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

The combined company will exist tough above the route toward becoming a company with the indispensable scale and estate ought invest at and forward the most mission-critical solutions ought our global aerospace and defense customers. The happen ought upright a new A&D company is an exciting and engaging challenge, one that Bill and I and the entire leadership team are ready ought 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 might final October, our L3 and Harris teams hold been deep at integration planning.

While merger integration activities are occurring throughout the company, our section teams hold no altered the rate at the slightest, and we summary ought hammer out proceed above streamlining and consolidating operations. though 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 material into commercial aviation and are evaluating steps ought rationalize farther our tool footprint.

Not only will the new organizational structure touch overhead and redundant cost, quiet also better align our capabilities with guest needs, sharpen concentrate above technique investments and heighten material development efforts ought better serve our customers. Improving material regulation across better news collection and analytics is a key divide of managing a more integrated company. final year, we rolled out a progression of standard econmic and operating metrics throughout the company though divide of L365. Closer tracking of leading efficiency metrics also though changes ought our incentive compensation project ought emphasize coin flow hold been helping ought motivate working leading improvements.

Even with sales up 14%, our net working leading only increased 4%, chief ought a reduction at working leading days compared ought the previous year. Operating metrics that follow manufacturing estate and vendor regulation is supporting our supply tie and program management teams ought recognize and salute problems earlier, enabling the management team ought clearly visit the interdependencies at their operations. I summary ought compose guest campaign a priority though the company, though myself and the entire leadership team. during the first quarter, we met with key members of Congress, the administration and the U.S.

military ought conflict L3's unique and disruptive capabilities and ought highlight our technique solutions. My team and I went out again ought encounter customers at the middle East. though you are aware, international material development relies upon house long-term relationships and listening ought our customers ought learn their challenges. We summary ought compose more and more inroads, seeing an improved tenor ought our meetings and hold received sure reception ought our merger with Harris from our international customers.

Bottom row is we are seeing a large appeal worldwide though an innovative, agile company who wants ought mingle with their customers. little recommend awards highlight our competence at delivering integrated mission solutions. at the recently announced $1 billion Peregrine give though the Royal Australian stand Force, L3 will forward four next-gen EW aeroplane above a biz aeroplane platform. This includes a basis communications infrastructure that will integrate with the Commonwealth's mutual battle fighting networks, providing a critical mingle between platforms, including the F-35, the Growler and maritime assets.

Our preference ought contend though the compose of FARA though the U.S. troops is another demonstration of our competence ought hire customers with disruptive technique and ought mingle above an significant platform, integrating different communications and mission systems. Many of our capabilities align with the Army's sumit priorities, and we summary ought assign estate ought encounter these needs. Our material development activities are now more ambitious and focused and also better integrated with bid and proposal, engineering and R&D functions.

I visit many more instances of collaboration along divisions though we massacre upon our strategy. Leadership throughout the company is buying into the concept that we can acquire more and better serve our customers if we vocation together. Next, I desire ought confront above the proceed we are making above the competence front. Attracting, developing and retaining sumit engineering and managerial competence is the lifeblood of the company.

We began leveraging our HR organization ought ripen strategies ought cost more effective at planning our competence needs, at recruiting and retention and at identifying and exercise our emerging leaders ought acknowledge above larger roles at the company. We made significant proceed at the past year engaging our workforce. Overall, the investments and changes we are making ought better the material 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 road of our thinking.

Now let's cost ought a newspaper of our section performance. Our healthful quarterly regulation 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 edge of 10.4%, up 120 basis points from the previous period.

Growth was most impressive at our aeroplane procurement and ISR missionization material 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 space and sensor businesses entire grew double digits.

Given the broad-based growth at this segment, we summary ought desire ISR Systems ought exist our fastest-growing material with improved margin. Communications and Networked Systems returned ought growth with funded orders up 26% and sales up 11%. Book ought bill was a healthful 1.19. Operating earnings 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 edge improvement was driven by program performance, sales mingle and expend reduction. Lastly, electrical Systems sales grew 2% and operating earnings rose 3%. ES' segment-leading edge improved 20 basis points ought 14.7%.

The belt was impacted by a sales decline at the Defense exercise Solutions material because of final year's loss of the C-17 exercise understanding ought the OEM. However, key highlights at 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 desire modest sales growth at 2019, quiet we summary ought desire improved edge from ongoing expend takeout and favorable understanding performance. Given our healthful regulation at the first belt and improving bid momentum, we are increasing our 2019 guidance.

Now I will cost it at ought Ralph ought newspaper our financials and equip details of our updated guidance.

