L3Harris Technologies, Inc. (LHX) Earnings Call Transcript & Summary

Okay. Well, thank you, and good morning. It's great to have with us today, Bill Brown, the Chairman and CEO of L3Harris. Also with him is the CFO, Jay Malave. I want to let everyone know as they have questions, they should submit them through Pigeonhole. That link is on left side of your screen. And also at the end, there is Procensus poll, very short, that you'll see the immediate results from when -- I encourage you to participate in that at the end. And so I know Bill has a few words he wants to start with, and then we'll move into the fireside chat. But right now, I'll turn it over to Bill.

So thanks, Doug, and good morning, everybody. Let me start off with a quick shout out to all the L3Harris employees who are working really tirelessly through this crisis to deliver on the essential missions of our customers. As many of you saw, we reported Q1 just a couple of weeks ago. We're off to a solid start with revenues, margins, earnings per share, funded backlog, all up year-over-year and more than $0.5 billion worth of free cash flow generated, again, in the first quarter. We had to adjust our guidance for the year due to the pandemic, and it's primarily as a result of the pressures that we are seeing and many others are seeing in our modest commercial exposure. But we're able to offset more than half of the headwind with accelerated integration benefits from the merger. And we increased the -- our margin guidance to the upper end of the range of about 17.5%. This is truly an unprecedented time, but I believe as we work through our agenda, we execute on our core strategies that we outlined in the first quarter and also last year around integration, driving operational excellence, investing in technology, shaping the portfolio, maximizing cash, which, really, to me, is a back to basic sort of approach on the things that we can control. And I think our focus on that and execution on those priorities certainly is going to serve us well in this environment. So Doug, again, thanks for hosting us, and I'll turn it back to you for your questions.

Thanks, Bill. The first thing, just because it's the issue of the moment. I'd like to spend a little bit of time on COVID-19. You did discuss some of the impact you're seeing. You talked about that in Q1 results. But can you just update us since you reported how you're seeing things play out? And I mean that both sort of operationally related to your defense businesses and your defense customer, but also on the commercial side, the commercial aerospace and public safety businesses.

Yes. So Doug, let me just take you back to what we reported at the first quarter earnings release. Again, we trimmed our full year guidance to 3.5 -- 3% to 5% versus 5% to 7%, so down about 2 points at the midpoint. About 2/3 of the drop is due to commercial aerospace. The balance was public safety and international. And international, principally in the Middle East and in the Tactical, the night vision goggle and the electro-optical business. So really stepping back, the U.S. government, which is -- which includes mostly defense. There are a few other pieces, but that's mostly defense. That's about 75% of our revenue. That part of our business is up 8% for the year, and that's really due to strength in avionics, in tactical radio, ISR, the space business. Classified portfolio is going very, very well. We are seeing a few disruptions. They're relatively isolated. They're within a quarter. They're not going to affect the year. So that DoD U.S. government business, I think, is going reasonably well. I mean, international is about 20% of our revenue, and I talked about that being roughly flat. So I think sort of up 2% to 3%, roughly flat for the year. And I think in international, we've just taken a more conservative outlook on the Middle East given what we're seeing in oil prices, in COVID-related disruptions in the region, some logistical challenges. And that's really more preemptive because we haven't seen any specific order move out of the year, but we're expecting some softness in the Middle East. And then the last piece, which is the one that's impacted the most, it's about 5% of the portfolio. It's commercial. It's commercial aerospace and it's public safety. That part of the business will be down collectively 20% to 25%. So commercial aerospace is about half of that. We see that down 35% to 40% in the year. So beyond Q1, so Q2 through the balance of the year, down 50%, which is in line with what we hear from IATA. It's tied to the production rates we're hearing out of Airbus and out of Boeing. For a piece of that business, which is the commercial trainer business where we sell simulators, we basically zeroed out our simulators from the Q1 through the balance of the year. So I think we've taken a pretty conservative look on the simulator part of that business. And the other part of the business is public safety. And public safety, we're expecting to be down about 10% this year. We had expected it to be up low single digits, so it's 10% to 15% off our guide. And just to size it, public safety for us last year was about $0.5 billion. So those are the main pieces. As Jay noted on the earnings call, we expect the second quarter to be the weakest quarter of the year, and some of these trends for the year will be the most pronounced in the quarter. We see some improvement in the back end of the year. So we see sequentially earnings per share and revenue coming down in Q2, although we will see modest positive earnings per share growth here in the second quarter.

Now if we then move from that to the DoD budget. Can you tell us a little bit about how you're seeing that budget -- 2021 budget moving through Congress? And what the prospects are that coming through? And also that budget is flattening some. And as you see the budget flatten, how do you see L3Harris' programs look in that context for growth?

