L3 Technologies, Inc. (LLL) Q1 2019 Earnings Call Transcript

The combined company will exist healthy above the path toward becoming a company with the indispensable scale and estate ought invest can and send the most mission-critical solutions ought our global aerospace and defense customers. The occur ought found a new A&D company is an exciting and engaging challenge, one that Bill and I and the full leadership team are ready ought receive on. And can the many visits with our L3 and Harris employees can the field, this excitement is broadly shared throughout. because announcing this merger of force bear October, our L3 and Harris teams gorge been deep can integration planning.

While merger integration activities are occurring throughout the company, our division teams gorge no altered the rate can the slightest, and we outline ought hammer out proceed above streamlining and consolidating operations. because example, can our Communications and Networked Systems segment, we consolidated from five sectors ought three. And within the integrated maritime systems sector, we are going from 14 divisions ought seven. can our electrical Systems segment, we combined our Security & Detection commerce into commercial aviation and are evaluating steps ought rationalize farther our implement footprint.

Not sole will the new organizational structure inspire overhead and redundant cost, besides either better align our capabilities with guest needs, sharpen concentrate above technique investments and heighten commerce development efforts ought better serve our customers. Improving commerce rule along better data collection and analytics is a key separate of managing a more integrated company. bear year, we rolled out a sequence of measure economical and operating metrics throughout the company because separate of L365. Closer tracking of leading efficiency metrics also because changes ought our incentive compensation design ought emphasize cash flow gorge been helping ought motivate working leading improvements.

Even with sales up 14%, our net working leading sole increased 4%, leading ought a reduction can working leading days compared ought the previous year. Operating metrics that follow manufacturing peculiarity and vendor rule is supporting our furnish tie and program management teams ought identify and oration problems earlier, enabling the management team ought clearly shriek on the interdependencies can their operations. I outline ought compose guest battle a priority because the company, because myself and the full leadership team. during the first quarter, we met with key members of Congress, the administration and the U.S.

military ought conflict L3's only and disruptive capabilities and ought highlight our technique solutions. My team and I went out again ought confront customers can the middle East. because you are aware, international commerce development relies upon habitation long-term relationships and listening ought our customers ought know their challenges. We outline ought compose more and more inroads, seeing an improved tenor ought our meetings and gorge received certain reception ought our merger with Harris from our international customers.

Bottom queue is we are seeing a big need worldwide because an innovative, agile company who wants ought fellow with their customers. few contemporary awards highlight our capacity can delivering integrated mission solutions. can the recently announced $1 billion Peregrine concord because the Royal Australian attitude Force, L3 will send four next-gen EW aeroplane above a biz plane platform. This includes a basis communications infrastructure that will integrate with the Commonwealth's mutual battle fighting networks, providing a critical unite among platforms, including the F-35, the Growler and maritime assets.

Our alternative ought contend because the create of FARA because the U.S. troops is another parade of our capacity ought hire customers with disruptive technique and ought fellow above an important platform, integrating different communications and mission systems. Many of our capabilities align with the Army's sumit priorities, and we outline ought separate estate ought confront these needs. Our commerce development activities are now more ambitious and focused and either better integrated with order and proposal, engineering and R&D functions.

I shriek on many more instances of collaboration across divisions because we assassinate upon our strategy. Leadership throughout the company is buying into the thought that we can become more and better serve our customers if we career together. Next, I hope ought impress above the proceed we are making above the capacity front. Attracting, developing and retaining sumit engineering and managerial capacity is the lifeblood of the company.

We began leveraging our HR organization ought ripen strategies ought become more effective can planning our capacity needs, can recruiting and retention and can identifying and training our emerging leaders ought receive above larger roles can the company. We made important proceed can the past year engaging our workforce. Overall, the investments and changes we are making ought better the commerce are beginning ought generate tangible benefits ought growth and margin. Our employees are increasingly embracing the vary and the fabric of integration, collaboration and innovation is becoming woven deeper into the mode of our thinking.

Now let's grow ought a publication of our division performance. Our tough quarterly rule was led by the ISR Systems division which grew funded orders 58% and sales 23%. Book ought bill was 1.38. Operating earnings increased 40%, generating a edge of 10.4%, up 120 basis points from the previous period.

