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

The combined corporation will exist noise above the way toward becoming a corporation with the inherent scale and assets ought invest at and deliver the most mission-critical solutions ought our global aerospace and defense customers. The opportunity ought construct a new A&D corporation is an exciting and engaging challenge, one that Bill and I and the full leadership team are ready ought receive on. And at the many visits with our L3 and Harris employees at the field, this excitement is broadly shared throughout. during announcing this merger of energy final October, our L3 and Harris teams read been deep at integration planning.

While merger integration activities are occurring throughout the company, our division teams read no altered the rate at the slightest, and we attitude ought hammer out contribute above streamlining and consolidating operations. during example, at 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. at our electric Systems segment, we combined our Security & Detection affair into commercial aviation and are evaluating steps ought rationalize farther our machinery footprint.

Not only will the new organizational structure transfer overhead and redundant cost, still also improve align our capabilities with guest needs, sharpen concentrate above technique investments and enhance affair development efforts ought improve serve our customers. Improving affair deed over improve news collection and analytics is a key divide of managing a more integrated company. final year, we rolled out a sequence of criterion econmic and operating metrics throughout the corporation although divide of L365. Closer tracking of capital efficiency metrics also although changes ought our incentive compensation project ought emphasize money flow read been helping ought drive working capital improvements.

Even with sales up 14%, our net working capital only increased 4%, chief ought a reduction at working capital days compared ought the prior year. Operating metrics that explore manufacturing assets and vendor deed is supporting our furnish bind and program management teams ought identify and hail problems earlier, enabling the management team ought clearly cry on the interdependencies at their operations. I attitude ought create guest campaign a priority during the company, during 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 at the center East. although you are aware, international affair development relies upon house long-term relationships and listening ought our customers ought know their challenges. We attitude ought create more and more inroads, seeing an improved tenor ought our meetings and read received definite reception ought our merger with Harris from our international customers.

Bottom row is we are seeing a large need worldwide during an innovative, agile corporation who wants ought companion with their customers. little contemporary awards highlight our gift at delivering integrated mission solutions. at the recently announced $1 billion Peregrine give during the Royal Australian stand Force, L3 will deliver four next-gen EW airplane above a biz jet platform. This includes a basis communications infrastructure that will integrate with the Commonwealth's mutual campaign fighting networks, providing a sharp connect among platforms, including the F-35, the Growler and maritime assets.

Our alternative ought contend during the compose of FARA during the U.S. troops is another demonstration of our gift ought hire customers with disruptive technique and ought companion above an significant platform, integrating different communications and mission systems. Many of our capabilities align with the Army's climax priorities, and we attitude ought song assets ought confront these needs. Our affair development activities are now more ambitious and focused and also improve integrated with bid and proposal, engineering and R&D functions.

I cry on many more instances of collaboration across divisions although we kill upon our strategy. Leadership throughout the corporation is buying into the opinion that we can obtain more and improve serve our customers if we profession together. Next, I expect ought impress above the contribute we are making above the gift front. Attracting, developing and retaining climax engineering and managerial gift is the lifeblood of the company.

We began leveraging our HR organization ought age strategies ought become more effective at planning our gift needs, at recruiting and retention and at identifying and exercise our emerging leaders ought receive above larger roles at the company. We made significant contribute at the past year engaging our workforce. Overall, the investments and changes we are making ought perfect the affair are beginning ought generate tangible benefits ought growth and margin. Our employees are increasingly embracing the alter and the fabric of integration, collaboration and innovation is becoming woven deeper into the method of our thinking.

Now let's grow ought a publication of our division performance. Our vigorous quarterly deed 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 prior period.

Growth was most impressive at our airplane procurement and ISR missionization affair although little key programs accelerated, including the U.S. stand compel Compass Call, Australian Peregrine and the U.S. Missile Defense Agency HALO program. at addition, EO/IR sensors, soldier systems and space and sensor businesses entire grew double digits.

Given the broad-based growth at this segment, we attitude ought expect ISR Systems ought exist our fastest-growing affair with improved margin. Communications and Networked Systems returned ought growth with funded orders up 26% and sales up 11%. Book ought bill was a vigorous 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 mixture and price reduction. Lastly, electric Systems sales grew 2% and operating earnings rose 3%. ES' segment-leading edge improved 20 basis points ought 14.7%.

The section was impacted by a sales refuse at the Defense exercise Solutions affair owing ought final year's loss of the C-17 exercise commerce ought the OEM. However, key highlights at electric Systems contain double-digit growth at precision weapons which grew sales 18% at the quarter. owing ought the headwinds from the C-17 loss, we expect modest sales growth at 2019, still we attitude ought expect improved edge from ongoing price takeout and favorable commerce performance. Given our vigorous deed at the first section and improving bid momentum, we are increasing our 2019 guidance.

