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

Next up we have L3Harris, LHX, Chris Kubasik, Chair and CEO; and Ken Bedingfield, CFO. So I'll turn it over to Ken for safe harbor forward-looking statements.

Yes. Thanks, David. Appreciate you having us today. And just before we get started, I'd just like to remind everyone that the comments today may include forward-looking statements, which include risks and uncertainties and more information can be found in our 10-K and SEC filings.

Great. So with that, we'll -- unless you have anything, we'll get straight into Q&A. So you and I, Chris, were just chatting about the budget process and how it's real straightforward. We know exactly how it's going to play out. But maybe if you could touch on your thoughts, all the different moving pieces between CR, FY '25, budget reconciliation, debt ceiling '26? So what I guess -- whatever your thoughts, whatever you're hearing, if it's any different from what we're seeing in the press?

Yes. Well, first of all, good morning, thanks for joining us. It was a few months ago that we said 2025 was going to be a year of unprecedented change and uncertainty and volatility. And I think that is playing out as we pick up the paper, read about what's going on every day. I think we're at over 70 executive orders in just a couple of weeks. But to calibrate everybody, I think we generally look at the top line as kind of a proxy for defense growth. In 2024, it was about $850 billion. We do not have a 2025 budget, as you all know. And there are discussions that you'll hear the House is looking at about $100 billion markup. The Senate is looking at a $155 billion markup. So there are positive trends for the 2025 budget. We are in a continuing resolution, I think, for the 14th out of 15th year. So this is kind of business as usual. I think what's interesting, there's talks of a full year continuing resolution. But as it's been portrayed, there will be what's known as anomalies, which are exceptions to the traditional continuing resolution. And one of those is to allow new starts. So I feel comfortable that ultimately, there will be a 2025 appropriations budget, whether it's past or the 12 months run out, I'm not sure it's going to make a big difference as long as there are these markups, which will all come together in a reconciliation process. So I know it's a little confusing but the tailwinds are positive. There's a lot of politics going on. It's difficult to follow hour by hour and day by day but that's generally the -- how I see 2025 playing out. Now if you go back to the last 2 administrations, the whole process starts with what's known as a PBR, a Presidential Budget Request. So under Trump 1, we had 4 Presidential Budget Request. Biden had 4. Obviously, the fourth did not get passed. But in all 7 years, Congress ultimately approved an appropriation bill higher than the Presidential Budget Request and significantly higher each and every year for the last 7. This will be the 8th [Audio Gap] budget. So that's kind of what we're looking at. That's who we're talking to. That's who we're trying to shape. So that's how I look at the budget. Yesterday, there was some media coming out about reprioritizations. I know it caused a lot of confusion. I think there's usually an announcement and then there's another announcement clarifying what the announcement meant. And then there's a third announcement clarifying the second. End of the day, this happens every year. There's a change of administration. It's a reprioritization. They opted this time to use dollar amounts, which is fine. They're looking for $50 billion as I take it from the budget, to reallocate it and put it with 17 priorities for the President. So it's not a strange concept. It just seems to be getting a lot of media, causing a lot of confusion. So if you look at those 17 priorities, they're out there. We feel pretty good about our portfolio and how it aligns with those priorities over the last 5 years. We've divested about just under $3 billion of revenue. We've made acquisitions for $2 billion of revenue. Bottom line, it's all to align the portfolio for the future of warfare. And I feel real good with where our portfolio is, where the priorities are and how the future is going to play out.

Get the DOGE question all the way early on. Seems like still kind of early days as how this might play out with regard to DoD. But your thoughts on if DOGE for DoD is about cutting programs or more about kind of reforming how DoD operates, structure, overhead, contract -- how they contract. I mean I'm sure there's probably going to be some mix of that. But your thoughts on how this might actually play out?

