L3Harris Technologies, Inc.

Greetings and welcome to the Harris Corporation's third quarter fiscal year 2019 earnings call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the form of presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Anurag Maheshwari, Vice President of Investor Relations. Thank you, you may begin.

Thank you, Michelle. Good morning everyone and welcome to our third quarter fiscal 2019 earnings call. On the call with me today is Bill Brown, Chairman and Chief Executive Officer, and Raul Gai, Senior Vice President and Chief Financial Officer. First, a few words and forward-looking statements. Discussions today will include forward-looking statements and non-GAAP financial measures. These statements involve assumptions, risks and uncertainties that could cause actual results to differ materially from those statements. For more information, please see the press release at the presentation and Harris SEC filings. A reconciliation of non-GAAP financial measures to comparable GAAP measures is included in the quarterly materials on investor relations section of our website, which is .harris.com, where a replay of this call also will be available. With that, Bill, I will turn it over to you.

Okay, well thank you, Anurag, and good morning everyone. Earlier today we reported strong third quarter results with non-GAAP earnings per share of 30% to $2.11 on revenue growth of 11%, the highest top-line growth we've seen in eight years. Overall, company margin expanded 80 basis points to .7% and free cash flow improved by over $250 million compared to the third quarter of last year. These results extend our exceptional -to-date performance with non-GAAP earnings per share over the first three quarters of 26% on 10% revenue growth and free cash flow up 75% to $788 million. The highlight again this quarter was our accelerating top-line growth, a double-digit increase after three quarters of high single-digit increases, with strong growth in all three segments and continued solid operating performance. Quarter momentum remains strong with a book to bill of 1.03 for the quarter and 1.1 for the first three quarters, with total company funded backlog up 15% over last year. These results demonstrate a relentless focus on -to-day execution by our team in the midst of integration planning, and I want to especially recognize and applaud their efforts. With the approval from both L3 and Harris shareholders and Harris signing a definitive agreement to divest our night vision business, we remain on track to close the merger in mid-calendar 2019. Let me start by first providing some details of the quarter performance before closing our preparatory marks with some additional color on the merger. So turning to slide four in the webcast, communication systems revenue grew double digits for the fourth consecutive quarter up 19%, driven by solid growth in DOD tactical communications and public safety. DOD tactical delivered another strong quarter with revenue up 55%, driven by more than $100 million of modernization revenue from the Army, Marine Corps, and SOCOM. This rampant modernization, combined with strong readiness demand in the first quarter, has driven -to-date DOD tactical revenue growth of 28%. With 100% of Q4 revenue in backlog, we now expect DOD revenue to be up mid 20% versus the prior expectation of low 20% growth at mid-teens when we start at the year. International tactical is flat for the quarter as the ramp of Australia modernization program, early adoption of multi-channel products in Canada, and ongoing counter-terrorism support in the Middle East were offset by a tough compare in Eastern Europe. With international tactical revenue of 4% for the first three quarters, 70% of Q4 revenue in backlog, and increasing demand for multi-channel products, we're confident that international will grow low to mid single digits in fiscal 19. And we continue to execute well in our tactical radio strategy. We and all DOD ground radio modernization programs leverage platform investments to maintain international leadership and expand our addressable market into network systems and airborne. On DOD ground radios, we're at the front end of the Army modernization ramp, and with SOCOM and Marine Corps following close behind, we're expecting strong multi-year growth well supported by the president's recent budget request. In GFY 20, the total tactical radio budget across the services grows to over a billion dollars, with the Army HMS request at $504 million, or about two-thirds higher than GFY 19. We're expecting another LREP on both the HMS ManPak and two-channel radio this summer, reflecting the Army's commitment to ramp from low rate to full rate production after the operational test in 2020. For the SOCOM two-channel handheld program, we've completed the operational user acceptance test and received a $39 million production order in the quarter as we progress toward full rate production. And finally, from the Marine Corps, we received an initial order for HF and multi-channel ManPak radios, solidifying our incumbent position as they begin their modernization effort. All of these programs are well supported in the FIDAP, with a tactical budget request once again growing by more than $1 billion to $7.3 billion over the next five years. The successful launch of our multi-channel products and recent US DoD wins have driven faster international adoption than we expected. In the quarter, we received an order from the Canadian Armed Forces as part of their multi-year modernization program, and were selected by the special forces of two other NATO countries to supply two-channel radios as they standardized on Harris in support of NATO and US coalition interoperability. And we continue to have a strong pipeline of opportunities across Europe, Asia Pacific, and the Middle East looking to refresh their large Harris-installed base of about 100, 350,000 radios with next generation products. And for the third prong of our strategy to expand into broader network systems, we recorded a win in New Zealand, leveraging our radio incumbency position, and were selected as the prime systems integrator to modernize and upgrade their command and control network. This win builds on prior successes in Australia, UAE, and other Middle Eastern and Asia Pacific countries as we open our aperture and provide more complete mission solutions. And then finally in March, we received our first international order for airborne radios on the Apache platform for a Middle East customer, opening a new market opportunity for us. This strategic win will help us expand in other air platforms in the region and increase our share of wallet with international customers as we grow our addressable market from ground to airborne radios. Overall for the first three quarters, tactical revenue grew 14% with a book to bill of 1.1, resulting in a 21% -over-year backlog increase to over a billion dollars. With strong growth in DOD Tactical and another quarter of double-digit growth in public safety, we're raising communication systems revenue guidance to be up about 12% for the year versus prior guidance of up 10 to 11%. In electronic systems, revenue increased 7% from continued strong growth in avionics and electronic warfare as they continued execute well in long-term platforms, the F-35, the FAA-18, and the F-16. Order momentum remains strong as well with ES, recording the seventh consecutive quarter with a book to bill greater than one. In electronic warfare, we received a $212 million contract upgrade electronic countermeasure capabilities for US Navy and Kuwaiti F-18s. This is our largest order to date on the F-18 platform, solidifying a 20-plus year relationship and bringing total contract value to $2 billion. In avionics, we were awarded a $129 million contract for the development phase of the open systems integrated core processor on the F-35. This strategic win, combined with previous awards to provide the aircraft memory system and the panoramic cockpit display, make us an integral part of the TechRefresh 3 program and position us well for future opportunities on the F-35 platform. We've also leveraged our open architecture technology and were selected to provide the processor for the newly redesigned trainer and MQ-25 platforms. We believe these wins provide us with a head start at open systems design and a foundation to build upon as additional platforms move towards a non-proprietary solution. In the C4I business in the UAE, following the successful completion of the initial operating capability phase of the ELTS program, we were awarded a contract to provide tech support and training to the armed forces. This is an important milestone in this $1 billion-plus opportunity, which includes full operational capability across five army brigades, tactical radios, and networking systems for other military services. -to-date, electronic systems revenue was up 7% and -to-bill was 1.2. With strong backlog and progress made in compressing the cycle time in our factory and our supply chain to accelerate the delivery of capability to our customers, we are increasing electronic systems revenue guidance to about .5% versus prior guidance of up 7 to 8%. Finally, in space and intelligence systems, revenue was up 7% as mid-teens growth in the classified business from the ramp of small sats, exquisite systems, and next-generation technology more than offset the headwinds on environmental programs. Order strength was broad-based across classified, environmental, and other civil programs, resulting in a segment -to-bill of greater than one. In classified, we received more than $400 million in orders, once again up double digits, as we leveraged investments in innovation and strong customer relationships to strengthen our incumbency and increase our share of wallet with existing customers. In civil, we strengthen our position as a trusted mission partner on long-standing environmental programs and on GPS. In environmental, we received a $293 million three-year contract extension for NOAA's GOESAR ground system program, increasing the total contract value to $1.7 billion. This brings -to-bill on environmental programs to 1.4 for the first three quarters and reinforces our confidence that the environmental business will return to growth next year. On the GPS program, our investment in a 100% digital mission data unit has extended our 40-year -of-choice position and resulted in a $243 million award for the first two of 22 space vehicles under the sole source GPS III follow-on contract. For space and Intel, -to-date performance was strong, with revenue up 7%, and with nearly all of Q4 revenue and backlog and high-confidence follow-on opportunities, we now expect revenue growth of about 7% for the segment at the high end of our previous guidance range of up 6% to 7%. With our strong -to-date performance, improving business outlook and growing backlog, we are once again increasing guidance across all metrics, with company revenue now expected to be up about 9% versus previous guidance of up 8% to 8.5%, earnings per share of $8.15, and free cash flow of approximately $1.025 billion. So now let me turn it over to Raul to cover financial results in more detail before I close with a few comments on the merger. Raul?

