L3Harris Technologies, Inc. ($LHX)

Good afternoon, everyone, and welcome back to the aerospace and defense track at the JPMorgan Industrials Conference. I'm Seth Seifman, the U.S. A&D Equity analyst here. And we are very grateful to have with us L3Harris. And we have with us the President of Missile Solutions and soon to be the President of a to-be-named Missile Solutions company, Ken Bedingfield. Also, if you -- he is 3 days in the job, I think. So we have the new CFO of L3Harris here, which is Ken Sharp. And then I think a lot of you know Tony Calderon from Investor Relations. So thank you all for coming. We really appreciate it. I think we'll do Q&A. I will ask a bunch of questions, but also happy to go out to the room and take questions here from the group as well.

And Seth, maybe just before we get started, if I could just make a couple of quick comments. But certainly, our comments today may include forward-looking statements, and those include risks and uncertainties. And for more information, I would refer you to our SEC filings. And certainly, today, I'm day 3 into my one job as the President of Missile Solutions, certainly as we look to grow the business and take it public with L3Harris as the majority shareholder. But here to discuss all things, L3Harris, certainly to include MSL.

Excellent. We'll probably -- so we'll divide the time. We've got about 35 minutes, so a little bit less now, and we'll make sure that we get to all of the businesses within L3. Maybe we'll start with Missile Solutions. I know it's a focus area for investors and it's at the top of the news as well. Maybe you could give us a sense of the time line here. When should we expect a Form 10, if that's kind of something you should -- you can share? Do you expect that the new business will have segments? Will there be stuff that you'll disclose about customers who might be -- have a high percentage of sales?

So we are working diligently towards the planned IPO of the business. And a number of moving parts in that, certainly closing the announced investment from the government for, call it, the anchor investor in the IPO, making good progress around all the regulatory requirements in terms of carve-out financials and Form S-1 and all those things. And we are looking forward to a planned second half timing in terms of an IPO. Importantly, we are certainly working actively with our customers to address the need to accelerate capacity, accelerate production of all things relative to Missile Solutions Naturally, people think about solid rocket motors, which is the biggest component, but certainly critical capability around divert and attitude control systems, how do you precisely control a missile as well as fuses and weapons release systems and other advanced electronics. So more and more components of a missile within the newly combined MSL entity within L3Harris. Making great progress in terms of negotiations around multiyear contracts for some of the critical capabilities that we provide. And as importantly, we're making great progress around our investment plans. I will remind everybody that one of the big rationales for this agreement was that we could move faster with the confidence in terms of the government being willing to invest. And before all of the agreements and contracts are finalized, we'd have the confidence to go forward and invest. And we are making some of those investments, whether it's facilities, CapEx, equipment, automation, but also purchase orders for materials, thinking about a little bit more like a commercial model, I think appropriately risk-adjusted. So we are ready to grow this business. We are ready to close the investment, and we are ready to get to our planned IPO.

Excellent. Excellent. The investment plan is definitely something I wanted to talk about more, slightly different segment last year, but when it was Aerojet Rocketdyne, I think the CapEx there was $116 million. So we're talking about decades of Aerojet Rocketdyne CapEx happening over the next 4 years or so, if that's -- is that the right time frame? And then how is that going to look -- make the production base look different? What is building a missile in Camden and Huntsville look like in 2030 when you guys are done with that versus the way it looks today? And what does that imply also for return on sales?