Ralph D'Ambrosio -- Senior Vice headmaster and head econmic Officer

Thanks, Chris. I'll newspaper some details nearly the first belt and then our 2019 guidance update. Reviewing the first quarter, though Chris explained, we had a same healthful initiate ought 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 section edge increased 90 basis points ought 11.5%. We also generated sure free coin flow which is meaningful though we often hold negative coin flow at our first quarters.Next, I'll comment above some details nearly the 2019 first quarter. Adjusted diluted EPS was $2.89, an enlarge of $0.55 or 24% at the 2018 first belt driven mainly by operating earnings growth stemming from our 14% sales growth and our 90 basis points of edge expansion. Adjusted diluted EPS excludes integration and transaction expenses related ought the L3 Harris merger and a $2 million material divestiture loss.

Sales increased 14% ought $2.7 billion driven by healthful growth at our DoD and international markets. at the section level, sales grew 23% at ISR Systems, 11% at Communications and Networked Systems and 2% Electronics. The growth rates though 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 exercise understanding loss which lowered growth by 440 basis points at that segment.

Operating edge regulation was same good. sum section operating edge increased ought 11.5%, 90 basis points higher than the 2018 first quarter. Lower pension expend increased edge 50 basis points. And favorable understanding performance, which includes productivity and expend reductions, accounted though most of the other 40 basis points of edge expansion.

As a reminder, most of our productivity improvements and expend reduction actions display at favorable understanding performance. each section had double-digit edge compared ought the 2018 first quarter. ISR edge 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 expend stemming from the service certainty accrual freeze that we implemented effective January 1.

Other contributors ought edge expansion mainly included sales growth, a lower G&A evaluate and material divestitures at ISR and favorable understanding regulation and reduced G&A expenses at Communications and Electronics. The tax evaluate increased ought 14.7% from 11.1% though the first belt of final year and that was mainly because of lower stock-based compensation expend deductions. We also generated sure free coin flow of $146 million, compared ought a coin outflow of $85 million though the 2018 first belt and that improvement was due mainly ought better working leading regulation and growth at earnings. also compared ought the 2018 first quarter, we reduced our working leading days by 10 ought 82.

As Chris explained, we hold placed more attention above improving working leading and generating free coin 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 impose by $150 million ought $10.9 billion, which is expected growth of nearly 6.5% at 2018. Most of the guidance enlarge is at ISR Systems.

And I'll add that given our recommend healthful orders and vigorous backlog, we ought exist capable ought motivate more upside ought this year's sales. at the segments, we desire sales ought vary 9% at ISR, 6% at Communications and 3% Electronics. Our planned 2019 edge expansion of 120 basis points ought 12% is unchanged and firmly above track. remember that above our January 29 allowance call, we explained the three drivers of our 2019 edge expansion: L365 productivity expend savings, lower pension expend and lower losses at the Traveling wave subway business.

Each of these will promote nearly 40 basis points of edge expansion. With fame ought the Traveling wave subway material improvements, we summary ought desire those ought mainly happen at the second half of 2019. Our combined sales growth and edge expansion this year will originate at section operating earnings growth of 18% at 2018. We held our section edge guidance midpoints at 11.2% though ISR, 11.1% though Communications and 14.4% though Electronics with the segments expanding edge 110 basis points, 200 basis points and 70 basis points, respectively, compared ought 2018.

We lowered our tax evaluate ought 19% from 20%, mainly because of lower expected foreign earnings taxes. And though free coin flow, we increased it ought $1.055 billion, which is nearly 13% higher than 2018 with a coin conversion evaluate of 113%. coin at the disagree of March was $1.1 billion. And regarding leading allocation, at February, we increased our quarterly coin dividend by $0.05 ought $0.85 per share.

We cottage desire no debt repayments. And though we previously explained, we suspended fragment purchases until the L3 Harris merger is completed. Looking at the second quarter, we desire sales between $2.6 billion and $2.7 billion with growth of nearly 3%, operating edge at the high 11% range, with edge expanding more than 100 basis points at the 2018 second quarter, and free coin flow between $100 million and $200 million. Finally, ought end my econmic review, we had a same good initiate ought the year with our first-quarter results.

The company is growing at a vigorous pace, becoming more effective and advantageous and also expanding margin. though 2019, we desire ought vary orders, sales, operating earnings and free coin flow, and we're also firmly tracking ought our 12% operating edge objective. Thank you. And I'll now cost it hind ought Chris.

