nearly what we still eat looking ahead. There are clearly F-16 habit opportunities. We won a U.S.

and an international customer. And we maybe eat three ought four extra bids noted that could exist worthy $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 eat been spending time at the middle East. I fancy we eat some interesting strategies and partnerships there that could direct ought significant growth. And the classified world is indeed picking up. That's an region we've been focused above and eat seen some growth, and given some of the next generation capabilities we have, I expectation more wins there.

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

Carter Copeland -- Melius inquiry -- Analyst

Great, that's great. Thanks. And impartial a fast clarification above the org structure and leadership announcements you said terminate ought close. ought we guess that's impartial an 8-K disclosure identical near, implication impartial ago your intended close?

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

Yes. I mean, I fancy that's fair. Bill and I still eat ought profession out the details. It depends while we're going ought near above the timing and such.