So it's a great question on the CapEx and how we manage that. And I'll say a couple of things. I mean, first of all, yes, we spent $100 million and change in CapEx at legacy Aerojet Rocketdyne last year. And if you look back to pre-acquisition, I believe as a stand-alone company, the year before we acquired it, Aerojet Rocketdyne spent about $20 million in CapEx. So we significantly increased that almost immediately after acquisition, tripling, quadrupling CapEx. But maybe as importantly, as we are executing on the strategy, we have been working closely with our customer, and we've been building some facilities under what's called the Defense Production Act. And we've been building out facilities for GMLRS, the guided multiple launch rocket system as well as Javelin and Stinger, again, along with our customers. And that really gives us the confidence to take those buildings and that infrastructure that we've been overseeing and using that as kind of the blueprint for some of the facilities that we'll be constructing now, whether those are some accelerated program-specific buildings. We've got large solid rocket motor facilities that we're investing in to support things like Sentinel, NextGen Interceptor, Zeus, some classified programs, MPPD, among others, as well as facilities to support Munitions Acceleration Council programs. So I think we've become very good at construction at managing how we build the facilities, how we get the equipment in, how we get everything calibrated, how we bring it online. And we'll plan to use that as the blueprint for how we kind of do this going forward. In terms of sort of the model as we look forward, we absolutely believe that we will be able to automate how these systems are produced. So in the past, it's been very labor intensive, not only labor-intensive, but really I guess, using procedures that just aren't what you would use in a modern factory. Yes. So as we look forward, a lot of automation, robotics, precision application of liners and insulators and things like that, precision ways to cast and cure the motors and that sort of thing. So it will be, we think, the world's most advanced factory for production of solid rocket motors ultimately. And that should yield opportunity for us to expand margins on production programs. And we ought to be able to yield those margins to the investors in MSL. What I would say because I get a lot of questions around growth and margin expansion. And yes, we do expect both. But I think growth is the biggest driver of value. If you look at MSL, will there be some margin expansion? Yes. Can production programs get to solid significantly ahead of our average margins today? Yes. But we will always have kind of that healthy mix of development programs as well. And the development programs will inherently have lower margins as we work through risk. So today, we're on Sentinel program. We're on Next-generation Interceptor. We've got some classified programs that we're working on. We've got continued investment in hypersonics, as an example, some low-cost missiles. So as we manage to make sure we've always got that right mix, that right life cycle of contracts, that will ultimately be the limiting factor on multiple -- I'm sorry, on margin expansion, not our ability to perform. I think we can perform very well on our production programs, but we never want to become a cash cow, obviously.

Right. Okay. Okay. You've kind of -- the framework that the company laid out at the L3Harris Investor Day recently was for kind of a high teens CAGR in Missile Solutions through 2028. I guess, do you feel like the supply chain is there to support that right now? And then also, how much of that can you do with the existing footprint versus how much requires some of the big investments that are coming with the capital that's going to come from DoD and from the offering?

Yes. We're working very actively with our supply chain. And we didn't wait. We haven't been waiting in order to get either the investment or the contracts done. So as soon as we started discussions with the Department of Water about the Munitions Acceleration Council, we actually brought all of our suppliers into our facility, had a discussion about the investments we were planning to make, seeing the demand signals that we were. We got commitments from our suppliers to do certain things to drive their ability to deliver more capacity. We've actually worked with some of our suppliers to sponsor them into Defense Production Act funding. In some cases, we'll fund our suppliers for some of the capital that they need that would be used for our production purposes. And where there are suppliers, there's a lot of motors, DACs and other systems to be built. We're certainly trying to derisk the supply chain to ensure that we have multiple sources while I think all of these suppliers will still have plenty of capacity for them to invest and for them to grow their business significantly. So very actively working the supply chain. Look, the plan is to get motors and DAC systems and fuses and all of the other products that we provide into the hands of our customers as quickly as possible and at a rate and a pace ultimately that no one else can. We plan to be the world's biggest supplier of solid rocket motors and other products for missiles. And it's a race. It's certainly a lot of demand out there and a lot of interest and other parties to get into it. And we welcome competition. But at the end of the day, we produce over 100,000 motors a year today. We think we can scale at a pace that no one else can. And ultimately, we think we able to build more motors than anybody else can, and that's what we're off to try to do.

Is there a -- if we think about that 100,000 today, is there a number we should have in our head, let's say, 6 or 7 years from now of what that could be?