Yes. I think it's going to be a little bit of both. I think I'm one of the few that might be more excited about DOGE than your average person. And you kind of get how you ended up in this situation. And there's a lot of policies and there's a lot of procedures and regulations that are put in place that are well intended to reduce risk. And then just like corporations that I run and you guys work at, after 1 decade or 2, the cumulative effect of all these regulations, rules and policies are actually creating more risk than reducing risk. So I think it's refreshing to take a fresh look at the whole process and see what can be streamlined. Now I think we have some credibility here because we rolled out what we call our LHX NeXt initiative. We should [Audio Gap] back then and as you saw, we took out $800 million of cost from L3Harris last year. We've committed to another $400 million, so $1.2 billion over 2 years. This is in addition to the $650 million we took out when we had the merger 6 years ago. So everybody thinks their companies are well run and efficient. But when you actually dig in and look at each and every process, the policies, take the power of the enterprise, renegotiate supply chain. We've reduced the workforce by about 7%, not easy to do but we've done it. All that is contributing to our industry-leading margins. So I think it's refreshing how the process works out. I'm not sure. I think there'll be some things that are broken/fixed. But I got to believe at the end of the day, the defense industrial base and the Department of Defense will be in a heck of a lot better place. And there are just things out there. On program cuts, I'm not going to comment on any specific programs. We were looking at some counter-UAS, everybody talks about counter-UAS, counter-UAS. It's just the fact the DoD buys counter-UAS systems from 200 different companies. And it seems like a lot to me. So if they get to the point and say, why don't we just buy from 20 companies, not dissimilar to what we've been doing with supply chain. You got to get all the data, bring it together, negotiate a better deal, lower the cost. So that's just one example where you say, why is the Department of Defense buying counter-UAS systems from 200 companies. Pick 20, 25, 10, I really don't care. Hopefully, we're one of them, if we're not, we move on and buy from them. And it's nobody's fault. It's every function, every service, every subservice, there's probably 200 people all buying one and thinking they're doing the right thing. So you got to elevate it. I think the use of data is going to be powerful and things like that are going to pop out. I wrote a letter to the DOGE, as you know. It's been getting great -- a little bit of press but a lot of feedback from members of Congress and people in the Pentagon. And I threw out some ideas there but it's really to get the dialogue started.

It seemed like a common sense kind of stuff.

Well, I'm a simple guy, as you know. It seems common sense...

[Technical Difficulty] 1,000 times on the same program, yes.

Yes. So it's really the -- all I want is the defense industrial base has a perspective. So there's great current members, retired members of Congress and the Pentagon. I just don't think those 2 groups ought to get together and fix the Pentagon and the acquisition process without including us. So I've tried to speak up. I'd encourage others to speak up. Let's get together and find a way to fix this once and for all.

Okay. So I think your partnerships with some of the nontraditional players, obviously, Palantir that's gotten a lot of press recently. I mean it's been in place for a while but getting more and more press. I guess how did that all come about? What's in it for you? What's in it for them? Why did they decide, Palantir and Shield -- why did they decide to partner with you kind of that relationship?

Yes. I'll take the Palantir on and that kind of is probably a good proxy for what we're doing with others. We -- first of all partner with the best technology out there. There's [Audio Gap] it starts with your culture and self-awareness We are not the best in everything. And we believe that the future of warfare is going to be a convergence, not only of hardware but software and AI. So that's kind of the philosophy of the company we put together. That's why we're more of a technology company. We don't have a lot of services. We don't have a lot of big platforms. We have kind of the brains and then some of the key software-defined hardware that enables the war fighters to be successful. So in that case, we had, had a relationship with Palantir kind of mid-levels on and off for 5 years and received a call from to Alex Karp to get together [Audio Gap] based on their review of the industry and a variety of things, we were their first choice to partner with. And ultimately, you do need some form of hardware. They have some great technologies. So we've rolled this out. What I like about our approach, again and there's some commonality as we're willing to prime, we're willing to sub, we're willing to be a merchant supplier, joint venture. We're just trying to get the highest probability of winning and growing the business and serving our customers. So we formed this partnership. It was really just back in October. So it's gaining a lot of momentum. We have regular meetings to identify opportunities. We have about 3 bids that are real-time bids in 2025 that I'm super excited about. So I'm thinking that's going to help ignite this from a revenue side. And I'll let Ken talk about what we're doing internally. We're also using their software as part of our LHX NeXt. If you want to give a few examples of what we're doing there with foundry?

