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

So pivoting to the CSD margins, can you talk about the sustainability of margins of that segment? And should the mid-20s level, is that a sustainable number in the medium term?

Yes. And I think we feel pretty good about the mid-20s. That's been our guide. The business has drifted up a little bit. I think we'd like to keep that guide just in general because I want to make sure -- we want to make sure we're making investments in the business. There's other parts of that market that we could probably invest in spend some more energy in. I mean we have amazing technology with radios, and there's parts of that market that we're not really in, in a big way. So I think that's where some of the opportunity space looks and sit. So we just need to make sure the team gets the R&D money, whether it's in radio expansion or software capabilities and so forth, we want to make sure we're putting the investment back so we stay on top.

Great. And in the first half of the year, your ISR business was being pretty stellar, very strong. So when we think about the trajectory of that, can you talk about the variables that drive that growth? And do you see this strength continuing through the rest of the year? And how does that trend in the next few years?

Sure. So I mean, one, the backlog, the awards, the pipeline for ISR is very good. And for those of you that maybe aren't as familiar with the portfolio in the ISR business, is there's aircraft. So that's what we talk typically about ISR is the aircraft side. There's the space side, right? So I think missile warning, missile tracking, a lot of classified content, but satellites up in space or stuff down on the ground doing things with space. I think that's important parts. Then we have a cyber component that's in there, which you'd argue that's also sensing. So all the theme around this is sensing and then there's a maritime component in there as well. So I would say when you look at the portfolio, the maritime piece has probably been a little slower. Everybody says our stuff goes on to the ship at near the end as a life cycle, you think about putting ships together, so you would expect our maritime business to accelerate on the space side. I mean, we've had just really positive success, right? So missile warning, missile tracking, Golden Dome, they've had kind of 5 tranches it's hard to keep track because they keep renumbering, it started with 0, and now we're on 3. But I think we were the only prime that actually launched a satellite, and it actually worked, so that's a positive. And I think we're the only prime to win all 5. So I think we feel really good about it. We've got an exquisite payload, provides a lot of capability. So I think the team is pretty excited there. Of course, last quarter, we had an award AMDT3. So that's the tranche 5 that the 3 is tranche 3 but anyway, someone else will figure it out. But I think that's good. There's other opportunities on the Golden Dome franchise. So Sam certainly very energized about that. So we'll see what that looks like. There's different orbits. And I would actually -- maybe I should back up because people always ask me what excites me the most about L3Harris and then somehow we end up talking about missiles. And then I'm like, okay, but it's really -- missiles is very exciting, of course, but I would argue what's really exciting is thing -- and by the way, everybody knows the missile story. So we don't need to talk a lot about it, but I would argue things like we built the satellite franchise really on the back of our P&L, we probably didn't do as well financially. We didn't tell investors, that's what we were doing, maybe we did, we didn't, and it was very hard to forecast and build this kind of prime position that I would argue is going to be a franchise position that we really put ourselves into. So we've done all this. We spend probably half a decade doing it. Now it's about how do you get the value for all the investments we've made. I mean, we've got high bays and factories and all this great stuff. And we've got 70 satellites, I think that we're in process of building that we need to get up and running, up in space. And then I think everybody realizes how space works, depending on what orbit, the lives of these satellites are pretty short. The minute you get them up, you're working on the next batch. And they tend to work in constellation. So you may have a need for a build-to-print of another 5 or another 4 of the same thing or 8 or whatever the numbers are, I think we would expect to see a lot of that just based on the capability we bring, the positioning, the payload is differentiated. So it's hard to kind of compete with L3Harris in that space. So I think the moat's pretty deep. And so we look forward to kind of seeing that business do well. And then the aircraft side, that piece is, I'd argue a little different, right, because we do -- we basically buy an aircraft. We go in and rip it all apart, and it's usually a business jet-sized aircraft, it doesn't always have to be, I think, people can find the news and we can build some big stuff or redo some big stuff. In that, these aircraft get stripped down and the amount of electronics that goes on this aircraft, it's amazing and we cut holes in the frame. We have to get the airframes recertified. So it ends up being a little bit of our know-how and technology that we build into these when they go up, you're getting the capability a lot faster, and it's a lot less expensive to buy and certainly a lot less expensive to operate, so I think that's why it's so exciting. Now you get some a little bit of kind of bumpiness with it because we're buying aircraft, and we try to control that -- control's the wrong word, but maybe a little bit of own the supply chain a bit because if somebody wants to go out and buy a G550 and deliver it to us and say to kind of [ it go ] fix this and make it work for what we wanted. You don't know what condition it's in and all that other stuff. So it's a lot easier for us to take that risk from risk out of the equation, take it away from the customer so we end up with kind of pretty decent margins for the business, but we end up with some lumpiness on the revenue side. And you can imagine, if you're buying an aircraft, it's hard to get a 15% or 20% margin on top of the aircraft cost. So it really ends up kind of diluting the margin. But I think owning the supply chain with it and making sure we bring the customer the best value and taking the risk out on our side is pretty important. So that's what we've been doing. I think first half, we had pretty elevated growth in there. We had some -- I think we talked about in Q1 some material stuff flow through that drove a lot of revenue, but I still think that business is doing great. We raised the guide on it last quarter, and I think you'll see that business continue to perform.