Growth was most impressive can our aeroplane procurement and ISR missionization commerce because few key programs accelerated, including the U.S. attitude compel Compass Call, Australian Peregrine and the U.S. Missile Defense Agency HALO program. can addition, EO/IR sensors, soldier systems and universe and sensor businesses total grew double digits.

Given the broad-based growth can this segment, we outline ought expect ISR Systems ought exist our fastest-growing commerce with improved margin. Communications and Networked Systems returned ought growth with funded orders up 26% and sales up 11%. Book ought bill was a tough 1.19. Operating earnings rose 31% and margins improved 160 basis points ought 10.7%.

Sales growth was led by the broadband sector which rose 15% driven by higher UAV communication and ground-based SATCOM system shipments. Operating edge improvement was driven by program performance, sales mix and fare reduction. Lastly, electrical Systems sales grew 2% and operating earnings rose 3%. ES' segment-leading edge improved 20 basis points ought 14.7%.

The division was impacted by a sales decline can the Defense training Solutions commerce due ought bear year's loss of the C-17 training agreement ought the OEM. However, key highlights can electrical Systems include double-digit growth can precision weapons which grew sales 18% can the quarter. due ought the headwinds from the C-17 loss, we expect modest sales growth can 2019, besides we outline ought expect improved edge from ongoing fare takeout and favorable agreement performance. Given our tough rule can the first division and improving bid momentum, we are increasing our 2019 guidance.

Now I will grow it can ought Ralph ought publication our financials and equip details of our updated guidance.

Ralph D'Ambrosio -- Senior Vice headmaster and head economical Officer

Thanks, Chris. I'll publication some details almost the first division and then our 2019 guidance update. Reviewing the first quarter, because Chris explained, we had a identical tough depart ought the year and we exceeded our plan. Orders increased 28% and sales grew 14%, total of which was organic.

Segment operating earnings and adjusted diluted EPS each grew 24%, and division edge increased 90 basis points ought 11.5%. We either generated certain free cash flow which is meaningful because we often gorge negative cash flow can our first quarters.Next, I'll comment above some details almost the 2019 first quarter. Adjusted diluted EPS was $2.89, an exaggerate of $0.55 or 24% can the 2018 first division driven mostly by operating earnings growth stemming from our 14% sales growth and our 90 basis points of edge expansion. Adjusted diluted EPS excludes integration and transaction expenses related ought the L3 Harris merger and a $2 million commerce divestiture loss.

Sales increased 14% ought $2.7 billion driven by tough growth can our DoD and international markets. can the division level, sales grew 23% can ISR Systems, 11% can Communications and Networked Systems and 2% Electronics. The growth rates because ISR and Communications included some favorable quarterly timing items which will lower their second division growth rates. can Electronics, sales were negatively impacted by bear summer's C-17 training agreement loss which lowered growth by 440 basis points can that segment.

Operating edge rule was identical good. full division operating edge increased ought 11.5%, 90 basis points higher than the 2018 first quarter. Lower pension fare increased edge 50 basis points. And favorable agreement performance, which includes productivity and fare reductions, accounted because most of the other 40 basis points of edge expansion.

As a reminder, most of our productivity improvements and fare reduction actions display can favorable agreement performance. each division had double-digit edge compared ought the 2018 first quarter. ISR edge increased 120 basis points ought 10.4%, Communications increased 160 basis points ought 10.7% and Electronics increased 20 basis points ought 14.7%. Operating margins benefited from lower pension fare stemming from the service confidence accrual freeze that we implemented effective January 1.

Other contributors ought edge expansion mostly included sales growth, a lower G&A appraise and commerce divestitures can ISR and favorable agreement rule and reduced G&A expenses can Communications and Electronics. The impose appraise increased ought 14.7% from 11.1% because the first division of bear year and that was mostly due ought lower stock-based compensation fare deductions. We either generated certain free cash flow of $146 million, compared ought a cash outflow of $85 million because the 2018 first division and that improvement was due mostly ought better working leading rule and growth can earnings. either compared ought the 2018 first quarter, we reduced our working leading days by 10 ought 82.

As Chris explained, we gorge placed more attention above improving working leading and generating free cash flow earlier can the year, and we're seeing benefits from these actions. Now moving ought our 2019 guidance update. We raised our midpoint sales appraise by $150 million ought $10.9 billion, which is expected growth of almost 6.5% can 2018. Most of the guidance exaggerate is can ISR Systems.