Sure. Yes. So foundry and partnership with Palantir and some of their technologists has been a big part of the LHX NeXt program, how we gather data across disparate systems, multiple ERPs, manufacturing systems, labor systems, pull the data up and really be able to kind of analyze and make decisions across the entity. So it's been a great partnership to enable us to really aggregate and gather data in an efficient manner and enable us to drive a significant amount of the cost savings of the LHX NeXt program. And I think that then led to the additional opportunities with Palantir to really do what I think is the more interesting and value creating aspect of how do we partner to provide AI-driven mission solutions for our customers. And to me, it's exciting. And I think it's a validation of the Trusted Disruptor strategy that L3Harris is the company that Palantir wanted to work with. I think it says that we are a bit more agile, a bit more nimble, really working to bring capability at speed to the customer. And we don't necessarily think of ourselves as a traditional defense company. But of the defense companies that have been in the market for a long time, that have supported the customer for a long time, that understand the missions and can be that connective tissue, I would say, between the technology and the mission and how you turn technology and mission capability. I think it really just is a validation of that strategy and that it's working. Chris mentioned, there's a couple real-time bids that we're working on together. And I think there's a huge opportunity here and really excited to see how it plays out in '25 and entering '26. And Chris mentioned, I think, on the earnings call, that we would certainly expect this to turn into some amount of revenue growth as we enter the '26 financial framework. So...

And I'll just -- the reason we say we're not a traditional, we kind of straddle between these new entrants and what's perceived as these traditional primes is our business model. So about 20% of our revenue and earnings come from what we call the commercial business model, which is a lot more efficient than the traditional bureaucratic long-cycled DoD acquisition process, which was kind of the thing I pulled out is, if everybody likes what these new entrants are doing, they go fast and they don't have to provide their cost and pricing data and get audited by DCMA for years on end and why don't we migrate more and more of the defense budget to a commercial business model. You have competition. We put in a bid, someone else puts in a bid and I could be making 70% margins. I could be making 2% margins. Who cares? Buy my product, it's a good price. It's lower than the other guy and let's rock and roll but it's common sense. And I think everything we've been putting in place for 4 or 5 years, it just seems to be coming together. That's why I'm excited about DOGE, even though I can't explain how it's going to end. All the dialogue, all the discussions, something good is going to come out of this. It probably isn't going to be this week. It may not even be June or July. But when everything settles down, I just can't be more excited about the future.

So following up on -- from a growth perspective, so you have these -- getting into some of the financial forecasts, you have these -- you have the 2026 targets. I think the one that gets questioned the most by investors is the revenue target and 2025, the growth being a little bit slower, the acceleration that's being called for in 2026. How much of that 2026 revenue outlook is in backlog today, you've got it in hand versus what you still kind of got to go out and win?