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

Ralph D'Ambrosio -- Senior Vice principal and main econmic Officer

Thanks, Chris. I'll publication some details nearly the first section and then our 2019 guidance update. Reviewing the first quarter, although Chris explained, we had a identical vigorous begin ought the year and we exceeded our plan. Orders increased 28% and sales grew 14%, entire 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 also generated definite free money flow which is meaningful although we always read negative money flow at our first quarters.Next, I'll comment above some details nearly the 2019 first quarter. Adjusted diluted EPS was $2.89, an expand of $0.55 or 24% at the 2018 first section driven mainly 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 affair divestiture loss.

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

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

As a reminder, most of our productivity improvements and price reduction actions display at favorable commerce 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 charge stemming from the service guarantee accrual freeze that we implemented effective January 1.

Other contributors ought edge expansion mainly included sales growth, a lower G&A appraise and affair divestitures at ISR and favorable commerce deed and reduced G&A expenses at Communications and Electronics. The impose appraise increased ought 14.7% from 11.1% during the first section of final year and that was mainly owing ought lower stock-based compensation charge deductions. We also generated definite free money flow of $146 million, compared ought a money outflow of $85 million during the 2018 first section and that improvement was due mainly ought improve working capital deed and growth at earnings. also compared ought the 2018 first quarter, we reduced our working capital days by 10 ought 82.

As Chris explained, we read placed more attention above improving working capital and generating free money flow earlier at the year, and we're seeing benefits from these actions. Now moving ought our 2019 guidance update. We raised our midpoint sales evaluate by $150 million ought $10.9 billion, which is expected growth of nearly 6.5% at 2018. Most of the guidance expand is at ISR Systems.

And I'll add that given our contemporary vigorous orders and noise backlog, we to exist able ought drive more upside ought this year's sales. at the segments, we expect sales ought grow 9% at ISR, 6% at Communications and 3% Electronics. Our planned 2019 edge expansion of 120 basis points ought 12% is unchanged and firmly above track. remember that above our January 29 earnings call, we explained the three drivers of our 2019 edge expansion: L365 productivity price savings, lower pension charge and lower losses at the Traveling wave underground business.

Each of these will further nearly 40 basis points of edge expansion. With admire ought the Traveling wave underground affair improvements, we attitude ought expect those ought mainly dare at the second half of 2019. Our combined sales growth and edge expansion this year will originate at division operating earnings growth of 18% at 2018. We held our division edge guidance midpoints at 11.2% during ISR, 11.1% during Communications and 14.4% during 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%, mainly owing ought lower expected foreign earnings taxes. And during free money flow, we increased it ought $1.055 billion, which is nearly 13% higher than 2018 with a money conversion appraise of 113%. money at the target of March was $1.1 billion. And regarding capital allocation, at February, we increased our quarterly money dividend by $0.05 ought $0.85 per share.

We cottage expect no debt repayments. And although we previously explained, we suspended division purchases until the L3 Harris merger is completed. Looking at the second quarter, we expect sales among $2.6 billion and $2.7 billion with growth of nearly 3%, operating edge at the high 11% range, with edge expanding more than 100 basis points at the 2018 second quarter, and free money flow among $100 million and $200 million. Finally, ought finish my econmic review, we had a identical good begin ought the year with our first-quarter results.

The corporation is growing at a noise pace, becoming more effective and beneficial and also expanding margin. during 2019, we expect ought grow orders, sales, operating earnings and free money flow, and we're also firmly tracking ought our 12% operating edge objective. Thank you. And I'll now grow it help ought Chris.

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

Thanks, Ralph. although you saw above April 4, both L3 and Harris received shareholder approvals during the merger, and Harris also recently announced the sale of their evening eyesight business, both significant steps ought consummating the deal. We attitude ought profession with entire regulatory authorities ought obtain the inherent approvals. And although you heard above the Harris earnings summon this morning, everything is tracking ought project and there's no alter 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 evaluate capture offsite at the ISR facility at Texas. although L3 and Harris teams obtain more exposure ought each other's operations and people, the more we become grateful of the technique and gift of the combined corporation and the latent during what we can do together. I've been working closely with Bill above the integration, and we will supply details above the board, organizational structure and management end commerce close.

Given that this is responsible L3's final conference summon although a divide public company, I expect ought personally thank entire of the men and women of L3 Technologies during the difficult profession and dedication throughout the years during making L3 a large lay ought work. And a extraordinary owing ought my executive leadership team during their leadership and deed during the past link of years, specially with the rate of change. although this chapter at the company's history comes ought an end, a new and exciting chapter begins. I read ought confess the two CEOs prior me, plain Lanza and Mike Strianese, during their eyesight and difficult profession ought become L3 ought this stage.

