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

Okay, I have 5 seconds on the clock, but I'm going to get it started a little early. So we got a little bit of extra time with L3Harris. Thank you guys so much for being here. My name is Sheila Kahyaoglu, with the Jeffreies Aerospace and Defense team. We have the L3Harris team with us, Mark Kratz Investor Relations; Michelle Turner, CFO; and Christopher Eugene Kubasik, who's Chair and CEO. So Chris, thank you for being here with us. It's been an eventful 5 years, I think, for you since you became CEO of L3, yes. And since then, you merged with Harris, I can't keep up. You divested an asset bought ViaSat TDL, announced the acquisition and closed Aerojet. I think you announced it and closed it in 221 days, 10 hours, 8 minutes, but who's counting. So you've kept us busy and more so, Michelle than anybody else.

So to start, congratulations on closing a deal in defense with Aerojet Rocketdyne. It's your fourth segment, representing about 10% of sales.So, can you walk us through your expectations, how you got the Aerojet deal across the finish line? And now that you've owned it for, I think, since July 28, again, who's counting, not me, how the integration is progressing?

Okay. Well, good morning, everyone, and thank you all for joining and Sheila, thanks for the invite. Yes, we did close Aerojet in a little over 7 months. And I think it really speaks to the culture of the corporation. We kind of have this can-do attitude. We developed a strategy, and we executed it. It was a small team at the highest levels of the company that went about this. We didn't outsource it. We didn't hire consultants. We didn't hire attorneys. We did the work ourselves and met face-to-face with the key decision makers. And I think part of the success of being a defense contract or a government contractor is being able to navigate Washington and work in Washington. You have Congress, the DoD, FDC and other stakeholders. it's one of our core competencies. And I think the fact that this was approved in 7 months is an example of the influence and the ability that we have. And in some cases, it's probably actually a barrier to entry for a lot of these new entrants, which is why strategically, we've opted the team with the companies from Shield Capital, the venture capital fund that we invest in, some of the new entrants and work collaboratively. So we're moving forward with Aerojet Rocketdyne. On the integration, it's about 10% of our enterprise value. And I wouldn't want to say it's easy, but it's relatively easy compared to what we had to do. 4 years ago with L3 and Harris. There was a merger of equals, best of the best. We had to make decisions and such. But this was a good old-fashioned acquisition. I'm going to say some things because I still get questions, we bought them. The Board doesn't exist, they were gone day 1, CEO, gone day 1. Most of the leadership team gone day 1. We bought them, plain and simple. And the integration is going well. On January 1, they'll be on our payroll system on January 1, they'll be on our benefit system. So pretty cut and dry. We know how to do it. The IT stuff takes a little longer the technology and such. So we have a road map there to combine and consolidate the systems. I think something that may not be fully understood is, from the time we signed it until closing, the Department of Defense provided DPA Defense Production Act money in excess of $200 million. So I kind of roll that under the integration. So while we never had a plan to close or shut down facilities based on the fact that it wasn't a competitive competitor of ours. We actually have this $215 million to expand the facilities modernize and have the digital engineering. So I would say the integration is going reasonably well based on 6 weeks. We're going to meet our cost synergies. Most of those will come in 2024, and then maybe inherent in the question is just how is it going after 6 weeks. We've been very active at the sites. I'd say no surprises. They have some, like all of us, they have some really good programs. We call Green programs that are profitable on time, on schedule. There's some Red programs that have been well documented and we're identifying the root causes and coming up with corrective actions. There'll be some quick hits in the next few months and some things will take a little longer. So, glad to get it down and glad to move on. .

It's great to just get a deal done. But Aerojet was relatively [ undervalued ] on the streets. So not everybody might know what it actually does? How it changes LHX and how it contributes to your growth rate? So maybe if you could talk about that in the revenue synergies that are potentially there?

Yes. I think just at a high level from the financial perspective, they're in two main markets, the largest being missiles, ammunitions, weapons, making rocket motors supporting the pretty much all the primes that make the ultimate end product, whether it's Stingers, Javelins, PAC-3, Standard Missiles, the list goes on and also space propulsion systems, not only for satellites, but for launch vehicles. So it's going to be accretive to our growth rate. They're going to grow double-digits. I believe there's a significant margin potential for that company as a result of the synergies and improved performance on some of these key programs. Gives us longer-term visibility, longer cycle business into our backlog. And then 4 to 5 years out, we see it being accretive to our ROIC. So again, from the day we signed it till today, we had the DPA money of $215 million come in, which is great. And additionally, the '24 budget came out, and we're looking at significant growth in the ammunitions line double-digit. Of course, we're still going through the budget process, but high-growth markets. So I think it really does really does change the company for those reasons, and it fits nicely into what we were trying to do in building L3Harris. It gets us into a new domain. As you know, we're in space, we're in air, we're in land, maritime cyber, and this really gets us into the weapons ammunitions which is a missing part of the portfolio.