Thank you both. Good morning, everyone. Discussions today are on a non-GAP basis, excluding L3 deal and integration costs and one-time adjustments in the prior year. Turning now to the total company results on slide five. Revenue was up 11% in the third quarter, and earnings before interest and taxes increased 15% on higher volume and operational efficiencies, resulting in margin expansion of 80 basis points to 19.7%. EPS grew double digits for the sixth consecutive quarter to $2.11, and free cash flow increased 3X to 317.9%. As we reduced 12 days of working capital, driven by structural improvements, resulting in a more linear cash flow through the year. We also repaid $300 million of debt in the quarter, completing the last tranche of planned debt repayment, enabling us to return future cash flow to shareholders through dividends and share repurchases. -to-date revenue was up 10%, and earnings before interest and taxes increased 15%, with margin expansion of 90 basis points to 19.6%. Free cash flow was robust in the first three quarters at $788 million, a 75% increase over the prior year, and was approximately $1.25 billion over the last 12 months. Turning to the third quarter EPS bridge on slide six. -over-year EPS grew by 30% or 49 cents. Of this, 30 cents of growth came from higher volume and solid program execution, which was partially offset by product and program mix. A lower tax rate, including benefit from tax reform, contributed 19 cents. Segment details on slide seven. Communication systems third quarter revenue was $568 million, up 19% versus the prior year. In addition to strong growth in tactical, revenue was up double digits in public safety as the business continued to gain traction with federal and state agencies. Operating income for the segment was up 19%, with strong margin at 30.3%, from volume and operational efficiencies, partially offset by product and program mix. -to-date segment revenue was up 15%, with strong growth across all three businesses, and operating income increased 17%. Operating margin was up 80 basis points to 30.1%, and -to-date book to bill was 1.1. Historical information for tactical orders, revenue and backlog is included as supplemental information at the end of this presentation. Electronic systems on slide eight. Revenue was up 7%, driven by growth in avionics and electronic warfare, partially offset by transition on the ELTS program from initial to full operational capability. Segment operating income increased 14% to $123 million, and margin expanded 120 basis points to 19%, from increased volume and strong operational performance. In addition to strength on long-term platforms, F35, F18, and F16, double-digit growth in weapons release systems led to -to-date segment revenue growth of 7%, and operating income increased 13%. Operating margin was up 90 basis points to 19.1%, and -to-date book to bill was 1.2. In space and intelligence systems on slide nine, third quarter revenue was $514 million, up 7%, and operating income grew 5% to $87 million, from higher volume and strong program execution, partially offset by higher investment in R&D and selling expenses. -to-date segment revenue increased 7%, with continued growth in classified programs, partially offset by a decline in environmental revenue. Operating income increased 6%, and operating margin remained strong at 17.5%. -to-date book to bill was 1.1. Moving to slides 10 and 11 for full-year guidance. As Bill mentioned, given a strong -to-date performance, we now expect revenue to be up approximately 9%, versus the prior guidance of up 8 to 8.5%, reflecting strength in all three segments. We're increasing EPS guidance to approximately $8.15, or by 20 cents from the midpoint of prior guidance of $7.90 to $8. Higher volume is expected to contribute 11 cents of this increase, with lower tax rate contributing the remaining 9 cents. EPS now is expected to be up approximately 28% for the year, with about 60% of the growth coming from operations and a balanced 40% from lower share count and the benefit of a lower tax rate. We're also increasing free cash flow guidance to approximately $1.025 billion, versus the prior guidance range of $1 billion to $1.025 billion, driven by higher earnings. In fiscal 17 and 18, over 50% of free cash was generated in the fourth quarter. And as I mentioned earlier, we have made structural working capital improvements to smoothen cash generation through the year, resulting in about 25% of the expected fiscal 19 free cash guidance to be generated in the fourth quarter. We expect to end fiscal 19 with working capital of 43 days, a two-day improvement over fiscal 18 and a 35-day improvement since the Excelis acquisition. Tax rate guidance is now approximately .5% versus approximately .5% previously. But half the one-point reduction was due to lower international tax, primarily from increased FDII benefits and the other half from additional tax planning. Switching to segment outlook. In communication systems, we now expect revenue to be up approximately 12% versus up 10 to 11% previously, driven by strength in DOD tactical and public safety. In electronic systems, we now expect revenue to be up approximately .5% versus up 7 to 8% previously, driven by strong growth on long-term platforms. In space intelligence, we now expect revenue to be up approximately 7% at the high end of the previous guidance range of up 6 to 7% from continued momentum in the classified business. Martens for all three segments are expected to be at the midpoint of the previous guidance ranges, approximately 30% in communication systems, 19% in electronic systems, and .5% in space and intelligence. And with that, I would like to turn it back to Bill for his closing remarks.