Well, first, in terms of just -- I've had a number of conversations with congressional leaders over the last couple of weeks. I mean, one of the benefits of people working remotely is that you can get -- there's a lot of accessibility. So a lot of good dialogue -- and clearly, what we're hearing, I think others are, the dissent is making very good progress on the NDAA. My understanding is the week of the 8th of June, there's going to be a markup. They expect it to be on the floor by July 4 or sometime early in July. The house has really committed to that in terms of the Armed Services Committee, but both the chairman there and the ranking member in connection with the leaders of Senate Armed Services are all committed to getting an NDAA done by the end of September, which is very important for a lot of different reasons. On the appropriation side, we do continue to expect a CR through the end of the year given some of the priorities on COVID and other bills that are maybe pending plus the election coming up. But that's something that, unfortunately, we've become accustomed to and we can manage through. So the top line is pretty well set for fiscal '21 according to budget agreement last year. It's up a little bit, 0.5%, a couple of billion dollars, but at a very elevated level, $740 billion. So it's at a relatively high level, and again, it's roughly flat. In terms of some of the things that we're looking at in the budget, and I do expect that, that number will be adhered to in the final passage of the appropriations bill. Obviously, tactical radio for us is an important line item that has remained well-funded. It seems to be that way in the '21 budget as well. Those line items, up about 20%, which is pretty substantive. It's about just over $1.2 billion. And that's not just the Army, HMS programs, it's SOCOM. It's Marine Corps. It's other parts of the services as well. That line item is growing quite nicely. It's double what it was back in 2018, so that actually looks pretty good. Space is up 30%. We're highly levered to the space side of that -- the budget. C4i is -- we look at ourselves as a -- C4i is our powerhouse in the defense space, and that budget is up around 10%. And of course, the one thing that I think is really important is all the intelligence budget. So the Military and National Intelligence budget still to be running relatively elevated in the mid $80 billion, $86 billion, $85 billion range, which is very, very healthy. And it's up more than 20% from about 5 years ago. So all of that, I think, bodes well for our company, not just in '21, but beyond that. I think there's good trends that support some of these key line items in the national defense strategy.

One of the parts of the budget that has been growing better than the total has been the O&M portion. And your -- one thing that differentiates you is your revenues have been about 50% of your defense revenues tied to O&M. That's -- we've seen that as positive. But if you look at MiFID going forward into future years, that slows down some. I mean how do you -- do we take anything away from that? I mean how do you think of your O&M exposure here and how that goes forward?

Well, I think it's going to be positive. Look, the O&M budgets have come up over the last several years. They're between base and OCO in the $290 billion range, up about 3% here in fiscal '20. As you point out, it is flattening out in '21, and according to the [indiscernible] is relatively flat, but at a very, very elevated level relative to what it's been over the last number of years. Some of the things that we do coming off of the O&M budgets are essential missions. They're ISR missions. They're critical. We've been on them for 10 or 20 years. They've always been well-funded. Certainly, through this sequester, they're well-funded. And I expect that's going to continue into the future. And it does offer some buffer depending upon what happens with the procurement or the investment account. It does provide some buffer. So I think we see it to be sort of a helpful item to us, not a hindrance.

Okay. You mentioned space. Space has been the fastest-growing area in the budget, '21 budget, '20 budget. Can you walk us through your strategy for space? And how you expect to be participating in that growth?