Yes, I can jump into that, David. So from a backlog perspective, about -- almost half of our backlog will turn into revenue in 2025. And I think it's like another 30-plus percent for '26. So we have either in backlog or probably currently in negotiations are working through discussions with our customers, a significant portion of the 2026 revenues. There is an acceleration of growth in '26 over '25 and there are some programmatic drivers of that. So as an example, F-35, we do multiple components for that aircraft, represents about 3% of our revenues. But as we are ramping down on finalizing some of the development of the TR-3 capability and transitioning into some of the production aspects of that program, the ramp on the production just doesn't quite cover the ramp down on some of the development work. Aerojet Rocketdyne, I would say, is another example of where we see an opportunity for acceleration in '26. You know that we've got a incredible amount of demand for solid rocket motors, largely small to medium solid rocket motors in the near term. We've been hard at work to invest to drive capacity increases, investing in equipment, investing in facilities. We've partnered with the DoD, where we received some Defense Procurement Act funding. It took a little while to get through some processes to get that deployed. But now that's off and running. And -- but the fact is it takes a little time to get that capacity into the system. We'll start to see the ramp in late '25 but more so it will hit in 2026. We've also got some international opportunities that will hit in '26. In particular, we're working with some customers around missionized biz jets for ISR. So there's -- there are some logical program connections. Space also had a little bit of a pause just as we look at the programmatics that we're working on today. We've got a few contracts that just had a bit more volume in '24. Space budgets were a little bit pressured in '25 and we see that returning back to some stronger growth in '26. There's a few programs that are kind of nearing completion, some of which you probably saw in '24, we had a few challenges on. And then as we look at Iron Dome for America, that's really over and above the growth that we projected. So we think we very squarely fit into opportunities there, in particular, missile tracking, certainly propulsion for interceptors. So that would be, again, over and above the growth that we've currently projected for '26. So I think the bottom line is, we remain very confident in the '26 financial framework. We believe that we will and can hit the revenue targets, $23 billion, at least 16% margins. So growing the business while increasing margins and expanding our cash flow from -- I think we forecast $2.4 billion to $2.5 billion in '25 and accelerating that to $2.8 billion in '26. [Audio Gap] capital, we'll be getting back into value-creating share repurchases that should reduce our share count. And I think that really even further accelerates our free cash flow per share. So we think it's a great model. And again, we've got a lot of confidence in our '26 framework.

Yes. I'll just say, of all the executive orders, the Iron Dome one is the one that excites me the most because we have a couple of different agencies. This is -- there's 8 different components and we talk about being agile like everybody else. But within 4 hours of this coming out, we had identified one of our executives to lead this process for the entire company to look at all these capabilities. There's RFIs out. I think we're responding to 7 of the 8. The one that gets the most attention would be the missile tracking, missile defense. Missile Defense Agency awarded 2 companies, us and someone else, what they call the HBTSS program. Ours is the only satellite in orbit that's working. The SDA, Space Development Agency is another agency. You've heard us talk about this Tranche 0, 1, 2, 3. Again, we're the only guys that have satellites in orbit that are working. So if we go fast, it's a quick turn. We want to get more satellites up there, past performance and actually having your assets work in space is pretty credible. And this would be an example where the RFP, RFI is going to come out for Tranche 3, 54 satellites, 3 companies are going to win 18 and I'll be lobbying hard to say, based on our performance, you ought to give us 36 or 27. Let's put all this peanut butter, give it to the company that's performing, we're performing. If this is a threat, give us the contract and let's launch them. So that's going to clearly help get to the '26 framework and double-digit EPS growth, double-digit free cash flow per share growth. It's a pretty good story.

Wanted to ask you about program execution across the portfolio. So obviously, good [Audio Gap] savings and so on. But how do you see, I guess, over the last couple of years, program execution came below the service, where we can't really see program execution, how you're doing? I mean, I remember last year at this conference, we talked a lot about IMS and the challenges there. That seems to have gotten better. Space recently has come up with some of the negative EACs you've taken there. So how do you see program execution, I guess, [ Red ] -- portion of [ Red ] programs, how do you see that across the portfolio?