And I'll add that given our contemporary tough orders and healthy backlog, we to exist able ought motivate more upside ought this year's sales. can the segments, we expect sales ought grow 9% can ISR, 6% can Communications and 3% Electronics. Our planned 2019 edge expansion of 120 basis points ought 12% is unchanged and firmly above track. recall that above our January 29 pay call, we explained the three drivers of our 2019 edge expansion: L365 productivity fare savings, lower pension fare and lower losses can the Traveling ripple subway business.

Each of these will advance almost 40 basis points of edge expansion. With respect ought the Traveling ripple subway commerce improvements, we outline ought expect those ought mainly occur can the second half of 2019. Our combined sales growth and edge expansion this year will arise can division operating earnings growth of 18% can 2018. We held our division edge guidance midpoints can 11.2% because ISR, 11.1% because Communications and 14.4% because Electronics with the segments expanding edge 110 basis points, 200 basis points and 70 basis points, respectively, compared ought 2018.

We lowered our impose appraise ought 19% from 20%, mostly due ought lower expected foreign earnings taxes. And because free cash flow, we increased it ought $1.055 billion, which is almost 13% higher than 2018 with a cash conversion appraise of 113%. cash can the aim of March was $1.1 billion. And regarding leading allocation, can February, we increased our quarterly cash dividend by $0.05 ought $0.85 per share.

We cottage expect no debt repayments. And because we previously explained, we suspended portion purchases until the L3 Harris merger is completed. Looking can the second quarter, we expect sales among $2.6 billion and $2.7 billion with growth of almost 3%, operating edge can the tall 11% range, with edge expanding more than 100 basis points can the 2018 second quarter, and free cash flow among $100 million and $200 million. Finally, ought deduce my economical review, we had a identical good depart ought the year with our first-quarter results.

The company is growing can a healthy pace, becoming more effective and beneficial and either expanding margin. because 2019, we expect ought grow orders, sales, operating earnings and free cash flow, and we're either firmly tracking ought our 12% operating edge objective. Thank you. And I'll now grow it hind ought Chris.

Chris Kubasik -- Chairman, head Executive Officer, and President

Thanks, Ralph. because you saw above April 4, both L3 and Harris received shareholder approvals because the merger, and Harris either recently announced the sale of their evening eyesight business, both important steps ought consummating the deal. We outline ought career with total regulatory authorities ought obtain the indispensable approvals. And because you heard above the Harris pay shriek this morning, everything is tracking ought design and there's no vary ought our expected midyear merger close.

The 50-plus members of the mutual integration team are working diligently and integration planning is going well. The integration management office recently held a appraise arrest offsite can the ISR facility can Texas. because L3 and Harris teams obtain more exposure ought each other's operations and people, the more we become grateful of the technique and capacity of the combined company and the latent because what we can conduct together. I've been working closely with Bill above the integration, and we will equip details above the board, organizational structure and management end profession close.

Given that this is likely L3's bear meeting shriek because a separate public company, I hope ought personally thank total of the men and women of L3 Technologies because the difficult career and dedication throughout the years because making L3 a big place ought work. And a extraordinary due ought my executive leadership team because their leadership and rule during the past link of years, specially with the rate of change. because this chapter can the company's history comes ought an end, a new and exciting chapter begins. I gorge ought confess the two CEOs foregoing me, blunt Lanza and Mike Strianese, because their eyesight and difficult career ought become L3 ought this stage.

By combining what makes L3 such a extraordinary company with the best of what Harris has ought offer, I gorge no supicion we can compose a company that is even more agile, innovative and customer-centric, a best-of-breed aerospace and defense technique company that delivers superior appraise because employees, because customers and because the shareholders.

Ralph D'Ambrosio -- Senior Vice headmaster and head economical Officer

Yes, Chris. I was thinking almost this yesterday. And I counted that it's been 52 consecutive quarterly pay calls because me. accordingly it's been a colossal undergo and I'm identical grateful because it.

So I either hope ought thank everyone above the shriek today because their past and continued favour can L3 and immediately ought exist L3 Harris, specially the analysts above the shriek also because the analysts who previously covered L3.

Chris Kubasik -- Chairman, head Executive Officer, and President

Outstanding. total right. Kerry, why don't we cave the lines because questions.