Well, sure. Yes. So space today is considered to be a theater of war. It's a contested environment. And you can see the support of the administration in DoD for space architecture through the formation of the space force, the increases in the budget. And we think that's going to be a trend that's long-term, not short-term. Our position there is multifaceted. We've -- we have -- we've been known for the payloads or a number of payloads for exquisite systems. That business remains very robust. Our legacy at Harris was really an RF capabilities with Exelis becoming optics, augmented that with the merger here with L3. So we have a lot of capabilities to support the exquisite side of the house. The responsive or the smallsat type business is actually growing very, very well. We're well-positioned there as well. It also then extends to the ground mission, so ground space situation awareness, counter communications, training for space force, other things that are ground based. And we just won a recompete of the sensor program that Exelis had. It's called SENSOR. It's -- the new name is Mosaic. And that's really a sustainment and upgrade system for the dozen or so radar and optical systems around the world. And that's a very important contract for us. The IDIQ is about a $1.2 billion opportunity. It could grow from there as we would expect. So on smallsats, our position has been very good. We've been investing in that area for a number of years. We see it as augmenting the exquisite capabilities we happen to have. We've launched 4 smallsats to date. There's several more that'll be launched in the coming months. We have 24 on contract across 4 different customers, so it's pretty broad-based. And as we look at it this year, the RFP activity in this responsive space area is pretty robust as they move from launching a couple of satellites and now building constellations. And really, what's behind this is a desire for resiliency, for lowering cost, increasing the speed to orbit. For our smallsats that we're launching, from the time of order to launch was just under 2 years, which is pretty impressive for space capabilities. And what's happening now with these smallsats, because they're responsive, you do processing of data onboard the satellite, so the capability to transmit information directly down to feed or to a combatant commander, which gives it real live information on the spot. And since it's a fast launch, lower cost satellite, it is affordable for various parts of DoD. So it's opening up new markets for us that weren't there before. So it's been a very important initiative and we're growing very well there. Of course, we do a lot of the nonclassified side as well beyond the GPS III, IIIF. We've been on every GPS satellite that's ever been launched. We are on this new vanguard next-generation GPS satellite called NTS-3 with AFRL, that could grow into a very large platform, is developing technology that will either stand-alone or be onboarded into GPS IIIF. And of course, we do optical sensors for NOAA. So it's a very broad platform we have of capabilities. And really, what our strategy is, is to leverage all the various sensing capabilities from RF to optics, hyperspectral systems, tie them all together, provide more capabilities, including the ground systems, and that's where we're heading. And that focus is opening up great new market opportunities for us.

Well, and when you look at this, one of the things I found challenging about space is that the budget is growing. You're seeing backlogs grow, and everyone participating in this area. But it takes a while often for these backlogs and warrants to turn into revenues. I mean, how should we think about the growth rate, growth trajectory for the space portion of your business?

Well, the business has been growing for us reasonably well over the last 4 or 5 years. And again, there's 30% growth in the budget next year. And you can see it growing beyond that with a lot of support in the classified side as well. So that business should continue to grow in the mid- to high single digits. I think we'd be disappointed if it wasn't in that area. We talk about taking time for backlog to roll off. The reality is in the responsive side of our business, again, since the time to orbit is relatively short from order to delivery is in a 2-year or less period of time because it was 2 years from the -- including the development of the first smallsats that we launched. So obviously, going forward, it will be something less than that. The time to launch is going to be a lot shorter, and therefore, the back roll off will be faster as well.

Yes. That sounds very important because, I mean, historically, with a lot of largesat programs, these have taken a long time to materialize.

Well, it's because a lot of them are -- they take 8 to 10 years to develop that capability. And again, that exquisite business model is going to remain. There is a re-architecting of that particular side of the space architecture. There's -- that's happening. It's getting reconfigured. And we were pleased to support various primes on those particular programs with some really important exquisite capabilities. On top of augmenting that with responsive systems, which is something that we are now priming on end-to-end mission basis.

Well, switching gears a little bit. Can you talk about international opportunities? That certainly -- you've expressed that it's certainly very important. And IMS and tactical radios, where do you see the opportunities to grow there?

So international for us, again, is about 20% of our revenue, and I made that comment upfront. So relative to a few other primes, we're underpenetrated. And I think while we trimmed the outlook for the year, to now be flat versus up low single digit, it was preemptive. We haven't, again, seen cancellations or some opportunities that we're seeing shifting right a little bit, a few shifting left. Overall, still stable, which I think is good in particularly the Five Eyes countries, which has been probably one of the more important markets for all of the defense players in the U.S. So as I noted on the call, the place where we have to keep a close watch is the Middle East. It's about 3% of our overall revenue and given the price of oil, COVID, logistics, but also just the -- sometimes resistance in Congress based on what's happening in the Middle East. We just have to keep a close eye on the trajectory, the passage of orders and opportunities through the Middle East to benefit for us for this year. We reflected in our guidance now what we believe to be the case we'll see for the year. Again, no slip-out for the year, but some moving to the back end of this -- of calendar '20. So in terms of some of the things that we're watching, we've got a pretty broad-based business. Again, it's only 20% of the revenue, but we're in more than 100 countries. We have many different products and programs across Tactical. You mentioned that electro-optical and a bunch of other business areas. But where we're seeing the trend really is the movement internationally, the modernization movement, like we see the DoD rolling international. And that's for us mostly in C4ISR capabilities, so ground-based systems like we saw in the U.A.E., building on top of that, going across the GCC into Australia, Philippines, other places. It's a very important trend that we happen to see. On the airborne side, as you know, we are the prime on ISR upgrades for the Air Force. That has now moved to business jets. There's opportunities internationally. We talked about the Peregrine program with Gulfstream aircraft in Australia. There's opportunities to build on that for other countries around the world to refresh the C4ISR through BizJet-type capabilities. And the same thing on the maritime side like the Canadian surface combatant and other opportunities. So really, a lot of what we see is modernization trends following along this broad C4ISR domain.

