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

Good morning, everyone, and welcome back to the Barclays Industrial Select Conference. I'm David Strauss, aerospace and defense analyst at Barclays. Next up, we're pleased to have L3 Harris. And with us today is Bill Brown, Chairman and CEO of L3Harris; and Jay Malave, CFO of L3Harris. In terms of housekeeping on your screen, you should see some questions, audience response questions. We appreciate you took the time to complete those. And we're going to share the responses, the results, with everyone when the conference is concluded. So with that, I'll turn it over to Bill for some opening remarks before we get into the Q&A portion of the session. Bill, over to you and thanks again for joining us this morning.

You bet, David, and thank you. Thanks very much and good morning, everybody. I certainly appreciate you inviting us again this year. It sure has been a challenging year since we met last year in Miami. So good to be back. So a few weeks back, we released our earnings. We're very pleased that we were able to deliver earnings per share up 13% and above the midpoint of our pre-COVID guidance, with free cash flow towards the upper end of the range. And that's really resulting from very strong execution by the team on integration, operational excellence and our working capital agenda. And we expect this year that, that level of execution is going to continue. The guidance we provided for this year points to that double-digit earnings per share and free cash flow per share growth. That comes on the back of mid-single-digit top line growth, rising margins and continued significant share repurchases as we laid out with investors just a couple of weeks ago. We continue to strategically reposition our portfolio as a mission solutions prime. This has been something that's been a strategy and on our mind since we merged and announced the deal back in October of '18, with a position across all domains, both U.S. and international. And we're also continuing to divest some of our nonstrategic businesses and continue to make progress there. So again, David, thanks for the opportunity. I look forward to your questions and those of the investors.

Great. Thanks, Bill. So let's launch right into it, starting with the biggest question on all investors' minds is the forecast around the DoD budget and how you see L3Harris growing within that. So for this year, you forecasted low single-digit growth in DoD within that 3% to 5% revenue guide. I think you did 9 -- or sorry, 7% DoD growth in 2020. So before, you had talked about the cumulative gap in unspent appropriations, relative alleys that would drive growth well beyond kind of the budget peak. Can you talk about how you're thinking about things today and why you're seeing this level of deceleration in your DoD business?

Yes. So David, thanks for that. Look, our guide of 3% to 5% is 4% at the midpoint. And at that midpoint, it reflects growth in our core U.S. business of about 3.5% to 4%, so right in that mid- single-digit range or maybe just below that. With international, we expect we'd be doing a little bit better, so up mid-single-digit-plus and some contraction in our commercial business. It will be more mild than it certainly was in 2020. But that will still come down a little bit this year. So I made a comment on the call about low single digits for DoD. And that was excluding about 1 point or more of growth coming from revenue synergies. So again, pretty solid overall when you look at the DoD business. It is softer, slower than in '21 than calendar '20. We had a very strong year last year. And DoD Tactical was up more than 20%. Mission Avionics was up pretty strong. The Maritime business was up pretty strong last year. We do expect that's going to moderate this year. That's partially offset by growth in space. I'm sure we'll talk about that sometime this morning. But that business last year was down in transition. This year, it will be up. So we do see some growth coming in the space business. Look, we've got a new administration. We've got democratic control of Congress. You've got higher debt levels because of the stimulus. We now see the defense budget being more flat to up a couple of points, which was with the prior administration. So all that comes together in a guide for us in 3% to 5%. And a big piece of that is going to be coming out of DoD.

So let's touch on space. Obviously, that's a big area of focus for a lot of investors. You did touch on that space actually did -- your space portfolio actually did see a drop last year. So talk about what drove that. And I think you're forecasting high single-digit growth on the other side this year. So what are the big moving pieces there?

Yes. But yes, that's -- and I'll come to that. For context, this has been a really good strategy, good execution of a multiyear strategy to reposition our space business going back probably 4 or 5 years ago. We were solely a provider of exquisite payloads, mostly RF technologies. We moved into electro-optical then hyperspectral into hosted payloads, small resilient systems based on the DoD need for more resiliency, disaggregation in space, deterrence. And we follow those trends. We invested very early. We own our own satellite. We've launched several on our own. And we've become a pretty big player now in sort of that responsive space market. So today, our space business is a couple of billion dollars in size. About 1/4 of that is coming from that resilient, responsive space business. It's a key part of our $10 billion pipeline coming forward. We're winning in some new areas in missile defense, both SDA tracking as well as the new MDA HBTSS system. We were prime on both of those 2 mission systems. So overall, I think we're well positioned. And we do have a lot of optimism of good and increasing position in a growing market into the future. So last year, we did decline. It was a couple of different factors. One, there was a program transition mainly going from a sensor program called SENSOR, which was something we acquired with Exelis, transitioned to a new program called Mosaic, which we competitively rewon, which was very, very important. We had some late wins on some of the next-gen programs in calendar '20, which are going to benefit '21. And we grew pretty healthily in calendar '19, up high single digits, which we expect we'll repeat here in calendar '21. So overall, I think we've got a good business here. It's much broader, more diversified, from payloads to small satellites to ground systems as well as on the commercial space side as well. So a pretty broad business and we expect good growth here in '21.