And how do you think about their margins going forward? Is there opportunities there in your view?

Absolutely. Absolutely. There'll be a couple, we have, as part of the FTC review process, I just want to highlight we have existing contracts that will honor. We did not sign any kind of consent agreement. I did give assurance to the Department of Defense that Aerojet Rocketdyne L3Harris would remain a merchant supplier providing rocket motors to every and anyone in the world that can legally buy them. So there was some concern that we would somehow vertically integrate, which made no sense. So we're going to be a merchant supplier. We'll renegotiate contracts based on actual cost. And I think when we look at some of these investments, when we digitize the engineering, take our processes, some of our procedures and tools, we're going to see some significant improvement they're behind on several of their programs, significant backlog of motors that haven't been delivered. So we'll we'll catch up on those in due course. And then I think when you look at the growth, not only here in the U.S. but internationally, I think people are going to look back and see the logic of this acquisition.

Sounds like a home run, right? Nothing not to like. Let's talk about your Comms Business. A lot of soldier-level equipment there, whether it's Terminals, Night Vision and some of the broadband businesses. How do you think about the positioning of that business overall? And where are you seeing the biggest opportunities?

Yes. Comms, Communications is a key part of the company. It's a lot of our legacy and heritage. And I think one thing that came out in the Ukraine war is the importance of resilient Comms. You keep hearing about it and hearing about it. But it's a priority for the DoD, and you're starting to see money flow into the, providing these technologies. So we have a Tactical Communications Radio business, probably the best in the world. We have a very strong position in there. It's a commercial business model, so very good margins. The DoD is modernizing. So we're looking at double-digit growth this year in Tactical Communications. Internationally is going well. We've been big supporters of Ukraine, and we see a lot of interest from Saudi to Europe to the Far East. So we're doing quite well there. On the BCS or the Broadband Communications. That's where we made the the ViaSat Tactical Data Link acquisition. So this gives us a footprint and access on 20,000 platforms through what's was -- what's currently known as Link 16 gives us the ability to upgrade those and that deal closed in January. The integration is pretty much done. And already, we, as a result of making this acquisition, we received a large order earlier this year, 3x larger than anything possible. So a lot of interest from the customer, a lot of ability to connect the various pieces. And I think we're in a sweet spot when it comes to Communication. We're looking at double-digit growth there as well. Some of that is inorganic, but we're really well positioned in Communications. And we're disrupting ourselves and maybe looking at different ways to monetize some of our waveform, some of our software. So in addition to just selling a radio with some of this technology, we're looking for some creative ideas to monetize software in addition to embedding it in our own products. So pretty exciting times there.

No doubt, you're being creative about it. So, when it comes to ISR, you've been relatively conservative in how you're guiding for that just given the prior experience, the orders sometimes slip, they're long cycle. How do you think about that type of pipeline? And when do you see these U.S.-based contracts like Overwatch coming to fruition? And how do you think about leveraging that internationally?

Yes. ISR is our Intelligent Surveillance Reconnaissance business for aircraft. I think what's unique about us is we're platform agnostic. So we don't actually have an aircraft. And I think that's how we've been able to grow. We listen to the customer. This goes back maybe 7, 8 years where there was a program known as Compass Call where we listen to the customer and it appeared that they needed a business jet to satisfy their mission, whether it was endurance and such. So we take that approach where we go out based on the contract, and we will team with a different business jet provider or sometimes depending it could be a King Air or in the case of Armed Overwatch, it's actually a Crop Duster. So I think that's one of our secrets. The pipeline is about $25 billion of opportunities. I don't, being conservative, probably being prudent. I think everybody in this industry puts in their plan and guidance international orders. And then after 3 or 4 years, you realize that you ultimately get the order, but it's 1 or 2 quarters or a year off. So, we've been conservative by saying we're not going to include international awards. We just reviewed one the other day for a big customer in the Far East, which could be a couple of billion dollars. We have a lot of interest in the Mid East. A couple of opportunities in Europe. A lot of these countries don't like to have their names disclosed, but I see at least 4 opportunities that we're looking at in the next 12 months, but a lot of these get complicated. One country has an election coming up. So if the RFP comes out, there's an election, there may be a change in government could be a change. All those things add to the delays. But about 2/3 of the business is U.S.-based. So you mentioned Armed Overwatch. That's the Crop Duster that we selected Air Tractor and that's off to a good start for special ops. We won a program with called Athena. We have Compass Call for the Air Force. So the domestic business is doing quite well. And, it's nice to have a $25 billion pipeline.