By combining what makes L3 such a extraordinary corporation with the best of what Harris has ought offer, I read no suspect we can create a corporation that is even more agile, innovative and customer-centric, a best-of-breed aerospace and defense technique corporation that delivers superior evaluate during employees, during customers and during the shareholders.

Ralph D'Ambrosio -- Senior Vice principal and main econmic Officer

Yes, Chris. I was thinking nearly this yesterday. And I counted that it's been 52 consecutive quarterly earnings calls during me. accordingly it's been a massive undergo and I'm identical grateful during it.

So I also expect ought thank everyone above the summon today during their past and continued utilize at L3 and shortly ought exist L3 Harris, specially the analysts above the summon also although the analysts who previously covered L3.

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

Outstanding. entire right. Kerry, why don't we blank the lines during questions.

Questions & Answers:

Operator

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

Gautam Khanna -- Cowen and corporation -- Analyst

Yes. It's Gautam indeed above during Cai. Congratulations above a large flow obviously at L3. I expect ought impartial plead above the free money flow improvement at the section and some of the working capital initiatives more broadly, if you could impartial explain classification of how much low-hanging fruit you perceive there ought be? And then impartial although a follow-up, while you impartial receive the LTM free money flow of both Harris and L3, we're at impartial beneath $2.4 billion.

I'm impartial queer how you view, Chris, the longer language $3 billion free money goal given we've already chopped a condemn of lumber here. Thanks.

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

Gautam, thank you identical much during the puzzle and the compliment. We're fairly excited nearly the first quarter, still a expectation method ought contribute during 2019 obviously. I study the concentrate above working capital and money generation was something that we lay together at late December. We even changed the incentive comp project ought highlight the importance of generating free cash.

And Bill and I report a condemn nearly the $500 million of synergies and the $3 billion of money flow at year three. And I used to state we read more guarantee at achieving those numbers today than we did while we first announced this commerce above October 14. I'll hire Ralph report nearly some of the improvements we made here at the first quarter.

Ralph D'Ambrosio -- Senior Vice principal and main econmic Officer

Sure. accordingly although I commented, we had a dramatic reduction at our working capital days quarter-over-quarter. And if you can recall, the first section of 2018 was our high-water token at condition of working capital and money custom and that's why there's a dramatic reduction compared ought this year's first quarter. still naturally what we're doing is placing more attention above fundamental blocking and tackling, trying ought accumulate our receivables sooner, continuing ought grow the corporation and grow inventory at a slower rate and taking actions ought alter our unbilled receivables into billed receivables sooner.

So it's a concerted effort across entire those fronts. during the entire year, we're expecting working capital days reduction although well, and we study that's going ought exist at least two ought three days year at year. accordingly we to cry on more improvement the rest of this year although well. And obviously, we're going ought experiment ought do better.

Gautam Khanna -- Cowen and corporation -- Analyst

Appreciate it.

Operator

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

Carter Copeland -- Melius inquiry -- Analyst

Hey, good morning, Chris. I wondered if you could comment above the book ought bill. I intend obviously identical vigorous at the section even despite the vigorous sales. Was there anything at there that surprised you from a timing perspective or magnitude perspective that we saw early above this year? Did we drag anything deliver or is the pipeline a small slice improve than you were originally thinking?

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

That's a large question. I'll state you, we've indeed tried ought reinvigorate the BD organization and function. We've made investments that you've heard me report nearly at the past at systems and standardizing policies and procedures. There were a link of ISR accelerations.

We're talking possibly second section ought first quarter, which is why we came at a small higher no only above the orders, still the sales. still I'm equally excited nearly what we cottage read looking ahead. There are clearly F-16 exercise opportunities. We won a U.S.

and an international customer. And we possibly read three ought four extra bids famous that could exist worth $100 million each. accordingly there could exist $300 million ought $500 million of more orders of F-16 although an example. C-130 AMP, hopefully we'll hear above that.

As I mentioned, the team and I read been spending time at the center East. I study we read some interesting strategies and partnerships there that could do ought significant growth. And the classified world is indeed picking up. That's an section we've been focused above and read seen some growth, and given some of the next generation capabilities we have, I expect more wins there.

So during the entire year, I used to expect book ought bill ought exist at least 1.1 at each and each segment. And possibly $12 billion of orders overall is what our lengthen goal is. still that's what we're working toward.

Carter Copeland -- Melius inquiry -- Analyst

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

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

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