And when you think about that 20% today of your revenues, if you roll that forward 5 years, do you think that's going to grow? Or is that going to grow faster than the -- than your U.S. opportunities?

Well, in the last couple of years, the U.S. has been a robust budget. So it's -- U.S. business is growing faster than international, so we moved back probably a little bit in terms of percentage of revenue. At the end of the day, I think we see international opportunities continuing to grow. We see the DoD continuing to grow. Whether it's going to be 20%, 23%, 25% of the business, it's hard to say at this point, Doug, based on trends that we're seeing here. We're focused on it. We prioritize the countries we're going after. We're building the infrastructure, putting new relationships in place. And our objective is to maximize our growth opportunities in international, whether it's the same number today in terms of percentage of revenues or it's higher.

Well, if we switch over to the L3Harris integration efforts. First question, now you've been at this for a little while, I mean, you had done a smaller scale, but you'd done the Exelis integration before. How do you look at this, call it, L3Harris process and contrast it with what you saw and you did in Exelis? What's easier, harder? Where are the opportunities greater?

So it's mirrored off the process we embarked on with Exelis, which I think was pretty successful. So it's a broader process. It's a bigger integration. It's -- there's a lot more complicating parts of it as you'd expect in a large MOE, but the fundamentals are basically the same. We're leveraging the same framework, some of the same team leaders that were involved in Exelis. We've put some of our best leaders on integration, full-time focusing on both functional integration as well as value capture, regular reviews, which, to me, is so fundamental, Doug. I mean, that's why I believe larger acquisitions, larger mergers make sense. It drives my attention, Chris' attention, Jay's with our Board. Every Monday, going back almost to the time we signed the agreement back in October of '18, we've had weekly reviews that are very thorough and driven to kind of capture opportunities. And we continue to move it very aggressively. We knew in this merger, we would see significant opportunities in CHQ and segment consolidation. So that's basically now behind us. We've reduced basically by 1/3. The numbers of segments, the numbers of sectors, the number of divisions, so we reduced a lot of complexity. The corporate offices are consolidated. There's been a lot of -- a tremendous amount of opportunity on the supply chain side. We're seeing right now on the indirects, but we're seeing good opportunities on direct savings, which will happen probably later this year and into '21, tremendous leverage. You can imagine just because L3 was running a very decentralized way, just simply pulling together that information and negotiating with companies as a whole company, as an enterprise, as opposed to 80, 70, 90 different entities, we're going to see a lot of savings here. And we are seeing that. We just completed a negotiation on mobile phone, cell phones, just very recently. When we look at the data, the legacy L3 cost per phone was something like 50% higher than we were at legacy Harris because we combined all of that following the Exelis integration. As we now combine that, we're bringing that down by about 25% per phone. So lots of opportunities, tremendous opportunities to outsource capability to centralize tri-shared services and then outsource capability. So today, we run IT as one centralized function. A lot of piece of finance around centrally payroll is centralized and offshored. We're reducing our cost per check by more than 40%. And so there's just tremendous opportunities that are happening right now. The facility footprint is probably a little bit further off. With Exelis, we had one big opportunity in footprint rationalization. It was moving the radio facility out of Fort Wayne up to Rochester. Here, it's much more fragmented. We have more than 400 different locations. So it's a more fragmented approach. It will take us longer to get at it. But we see great opportunity there as well. The last piece I'll say is on the system side. This is one of the areas on IT that I think we executed very well with Exelis. We went from more than 25 ERP systems down to 3 or 4. We'll probably do the same thing with L3. We have more than 70 different ERP systems today. We don't get down to 3 or 4, but it will go down to the 20, 22 range over the next 3 to 4 years. Again, all that focus on simplification, getting data, getting visibility, to me, is going to continue to show benefits on integration this year, into next year and beyond.

That's one of the things that I was assuming here is that when you look at L3, meaning 80-plus and onetime even more businesses and I would -- I'd argue that somewhat unmanaged for a number of years, it just seems like there must be an opportunity that would kind of keep on giving. I mean, this isn't something that can all be optimized within a year or 2.