Not bad. Let's talk about space. You've had really good success on the smallsat side there, growing the business as into a prime integrator. How much runway is there in that business? Just given stuff like SDA, and how much has LHX evolved either from a domain expertise or just capacity to develop overall?

Yes, the Space Business, I think, is a great success story. And that's probably the example I used most when I talk about our trusted disruptor strategy, you mentioned going back to 2018 or so, trying to create this new company to provide more competition, move up the food chain and prime, and we have absolutely disrupted the space market. We are beating the traditional OEMs in these satellites as a prime. You mentioned SDA, which is now part of space force. So we were successful in which they call Tranche-0 for the tracking system, Tranche 1. Tranche 2, the RFP just came out earlier this week. So we'll be bidding there and hopefully, being successful as well. So I think there's a lot of opportunity for our space business. I don't think it's always fully appreciated. We're the premier provider of weather satellites for NOAA, NASA and a couple of international countries. They're on a long-cycle recapitalization. So we're actually in that sweet spot. So there's about $3 billion of opportunities over the last 12 months, next 12 months. We've already booked about $1.5 billion so far. We should have an award in the next couple of weeks. So the Weather Satellites is kind of our legacy, and that's actually, which was, you've heard me say before, that's actually how we got into missile tracking using those weather satellites, monitoring the weather and then seeing these hotspots, which turned out to be launches of different vehicles, and then we kind of migrated that technology for missile tracking. So we're investing in space. We'll be opening a new factory, a space factory, satellite factory in the next year or so. I think we have a lot of capacity, a lot of high volume, and we're in all domains when it comes to payload, whether it's Missile Tracking, IR, EO, Weather, I'm really pleased with the position we're in. And the payload is where all the value is. And just like I said, we're Airplane Platform Agnostic. We're kind of bus agnostic. We work with whatever company provides the best bus for our payloads to be integrated on and then we go ahead and launch. So really excited. We have a bunch of launches coming up in the next 12 months. And being a floor it in, we can just look outside and watch them go into space, kind of fun.

Really cool. Let's talk about the rest of the SaaS portfolio space. You have about a $2 billion business there for Airborne Systems. Obviously, F-35 made the news yesterday. What are the puts and takes of the newer opportunities versus some of the legacy programs there? And how do you think about the overall growth rate?

Yes, I think that the growth rate has been flat, to be honest with you. And a lot of the missions that have historically been airborne are migrating into space. So we have the benefit of being in both of those domains, but we're seeing a lot of the missions that historically were carried out by the aircraft moving into space, which is where we're seeing the growth. We're involved with F-35, F-18, F-16, we have the different mission systems, core processing, electronic warfare. So that's a stable business. We'll be, with the Air Force customer next week in D.C. at their AFA Air Force Association Symposium and we'll continue to meet with customers. They're looking at new unmanned aircraft, there's some next generation. We'll have a piece of all those. We will never, as I foresee it be a prime in airborne. We have this modular systems that are critical to these aircraft. Some day, the customer might buy the systems directly from me and just give them to the aircraft manufacturer. But for now, we go through that food chain. So it's a flat market. We have good technology. And if we get any growth, it's going to be coming probably from the international upgrades, but we're well positioned and proud of what the team is doing.

And one of the things I'm getting from our discussion is in a unique position because you could actually use your balance sheet to grow inorganically, but you're also using your trusted disruptor strategy to grow organically, too. So a lot of people look at defense plans and say, base budget is growing 4%. This is the growth outlook for LHX. How do you think about your growth outlook and your different businesses?

Yes. We have 4 segments currently in 16 sectors underneath them, rather diverse portfolio, as I mentioned, in all the domains. Our goal and a result of some of these acquisitions, at least the two we've made probably aren't going to make for a while given our balance sheet and the debt capacity have been growing faster than the defense budget. We still need a defense budget. There's, you've seen the numbers, and you've written your reports, $842 billion, which is just a number, right? It was a pretty big number. But I think more importantly, what people forget 2 years ago, that same defense budget top line budget, which we all use as a proxy was $742 billion. I mean, we've added $100 billion to the DoD budget in 2 years. So admittedly, the growth rate going forward, we'll have an election, we'll see what it will be. But it's a small market. There's only so many companies in it, and I like our position. And we would expect to grow faster than the addressable market.

