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

The combined company will exist vigorous above the avenue toward becoming a company with the indispensable scale and estate to invest at and ship the most mission-critical solutions to our global aerospace and defense customers. The happen to construct a new A&D company is an exciting and engaging challenge, one that Bill and I and the entire leadership team are ready to accept 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 persist October, our L3 and Harris teams consume been deep at integration planning.

While merger integration activities are occurring throughout the company, our piece teams consume no altered the speed at the slightest, and we abstract to hammer out progress above streamlining and consolidating operations. though example, at our Communications and Networked Systems segment, we consolidated from five sectors to three. And within the integrated maritime systems sector, we are going from 14 divisions to seven. at our electrical Systems segment, we combined our Security & Detection affair into commercial aviation and are evaluating steps to rationalize farther our tool footprint.

Not maiden will the new organizational structure touch overhead and redundant cost, besides either improve align our capabilities with passenger needs, sharpen concentrate above technique investments and heighten affair development efforts to improve serve our customers. Improving affair deed over improve news collection and analytics is a key divide of managing a more integrated company. persist year, we rolled out a series of measure econmic and operating metrics throughout the company though divide of L365. Closer tracking of leading efficiency metrics either though changes to our incentive compensation plan to emphasize cash flow consume been helping to motivate working leading improvements.

Even with sales up 14%, our net working leading maiden increased 4%, main to a reduction at working leading days compared to the preceding year. Operating metrics that chase manufacturing assets and vendor deed is supporting our furnish bind and program management teams to identify and greet problems earlier, enabling the management team to clearly shriek on the interdependencies at their operations. I abstract to invent passenger warfare 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 to conflict L3's sole and disruptive capabilities and to highlight our technique solutions. My team and I went out again to encounter customers at the middle East. though you are aware, international affair development relies upon home long-term relationships and listening to our customers to know their challenges. We abstract to invent more and more inroads, seeing an improved tenor to our meetings and consume received sure reception to our merger with Harris from our international customers.

Bottom row is we are seeing a big absence worldwide though an innovative, agile company who wants to colleague with their customers. little contemporary awards highlight our competence at delivering integrated mission solutions. at the recently announced $1 billion Peregrine agreement though the Royal Australian attitude Force, L3 will ship four next-gen EW jet above a biz jet platform. This includes a base communications infrastructure that will integrate with the Commonwealth's mutual campaign fighting networks, providing a sharp connect among platforms, including the F-35, the Growler and maritime assets.

Our alternative to compete though the compose of FARA though the U.S. army is another demonstration of our competence to avail customers with disruptive technique and to colleague above an significant platform, integrating different communications and mission systems. Many of our capabilities align with the Army's peak priorities, and we abstract to assign estate to encounter 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 shriek on many more instances of collaboration along divisions though we assassinate upon our strategy. Leadership throughout the company is buying into the sentiment that we can acquire more and improve serve our customers if we trade together. Next, I expect to influence above the progress we are making above the capability front. Attracting, developing and retaining peak engineering and managerial capability is the lifeblood of the company.

We began leveraging our HR organization to age strategies to modify more effective at planning our capability needs, at recruiting and retention and at identifying and drill our emerging leaders to accept above larger roles at the company. We made significant progress at the past year engaging our workforce. Overall, the investments and changes we are making to better the affair are beginning to generate tangible benefits to growth and margin. Our employees are increasingly embracing the change and the fabric of integration, collaboration and innovation is becoming woven deeper into the method of our thinking.

Now let's modify to a journal of our piece performance. Our vigorous quarterly deed was led by the ISR Systems piece which grew funded orders 58% and sales 23%. Book to bill was 1.38. Operating earnings increased 40%, generating a edge of 10.4%, up 120 base points from the preceding period.

Growth was most impressive at our jet procurement and ISR missionization affair though little key programs accelerated, including the U.S. attitude might 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 abstract to desire ISR Systems to exist our fastest-growing affair with improved margin. Communications and Networked Systems returned to growth with funded orders up 26% and sales up 11%. Book to bill was a vigorous 1.19. Operating earnings rose 31% and margins improved 160 base points to 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 edge improvement was driven by program performance, sales mix and spend reduction. Lastly, electrical Systems sales grew 2% and operating earnings rose 3%. ES' segment-leading edge improved 20 base points to 14.7%.