Super helpful. Thank you, Ken. And you touched on space as part of your commentary with ISR. When you look at the execution risk that the space industry is facing, especially with some of the supply chain challenges and you kind of talked through some of these things. What gives you the confidence that you can get the higher return on the space business, especially as the business scales?

Sure. So I mean, one, and I think it just becomes at the end of the day, the know-how just becomes reality would be my argument. But I will be very clear, we're booking margins far below what we're bidding at. Ken set this up, Bedingfield, I think he did a really nice job with it. And I think the Board also believes that's very appropriate is we kind of earn the right. So if you did bid at 15%, we're booking at 10% and you earn the right to get to that 15% through execution. I think that's a thoughtful way of doing it. We're certainly not going to change that. So and then a lot of these programs that they're kind of repeats to some degree. I don't want to call them build-to-prints because I think that does it in injustice a little bit. And I'm still waiting -- I used to spend some time with one of our colleagues that was out there, [ Barry ], on the satellite side at orbital. And I always think that it's really hard until it's up and running and doing what it needs to do. I'd rather give it some time. I think with me and [ Barry ] so one, we've been bidding higher margins. And then two, I think we're booking at a lower booking rate in general than what we're bidding at. So I think it will evolve over time. That's why I feel really good about the business, and we just need to go execute at the end of the day.

Now on Golden Dome, can you talk about L3Harris' progress on this? And how do you see the architecture of the program evolving? And what's your role for the program?

Yes. So one, we're very happy to support the administration. We think it's a very important program. At the end of the day, defending the homeland is an absolute honor to be part of that. So clearly, the missile warning, missile tracking, we've done a phenomenal job on getting the awards, the team and the technology that we bring, I think, it's demonstrated we have the capability. So I think that's really positive at the end of the day. The challenge with Golden dome, and then by the way, we also have a lot of other awards maybe part of Golden Dome, maybe not that are classified. So I think there's pieces there that are also good or potentially good. And then the architecture itself, I think, continues to be classified. So I think that -- but you can imagine, right, and if you're going to have a missile warning, missile tracking and an ecosystem, you would fully expect there'd be some kind of way of disrupting an inbound missile or whatever. So I think we look at the rest of our portfolio and say, we have great capability with that, and we look forward to supporting the nation at the end of the day in our allies. And by the way, that's the piece I think people aren't always picking up as well. I think Golden Dome would ultimately be something broader that would be really important. [ I have ] a lot of longevity as this current administration is talking about having other countries support kind of the industrial base and support their own defense at the end of the day.

And Ken, it sounds like you've got visibility for growth. You've got some balance on margin and there should be upside. Free cash flow is pretty robust. So when we think about capital deployment priorities for this year and next year, how should investors think about your approach?

