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

Yes. So if you had to dissect the segment and look at the sector, the space businesses, lower than the average margin in the segment. So certainly, getting that to perform better is important. And as you can imagine, like Tranche 5, AMD T3 is tranche 5. So as you get into that next level, certainly, we've learned a lot as far as what buses were using, what other components are on a spacecraft. And just getting kind of better on the supply chain side, the engineering, I think, has been where the team has been after. I think they've been doing a nice job, how we bid the programs has shifted. And I think we've been trying to be more thoughtful around or disciplined around the economics. So I think that part is good. And the truth is, we've been kind of being somewhat conservative on our booking rates on the margins to make sure we deliver. And then as we derisk the programs, you'll see better and better margins. So in the past, we probably didn't run with a level of management reserve on the programs that we've kind of built into the programs now.

Maybe I just want to close the loop on the segment margins as we think about space only representing 1/3. How do we think about the ISR business? It's gone through transformation here and it's on a positive trajectory, where margins sit there and the remaining 1/3 of the business?

Yes. And I think the ISR piece is closer to the average margin in the business. So I think it is, to your point, and Tony was there. They did a great job of getting that business where it needed to be. We've got a couple of very large newer wins as far as new aircraft types. So just kind of getting those kind of laid flat, getting the -- I mean, and these are real hard until you go on one, you don't realize what the team is doing. I mean, they're cutting new holes. They're filling them full of electric -- cutting new holes in the [indiscernible], sorry, and redesigning kind of the airplanes and what they can -- the loads they can carry, how to carry them, how to also do the ISR work that the payload is doing inside. So I think the team has done a nice job. They'll get to a level that it's repeatable, right? They've done that on the domestic side and these new international variants. That's what they're working through now. I think there's a lot of -- you asked about growth, I think, both on the space side, specifically in the ISR side for the aircraft, I think there's a lot of opportunity.

That's great to hear. Maybe just on CSD, let's go to communications, we could finally touch on it. You talked about resilient communication orders of over $1 billion from European allies like Germany, Poland and Netherlands. I guess, how do you -- first, maybe let's size the total communications business and how you think about demand both U.S. and internationally?

Sure. And it moves around a lot because -- and maybe for folks if they don't fully get our radios business, it's generally kind of the military radios. They're highly effective. So if we have them deployed in Ukraine today, the Russians are very good at jamming communications. So our radios are the best. So we're very good about uploading new capabilities into the radios to get them on different spectrum and so forth. So -- or waveform. So people can communicate. They don't get jammed. So at the end of the day, it's a great business where we get into the kind of out of the revenue ebbs and flows we go through upgrades like your iPhone or whatever device you use. We're -- right now, we're on Falcon 4 domestically. Falcon 4 will go to Falcon 5 in the next probably 1.5 years. That drives a little bit of demand signal as well because you get better capabilities and may be different than -- I don't know if you guys ever look at a warfighter, but they have a screen in front of them, a radio and a battery over a year, it's still pretty big, right? It has to have a lot of capability, survive in combat. So the form factor is important to work down the compute power, the communication power of the radios are all still unlike your phone, and I'm not a kid, so I might have to ask my kids, but they do different things when you get the newer phone, but they all kind of seem to be the same to me. I think our radios aren't all the same. So -- and maybe Chris' frustration with Rochester was they're too hot, and we weren't working the form factor fast enough. And I think we've worked the form factor well and the Falcon 5 will be that. In the international space, we tend to be on Falcon 3, move to Falcon 4. When we talk about software products going out on these radios, you need the newer variants for the software products. And if you think about [indiscernible] being this kind of fence that goes around with every radio that you can detect drones coming in and literally, it will detect it, sense it and then jam it and drop these drones down if there are a drones, it's pretty important. So -- and for me, I mean it's like a personal thing because I used to be a war fighter and I got a young kid that comes to my house. He's an Army Ranger. And at the end of the day, I said, "Hey, watch this video tell me what you think?" And he's like 1 in the Ranger Patalion. So these are the guys that get deployed all the time. He's like, hey -- I mean, he has a lot of choice words. There's too many people here, it's probably recorded. So I won't use his words, but he would say it's very important. And how do we get it, and we're working with SOCOM on something like that, and he's very big too, by the way. So I try to be really nice to them. But he dates my daughter. I should probably given you guys too much. So I get a little worried about that, too. But any, that's the importance of the radios. That's why I think getting these software products out, getting capability in the war fighter. I mean if you think about it, if the swarm of drones comes in, you can't take it out with munitions and firing and kinetics. It has to be kind of jamming and whatever else. It's just a really cool capability. That's what our radios do without any additional kind of way, that's just software. So I think it's a great business. Tony is now in the business that does the turrets with Wescam and also the counter UAS. I think that's also a really good business. We've talked about $1 billion in pipeline that showed up out of nowhere because everybody now feels like they need counter-UAS systems. Our first round of that is really kind of firing $30,000 missiles and drones. The kill rate on, it's about 80%, it's probably better now. But we've been working through all the algorithms and so forth. It's been fielded in Ukraine. So it's had live fire activity. So I think Tony is like probably the best salesman for it. Is that right, Tony? Yes.

