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

My name is Sheila Kahyaoglu with the Jefferies Aerospace and Defense Equity Research team. Thanks so much for being here. We have L3Harris Technologies here. We have Chris Kubasik, who's Chairman and CEO in case you aren't aware. And counting Ken over there, but I hesitated on the introduction. Thank you, Ken Bedingfield, for being here, who's CFO. Ken has a quick disclaimer he's got to read and we're going to get right into Q&A.

Thanks, Sheila. It's great to be here. And just to remind everyone that today's discussion will include forward-looking statements. Those statements do include risks and uncertainties, and they can -- you can find more information in our SEC filings.

Thank you. Chris, maybe just to start broadly here. Thank you for being here, as always, and supporting the conference. There's a lot going on with budgets. And I think -- we saw your interview yesterday on FOX. And I think we all look to you to see what's moving with the DoD to be quite frank. So how do you think about budgets and strategy from reconciliation from here? I think you guys have a lot going on with Golden Dome and the most we've heard so far and how do you think about European defense budgets contributing?

Okay. Well, thank you. Thank you all for joining. It is somewhat confusing to try to keep track of everything going on. But I would say we have a huge tailwind when it comes to the defense budget. Just the other day, I think the Senate brought forward $878 billion budget for 2026. But the big news is the reconciliation bill of $155 billion. Normally, those would spread over 10 years, but the administration has been pretty clear that, that $155 billion will be spent in a 3- to 4-year period. So that's how you hear this $1 trillion number. So from the U.S. perspective, there's never been more money in the DoD budget than we have for '25 and definitely for '26. President Trump has been pretty clear that he wants NATO and our allies to pay their fair share, and they've stepped that up as well. So when we look at the budgets around the world and specifically Europe, again, huge opportunities. We're about 23% of our revenues derived internationally. So additional growth opportunities for us. Golden Dome has been getting a majority of the discussion. Again, in January of this year, the President signed an executive order directing the Department of Defense to establish a missile shield to protect the nation. So that is an executive order. They recently confirmed the leader in the position, General Guetlein, and he will be a direct report somewhat unusual, a direct report to Steve Feinberg, who is the Deputy Secretary of Defense. So cutting out a lot of layers, a lot of bureaucracy and the budget there initially is $25 billion. So as it relates to L3Harris, we've been on a role here in the last several years with space. Historically, we were a payload provider. We're now a prime. We have built and launched a hypersonic ballistic tracking satellite for both the Missile Defense Agency and the Space Development Agency. You've heard us talk in the past, we've won Tranche 0, Tranche 1, Tranche 2. So we have more backlog than anyone in this particular domain. So part of Golden Dome will be tracking hypersonic and ballistic missiles. And we think we're well positioned to build these satellites, launch them, and there is a scenario where we can have these up in an orbit while President Trump is still in office. We're just waiting for the go sign from the DoD. The other part of -- two other parts of -- at a high level of Golden Dome are the solid rocket motors, the munitions, you hear of Standard Missile, PAC-3, THAAD, NextGen Interceptor, Glide Phase Interceptor, Sentinel. We provide the solid rocket motors for every one of those programs, and there will be an increase in the volume. Some of those are long-term production programs, some are development. And then the third piece, which is still evolving, and we're still focused on trying to figure out our strategy is for the space-based interceptor where there will be interceptors in orbit, and we have great technology. We have to decide if we're going to prime sub-merchant supply or some combination thereof. So been in the industry a long time, never seen these kind of external tailwinds. And I think it bodes well for us in this defense industry for the next several years.

With the $25 billion for Golden Dome, if I could just double click on that. How do we think about that being generating revenue for LHX and the potential opportunities there?

And just real quick to clarify, the $25 billion is the FY '26 piece of Golden Dome.

Well, I think, it's going to be sooner rather than later, mainly because of the executive order by the President. I know a few people have asked, is this going to slip? I think it would be a bad strategy for the Department of Defense to ignore this directive from the President. So I feel confident that something is going to happen here in the next several months relative to orders and contracts. And then we would probably think we could get 10% to 15%, maybe 20% of that would be addressable to us. And I think it would start hitting the income statement pretty quickly thereafter. So I think this will be a good tailwind and definitely give us even higher confidence in our 2026 framework, which I know you ask about every time I talk to you.

I'll go on to that question next. As we think about -- you've laid out 3-year targets with your fiscal '26 framework for $23 billion of revenues, which basically implies mid-single-digit growth. But if we look at the opportunities ahead, Golden Dome, coupled with European defense budgets, your recent wins and just the U.S. defense budget in itself, how do we think about the range of outcomes and maybe opportunities folks aren't factoring in?

