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

The combined company will exist strong above the avenue toward becoming a company with the indispensable scale and goods ought invest at and dispatch the most mission-critical solutions ought our global aerospace and defense customers. The chance ought build a new A&D company is an exciting and engaging challenge, one that Bill and I and the total leadership team are ready ought accept on. And at the many visits with our L3 and Harris employees at the field, this excitement is broadly shared throughout. although announcing this merger of force final October, our L3 and Harris teams read been deep at integration planning.

While merger integration activities are occurring throughout the company, our division teams read no altered the speed at the slightest, and we summary ought hammer out further above streamlining and consolidating operations. although 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 equipment footprint.

Not unique will the new organizational structure inspire overhead and redundant cost, besides during either improve align our capabilities with guest needs, sharpen concentrate above technique investments and heighten affair development efforts ought improve serve our customers. Improving affair deed along improve news collection and analytics is a key isolate of managing a more integrated company. final year, we rolled out a sequence of measure economical and operating metrics throughout the company although isolate of L365. Closer tracking of leading efficiency metrics although strong although changes ought our incentive compensation scheme ought emphasize money flow read been helping ought motivate working leading improvements.

Even with sales up 14%, our net working leading unique increased 4%, leading ought a reduction at working leading days compared ought the preceding year. Operating metrics that chase manufacturing assets and vendor deed is supporting our furnish fasten and program management teams ought identify and salute problems earlier, enabling the management team ought clearly yell on the interdependencies at their operations. I summary ought create guest warfare a priority although the company, although 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 unique and disruptive capabilities and ought highlight our technique solutions. My team and I went out again ought satisfy customers at the center East. although you are aware, international affair development relies upon refuge long-term relationships and listening ought our customers ought learn their challenges. We summary ought create more and more inroads, seeing an improved tenor ought our meetings and read received certain reception ought our merger with Harris from our international customers.

Bottom row is we are seeing a big ask worldwide although an innovative, agile company who wants ought companion with their customers. little tendency awards highlight our capability at delivering integrated mission solutions. at the recently announced $1 billion Peregrine give although the Royal Australian attitude Force, L3 will dispatch four next-gen EW aeroplane above a biz aeroplane platform. This includes a base communications infrastructure that will integrate with the Commonwealth's mutual warfare fighting networks, providing a critical link between platforms, including the F-35, the Growler and maritime assets.

Our alternative ought contend although the create of FARA although the U.S. troops is another parade of our faculty ought apply customers with disruptive technique and ought companion 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 divide goods ought satisfy these needs. Our affair development activities are now more ambitious and focused and either improve integrated with order and proposal, engineering and R&D functions.

I yell on many more instances of collaboration along divisions although we massacre upon our strategy. Leadership throughout the company is buying into the conception that we can advantage more and improve serve our customers if we vocation together. Next, I expect ought impress above the further we are making above the capacity front. Attracting, developing and retaining climax engineering and managerial capacity is the lifeblood of the company.

We began leveraging our HR organization ought ripen strategies ought grow more effective at planning our capacity needs, at recruiting and retention and at identifying and drill our emerging leaders ought accept 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 convert 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 division performance. Our strong quarterly deed was led by the ISR Systems division 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 basis points from the preceding period.

Growth was most impressive at our aeroplane procurement and ISR missionization affair although little key programs accelerated, including the U.S. attitude force 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 complete grew double digits.

Given the broad-based growth at this segment, we summary 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 strong 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 margin improvement was driven by program performance, sales mingle and spend reduction. Lastly, electrical Systems sales grew 2% and operating earnings rose 3%. ES' segment-leading margin improved 20 basis points ought 14.7%.

The district was impacted by a sales refuse at the Defense drill Solutions affair due ought final year's loss of the C-17 drill jam ought the OEM. However, key highlights at electrical 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, besides during we summary ought desire improved margin from ongoing spend takeout and favorable jam performance. Given our strong deed at the first district and improving order momentum, we are increasing our 2019 guidance.

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

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

Thanks, Chris. I'll journal some details approximately the first district and then our 2019 guidance update. Reviewing the first quarter, although Chris explained, we had a same strong begin ought the year and we exceeded our plan. Orders increased 28% and sales grew 14%, complete of which was organic.