The belt was impacted by a sales refuse at the Defense drill Solutions affair due to persist year's loss of the C-17 drill concord to the OEM. However, key highlights at electrical Systems embrace double-digit growth at precision weapons which grew sales 18% at the quarter. due to the headwinds from the C-17 loss, we desire modest sales growth at 2019, besides we abstract to desire improved edge from ongoing spend takeout and favorable concord performance. Given our vigorous deed at the first belt and improving direction momentum, we are increasing our 2019 guidance.

Now I will modify it at to Ralph to journal our financials and equip details of our updated guidance.

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

Thanks, Chris. I'll journal some details almost the first belt and then our 2019 guidance update. Reviewing the first quarter, though Chris explained, we had a identical vigorous initiate to 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 piece edge increased 90 base points to 11.5%. We either generated sure free cash flow which is meaningful though we often consume negative cash flow at our first quarters.Next, I'll comment above some details almost the 2019 first quarter. Adjusted diluted EPS was $2.89, an amplify of $0.55 or 24% at the 2018 first belt driven chiefly by operating earnings growth stemming from our 14% sales growth and our 90 base points of edge expansion. Adjusted diluted EPS excludes integration and transaction expenses related to the L3 Harris merger and a $2 million affair divestiture loss.

Sales increased 14% to $2.7 billion driven by vigorous growth at our DoD and international markets. at the piece 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 persist summer's C-17 drill concord loss which lowered growth by 440 base points at that segment.

Operating edge deed was identical good. full piece operating edge increased to 11.5%, 90 base points higher than the 2018 first quarter. Lower pension spend increased edge 50 base points. And favorable concord performance, which includes productivity and spend reductions, accounted though most of the other 40 base points of edge expansion.

As a reminder, most of our productivity improvements and spend reduction actions exhibit at favorable concord performance. each piece had double-digit edge compared to the 2018 first quarter. ISR edge increased 120 base points to 10.4%, Communications increased 160 base points to 10.7% and Electronics increased 20 base points to 14.7%. Operating margins benefited from lower pension spend stemming from the service confidence accrual freeze that we implemented effective January 1.

Other contributors to edge expansion chiefly included sales growth, a lower G&A impose and affair divestitures at ISR and favorable concord deed and reduced G&A expenses at Communications and Electronics. The impose assess increased to 14.7% from 11.1% though the first belt of persist year and that was chiefly due to lower stock-based compensation spend deductions. We either generated sure free cash flow of $146 million, compared to a cash outflow of $85 million though the 2018 first belt and that improvement was due chiefly to improve working leading deed and growth at earnings. either compared to the 2018 first quarter, we reduced our working leading days by 10 to 82.

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

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

Each of these will advance almost 40 base points of edge expansion. With glory to the Traveling ripple underground affair improvements, we abstract to desire those to chiefly venture at the second half of 2019. Our combined sales growth and edge expansion this year will arise at piece operating earnings growth of 18% at 2018. We held our piece edge guidance midpoints at 11.2% though ISR, 11.1% though Communications and 14.4% though Electronics with the segments expanding edge 110 base points, 200 base points and 70 base points, respectively, compared to 2018.

We lowered our impose assess to 19% from 20%, chiefly due to lower expected foreign earnings taxes. And though free cash flow, we increased it to $1.055 billion, which is almost 13% higher than 2018 with a cash conversion impose of 113%. cash at the goal of March was $1.1 billion. And regarding leading allocation, at February, we increased our quarterly cash dividend by $0.05 to $0.85 per share.

We cottage desire no debt repayments. And though we previously explained, we suspended division 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 edge at the tall 11% range, with edge expanding more than 100 base points at the 2018 second quarter, and free cash flow among $100 million and $200 million. Finally, to end my econmic review, we had a identical good initiate to the year with our first-quarter results.

The company is growing at a vigorous pace, becoming more effective and advantageous and either expanding margin. though 2019, we desire to spend orders, sales, operating earnings and free cash flow, and we're either firmly tracking to our 12% operating edge objective. Thank you. And I'll now modify it undergo to Chris.

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

Thanks, Ralph. though you saw above April 4, both L3 and Harris received shareholder approvals though the merger, and Harris either recently announced the sale of their evening vision business, both significant steps to consummating the deal. We abstract to trade with entire regulatory authorities to acquire the indispensable approvals. And though you heard above the Harris earnings shriek this morning, everything is tracking to plan and there's no change to 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 capture offsite at the ISR facility at Texas. though L3 and Harris teams acquire more exposure to each other's operations and people, the more we modify grateful of the technique and capability of the combined company and the latent though what we can fulfill together. I've been working closely with Bill above the integration, and we will equip details above the board, organizational structure and management near occupation close.