I'm sneaking in a few more questions than we would have originally. So I'm too...

We agreed to 6 questions.

Yes, I'm already two over. I'm going to go four over. So two more left for you. Free cash flow has been a big focus of LHX overall. Obviously, a lot of puts and takes with items like tax that are out of your control. So what are the drivers of free cash flow growth here? And just how do you think about the revenue growth margin profile and free cash flow of your business or we could wait until December when you have your Analyst Day?

Yes, December 11 and 12 in Florida. I look forward to seeing everyone there. We're going to have a great a great couple of days. I guess we hadn't announced that previously, but now you know, the benefit...

Mark's smile said it all.

Mark wrote it down, December 11, 12. I think it's a Monday, Tuesday, we'll be there. No, we'll talk,generally, what we've seen is the cash flow for all of us has been there's been headwinds for two reasons: the taxes, but that takes 5 years to kind of run out. I know everybody is optimistic that the the tax level change. I am not one of those guys, which is why our guidance has always been based on the current rules and regulations. And then the last couple of years with the supply chain challenges and the pandemic, we've built up. And you can see it on our balance sheet, which always gives me comfort in some perverse way. You can see the receivables and the inventory growing. So I know it's there, and we need to bring that down as the we start making these deliveries. We did a really good job in the defense industry, you can get build, you can collect your cash one or two ways. You can do the progress payments, which means every 2 weeks, you send a bill, you show up and you get paid. It's kind of a lazy way to do it. Or you tie it to performance, which I'd like to do, which is performance-based payments, like I give you a product, you give me cash. So it kind of makes sense and it kind of correlates the performance. But when there's a backlog of products for all sorts of reasons that nobody cares about, you don't actually deliver those products like Radios and Night Vision Goggles, you don't get your cash. So we do have that backlog and it's coming through. So I feel pretty good about it. We'll probably start talking more about free cash flow per share. AeroJet will be cash flow accretive in year 2, EPS accretive in year 1. We'll give more guidance. We'll give guidance in October, but that's just for a 5-month stub. But hopefully, in December, we'll give you some insight into 2024. But looking pretty positive about what we're doing.

And maybe just to wrap it up going for all circle. You've given us an eventful 5 years with the L3 Harris merger behind you, 2 acquisitions behind you, what should investors and more so Michelle look forward to over the next 5 years? And what do you think is most misunderstood?

Was that one question? Yes. Well, it's misunderstood. All right. Well well, first of all, we're significantly undervalued. There's no doubt about that in my mind. Every day, it gets more so. But I think what's misunderstood is, the fact that we're actually doing what we said we would do. And I can appreciate there are so many companies out there that you guys follow we all come up here. We all kind of look alike, sounded alike we throw out acronyms programs, and it's just like a blur. But if you go back, as you mentioned, maybe to the 2018 time period, what we said or what I was saying is we want to create a new company, right, to give our customers alternatives and disrupt the market. It's slow. It's expensive. It's bureaucratic. So I view L3Harris as the 52,000 employee new entrant. There's lots of other companies that are out there. They're great. They've got a few hundred employees, a few hundred million of revenue. we're close to $20 billion of revenue, 52,000 employees, 25,000 engineers, 25,000 people with clearances and we are doing what we said we would do, which was to build this company. Now we've had a few bumps in the road like the pandemic inflation, attrition, but that's behind us. We all dealt with it. And I would just say, if you look back 5 years, you look forward a couple of years, what you're going to see is this company, it will be focused. It will be in all domains, and we will be in high-growth markets. It will be a technology company, and we will divest the non-core assets. We started some of that clearly, with the interest rates and some of the challenges, we have some more to do. But L3 and Harris were decent companies, midsized companies, as I used to say, we were too small to be big, too big to be small, we came together, made a few acquisitions, divest non-core when the dust settles, which it will, we will pay down our debt. We will remain investment grade. We'll have a focused portfolio where our customer priorities are, where the budget is aligned. And the next couple of years, it's going to be generating the cash, paying down the debt and then continuing with returning cash to our shareholders, competitive dividend, year-over-year increases, share repos and we'll get there sooner than people may give us credit for. So...

We look forward to, you keeping us on our toes. So appreciate you Chris, and thank you all for joining and listening in.

Okay. Thank you.

Bye.