So you mentioned the SDA and missile defense satellite wins, HBTSS, if I get that right. Talk about how those programs progress from here. And if you could size them, how do they -- what size do they start out at? How big could they grow to? And what kind of margins those programs could come with? What kind of impact can we see on margins at SAS?

Yes. So together, the award was about $320 million between the 2 programs. One, SDA, the Space Development Agency tracking layer, where we'll field launch 4 satellites in calendar '22. And then the MDA, the Missile Defense Agency with HBTSS, which is hypersonic and ballistic tracking space system. It's a different technology to track hypersonic weapons and ballistic missiles. And we're now prime on both of those 2. They're both competitive. The competitor on the SDA, one is SpaceX, the other one is Northrop. So we won a good position here. We expect these programs will eventually lead to constellations. Combined, they could be in excess of $5 billion. Depends upon time and numbers of satellites but they're going to be quite large into the future. Again, starting off with relatively small number, 4 and 1. So a total of 5 prototype satellites, which we'll be launching in '22 and '23. On the margin side, look, these -- they start off a little bit light on the initial years as you're -- we are entering a new franchise area, which we think will be quite big over time. It's pretty typical for new programs like this. But over time, we'll see the margins ramp. And we've accounted for that guidance here in our '21 numbers.

I want to switch over and talk about the IMS business and the 2 big pieces within that, the ISR legacy L3 business and then the -- your Maritime business, that big focus area and growing very quickly. So first of all, the ISR business, how is that performing? I know under L3, there was a bit of a mix history there, both in terms of performance on some of the programs and the inventory. And just talk about where that -- how that business has progressed post the merger and where we stand today.

Yes. So ISR is a good business. It' a strong business. It's steady. We've got a good position here in the domestic market with the U.S. Air Force. It's across multiple programs. We've been on it for multiple decades. So it's a strong base. We've got unique technologies. We're in a lot of different platforms. So it's actually been a very good business. We have growth opportunities from that into other platforms, other domains and as well as international. We have an opportunity to take some of those core technologies and sell them internationally, loading that ISR capability on to business jets. That market can be a little bit lumpy as we saw late last year. We see a number of countries building off of the program that was sold to Australia with missionizing business jets. We talked about a program that slipped out of 20 -- calendar '20 into '21. It was a program in Europe. It was upsized dramatically towards the back end of last year, which caused that government to go back and have to relook and reapprove the program. But it was -- net-net, it's good news. That part has approved, that we should be seeing the order any day now. And we should see that business continue to grow. So it's a little bit lumpy on the international side. But we see good growth opportunities in ISR outside the U.S. to build on the capabilities we have here in the domestic market.

On the maritime side of things, so both from a manned and unmanned perspective, you've had some nice wins. You just won the frigate integration. What exactly is the opportunity there? What's the competitive set? It seems like everyone is kind of going after the unmanned space when it comes to the Navy side of things.

Yes. So the Maritime business has been a good surprise for us. I mean it was a legacy L3 business. They built it over some time. It's roughly about $1.5 billion in size. It grew double digits last year. The orders were very good, a good above 1 book-to-bill last year. So we'll see another growth here in calendar '21 in the Maritime business. Pretty broad capabilities across power conversion, power distribution, propulsion systems, a variety of different sensor systems, the optical systems so photonic mass. So we've got a good position here. It's both manned and unmanned. It's always aftermarket as U.S. -- international. So it's pretty broad. And I kind of like that part of it. We've got a number of key programs. We've got good content on the Virginia and Columbia class submarines in the U.S. Coast Guard with their networks to array systems. And where we see growth, you mentioned the future frigate. We're a mission system integrator with Fincantieri. That's a great program. It's over $300 million. And we think that's going to be an important one for us to execute on. We've got a number of different classified programs on the underwater side in maritime. And like you pointed out, it's the -- on the unmanned side, we've got an early toehold to what we all believe will be a growth market. So we are the prime contractor on the only unmanned surface vessel program that's been led by the U.S. Navy. That's the medium unmanned surface vessel. We're on contract for 8 plus 1 vessels, $281 million in value. So that's an important piece of it. We are a partner to somebody on a study contract for the large USV. And like others, we've got a good position on the underwater side. So on the small, we've got an Iver technology with some pretty good uniqueness there as well as partnering with some other players on the medium unmanned underwater vessel and also a sub on the large one. So we've got an early toehold here. We think unmanned is going to be a driver of growth in maritime. And we've invested ahead of the curve, got some good capability on autonomous systems. And you'll hear more about this from Sean at the Investor Day coming up in -- sometime in March, March 10.