I'll check out at AUSA next month, so I might get to see Tony 1 more time.

Fabs. You'll see them a bunch because that's going to be a odd spot, right? So -- I mean, like with all things like this, we have a huge ramp in front of us. trying to get all the electronics, like literally, I think, 2 weeks ago, we're working through, how do you get the Department of War certifications behind you internationally because the AI demand is huge. So I think we've talked about a huge ramp second half. And I've said, hey, revenue ramp second half. We still firmly believe it will ramp second half, but it's probably more fourth quarter weighted, second -- third quarter is probably flatter at the end of the day. But that's a little frustrating because it's such a great business. We want to see the product out. And but I will tell you, Sam is working that with the team night and day because we got a drive to get the supply chain laid flat. It's really 2 vendors, and it's like fourth-tier materials and that kind of stuff. So just show to the world we live in today, right?

I have 2 follow-up questions for that. As we think about the U.S. market, Falcon 4 to Falcon 5 over the next 1.5 years, what does that mean? Is it a software upgrade? What does that mean in terms of the investment ahead? And how do we think about the U.S. modernization cycle in terms of what's completed and what's ahead?

Sure. So it's a whole new radio. So it's all hardware. So think of something that's -- this is like big going to something maybe half the size and hopefully has better battery life, heat, more capacity for communications, so more ability to put software on it. So that new radio will probably effectively roll out the end of next year. So we don't want to get ahead of ourselves because we also want to keep selling Falcon 4s because they're very important, and we have to keep everything moving. So I think this will just be the next iteration like your iPhone. Like I said, it's kind of like going from an iPhone 5 to a 14, which then I'm not really sure which one they're at today, but not maybe a 17 because my kids don't mean we need a new one. So -- but anyway, I think it's kind of a pretty big evolution. So we're very excited about it.

And what's the percentage in terms of the modernization that you think -- how do you think about the modernization cadence as we progress every year?

Yes. I think somewhere around -- we've been at like 40-plus percent in the U.S. And then internationally, it's a lot harder, right, because every country, they don't all use our radios, but let's be -- if you're trying to communicate and you want this commonality between systems so you can communicate. And then if you're putting your kids on the battlefield, you want to give them the best odds of survivability. That's all L3Harris radios. So that's why we've been doing a really bang-up job internationally, and that's where you're seeing a lot of demand come in.

One more follow-up question. You mentioned, it's a very Q4-weighted business. How do we think about some of the, I guess, supply chain areas that you're keenly focused on to get that ensure you ship?

Yes. I would say it's predominantly kind of pieces that go into electronic boards. I mean we make these radios all ourselves. So it's always putting resistors and stuff like that on boards. So I would say there are some materials in the boards that have gotten to be a little bit harder. We've had to go dual source different vendors, also work with countries that some of these suppliers are not in the U.S. So trying to go explain to them, "Hey, it's important for the Department of War, engage with the department of War with them, which Sam has done and vendors -- a little bit of a positive surprise candidly. The vendors have said, okay, we're prioritizing you. Our demands aren't as high as like somebody building a bunch of boxes for a data center. So maybe that's why it's been a little bit easier. But we hit a little bit of a bump, and I think we'll work our way through it. But we'll certainly talk about it on the next call for sure.

That's helpful. Maybe if you could talk about last year, the team had mentioned Link 16. You've kind of highlighted success of getting Link 16 into space. Can you talk about what that means and how you think about next-gen jammer low-band pods, and how does the integration of Palantir's AI platform help with your sensor business?

Yes. So I would say you've got a big universe there. So let me try. So Link 16 in the space, I think it's just kind of -- it's important from a comms perspective and we're a big comms company. So owning kind of the framework, how things work I think is really important. So -- and that was also part of why we bought the business. So I think that's a positive all the way around. Let's see you then mentioned, next-gen jammer. The team would say they're absolutely on schedule, on price. We're kind of in the first phase of the contract. There will hopefully be another booking somewhere in the distant future, not too distant future, excuse me, on next gen jammer. I think Sam would say it's working really well. I checked them out on the next-gen jammer recently. But we're in a development phase on the program. So it's cost type, lower margins. So look, we just need to work through the program. It's a great program to have, right? And we like the position we have with it. And you asked about pods, electronic warfare in general?

Because we've segmented into 2 segments now. So we need you to break out again and get more, so I'm not jamming all these questions at...

It's all good. Yes, yes. So -- and then just kind of electronic warfare in general, I think we -- like everybody, right, where I think it's a very important part of the business, even putting -- I was spending some time the other day just even getting EW platforms on relatively small drones just so you can fly in contested environments and be able to make deliveries even believe it or not on ships, for example. That's been one of the mission as of late. So I think there's a whole lot going on. It's -- I think it's an important space.

Moving on to some financials, the CFO stuff now get to talk about. So LHX next, that seems long ago now. How do you think about the next steps of implementation? You've exceeded your targets of $1.2 billion of savings. How do we think about next steps in terms of residual -- sorry, margins from here?