That's true. In fact, that's -- when we talk about building this muscle on operational excellence, it's really to drive these opportunities over the long term. Our integration period, we defined it as 3 years, but it just drives a milepost. It says, okay, let's get this done in 3 years, but integration "doesn't end at 3 years in a day." It becomes driving operational excellence. So all of the muscle we're building here today, all the data gathering, all of the things that we're focused on to drive integration is going to allow us to continue to drive operational excellence savings over time. In fact, even now, we're seeing side-by-side, not just the core savings coming off of integration, which you know is now $165 million net in calendar '20. But on top of that, we're getting savings from driving E3 operational excellence that are additive to that. Now these 2 processes will merge in a couple of years, but we're seeing benefits on both sides. And to me that that's fundamental in running a business, is that every year, every day, taking out costs and getting -- and making yourself better. The systems consolidation I was mentioning is going to happen -- it's going to continue way beyond the next 2 years. So there's lots of opportunities, Doug, to continue to refine this business model, both with inside this 3-year period and as well as outside of that.

Yes. So on that, so you mentioned $165 million. That's up from original $115 million assumption for the -- for 2020. You've been targeting gross cost synergies of $500 million, net $300 million. But when you look at that, you're ahead of plan with $165 million. I mean, is that $300 million net synergies in 2022? I mean, you're pretty far down the road, and you've got a lot of work you're doing. It seems like that could be a low number. It seems like awfully conservative now given what you've described.

Well, well, I mean, a couple of things. One, we did about $65 million net in a stub year, which was better than we had expected. And again, your comment was right. We raised it by $50 million, even coming out of the first quarter to $165 million. So cumulative, about $230 million worth of net savings by the end of this year. Now as you know, we pull forward our $300 million net, $500 million gross in '22. We pulled forward that by a year. We now expect that in calendar '21. And we're running pretty hard at it. We're still early in this year. I do expect we'll do probably better than that next year, and we're not going to end in '21. I think '22 is ultimately going to be better than we first expected when we first guided to as we announced the merger to how much cost savings will come out. We continue to find good opportunities that are now really additive to the original targets.

Yes. I want to get into a couple of the business units a little bit, but a couple of questions came in, and they relate to just what you're talking about. When you think of the integration progress and then the other improvement efforts you have underway, how should we think about your medium and long-term margin trajectories for the company as a whole?

Yes. So this year, we're guiding to about 17.5%, which, again, is up a little bit from where we were at the -- when we gave guidance for the full year. It's up about 80 basis points on a proforma basis year-over-year from '19. So 17.5% is pretty good with the synergies flowing through, with operational excellence coming through, even offsetting some of the headwind that might be around development work and other things that we're doing. We see margin growing north of 18% over the next year or 2. It's -- we're on a great trajectory. It's hard to go out beyond that until we really see what happens to the shape of revenue. But when I look at the momentum that the team has built on operational excellence and the progress we're making on cost takeout, clearly, we're doing better than we thought we would just 3 months ago in the year in terms of margins. I see that kind of building into '21 and beyond.

Another area where you seem to be doing better than you thought was working capital. So you've already exceeded your expectations for the merger with respect to working capital. Can you give us an update on how that looks today and what you see as the trajectory now?

Well, we're making really good progress in working capital. And Chris Kubasik and his team are really focusing heavily on this. Jay and I are supporting this. And it's a real strong effort inside the company. So operationally, we've taken out 10 days since the close, which is better than we thought we would be. And I think it's part because we did a lot of work pre-close. We had built up a little bit of muscle in the company at legacy Harris just because we had focused on that a lot coming out of the Exelis acquisition. So again, making good progress there, 10 days. So we ended Q1, around 59, 60 days worth of working capital. The largest opportunity is in inventory. That's what we've been saying all along. We're taking a very methodical, very systematic approach here across the top 10 or 15 business units of the 60 or so that are in the company. Now just for perspective, it's in the back of our investor book. The top 8 business units have working capital days more than 70. That represent more than 60% of our total working capital. We have 4 that are more than 100 days. So we kind of know where the target-rich environment happens to be. And again, it's in inventory. So we saw some early wins, which I think is good. But a lot of the harder to achieve opportunities are still ahead of us. For example, bringing down buffer stocks, which requires us to get confidence in supplier on-time delivery, reducing variability of the supply base, shortening cycle times, improving our forecasting process. Reducing SKUs is an important focus area. It's not just the SKUs we sell out to the marketplace, but it's the component and the commonization of components that go into those SKUs. That was never really a focus area, and that is a great opportunity for us. So we've got to get better on our programs and managing the program milestones, avoiding the billing lag. All these various pieces, we've got line of sight to. We've gotten through the drivers of each of these 10, 12 businesses that we're focused on. We know what we need to do. We have a road map that goes out a couple of years. Some of these things just take time to work through, build a skill inside the business and work through your inventory balance. So I think, overall, very good. We -- at the end of this year, we'll see probably another day, pick up on watch capital. And as we get into the '21 and '22, we'll probably see another 3 to 4 days a year. That's what we're expecting, another 3 to 4 days in '21, another 3 to 4 days in '22. And if you do all that, and yes, just run the math, and you're sort of down in the low 50s, which is not so bad given the fact that we started at 75, but it's still good 5 days higher than a couple of the better peers, and it's 10 or so days more than where we happen to be with legacy Harris at 40. So there's really nothing structural about what we're trying to do that doesn't -- I would say we can't get to where legacy Harris was, which is in the 40-day range. So I'm pretty encouraged about this. We're on it. The teams are working hard. And I have to tell you, we're incentivized for it, Doug. 40% of the compensation for the executive team is based on free cash flow, and that certainly does drive focus.