So I wanted to ask about tactical, U.S. tactical. You've obviously seen tremendous growth out of that business. Talk about how much runway is left. You have this ongoing competition with Collins. There are obviously a fair amount of concerns about that business kind of having hit peak and it's going to run out of steam. But just talk about the opportunity that you still see there.

So the Tactical business is just a fantastic business. It's a -- so I've been watching it now for almost a little over 9 years. And it's really transformed itself. It remains a very strong global leader, 40%-plus share. We're more than 5x the share of the next-largest player in that space. It has been hanging in that 40%-plus range. In the U.S., we're sole source on all of the SOCOM programs. So the manpack and the handheld, we're sole source with the Navy. We're sole source with the Marine Corps on the manpack. We'll be competing in the handheld program this year. In the Army, you mentioned Collins. So we're one of queue with Collins on the manpack, the HMS Manpack program. About 50% share, they're splitting it. That will eventually get to be more competitive over time as they move to full rate production later on this year. On the handheld, we're competing against Thales there. We've been winning more than 50%, so a little north of 60% share of that program. Again, that will go to full-rate production later on this year. I think it's important to note as well for all of the HF radio modernization in the DoD that we are the sole source provider. And that was a big important growth driver last year. So I would say in the domestic market, our share has actually come up last year over the prior years. On international, it's more fragmented. We're very well established in a number of key countries. And incumbency here makes a big difference. We have about 380,000 radios installed in the international market across multiple countries. And a number of countries are going through an upgrade cycle. So this is going to be an important driver for us. There's more than a dozen countries that will go through a modernization cycle, just like we're seeing now in the U.S. And so we expect more than 200,000 radios will be upgraded. It's a $4 billion opportunity ahead of us. In the domestic market, we've seen over a couple of years' modernization picking up. But we think there's going to be 350,000 to 400,000 radios modernizing the DoD inventory. And to date, we're only 10% of the way through. So there's only 40,000 radios that have been awarded to us and everybody else in this 400,000 radio opportunity. And the budgets continue to point to modernization trends that will continue for some time. So even though we'll see slower growth here in '21, coming off of a very strong growth in the last couple of years, we believe we're on the front end of an important curve here. We remain well positioned. We've got -- we invest a lot in R&D, in fact, way more than anybody else, not just the hardware but the software, the waveforms. We've got a very strong customer focus here, a common platform approach between U.S. and international opportunities. One single facility in the world does all of our production, which gives us tremendous leverage. Margins are very good in this business. So it's a great business. We see continued growth trajectory coming out of this into the near future.

You generate about 5-or-so percent of your revenue from commercial-based businesses. So you've got the aviation portfolio and then the Public Safety business. I think you had about a $400 million headwind out of those businesses in 2020, most so on the aviation side. That was only really for 3 quarters. You still got the tough Q1 comp. So do you think -- I guess how are you thinking about those businesses? Do they actually grow in '21? And then maybe your longer-term -- your view beyond that a little bit longer-term for both those businesses.

Yes. So they were a substantial headwind for us in calendar '20. We do see them to be contracting mildly in '21. So the commercial aero piece, which is both avionics and commercial training, we see that business being down mid-single digits this year. Down pretty substantially here in Q1, so we're thinking about 50% down. It's pretty consistent with where we were in Q2, 3 and 4 of last year. More stability in Q2 because we have less of the year-over-year headwind. And then we see some recovery in the back half, maybe up 40% or so. Pretty well calibrated to what we see with the OEM build rates with IATA forecast. So we do expect the headwind to become more tailwind as we get towards the back half of the year. On public safety, we see that business being down low single digits this year, tougher first half, probably down 20%-ish in the first half. Some recovery in the back, not quite as strong as commercial but some recovery. Maybe 15% or so in the back half but, again, still down for the year. And really, when we look at '21, the public safety down still about 20% versus '19. And the Commercial business will be down pretty substantially still in '21 from '19. So both businesses will see a slow recovery towards the back end of '21. And as we get into '22, start to become more tailwind and helping us grow a little bit into '22 and '23.

So do you -- Bill, do you think the aviation business actually exits the end of the year from an absolute dollar standpoint at a higher level than where we are today?

It will be down a little bit overall, commercial, probably mid-single digits, David. When we look at '21 versus '20. When we look at '21 versus '19, it's still going to be down, I don't know, 40% or so. So it's going to be -- it's still a pretty big drop. But it will start to -- you'll see year-over-year recovery towards the back end of the year. And I do expect that '22 will be bigger than '21.

Okay. So let's transition over and talk about progress, merger progress. You've talked often, Bill, about transitioning the legacy L3 business to an operating company. Big question obviously. But where does that stand today?