Well, we've talked about doubling revenue, I think I believe at Investor Day, we talked about doubling revenue through the end of this decade. And it's not unreasonable to think about quantities following that in some linear fashion.

Right. With further growth beyond.

Absolutely. Yes, we think there's solid growth well for many, many years to come.

Okay. Well, when you're at the conference next year, we can make it all about Missile Solutions.

All right. Sounds good.

But for now, I'm just going to ask one more and then we'll pivot. So just understanding the cash flows around some of these large contracts, we've seen framework agreements between Lockheed and Raytheon and the department. I don't know if yours will be directly with the department or if it will be through the primes. But there's -- the impact of this on near-term cash flow seems relatively neutral in terms of what contractors are expecting. And is that something -- should we think about that meaning that at some point later on in the contract performance period, the cash conversion will be lower because a lot of cash came in sort of upfront to support the ramp-up?

From my perspective, I mean, first of all, most of our contracts today are with the missile primes. And in terms of the framework agreements signed at that level, I would refer you to their disclosures and their comments. There was a, I think, a release or there was a webcast that was held between Jim Taiclet at Lockheed and Secretary Duffy at the Department of War, which you could reference for some more information as well. So we're working our frameworks, ultimately, want to turn those frameworks into multiyear contracts that we can begin to execute on. And so we're in negotiations with the appropriate to get to where we need to be. From a cash perspective, what I would say is I think there's a recognition that on these multi -- first of all, the multiyear contracts are very helpful and supportive for the investments that need to be made to capacitize for this acceleration, new factories, new equipment, new automation tools, that sort of thing. And there's a recognition that as we're all making that multibillion-dollar investment that the cash flow needs to be favorable enough that the business case will close. As we continue to expand and grow this business, I don't see it as a lull or a drop in our free cash flow as we look out past 2028. We're certainly working to make sure that we get cash that offsets the capital as much as possible. And certainly thinking about it at the overall LHX level and how can LHX pull all the levers to manage the additional CapEx slug that we're pushing through in '27, '28 and maybe a little bit of '29. And so LHX is pulling all the levers, not just MSL. So it's going to be a strong cash story over the long term. And as we continue to grow the business, we'll continue to do this all over again. These multiyear production contracts tend to have milestone payments. We're going to work to accelerate our deliveries because the customer needs the product. And as you accelerate deliveries, we expect to have positive payment milestones tied to that. Team is performing very well, and we continue to expect to do that, and that will drive solid cash flow.

Okay. Excellent. Let's turn to aircraft missionization because that's emerged as a key growth driver for the business. I think if we were having this conversation a few years ago, maybe we'd be worried, maybe this mission was moving to space and you didn't need aircraft performing this IR mission anymore. And now you're looking at a $20 billion pipeline in this area. So can you talk about the growth opportunity there, maybe some of the duration of the growth opportunity there? And do you see this being outside of Missile Solutions being kind of the biggest growth driver for the company?

Yes. Look, I think the ISR team has done a fantastic job. I mean it's a great team based down in Greenville and Waco, Texas for the most part. And they've been performing well on their programs. A few years back, they had some challenges, and they've come through that. And I think we have a history of modifying business jets for militarized missions. And there's really a good model there for lower cost per flight hour. You can fly a bit higher, you can see more. You don't have -- there's a lot of missions you can do from space, but there are some things that you -- some missions that you want to or need to do from lower altitudes. And they've been doing great at establishing baseline performance and then working with customers to get confidence in their ability to deliver on cost and schedule for some of these key missions. So they've signed an over $2 billion agreement with Republic of Korea to deliver advanced early warning aircraft and often executing on that contract. And I think other countries are looking at that and saying, wow, that's a pretty attractive asset. And we've now signed that -- signed up another customer for that in the first quarter. NATO ally has made the decision to procure, and we see other opportunities. You mentioned a big pipeline there, so great work by that team. It's certainly a competitive field as well. There are international competitors as well as another U.S.-based competitor of larger ISR platforms. And we feel very good about how we're positioned.