Segment operating earnings and adjusted diluted EPS each grew 24%, and division margin increased 90 basis points ought 11.5%. We either generated certain liberate money flow which is meaningful although we often read negative money flow at our first quarters.Next, I'll comment above some details approximately the 2019 first quarter. Adjusted diluted EPS was $2.89, an expand of $0.55 or 24% above the 2018 first district driven largely by operating earnings growth stemming from our 14% sales growth and our 90 basis 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 strong growth at our DoD and international markets. at the division level, sales grew 23% at ISR Systems, 11% at Communications and Networked Systems and 2% Electronics. The growth rates although ISR and Communications included some favorable quarterly timing items which will lower their second district growth rates. at Electronics, sales were negatively impacted by final summer's C-17 drill jam loss which lowered growth by 440 basis points at that segment.

Operating margin deed was same good. total division operating margin increased ought 11.5%, 90 basis points higher than the 2018 first quarter. Lower pension spend increased margin 50 basis points. And favorable jam performance, which includes productivity and spend reductions, accounted although most of the other 40 basis points of margin expansion.

As a reminder, most of our productivity improvements and spend reduction actions exhibit at favorable jam performance. each division had double-digit margin compared ought the 2018 first quarter. ISR margin 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 spend stemming from the service confidence accrual freeze that we implemented effective January 1.

Other contributors ought margin expansion largely included sales growth, a lower G&A tax and affair divestitures at ISR and favorable jam deed and reduced G&A expenses at Communications and Electronics. The tax tax increased ought 14.7% from 11.1% although the first district of final year and that was largely due ought lower stock-based compensation spend deductions. We either generated certain liberate money flow of $146 million, compared ought a money outflow of $85 million although the 2018 first district and that improvement was due largely ought improve working leading deed and growth at earnings. either compared ought the 2018 first quarter, we reduced our working leading days by 10 ought 82.

As Chris explained, we read placed more attention above improving working leading and generating liberate money 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 tax by $150 million ought $10.9 billion, which is expected growth of approximately 6.5% above 2018. Most of the guidance expand is at ISR Systems.

And I'll add that given our tendency strong orders and strong backlog, we to exist capable ought motivate more upside ought this year's sales. at the segments, we desire sales ought grow 9% at ISR, 6% at Communications and 3% Electronics. Our planned 2019 margin expansion of 120 basis points ought 12% is unchanged and firmly above track. recall that above our January 29 revenue call, we explained the three drivers of our 2019 margin expansion: L365 productivity spend savings, lower pension spend and lower losses at the Traveling wave underground business.

Each of these will promote approximately 40 basis points of margin expansion. With admire ought the Traveling wave underground affair improvements, we summary ought desire those ought mainly happen at the second half of 2019. Our combined sales growth and margin expansion this year will arise at division operating earnings growth of 18% above 2018. We held our division margin guidance midpoints at 11.2% although ISR, 11.1% although Communications and 14.4% although Electronics with the segments expanding margin 110 basis points, 200 basis points and 70 basis points, respectively, compared ought 2018.

We lowered our tax tax ought 19% from 20%, largely due ought lower expected foreign earnings taxes. And although liberate money flow, we increased it ought $1.055 billion, which is approximately 13% higher than 2018 with a money conversion tax of 113%. money at the purpose of March was $1.1 billion. And regarding leading allocation, at February, we increased our quarterly money dividend by $0.05 ought $0.85 per share.

We still desire no debt repayments. And although we previously explained, we suspended segment 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 approximately 3%, operating margin at the high 11% range, with margin expanding more than 100 basis points above the 2018 second quarter, and liberate money flow between $100 million and $200 million. Finally, ought familiar my economical review, we had a same good begin ought the year with our first-quarter results.

The company is growing at a strong pace, becoming more effective and advantageous and either expanding margin. although 2019, we desire ought grow orders, sales, operating earnings and liberate money flow, and we're either firmly tracking ought our 12% operating margin objective. Thank you. And I'll now grow it assistance ought Chris.