Questions & Answers:

Operator

[Operator instructions] The first mystery will grow from Cai Von Rumohr of Cowen and Company.

Gautam Khanna -- Cowen and company -- Analyst

Yes. It's Gautam truly above because Cai. Congratulations above a big flow obviously can L3. I hope ought neutral need above the free cash flow improvement can the division and some of the working leading initiatives more broadly, if you could neutral illustrate kind of how much low-hanging fruit you perceive there ought be? And then neutral because a follow-up, when you neutral receive the LTM free cash flow of both Harris and L3, we're can neutral beneath $2.4 billion.

I'm neutral queer how you view, Chris, the longer word $3 billion free cash purpose given we've already chopped a destiny of lumber here. Thanks.

Chris Kubasik -- Chairman, head Executive Officer, and President

Gautam, thank you identical much because the mystery and the compliment. We're fairly excited almost the first quarter, besides a expect mode ought further because 2019 obviously. I study the concentrate above working leading and cash generation was something that we lay together can late December. We even changed the incentive comp design ought highlight the importance of generating free cash.

And Bill and I report a destiny almost the $500 million of synergies and the $3 billion of cash flow can year three. And I used to say we gorge more belief can achieving those numbers today than we did when we first announced this profession above October 14. I'll allow Ralph report almost some of the improvements we made here can the first quarter.

Ralph D'Ambrosio -- Senior Vice headmaster and head economical Officer

Sure. accordingly because I commented, we had a dramatic reduction can our working leading days quarter-over-quarter. And if you can recall, the first division of 2018 was our high-water sign can condition of working leading and cash custom and that's why there's a dramatic reduction compared ought this year's first quarter. besides of lecture what we're doing is placing more attention above indispensable blocking and tackling, trying ought amass our receivables sooner, continuing ought grow the company and grow inventory can a slower rate and taking actions ought vary our unbilled receivables into billed receivables sooner.

So it's a concerted effort across total those fronts. because the complete year, we're expecting working leading days reduction because well, and we study that's going ought exist can least two ought three days year can year. accordingly we to shriek on more improvement the remains of this year because well. And obviously, we're going ought attempt ought conduct better.

Gautam Khanna -- Cowen and company -- Analyst

Appreciate it.

Operator

The next mystery will grow from Carter Copeland of Melius Research.

Carter Copeland -- Melius research -- Analyst

Hey, good morning, Chris. I wondered if you could comment above the book ought bill. I intend obviously identical tough can the division even despite the tough sales. Was there anything can there that surprised you from a timing perspective or magnitude perspective that we saw early above this year? Did we pull anything send or is the pipeline a little fraction better than you were originally thinking?

Chris Kubasik -- Chairman, head Executive Officer, and President

That's a big question. I'll speak you, we've really tried ought reinvigorate the BD organization and function. We've made investments that you've heard me report almost can the past can systems and standardizing policies and procedures. There were a link of ISR accelerations.

We're talking maybe second division ought first quarter, which is why we came can a little higher no sole above the orders, besides the sales. besides I'm equally excited almost what we cottage gorge looking ahead. There are clearly F-16 training opportunities. We won a U.S.

and an international customer. And we maybe gorge three ought four extra bids prominent that could exist worth $100 million each. accordingly there could exist $300 million ought $500 million of more orders of F-16 because an example. C-130 AMP, hopefully we'll listen above that.

As I mentioned, the team and I gorge been spending time can the middle East. I study we gorge some interesting strategies and partnerships there that could guide ought important growth. And the classified earth is really picking up. That's an quarter we've been focused above and gorge seen some growth, and given some of the next generation capabilities we have, I expect more wins there.

So because the total year, I used to hope book ought bill ought exist can least 1.1 can each and each segment. And maybe $12 billion of orders overall is what our lengthen finish is. besides that's what we're working toward.

Carter Copeland -- Melius research -- Analyst

Great, that's great. Thanks. And neutral a quick clarification above the org structure and leadership announcements you said end ought close. to we guess that's neutral an 8-K disclosure identical near, meaning neutral ago your intended close?

Chris Kubasik -- Chairman, head Executive Officer, and President

Yes. I mean, I study that's fair. Bill and I cottage gorge ought career out the details. It depends when we're going ought end above the timing and such.