Okay. Excellent. Another growth driver for the company in the SMS segment is space, obviously. And L3 has been central to the development of missile tracking and missile warning satellites and that technology. Can you talk about the path forward there? We know that part of the business has grown. The latest award for tracking layer Tranche 3 kind of ensures the next leg of growth. But as some of this work kind of intersects with what's happening in Golden Dome and all the resources that are available for that. What are the next stages of your work in missile warning and missile tracking?

Yes, it's really interesting. And I agree with you. Space, all things space are definitely a growth area for us at L3Harris. Missile defense, missile warning, missile tracking is a big visible part of that. We do have a large classified portfolio as well that's got, I think, a solid growth trajectory. But if you look at missile defense, just as an example, 5 years ago, we had no satellites in this area. Quite frankly, we were a weather payload provider. The team did a great job in figuring out how to turn a very capable weather payload into an optical sensor for missile warning, missile defense. and add some algorithms and software and ultimately become a prime through SDA Tranche 0. And we're the only company that's been won Tranche 1, 2 and 3, and we look forward to continue to support that customer. We also were on a program called HBTSS, Hypersonic and Ballistic Tracking Space Sensor, I think it was, which is now called MDT3. Thank you, Tony. And so we look forward to hopefully a successful opportunity and bid on MDT3 to continue to provide the defense that our country needs for hypersonic threats, certainly a lot of capability that we have there displayed in the previous HBTSS program. So space certainly is a significant growth opportunity for us. I think that business will continue to win and continue to improve its operating margins. As when you move into a new area, there are some growing pains. And we've talked about some negative EAC adjustments on some restricted space programs and the fact that SDA, as we became a prime, would incrementally see margin improvement from Tranche 0 to 1 to 2 to 3, and we're seeing that. And so we think that SMS will have the ability to continue to expand its margins as it sees still pretty solid high single-digit growth.

Right. Right. I guess if we thought about being able to -- as the capability matures in space and as the ISR business grows with maybe a little bit more of an international mix, those 2 factors can be key drivers of margin expansion in SMS.

Yes. I think that will help. That certainly will help as well. International certainly has a higher margin expectation. Some of these big programs, obviously, there's risk and you want to be careful and think about that risk as you start to book your profit on that, burn down risk as you move through the schedule and then have the ability to increase your profitability over time. So we'll be careful as we work on these multibillion, multiyear estimates at completion and programs. But I think there's a huge opportunity for that segment.

Okay. Okay. We're like 25 minutes in. We haven't spoken about radios yet, but it's still an important topic within the company. Can you talk about maybe the relative size of the international and the domestic radio business and the growth trajectory for each of those?

Yes. From the size of the business, what I would say is that the -- the factory in Rochester that where we build the radios is able to modulate. They're awfully close to the domestic radios and the internationals, and they're able to modulate the factory pretty quick to deliver either U.S. Army, domestic, largely radios or international radios for our allies. And so the size of it, what I'll say is that as we -- as the Department of War has -- and the Army have put some priority around NGC2, we've seen some budget move from radio acquisition to NG next-generation command and control. We're certainly in the mix on that and seeing that as a growth driver for us. That's resulted in some slowdown of the radio acquisition and modernization for the Army. And we've been able to deliver more international radios while keeping quantities steady and growing a bit. So it's been a great model for us. That's a business that can get an order for a customer and oftentimes turn that around in the same month, if not the same quarter. So a business that knows how to scale quickly and get capability in the hands of the customer. We often get questions about that business and the international demand. And what I'll say is we have, we believe, the world's most capable radios, in particular, resilience, low probability of intercept and low probability of detect. And that -- we believe that capability is really what drives that continuing international demand. International customers will prioritize capability over politics in our experience.

Yes. I think you've probably seen that over the past year. What -- I guess when you think about NGC2, what does it mean for the domestic radio business in that -- is there still -- I assume there's still an intention to purchase radios. And I think of NGC2 is almost like this kind of architecture. I assume there's still an intention to purchase radios. And if so, I assume also that, that hasn't changed. So is it about figuring out how to -- exactly what radios they need and how to fit them into this new architecture? Is it about something different? I guess how is the Army communications portfolio changing as a result of NGC2?