Yes. For 2026, look, we laid out the $23 billion revenue target at our Investor Day back in late 2023. At the time, we had confidence, and I would say between then and now, there are a lot of questions on how are you going to get there, how are you going to get there? And now the question is, I think, how much upside is there to the $23 billion number for 2026. And Chris mentioned Golden Dome as a tailwind, and it certainly is, and it's a portfolio of opportunities between the space-based sensors and certainly, the interceptor acceleration. I think the space-based interceptor probably will be a little bit of a longer burn. But just looking at the portfolio, between the Golden Dome opportunity, some of that in SAS segment, some of that in Aerojet Rocketdyne segment, certainly the continued demand for international communications, software-defined radios and network upgrades as well as some opportunities in our ISR business within IMS, we are building more and more confidence that we will hit the $23 billion number. And look, from a '26 perspective, we'll give guidance in January, and we're not updating the framework today. But my opinion, Sheila, would be that there is more -- certainly more upside than downside to the $23 billion in sales for 2026.

And just as a reminder, we also gave margin and free cash flow as part of that framework, and both those numbers have been increased in the last quarter or 2. So our plan would be to exceed all those numbers for a 3-year framework. And then in the first quarter of '26, we'll have an investor conference and lay out a probably 2028 framework to give you a little more visibility longer term.

How do we think about -- maybe just starting with Aerojet. You acquired it in 2023 for about $4.7 billion, I believe. How do you think about what surprised you to the upside? How do you think about valuation today of the asset, and it's really driven some growth opportunities for you all?

Well, I'll start since I was the guy that paid the $4.7 billion. I think today, there's lots of people running around New York who would tell me that it's worth anywhere from $11 billion to $15 billion in just over 2 years. So we've seen a lot of growth. I'd say what surprised, I would say, we will start with the leadership. We've changed out the entire leadership. So I guess I was surprised that the leadership team wasn't up to the standards that we set. So we quickly upgraded all the talent from external hires and internal hires. I think a lot of people were questioning whether we had missile and solid rocket motor capability. We have more talent in that area than people gave us credit for. So the team is really operating well there. I'd say the workforce who had been through a lot with the failed acquisition, proxy fight is highly engaged. We do employee engagement surveys. The Aerojet Rocketdyne team is very excited to be part of L3Harris. So that's kind of on the people front. The demand turned out to be more than, I think, they were forecasting when they were selling. I do like to remind people that Russia attacked Ukraine in February of '22. We announced the deal in December of '22. So I'm not sure it's overly insightful to think there would be a surge in the need for missiles and munitions. But clearly, that was a start and the 30-day war or whatever was still going on 9 months later. So there's clearly demand there. I think the Golden Dome initiative is clearly more upside than was initially forecasted. And that's just the missile piece, which Ken is also the President of Aerojet Rocketdyne. So we foresee double-digit growth for the Aerojet Rocketdyne Missile segment for the foreseeable future easily a decade, if not longer. We're just trying to decide if it's 10% or 15%. But that's the visibility that we have. And then on the space propulsion side, again, great visibility and that market has had more demand. We have the RL10 upper stage for the United Launch Alliance. And of course, they have the contract to launch all the Kuiper satellites. So I think we have a couple of hundred engines there in backlog and then the RS-25 for Artemis through NASA was a little bit of a concern, but that settled down through the end of the decade at least. So I mean, pretty much everything from the workforce to the demand. And then the -- maybe surprised me a little bit, it's a turnaround story, how quickly we were able to turn it around. And part of that was just having a motivated workforce, and I'll let Ken pile on, but we've invested a lot. The government is investing, the customer is investing. It's all about capacity. At the end of the day, we're selling capacity. We're building factories and facilities in Arkansas, Alabama and Virginia, and we've ordered equipment such as ovens and mixers. And I think we're in a really, really good position and I think as I look back, so far, the acquisitions turned out to be better than I would have hoped for.

Yes. I think Chris covered it well. I'll just say really is an incredible business that I would say had some distractions and didn't have the right amount of investment into modernization. The workforce is engaged, very excited for what they do and supporting the war fighter and getting solid rocket motors out the door and into the hands of the primes or into the hands of the end customer and ultimately out to the battlefield. And just a couple of examples, Sheila, I would say, we have increased our deliveries in just 2 years by over 60%. So it really is impressive how quickly the team has been able to react, to really identify through good solid, I'll just say, like industrial engineering, identify the choke points, get some of those dealt with, get capacity out the door, get the team engaged a little bit of student body right and getting some overtime to get motors going to solve some challenges from the customer on product they need to get in their hands. And then we're making investments to really modernize the factories there. And that's going to be across the range of solid rocket motors from tactical motors that we've been making some investments in today, Stinger, Javelin, GMLRS. Certainly, a lot of investment will be going into the interceptor capacity. Chris mentioned THAAD, PAC-3, Standard Missile, Tomahawk and others. And some of that will be -- we're working very closely with the primes and with the DoD to make sure that, that investment that's across the entire supply base, and we've identified kind of 17 key suppliers that we're working with in order to really drive to what the customer needs in terms of delivery of these critical motors. And then strategic motors as well. So if you think about the large motors like NextGen Interceptor and Sentinel, where we have important positions. So many of these will be decades long runs. And so I think we're making important decisions today around how do we modernize, use robotics, use artificial intelligence to figure out what we're producing and when and where. And really, to get to some common production processes versus a legacy kind of program-by-program-by-program effort where each program owned its capital and we didn't have the ability to use across. So it really is an incredible business, incredible team, and I think we're making all the right decisions. And at the end of the day, I think, the theory has proven out correct that it's a much better business in the hands of L3Harris. And we've been really working to make sure we got great relationships with our customers, both the primes and the end customer, DoD as well as allied nations. And I think with the recognition that we sell capacity, we are capacity limited, we need to get on contract. When we get on contract, we will start to produce those motors first. And I think that's starting to yield results in terms of driving the revenue growth.