Also as part of this, you stressed in the merger, the importance of revenue synergies. I think you said, you've submitted 41 proposals that come out of this. Where are you seeing the biggest opportunities? And can you give us a sense of kind of the scale and timing of when we might see those benefits?

So you're right. I mean, we've had 41 proposals in, which is really good. There 16 that have been awarded, and we've been down selected and awarded 8 of them, so about a 50% hit rate, which so far is only in tens of millions of dollars in terms of orders. But the lifetime revenue potential for those 8 that we've prevailed on so far, if all the options are exercised, could be a couple of billion dollars. We're expecting around $2 billion. And those are the ones that we want or down selected on. The pipeline is quite large. It's in multiples of that $2 billion. So the team is working very, very hard on this. There's -- it will start to meaningfully impact revenue, probably 1 year, 1.5 years, 2 years out. Again, these things take time to percolate. They require R&D investment. Many of the opportunities right now, Doug, are in the classified domain. So we really don't talk much about it. It's certainly -- they're important areas, and they will eventually become shipped over into an unclassed environment. But a lot are very broadly in the category of C4ISR, as you'd expect, spectrum dominance, electronic warfare, communicating in contested environment. Space sensing is an important area for what we're looking at. So all of those areas are very, very important. They sort of underpin where the revenue synergies happen to be. And I mentioned the point about investing in IRAD. And it is a very important one. We do spend quite a bit of money on internal R&D. It's close to 4% of our revenue. It's higher than most of the peers, and the team has gotten at this really quickly to consolidate the projects, shift the money to things that have better return, including freeing up capacity to invest in some of these revenue synergy opportunities. These things do take generally some investment, and we're making sure that we can have the investment capacity available to go after these revenue synergies. That's what the team is doing by trying to tighten down what we're doing on R&D today.

Well, I want to turn to space and airborne systems. This is an area where you talked before about the growth potential in space. I know you're in avionics. You're broadening your content on the F-35. Your margins there, though, you've had very high margins, 18%. I know there's some benefits in there from amortization of intangibles. But do you think -- I mean, 18% margins for this business, if this business continues to grow the way you think it is, can you maintain those margin levels?

So you're right. I mean the team has done a great job in driving margins in the space business. So in Q1, we were at about 18.5%. We're guiding to about 18.75% in the year, which is up 20, 25 basis points over last year, which, by the way, last year was up something like 80 basis points over the prior year. So the team has done a very good job here despite some of the headwinds that you're talking about. I think over time, it's likely going to be a little difficult to expand the margin meaningfully beyond where we happen to be, given the mid- to high single-digit growth we see in the area driven by the development work, driven by the growth in F-35. Some of that is development work as well, some of the stuff that's happened in the classified domain. So the team is doing a great job in driving productivity. E3, dropping through the cost savings and using that to offset investments in IRAD and some of the headwinds around development. So overall, I think solid growth in that segment over time and sustaining these margins are in that high-teens range, I think will be a big success for the team.

And's then in communication systems, this is an area where we've certainly been expecting you to come through with a lot of growth, and you have. But book-to-bill in Q1, it was just 0.8 and you said this is a timing issue. Can you give us a sense of how you expect the backlogs and revenues to grow in this unit?