Yes. So one -- Sam should answer this question with us, right? And I've had -- I've quizzed Sam. So I think I'm okay to say what I'm going to say. But one, me personally, I love share buybacks. I know the administration, not a big fan, right, because they have a memo out an Executive Order that talks about dividends and buybacks, I would say, I think that's an important tool that we all should be able to deploy. And I think it's about -- I would argue the Executive Order was about making sure you're making investments in new factories and capabilities. And I think L3Harris demonstrates that routinely, right? We've invested in the missile capacitization, $2 billion at the end of the day, ahead of contract actually over $2 billion that feels like a wartime footing. So when we talk about the first half of the year, we bought back $525 million of stock. I think if you look at our peers, we're well out in front. I think we want to be thoughtful at the end of the day. We want to make sure our shareholders are rewarded, they stick with us. I would also add to that, right, part of the administration's focus is having a strong industrial base. A lot of that is investments in the business, certainly, but a lot of that's having good quality investors standing behind the industry, which I think right now we're a little shorter on candidly. I think all of our multiples have compressed. So I think we need the tools as a company to reward shareholders and keep people with us. So that's my bias. So I'll go back when we stack capital deployment, right? So today, investing in the business is number one. So I think that's really important. That's why we have products like Wraith Shield, that didn't come by accident, right? That was pure investment. We've been making investments in the missile capacitization. That's not by accident. In fact, we've been -- we get a lot of questions around dual sourcing and this and that. And as Ken Bedingfield, would say, we're going to win the race. What that really means is we've made the investments so we can win the race. And we've put kind of our money where our mouth is, so to speak. And I think that's what you'll see. And I think that's really positive. So I think kind of holistically, I think we're in a really good position. And then when you go down the capital allocation route, you have certainly debt, we probably have a little bit more leverage than our peer group, may be a turn. So I've got about [ $1.4 billion ] of debt coming due. So you can imagine maybe we pay down our debt. So I think that's fair. And then dividends, we've been a dividend grower for 24 years, I guess we're getting ready to hit that quarter century mark. So I think we'll keep looking at that. We like the smile on your face with that. So we want to keep putting -- we want to have that kind of dividend risk to [ correct ] model, I think that's important. So that will be there. And I think when you look down like things like M&A right now, we would say we really like what we have. So why don't we run it? I think that's maybe less interesting today as far as any large-scale M&A, Sam would tell me, we need to earn the right to go do large-scale M&A? What's really odd, right? And this is kind of my view coming in is we did a great deal with Aerojet Rocketdyne, but there's a lot of consternation in the system around was it -- and by the way, I think everybody would say it was a good deal. Maybe we didn't do a great job on explaining the thesis and it took too many years for the thesis to unfold. Maybe we just weren't thoughtful with how we engage with investors. So I think we're very mindful of that, and we don't want to kind of set ourselves down a path. It's [ to us ] right now, execution is probably the most important thing. So that's why we probably prioritize if you go down the stack, share buybacks make a lot of sense. Plus, by the way, look, we're trading for a 13x multiple. If you told me to go out and buy something for 40x or 30x earnings, and then explain it's really whatever number 20x, I'm not really good at that. So I would rather us just buyback our stock at 13x multiple, that would make some sense. So I think for the near future, that's kind of way the capital allocation will work.

Thank you, Ken. Now shifting gears, with Sam stepping up to the CEO role, does the leadership transition create an opportunity to revisit how the company is organized or how you reported? Are you guys considering potentially resegmenting the business?

Yes. So that's a great question.

You [ had ] to move cheese around.

Yes. I'm not really a cheese mover guy. And it's funny. So I'm not going to use my words. I went and talk to Sam because we spent the weekend kind of working through the announcements and all that other stuff. And then I think I spent the next day with the Monday with 18 investors going through kind of what Sam is planning on doing. And the reason I say that is because I kind of sat down when we went through a Q&A. And I said the worst thing that could happen is I start telling investors something on Monday and you have a different view I was very appreciative of his time and -- because I thought it was important to make sure we were interlocked on this. So question 1 for me was reorganizing. Question 2 was actually or do you have leaders for the segment. So question one, he looked at me, and I -- trust me, I was a marine so I was ready to take the hill. And he said, Ken, the last thing we need to do is reorganize the business. So at that point, I was kind of like putty and Sam's hand a little bit, and look, it's kind of hard to argue with the guy. We have a great portfolio. Let's go drive it. He was part of reorganizing it. So he's like, hey, we have what we need, let's go drive the business. Last time we reorganized, right, I think this is part of where some of the investors are like, hey, what's this piece, that piece? We created a little bit of confusion. Sam's gotten that feedback, and he's like, yes, I agree, we don't need to do that. And we resegment -- look, we resegmented the business. We did the [ Dow ] investment we did the IPO. We sold 60% of the commercial space propulsion. And then we did all of that in basically 5 months. So it's really hard on investors. And it takes a lot out of the team. So really about -- and by the way, that means the team is not focused on driving performance in the business, and that's been my band, right, is I want the finance team all over the CapEx build out, the R&D spend because when I see R&D spend on Wraith Shield, and we understand the product and what it's going to do, okay, great. But when you hear sometimes, and we've all seen this, right, where somebody talks about something and you're like, okay, well, what's the deliverable at the end, and it's not very sensible. That's where finance people, I think, can have add good value. So having the time to make sure we're doing those things versus reorganizing, I think, is the way to go. So I'm very happy with Sam's answer. I just smiled and say, hey, it's a good idea, Sam. So it was certainly his idea, not mine, but I would have tried to give them my idea if I needed to.