Yes. Let me cover that. From a program execution perspective, let me just first frame to say we take on very complex challenges. So you have to expect that there are going to be program execution challenges, issues as we proceed through the complications of complex multiyear programs. You mentioned some of the space challenges that we dealt with in '24 and I'll just say, these are very meaningful programs, not just for L3Harris in terms of aligning with our strategy and how we became a prime in space but supporting critical missions for our country and the military. And as we think about it, we've grown the space business from just a few years ago a -- largely a payload -- capable payload provider to a prime in space. We've got a number of satellites in orbit and I think we got over 40 satellites in backlog as prime. Chris mentioned opportunity for Tranche 3, at least another 18. We've invested in facilities, so we could certainly take on additional volume, the 27, 36 through the new factories that we've built and set up and ready for that. But we've certainly realized some challenges. But as we do, the team works really hard to figure out where we've got opportunities as well. And so if you look at our net EAC adjustments, we were positive in 2024. And we realized challenges in tens of millions, 20s of millions. I think we've done a good job of thinking about how much risk can we take on in trying to realize some reward and growing the business aligned to the strategy. So we've been able to avoid what we've seen with some of our competitors, where it's hundreds of millions or billions of dollars of charges. And I think the team is off and working hard and working through some of these complex issues. We're relatively mature on a couple of these programs. We've seen some things pop up in integration and test but we're confident that we'll be able to work hard. If we see some more challenges, we'll be actively working to try to yield some opportunities and make sure that we deliver on our margin commitments for '25.

I feel to -- answer the question, I feel we're getting better and better each and every year. And it's not an excuse but the impact of the pandemic did have a lagging effect. The DoD basically got a gift from industry. They didn't pay anybody an extra penny for any inflation. We all absorbed it based on our long-term contracts. So now as new bids are coming up, obviously, those are getting priced in. But look, there's only labor, material, overhead and profit. And we were the first to do away with hybrid back in May. And despite what people will say, you are just not productive if you're not in the office every day, not in the factory. So I continue to believe and it's water under the bridge. It's not helpful to run a major corporation when your employees are working remote. Plain and simple. So that had a negative impact in productivity, in my opinion, hard to quantify and prove. Supply chain is incredibly fragile as you get down to the second and third tier subs. So those are being rebuilt. Part of our LHX NeXt is build the resiliency of the supply chain, consolidating, given long-term agreements. We've been reducing the overhead through LHX NeXt, along with the labor and the materials. And we're bidding based on what we think is our actual cost and what we think is a reasonable fee. And not all of our customers are happy. But when you have the actual cost of what it takes to build it, that's what we're going to bid and it may cost us a few months of negotiation. But we'll hold pat and we'll get a good deal for ourselves and for our shareholders and that's what we've been doing.

One thing that came up at the conference last year was -- that I found interesting, Scott and you've talked a bit more about is the waveform license sales at CS. How meaningful is that today? How big could that be as we think about that over the next several years?

Do you want to take that one?

Sure. It's a significant impact for profitability. It's -- I would say it's north of $100 million in just waveform sales in a particular year. It's hard to precisely measure because some of the radios have the waveforms integrated into them in the sales price of the unit themselves. But it is a growing aspect of the business. And they are software-defined radios that are able to be updated and upgraded. And we've seen that as an additive service that we can provide to our customers. And certainly, as we invest in the R&D and the technology to bring the waveforms forward and then sell it as a license certainly drives that profitability. It's a little bit lumpy in terms of how it flows through. It's not kind of serial production like the delivery of the hardware. But I think when Chris came into the role, he was very clear that we are a technology company and we should focus on software and waveform as a service. And so we provide this regardless of the hardware, regardless of the radio to the customers to deliver mission capability. And I think it's been a meaningful change to the opportunity for the CS segment.

And the next step is to put -- work with AI and artificial intelligence. And effectively, these radios become sensors on the battlefield. So we're doing some R&D in that regard. And you don't think of it as a piece of hardware. It is a hardware but we have the software. So we're trying to morph more into a high-margin, low-capital investment software company. We work with Palantir on the AI front. It gets to be pretty powerful. We've worked this with our WESCAM turrets, which are effectively cameras on fixed and rotary wing aircraft. We do it with the radios, things going on in the night vision goggle world as well. So it's pretty exciting.

This program that's gotten a fair amount of press recently IVAS or however, your Integrated Visual Augmentation System, I mean, moving, Anduril's involvement, 2. -- I mean what is your role today? What does this all mean for your role moving forward on that program?