So yes. I mean -- so the book-to-bill in Q1 was a little bit light, but we talked about that, it can be lumpy quarter-to-quarter as it was. If you just go back to where we were since the merger, the book-to-bill there is 1.03. So we built a little bit of backlog, which is -- we're just about 1.04 the Tactical radio business. We expect the year book-to-bill to be in that 1.0 or better range. So a lot of it is driven by modernization. You see the budget line items in tactical radio. We see the same thing in night vision. So for the year, we've guided to about 4% revenue growth in the segment. So 3.5% to 5% is our guidance range. That's after growing 11% last year, which was really very strong. And again, doing 4% or so this year, when you have the public safety business down 10% and international Tactical basically flat, we're showing the resilience of that portfolio of businesses within CS. So again, going forward, the way we look at this, the DoD tactical radio business will continue to ramp. We saw that in Q1. We saw that last year. We see it in the budget growth as I mentioned earlier in this conversation. In night vision goggles, we're at the front end of, I think, a big modernization ramp on the ENVG-B program. Just for perspective, we've delivered less than 700 night vision goggles of a 10,000 unit directed requirement with a program of record competition happening later this year for 100,000. So this is a -- we see a good growth opportunity in night vision goggles. We see PSPC stabilizing after we get beyond this year. International should continue to grow in the low single digits after we get out of this year. So a lot of, I think, positive things happening in that business, again, but book-to-bill can be lumpy quarter-to-quarter.

In communication systems, also -- this is a business where most of your work is under fixed-price contracts. I think you have a pretty good percentage even under commercial terms, which has allowed you to get some very high margins. But also because of those contract structures, that's where you would expect to see a lot of the operational improvements and the synergies be able to come through in margin improvement. Can you talk about that and how you see the margins going forward in Communications?

Well, it's actually come up. So it's -- the team has done a great job. Here, Doug, it was up about 100 basis points last year. We're guiding to up about 135 basis points this year to 23.75%, which is extraordinary given the mix of businesses there. And it's -- in lots of ways, it's playing out as we had expected to. We've talked a lot about the margin pressure that we saw as you ramp modernization, ramp the radios, but then they eventually start to improve as you take cost out, you develop capabilities on the line, you start to get the volume benefits. And that's really what's playing out here, is you're starting to see the benefits of that coming through. The team does a great job on productivity. We -- so they're dropping through the cost synergies, but on the productivity agenda, we've talked a lot about an objective of 2% to 3% net of inflation in cost savings every year. And at this segment, they're at the high end of that range. And in fact, when you look at just the Tactical business, it's above the high end of the range. So they've got a muscle built even though the relatively high-margin products, they muscle build to continue every day, looking at how do you take out costs either on the labor side or in supply chain. And you can see it coming through in the numbers. 23.75% this year is a pretty good margin rate for that segment.

Yes. When you look overall at the portfolio, you've talked about divesting 8% to 10% of revenues over time. Can you give us a sense of how you think about this? What are the opportunities you look at for reshaping this portfolio, identifying candidates for divestitures?

So look, we've got -- I think we've made good progress here even in spite of the environment we're now in. We've completed about 1/3 of the objective we had set. We talked a couple of calls ago, about 8% to 10% of revenues that we would evaluate divesting over like next number of years. And we're about 1/3 of the way through there. We've sold 3 businesses. We've closed 2 down. So we closed the STS business. So we talked about that at the earnings release. That was about $1 billion. That's the biggest one by far. Smaller one we closed fairly recently. Another one, the third is probably by the midyear time frame. So we continue to make, I think, good progress in this area. The process remains active. Some opportunities are moving a little bit to the right given the environment, but we remain committed to maximizing value. I think we have a great opportunity to take a fresh look at the businesses that we're in and making sure that our management time, our resource, our capital are focused on the places where technology differentiates, where we can invest and where we can win. And I look at this in some ways as a growth lever, because as I saw with -- when we integrated with Exelis, getting out of businesses that distract management and you put more of your time and your focus on the ones that can strategically add value, those businesses get better. I think electronic warfare is a great example of that. Avionics is a good example of that as we got out of things that didn't matter. I see the same things happening here. So it's a very thoughtful process. Chris and I and Jay are driving this. We have regular engagements with the Board. So this is how we assess it. We look at the market, we look at our competitive position, and we look at what it would take for us to win. And based on that, we decide whether it's a better fit for us or for somebody else.

And then what about acquisitions? I mean, obviously, it's probably not the immediate thing on your agenda, but are you thinking about that as well?

Well, right now, it's not a high priority given everything else that's on our plate. Unless it's a strategic must-have, and that's what we've been talking about, unless we see something that just too good to pass up, I say we must be in that business. Those would tend to be a technology acquisition, a bolt-on, a tuck-in or something. But generally, our focus right now is on integration. It's on portfolio of shaping. We -- our plate is full. We've got a ton to do, and that's where we're putting a lot of our time. It's not really on the M&A agenda at this moment.

And then a question that's come in from the audience is, can you talk a little bit about how you are thinking about capital allocation over the next few years?