Yes. Look, as much as I love all things, radio frequency, I don't claim to be an RF engineer. Tony is an engineer, maybe he can come answer the question. But here's the way to think about it. There are a couple of contracts out there to really define the architecture. We are certainly involved in what is the transport layer within that architecture going to be across multiple layers, applications and that sort of thing. And as a part of that transport layer, we certainly expect to be delivering radios and other hardware, whether that's modems, data links, things like that. So yes, we absolutely expect to continue to deliver hardware under an NGC 2 architecture. In the meantime, we'll certainly continue to deliver radios that are today. And I think as you look at the battlefield today, it certainly continues to be a contested and quite frankly, more and more contested. And I think that the customer is, therefore, appropriately running some demonstrations to see how these products handle complicated RF environments like jamming and other challenges that adversaries will bring to the table. And as we do that, we see that our products continue to perform exceedingly well in those environments and others, I think, are challenging.

Okay. Okay. When we think about the path -- top line path that you laid out for the CSD segment last month, what role did the tactical radios play in that? Was there an assumption of kind of growth in line with the segment or above the segment, below the segment?

We don't necessarily break down the guidance below the segment level. But if I think about tactical radios, which is the single biggest piece of that business, I would say, roughly growing in line with the segment, mid-single-digit growth.

Okay. Okay. Maybe let's take a quick pause here, look out into the audience and see if anyone has any questions or I'll continue to ask. I guess one of the things I was wondering about, we see kind of a differing defense landscape here in terms of what the department is looking for from contractors. We see a more dynamic defense industrial base emerging. How does L3Harris think about M&A in that environment?

Well, first of all, this, we believe, is an environment that we thrive in. We talk about being the trusted disruptor in the defense industry, and I think this is where we differentiate. So if you think about the primes that have the capacity and the ability to deliver the best technology and capability and you have the new entrants who have different ways to do things, faster moving, but they don't have the capacity to deliver at a scale that's needed. We believe we sit pretty squarely in the middle. We understand kind of that legacy prime business. We have an installed base, but we can also move a bit faster and partner with some of the new entrants to bring that capacity and capability at scale that others can't do or can't do fast enough depending on who you're looking at. In terms of M&A, I mean, right now, we're very focused on trying to drive to the planned IPO of MSL. In the meantime, we do have an active strategy and M&A team that evaluates what's going on. Our leverage ratio is relatively low. We're in the sub -3, let's say. So we certainly have opportunity in the future, MSL will certainly, with its -- whatever its valuation ends up being, will have its own set of to evaluate as well. So we're looking at it. But we pretty firmly believe our portfolio is very well aligned to areas of customer need. So we don't feel the need to do anything unless it's value creating. And if you think about our portfolio and its alignment, certainly, Missile Solutions, we've talked about high double-digit growth, communications spectrum dominance, important business. You've got to be able to communicate on the battlefield, space, strong grower, ISR as kind of the key components of our alignment to areas of customer need.

Okay. Okay. Excellent. We're pretty close to time here. I guess maybe just to round out on that last point. When we think about your internal R&D then, are those areas that you just talked about, would those be the primary destinations as far as the company's IRAD dollars?

Absolutely. Yes, we are -- we've always been a heavy allocator of our resources to R&D. And I think what we're doing today is placing fewer big bets on things that we have -- that we believe in, that we think are critical for our customers and where we can provide game-changing capabilities. So we're not just trying to peanut butter spread across the business. We're picking big bets and making them, and we expect that to continue to drive to an outsized growth where we think if we're not the fastest grower in the industry, we're certainly among them.

Excellent. Okay. And with that, we are at time. Ken, thanks very much for being here. We really appreciate it.

All right. Fantastic. Thanks, Seth.

Thank you.