It really doesn't affect me, to be honest with you. I mean there's -- we have the world's best night vision goggles, which the troops wear in battle. This is an augmented reality as I understand it. Microsoft has been struggling with it for years. These things, I think, are $80,000, $90,000 a pop and they're not used for combat. So been a long believer that these 2 can work in conjunction. One is for maybe more training and such and ours are for the war fighter. So we see a several hundred thousand market opportunity. We've been successful in winning a majority of the competition with another company. But I view it as 2 separate markets, got a lot of press, doesn't bother me, doesn't -- I don't lose any sleep over it. Good luck to Anduril. Maybe they with their experience can help get this across the goal line. But this program has struggled for years and who knows? Maybe DOGE looks at it and says, why we wasted billions of dollars on something that nobody needs or doesn't work. But we'll see what happens.

Okay. Ken, last one for you. So with the guidance this year, you took out an intangible amortization, that adjustment, so cleaner numbers but lower EPS number as I think there's been some consternation over that, hasn't really changed the cash flow dynamic. So I mean, that's my main area of focus. So walk us through -- you beat your cash flow guidance a little bit this -- in '24, you upped the '25 a little bit. You've got this $2.8 billion target for '28. Can you just high level kind of walk us between '24 and 2026 in terms of working capital, cash taxes, adjustments. The numbers are getting cleaner but there's still some adjustments in that adjusted number -- cash flow number.

I think to reduce the number of adjustments between our GAAP results and non-GAAP, we did start in 2024 to try to really clean up the free cash flow between what's free cash flow versus adjusted free cash flow. And I think we took just about everything out of there with the exception of the cash impact of LHX NeXt implementation costs largely. So first step was try to get the adjustments out of free cash flow to a traditional measure. 2025, we went after EPS, again, to really try to get that to a closer adjusted to GAAP measure. But I think your question really goes to free cash flow and how that progresses. And I think at the end of the day, the biggest driver, '24 to '25 to '26 is growing the top line, expanding our margins and effectively managing working capital. As we look at '26, there's a little bit bigger of a jump. Again, I think it kind of tracks accelerating revenue growth, margins getting to north of 16% and then effectively manage our working capital. We've got a number of international opportunities, as an example, that will start to -- we'll start to see in '25 and '26. Oftentimes, on the international side, we're able to get some advances or deposits and those should help to derisk the working capital a little bit in '26. But the fact of the matter is, if you look at '24, we guided $2.2 billion in free cash flow. We delivered over $2.3 billion. The team knows how to do this and we've got every confidence in getting to that framework that we've talked about. [Audio Gap] taxes, I would say, not a headwind or a tailwind, really just kind of noise in the system on that front. But we've got confidence in getting to that $2.8 billion in free cash flow for '26.

Terrific. Can we real quickly scroll go through the audience response questions?

Outstanding.

I like that answer. How about you? It's kind of what you wanted.

Yes. Yes. Glad we came here.

I guess it depends on this answer.

That's right.

I thought you said double digit.

We did. We did.

Didn't say any of that.

I guess other guys have more than double digit.

No, I don't think so.

That's pretty even.

They've been saying it for longer and off a lower base.

I can predict the answer to this question.

It's always #3.

It's always #3.

#3. And we're accelerating earlier in the year this year.

Absolutely. I'm going for 6 on this one.

Yes. I'd be happy with the 4. Not bad. Must be the software. Right there, the editorials here.

Absolutely. I'm getting complaints from people that aren't here about what the questions are, what the answers are. I'm like, you need to come to the conference. Don't give it all away for free.

#5 should be you and me but they didn't put it on there. So thank you for that. Interesting.

Okay. All right. Chris, Ken, thank you very much.

Thank you so much. Thank you all. Thank you all for joining. Have a great conference.

Thank you. Appreciate it.

Thanks, Dave. I'll see you a little bit later. Thank you.

All right.