Great. And maybe if you could talk about the competitive backdrop for that business. I think the stat you provided, and I'm not sure if it's correct. But I don't want to misquote you, but the number of solid rocket motors LHX produces in this day is equivalent to all the competitors combined over a year. So if you could talk about that and the 60% increase in capacity over the last 2 years, and the $5 billion of revenue assumed for Aerojet by 2030? What does that factor in terms of new wins? Or is it just current production rates?

Yes. I would say that stat that you mentioned is accurate with respect to the new entrants, Legacy, ATK, Northrop does produce a fair quantity of motors as well. But we produce about 100,000 motors a year at Aerojet Rocketdyne. In terms of the new entrants, I would say, look, I think, it's a recognition that this market is very attractive, that there's a lot of capacity that's needed. And that we're in the right place at the right time. Now it takes a lot of time to get these motors qualified and be able to scale and meet all the requirements of max explosive load and where you build them and getting all the permitting and how do you burn off excess powder and excess materials and things like that. So there are complications. As we look at the new entrants, there are some interesting technologies. We're evaluating where those might be useful for us, such as 3D printing a propellant and things like that. But we're focused on what we can control, which is driving the capacity. Some of these new entrants will look at small motors, 2.75 inch or 4.25 inch or that type of thing. Some of the motors that we're focused on producing are 30-feet and 6-feet diameter size motors. So you could probably cast 750 or 1,000 of these small motors and what it would take to cast just one of these big ones. So we do have scale, and I think we do have a business that is very much specialized between a couple of the players here, and I think it would be tough for some of these new entrants to break in. That being said, we're looking to work with them when we can, see what makes sense. And -- but we're very satisfied about our growth story, and I don't think the new entrants are of a concern in terms of our ability to grow double digits for the foreseeable future.

And there really aren't that many new missile programs, and many of these programs have been around decades long and we have the intellectual property and such. So it's not easy to change out a supplier. And I've said before that we welcome competition, so bring it on, but we don't really need a third solid rocket motor provider. What I've been saying to everyone is it'll just go to the same supply chain. We need more companies that make nozzles. We need more companies that make igniters, we need more companies that make cases. So a third or a fourth solid rocket motor provider, they're going to call the same people that we already have hocked up for our supply chain, and they'll just have to get to the back of the line. So I think that's where my focus is, and that's where I think I've been pretty outspoken with the DoD and others. Let's fix the supply chain, let's get more capacity there because you can't make 100,000 motors a day or a year if we don't have 100,000 nozzles, 100,000 cases, 100,000 igniters and the other 14 suppliers that are critical. So that's -- I view the challenge and the choke point. And again, having a third SRM provider isn't going to solve the problem that we are going to have the appropriate budget to continue that modernization. Probably more exciting is the international market has really taken off. Europe, in particular, the budgets are larger. And one of the learnings coming out of Ukraine is the criticality of having resilient communications. And everybody will say they have resilient communications, but there are specific ways you can test. I think we are well recognized as the world leader when it comes to resilient communications, which means you can't jam it, you can't intercept it, you can't locate where the person is sending it or the person getting it. If you don't have that, it's -- you can fight, but you're not going to win. So this resilient comms is critical. We've booked over $1 billion just in Europe alone this year in countries that we never thought were addressable markets that have indigenous capability, whether it's Germany, whether it's Poland, Czechia, Netherlands, it's because of the threat and it's because of the superior technology. And when you have a war going on not too far from where you live, you're going to get the best technology and they're buying ours, plain and simple. And it's interoperable with the U.S. as we continue to approach other countries or they approach us. It's just kind of a bow wave because if five of your neighbors have our technology and the U.S. has our technology, it'd be pretty crazy to buy something other than that because of the interoperability. So we're super excited about the tactical comms market and the software-defined radios. I think people have been predicting that this is the last year for 20 years. But without comms, there are no bombs, as we say. And it's the key to warfare, plain and simple.

Okay. I did some quick math while you were speaking, Chris. So I might be mistaken, but I think the last time I went to Rochester, where you make the radios was 2018 and the stat was 10%. I haven't heard the 42% modernized yet. That was 7 years ago. So would it be fair to say you have 12 more years of runway in your software upgrades?

When were you last there?

2018.