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

Thanks, Ralph. although you saw above April 4, both L3 and Harris received shareholder approvals although the merger, and Harris either recently announced the sale of their evening sight business, both significant steps ought consummating the deal. We summary ought vocation with complete regulatory authorities ought acquire the indispensable approvals. And although you heard above the Harris revenue summon this morning, everything is tracking ought scheme and there's no convert 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 catch offsite at the ISR facility at Texas. although L3 and Harris teams acquire more exposure ought each other's operations and people, the more we grow grateful of the technique and capacity of the combined company and the latent although what we can perform together. I've been working closely with Bill above the integration, and we will supply details above the board, organizational structure and management end occupation close.

Given that this is responsible L3's final assembly summon although a divide public company, I expect ought personally thank complete of the men and women of L3 Technologies although the difficult vocation and dedication throughout the years although making L3 a big lay ought work. And a especial due ought my executive leadership team although their leadership and deed during the past link of years, especially with the speed of change. although this chapter at the company's history comes ought an end, a new and exciting chapter begins. I read ought admit the two CEOs prior me, blunt Lanza and Mike Strianese, although their sight and difficult vocation ought become L3 ought this stage.

By combining what makes L3 such a especial company with the best of what Harris has ought offer, I read no suspect 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 although employees, although customers and although the shareholders.

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

Yes, Chris. I was thinking approximately this yesterday. And I counted that it's been 52 consecutive quarterly revenue calls although me. hence it's been a massive undergo and I'm same grateful although it.

So I either expect ought thank everyone above the summon today although their past and continued advantage at L3 and at once ought exist L3 Harris, especially the analysts above the summon although strong although the analysts who previously covered L3.

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

Outstanding. complete right. Kerry, why don't we hole the lines although questions.

Questions & Answers:

Operator

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

Gautam Khanna -- Cowen and company -- Analyst

Yes. It's Gautam truly above although Cai. Congratulations above a big flow obviously at L3. I expect ought impartial ask above the liberate money flow improvement at the district and some of the working leading initiatives more broadly, if you could impartial explain kind of how much low-hanging fruit you perceive there ought be? And then impartial although a follow-up, when you impartial accept the LTM liberate money 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 liberate money purpose given we've already chopped a lot of lumber here. Thanks.

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

Gautam, thank you same much although the puzzle and the compliment. We're pretty excited approximately the first quarter, besides during a wish method ought further although 2019 obviously. I believe the concentrate above working leading and money generation was something that we lay together at late December. We even changed the incentive comp scheme ought highlight the importance of generating liberate cash.

And Bill and I degree a lot approximately the $500 million of synergies and the $3 billion of money flow at year three. And I used to talk we read more confidence at achieving those numbers today than we did when we first announced this occupation above October 14. I'll allow Ralph degree approximately some of the improvements we made here at the first quarter.

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

Sure. hence although 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 symbol at condition of working leading and money custom and that's why there's a dramatic reduction compared ought this year's first quarter. besides during naturally 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 at a slower speed and taking actions ought convert our unbilled receivables into billed receivables sooner.

So it's a concerted effort along complete those fronts. although the total year, we're expecting working leading days reduction although well, and we believe that's going ought exist at least two ought three days year above year. hence we to yell on more improvement the surplus of this year although well. And obviously, we're going ought attempt ought perform better.

Gautam Khanna -- Cowen and company -- Analyst

Appreciate it.

Operator

The next puzzle will bring 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 strong at the district even in spite of the strong 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 division improve than you were originally thinking?

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

That's a big question. I'll talk you, we've truly tried ought reinvigorate the BD organization and function. We've made investments that you've heard me degree approximately at the past at systems and standardizing policies and procedures. There were a link of ISR accelerations.

We're talking maybe second district ought first quarter, which is why we came at a moment higher no unique above the orders, besides during the sales. besides during I'm equally excited approximately what we still read looking ahead. There are clearly F-16 drill opportunities. We won a U.S.

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

As I mentioned, the team and I read been spending time at the center East. I believe we read some interesting strategies and partnerships there that could guide ought significant growth. And the classified earth is truly picking up. That's an district we've been focused above and read seen some growth, and given some of the next generation capabilities we have, I desire more wins there.

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

Carter Copeland -- Melius inquiry -- Analyst

Great, that's great. Thanks. And impartial a hasty clarification above the org structure and leadership announcements you said end ought close. to we presume 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 believe that's fair. Bill and I still read ought vocation out th