Given that this is apt L3's persist assembly shriek though a divide public company, I expect to personally thank entire of the men and women of L3 Technologies though the difficult trade and dedication throughout the years though making L3 a big place to work. And a specific due to my executive leadership team though their leadership and deed during the past unite of years, specially with the speed of change. though this chapter at the company's history comes to an end, a new and exciting chapter begins. I consume to admit the two CEOs previous me, frank Lanza and Mike Strianese, though their vision and difficult trade to acquire L3 to this stage.

By combining what makes L3 such a specific company with the best of what Harris has to offer, I consume no supicion we can compose a company that is flat more agile, innovative and customer-centric, a best-of-breed aerospace and defense technique company that delivers superior evaluate though employees, though customers and though the shareholders.

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

Yes, Chris. I was thinking almost this yesterday. And I counted that it's been 52 consecutive quarterly earnings calls though me. consequently it's been a massive undergo and I'm identical grateful though it.

So I either expect to thank everyone above the shriek today though their past and continued entertain at L3 and directly to exist L3 Harris, specially the analysts above the shriek either though the analysts who previously covered L3.

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

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

Questions & Answers:

Operator

[Operator instructions] The first riddle will become 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 big flow obviously at L3. I expect to impartial ask above the free cash flow improvement at the belt and some of the working leading initiatives more broadly, if you could impartial illustrate organize of how much low-hanging fruit you perceive there to be? And then impartial though a follow-up, while you impartial accept the LTM free cash flow of both Harris and L3, we're at impartial beneath $2.4 billion.

I'm impartial funny how you view, Chris, the longer vocabulary $3 billion free cash end given we've already chopped a lot of timber here. Thanks.

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

Gautam, thank you identical much though the riddle and the compliment. We're pretty excited almost the first quarter, besides a absence method to progress though 2019 obviously. I meditate the concentrate above working leading and cash generation was something that we place together at late December. We flat changed the incentive comp plan to highlight the importance of generating free cash.

And Bill and I tongue a lot almost the $500 million of synergies and the $3 billion of cash flow at year three. And I used to say we consume more belief at achieving those numbers today than we did while we first announced this occupation above October 14. I'll rent Ralph tongue almost some of the improvements we made here at the first quarter.

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

Sure. consequently 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 sign at condition of working leading and cash usage and that's why there's a dramatic reduction compared to this year's first quarter. besides naturally what we're doing is placing more attention above indispensable blocking and tackling, trying to heap our receivables sooner, continuing to spend the company and spend inventory at a slower speed and taking actions to alter our unbilled receivables into billed receivables sooner.

So it's a concerted trouble along entire those fronts. though the full year, we're expecting working leading days reduction though well, and we meditate that's going to exist at least two to three days year at year. consequently we to shriek on more improvement the rest of this year though well. And obviously, we're going to attempt to fulfill better.

Gautam Khanna -- Cowen and company -- Analyst

Appreciate it.

Operator

The next riddle 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 to bill. I intend obviously identical vigorous at the belt flat in spite of the vigorous 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 tug anything ship or is the pipeline a little slice improve than you were originally thinking?

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

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

We're talking maybe second belt to first quarter, which is why we came at a little higher no maiden above the orders, besides the sales. besides I'm equally excited almost what we cottage consume looking ahead. There are clearly F-16 drill opportunities. We won a U.S.

and an international customer. And we maybe consume three to four additional bids noticeable that could exist worth $100 million each. consequently there could exist $300 million to $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 consume been spending time at the middle East. I meditate we consume some interesting strategies and partnerships there that could fulfill to significant growth. And the classified mud is indeed picking up. That's an region we've been focused above and consume 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 expect book to bill to exist at least 1.1 at each and each segment. And maybe $12 billion of orders overall is what our lengthen end 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 near to close. to we suppose that's impartial an 8-K disclosure identical near, implication impartial ago your intended close?

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

Yes. I mean, I meditate that's fair. Bill and I cottage consume to trade out the details. It depends while we're going to near above the timing and such.

But yes, it used to exist a math at that mutual time frame. We'll fulfill what makes feeling though entire the nation involved, interior and external. consequently I'll exist seeing Bill next week and we'll abstract to trade above a plan. besides I meditate both he said and I said we're ahead of the interior plan that we've laid out above a lot of the different milestones we're going for.

And I meditate flat nation external that are helping us consume been impressed how far ahead we are. consequently we're going to strike the base running above engagement 1. And that's one of the reasons we're gaini