Well, as we said, look, it's -- our free cash generation, we deploy back to owners. So we've had a strong track record here on our dividend, again, pre close. And then since then, we raised our dividend 10% in August. We raised another 13% here back in February. So it's up quite a bit since we've closed. We're committed to share buybacks. We came out of the gauge very quickly on that. We did $700 million in Q1. We'll take the $1 billion out of the sale of STS and buy back shares with that in the third quarter. We'll probably not do further buybacks using free cash flow through the balance of the year, not because we don't have confidence in the generation of cash or the strength of our balance sheet, more just the political environment around buybacks at the moment. We'll keep evaluating that. We'll see at the end of the year, into early next year, whether we feel more comfortable with that. But we remain committed to making -- to deploying our cash back to owners, and you can see that in what we've done so far since the close.

I wanted to ask you a very broad question. I've known you for a long time and you used to be a commercial business executive. And we've seen a lot of cases in the past where it's been difficult for commercial leaders to transition to defense. So how do you think about this now? If you look back, what things were you able to bring from your commercial experience that have been valuable in running Harris and now, L3Harris?

Well, I think just, in general, Doug, I mean, we've known each other for a long time from way back at my UTC days. But I think what's unique about L3Harris is this commercial model that we have and the commercial mindset of a leadership team, which encourages taking out costs, encourages moving fast, investing ahead of need, which, to me, are some of the key long-term successes in defense, in the defense space. There's other companies that are more of a cost-plus model. You make money on change orders where taking out cost reduces revenue or operating income, and that's a focus. To me, we're focused more on prioritizing the speed of execution, focusing on the portfolio, driving lean day in and day out. Whether it's a fixed price or cost-plus agreement, we're focused on driving lean, streamlining our systems and our processes. All of those things, to me, worked well in a commercial business, in a commercial model or in a defense company like we happen to be today. So I think those are the things that we're pushing on pretty hard. You can see just the pace at which we're running at integration and the activity we've had. I mean, look, we have -- it's less than a year since we closed, and we're down the path on our portfolio. We're executing really well on revenue synergies, which to me, is a very, very positive surprise. Cost synergies going well. The company is integrating well. We're off to a fast start again, and not even at the 1-year anniversary. So I think those are the things that, to me, distinguish the company, and hopefully, we're trying achieve as a leadership team.

Well, to wrap up here, I just wanted to go back to the COVID crisis and the pandemic. So as you look through all of this, when we get to the recovery, do you expect to be doing anything different? Do you expect your priorities to change maybe in how you think about cutting costs, about where you invest? What do you think about the post-COVID environment?

So I think what's changing here is, in some sense, how people assess risk. Some businesses that we're seeing now in the commercial aerospace side aren't as resilient as we had thought. And I think there's more of an appreciation for near-peer threats. I mean, just imagine how fast this virus came out of China and moved its way around the world and the economic damage. To me, it certainly has raised that level of attention, even from a national security perspective, I think is very, very important. I think for us, I think we're going to stay balanced. I think we've got a good strategy. We're going to continue to execute on the priorities that we've laid out, which to me, are evergreen in lots of ways. We're going to continue to invest where we see good returns. And we do see good returns. We're going continue to invest heavily in technology because that's part of what we do and what differentiates us as a company. We'll probably spend a little bit more time, Doug, on evaluating supply chain resiliency and investing -- continuing to invest in better data, better information systems, not just at the Tier 1 level, but the Tier 2, Tier 3 level. We'll look at supply chains and are there opportunities to shorten them, tighten them up a little bit, bring something offshore, onshore, to me, is -- are some of the things that we're going to spend a little bit more time thinking about and talking about. We have half our workforce today that's working from home working remotely who are finding to work reasonably well. There are certain activities that have to be done on site, either in the production environment or a classified environment. So we'll continue to evaluate whether there are job functions that don't necessarily need to go back on site, and that's going to drive maybe a different thinking on our facility footprint. Part of the integration we're going after our facility footprint and taking a pretty good head at that. And so we're going to continue to look at where we need to have office space is something that's certainly on our agenda. We'll look at the technology we're in and is there opportunities, places where we don't have the capability or we have a gap and what's the best way to augment that. But overall, I think we're going to continue to focus on the things that we can control. And that's our quality, our cost, our timeliness, all those other sets of things and build resiliency in the model for those things that we don't control. And I think that strategy, I think, is going to play itself out very well.

Okay. Well, great. Well, let's wrap up it up here. Bill and Jay, I want to thank you very much for joining us today. I also want to encourage all the participants to complete the Procensus poll at the end here. But anyway, thank you, and all the best down there, especially through this time.

Thank you. Thank you, Doug. Thanks for hosting us.

All right. Thanks. Bye.