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

Thanks, Ralph. though you saw above April 4, both L3 and Harris received shareholder approvals though the merger, and Harris also recently announced the sale of their evening eyesight business, both significant steps ought consummating the deal. We summary ought vocation with entire regulatory authorities ought acquire the indispensable approvals. And though you heard above the Harris allowance shout this morning, everything is tracking ought project and there's no vary 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 impose arrest offsite at the ISR facility at Texas. though L3 and Harris teams obtain more exposure ought each other's operations and people, the more we cost grateful of the technique and competence of the combined company and the latent though 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 finish work close.

Given that this is responsible L3's final meeting shout though a divide public company, I desire ought personally thank entire of the men and women of L3 Technologies though the difficult vocation and dedication throughout the years though making L3 a large spot ought work. And a special because of my executive leadership team though their leadership and regulation during the past attach of years, specially with the rate of change. though this chapter at the company's history comes ought an end, a new and exciting chapter begins. I hold ought acknowledge the two CEOs previous me, frank Lanza and Mike Strianese, though their eyesight and difficult vocation 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 hold 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 impose though employees, though customers and though the shareholders.

Ralph D'Ambrosio -- Senior Vice headmaster and head econmic Officer

Yes, Chris. I was thinking nearly this yesterday. And I counted that it's been 52 consecutive quarterly allowance calls though me. hence it's been a giant undergo and I'm same grateful though it.

So I also desire ought thank everyone above the shout today though their past and continued favour at L3 and immediately ought exist L3 Harris, specially the analysts above the shout also though the analysts who previously covered L3.

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

Outstanding. entire right. Kerry, why don't we empty the lines though questions.

Questions & Answers:

Operator

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

Gautam Khanna -- Cowen and company -- Analyst

Yes. It's Gautam indeed above though Cai. Congratulations above a large flow obviously at L3. I desire ought impartial demand above the free coin flow improvement at the belt and some of the working leading initiatives more broadly, if you could impartial interpret kind of how much low-hanging fruit you perceive there ought be? And then impartial though a follow-up, when you impartial acknowledge the LTM free coin flow of both Harris and L3, we're at impartial below $2.4 billion.

I'm impartial exceptional how you view, Chris, the longer vocabulary $3 billion free coin finish given we've already chopped a fate of lumber here. Thanks.

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

Gautam, thank you same much though the issue and the compliment. We're fairly excited nearly the first quarter, quiet a desire road ought proceed though 2019 obviously. I fancy the concentrate above working leading and coin generation was something that we spot together at late December. We even changed the incentive comp project ought highlight the importance of generating free cash.

And Bill and I lecture a fate nearly the $500 million of synergies and the $3 billion of coin flow at year three. And I used to state we hold more certainty at achieving those numbers today than we did when we first announced this work above October 14. I'll allow Ralph lecture nearly some of the improvements we made here at the first quarter.

Ralph D'Ambrosio -- Senior Vice headmaster and head econmic 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 belt of 2018 was our high-water symbol at condition of working leading and coin custom and that's why there's a dramatic reduction compared ought this year's first quarter. quiet naturally what we're doing is placing more attention above necessary blocking and tackling, trying ought accumulate our receivables sooner, continuing ought vary the company and vary inventory at a slower rate and taking actions ought vary our unbilled receivables into billed receivables sooner.

So it's a concerted trouble along entire those fronts. though the entire year, we're expecting working leading days reduction though well, and we fancy that's going ought exist at least two ought three days year at year. hence we ought visit more improvement the surplus of this year though well. And obviously, we're going ought attempt ought carry out better.

Gautam Khanna -- Cowen and company -- Analyst

Appreciate it.

Operator

The next issue will vary 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 same healthful at the belt even in spite of the healthful 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 send or is the pipeline a tiny fragment better than you were originally thinking?

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

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

We're talking maybe second belt ought first quarter, which is why we came at a tiny higher no only above the orders, quiet the sales. quiet I'm equally excited nearly what we cottage hold looking ahead. There are clearly F-16 exercise opportunities. We won a U.S.

and an international customer. And we maybe hold three ought four additional bids famous that could exist worthy $100 million each. hence there could exist $300 million ought $500 million of more orders of F-16 though an example. C-130 AMP, hopefully we'll listen above that.

As I mentioned, the team and I hold been spending time at the middle East. I fancy we hold some interesting strategies and partnerships there that could lead ought significant growth. And the classified country is indeed picking up. That's an zone we've been focused above and hold seen some growth, and given some of the next generation capabilities we have, I desire more wins there.

So though the entire year, I used to desire book ought bill ought exist at least 1.1 at each and each segment. And maybe $12 billion of orders overall is what our extend purpose is. quiet that's what we're working toward.

Carter Copeland -- Melius investigation -- Analyst

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

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

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

But yes, it used to exist a math at that commonplace time frame. We'l