That made me happy and my team, too.

Yes. We all [ are going ] model.

So looking for the team is kind of hard following it around different segments. So I guess, look, there's a big push from the administration for dual sourcing. So how do we think about this for L3? Do you see this more L3Harris? Do you think this is more of a risk to your incumbent positions where you might be sole sourced? Do you see this as an opportunity to potentially be a dual source provider for other products? What are the puts and takes for you?

Yes. So one, we're really in the competition because at the end of the day, it's all about the war fighter and it's all about bringing capability to them. So we don't say, open up everything, let's have [ added ] for me personally, I'd say, open up missiles, the [ whole ] missile hierarchy and you let folks like us compete on [ seekers ] and things like that, because we've got one ready to go tomorrow, and we think ours is more manufacturable. So for me, things like that are very exciting. If people want to come into solid fuel rocket motors, I said I came out of a business that had solid fuel rocket motors. There's 2 of them really of scale in the U.S. It's not -- it's a great business. It's a great market. It just surprises me. I hear so much talk about it because at the end of the day, it's kind of dangerous work and it's pretty specialized and you're usually in the middle of somewhere in West Virginia, Camden, Arkansas or Orange, Virginia or wherever and/or Utah. And you're doing this stuff and very spread out facilities. And I just think there's a special expertise and skill. And then I keep hearing about like new entrants, bladeless mixers and they're going to build it in the office building and then my head hurts and they're going to print motors and all this other stuff. And we have bladeless mixers, right? I mean it's almost comical but some of these missiles, motors that we make are so complicated and they require you have to have bladed mixers right? So it's like -- I think everybody is trying to feel their way through it, but they're feeling their way with energetics. And I think we're best positioned and I think we'll outrun the competitors. So wherever it is, whether it's radios that we think we make a superior product, if somebody has something better that's going to protect the war fighter, I say bring it and it makes us better, we're happy for it. We just want the same opportunity. We want a level playing field, and we want to be able to actually bring more value to the war fighter.

Well, great. I think we have time for just one last question. So trusted disruptor, that was a key Sam's [ team ] for L3Harris in the past few years. Is that core to Sam's thesis and strategy for the company?

It's interesting because when I came here, there were certain parts of [ Chris' ] team talking about the trusted disruptor and what it means. And then we did a whole investor perception study and asked investors what they thought trusted disruptor means. And I know what it means to me, right? So and I would have argued my old employer was a little bit of a trusted disruptor. So I think that we need to do a better job as a company, explaining what trusted disruptor is, and I do believe it's here to stay. I think it's more of a culture at the end of the day. It's how you make investments, you support the war fighter, the trusted pieces, we have the manufacturing capability to know-how the capital behind us. So when we say we can do something, you can trust it and the disruptor is we're willing to go figure out how to invest our capital. And like I use this with one of our folks who were saying, well, we're not really doing that. The Pentagon doesn't believe it or whatever. And I said, well, on here for a second. I've been at prime. I see what primes do. We made a $93 million investment in AMDT3. The whole award came down to who could move the fastest and deliver on schedule. So guess what? We spent $93 million. We were ahead on everybody's schedule. So of course, we won. Right now, we took risk of doing that. By the way, the disruptors take risk, Wraith Shield is us making investments to build a better product. We could sit back and say, wait for an RFP, we don't. We actually built a better product. There's no RFP for Wraith Shield that exists. So we built a better product. And then we go and demo it and explain it to the customer why they need it, they love it, and they say, let's go. I think those are 2 great examples. Missiles, we spent $2.2 billion ahead of contract to go put shovels in the ground, invest in the supply chain, get the hardware invested. These are all elements of disruptor. We don't wait. We actually move. It's all about capability for the war fighter. So I think it's alive and well. You'll get some great answers from Sam, but I'm real happy. I mean, that's why I came to the company. I say this to people, but then I realized it kind of like a pig looking at a watch, looking at me because they don't know what it means, but I do, and we're going to run really hard to support the war fighter and our customers.

Well, thank you very much, Ken. This concludes this session in L3Harris.

Thank you. Appreciate it.