Yes. So I mean, one, I think it's very important. I just always margins. And I've had enough kind of time at L3 Arris now where people talk about noise in our financials and stuff like that and how to have cleaner quarters. So I'll be honest, I'm kind of a cleaner quarter guy. So we pulled all the one-timers out of our numbers or nonrecurring items and look at it and say, okay, we're not at our 16% margin. So what do we need to do to make sure we get to our clean way, right? When I say clean, it's not asset sale gains or nonoperational things. So I think a big part of the focus is how do we go drive the business to get there and be able to -- any of these one-timers that come up or kind of on top of the numbers at the end of the day. So the LHX NeXt program was important. I think this going in and looking at the business differently and spending a little bit more time operationally, I think it was good. I think Sam will -- candidly, I think Sam will take it to the next level, and he's already asking for tons of data on spend and consultant spend and different pieces that I think are really important. So...

I guess, how do we think about the next level deep? Is it -- what do you think is required, whether it's focused on supply chain? Is it just delivering on operating leverage? Is it mix transitioning from development to production? That's a broad scope for such a large company, but how do we think about some of the 3 -- maybe few buckets as you think about margin expansion?

I think one, getting out of the EAC charges we've had specifically, I know we had some ISR ones. We had some space ones. I think Ken Bedingfield did a nice job of -- and we've talked about this, right, making sure we put more management reserve on program starting off with lower margins. And then as we have the right to book larger margins, we book them up. I mean, we're bidding them at higher margins, but we are recording and recognizing. It's all appropriate from accounting. We're recognizing lower margins in the earlier stages because we have more risk. So I think maybe under -- or maybe previously, things got ahead of the company, and we're trying to make sure that we take a pretty conservative stance to new business and programs that are earlier stage. So I think that's kind of first piece. And then if I had to think about margins, it's like I'll use missiles as a great example. We're going to 3x, 4x, 5x, 10x volumes on different programs and some of it, you just kind of scratch your head a little bit. If you can't drive higher margin than that, you're doing something wrong, right? And I think some people probably here have even been to Ken's new building or facility in Huntsville. We took the Remington facility. I don't remember, I may square feet. It's huge. And part of that is how do we dual source stuff that's either creating issues in the supply chain or stuff where we think that the vendors aren't treating us fairly and make sure that we're getting the benefit of the cost reductions for all L3Harris shareholders. So we've got the capacity. So we'll be working through that. So I would like to believe you'll see missiles have kind of supplier margins than where they are. We're not trying to do it on the back of the customer. We're trying to do it by running a better manufacturing, a better operation, and I think Ken will do a nice job with that because that's what we set out to do and he was already doing that. So I think that's a piece. And just, hey, look, we got to stay focused and vigilant on the business and look at cost. And I think LHX NeXt was nice because I'm not sure we had taken a fresh look at cost. I think we need to keep doing that.

That's helpful. And maybe now that you guys have had some time to sit, not really a lot of time, but how do you think about the business, whether it's from a segment structure, I know you've realigned a few times, or from a portfolio standpoint, how do you think about just -- are there better fits elsewhere? Or do you think like maybe breaking down the segments a little bit more? What you'd like to see from here?

Yes, sure. So I'd like to see no changes. And I think our investors would like to see no changes. When we look at all the investor perception studies and everything, in fact, when Sam was getting announced, I sat down with them, went through Q&A. And as every good CFO, right, you want to make sure you're attached to the CEO, and you're not saying something different. And if you don't like what the CEO is going to tell you, you need to change it. So I literally -- like question one was, org structure, are you going to change it? And I was already for, hey, pump the brakes. We're not doing that. But I'll let him give his answer was that was the last thing we need to do again. And I went [indiscernible] good. I think we have -- and Sam was a big part of the portfolio and structuring it the way he did. And I think it actually makes sense, right? Now we could argue, could you split space and ISR, Okay, if you're -- we run it that way today. It's a construct of the businesses are together that way, but we run them in different sectors underneath. So, okay. But I don't think there's a wholesale. We're going to go shuffle the deck chairs. If we did that, I would probably lose my mind, and I don't think we want to do that. So -- and by the way, I think Sam would too. Sam's exact quote was, the last thing, Ken, we need to do is do that. I went, yes, that makes perfect sense is what I was thinking. And he said, and our stock was working really well when we weren't confusing investors, and we were driving the business. He'd actually said driving the business. I added confusing investors. And I think it's important because we did all this really fast. That is -- that was -- that is an L3Harris way. The problem is when you do things really fast, it's really hard to give investors all the data broken down by quarter, by different segments and the underlying data, not the segments themselves because we don't have it, right? So how can we give it to you. If you want a bookings by segment 3 years ago, I probably -- it would be hard for me to create that. When you do it fast. When you do it in a slower fashion, we have more of that data. So I would say we're very happy with the structure we have, and we want to continue providing transparency to the investors so they can understand what we know is the great company we have and why you should be investing in it.

Well, thank you for a lot of that clarity. So I appreciate you being here, Ken. Thank you very much, everyone, for listening in.

Thank you.