Okay, well thanks, Roel. We're now in the home stretch of fiscal 19 and performing very well and better than our S4 projections across all metrics, revenue, margin, and cashflow, and we're on track for a record year. President's budget request for GFY 20 and beyond is a real positive for Harris and the programs that we support, especially in strategic growth areas where we've invested in R&D over the past several years and have strong customer positions. In addition to tactical radio budgets, long-term platforms like the F-18, the F-35 are well supported in classified space and other IC budgets continue to trend up. And with outlays continuing to lag budget appropriations by more than a $100 billion in investment accounts, we expect growth momentum to continue in the medium term. Alongside our strong operating performance and execution, integration planning is progressing well. The team over the last six months has made significant progress in outlining an operational roadmap for the combined company to ensure a seamless transition on day one. We're also developing detailed capture plans to achieve the $500 million of cost synergies. In those still early, I've identified more than 100 ideas on potential revenue synergies. Chris and I remain very closely connected with the integration team through our weekly meetings and we're very pleased with the progress that's been made to date. I'm also pleased with the outcome of the divestiture of night vision, which we proactively initiated to address potential regulatory concerns. You'll recall this business was operating at break even with declining revenue when we acquired it with Excellus and through aggressive actions, we transformed it into a mid-teens margin business growing at double digits, resulting in a $350 million sale price, well above the implied value when we bought Excellus. This same relentless focus on operational excellence is clearly demonstrated in the track record of margin expansion at Harris and we expect to leverage and build on this op-ax muscle in the new L3 Harris to capture integration savings, improve underperforming businesses and drive long-term productivity gains. Overall, I'm increasingly encouraged and confident that this transformative combination will create substantial long-term value for employees, our customers and our shareholders. And with that, I'd like to ask the operator to open the line for questions.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to move your question from the queue. For participants using speaker equipment, maybe necessary to pick up your handset before pressing the star keys. One moment please while we poll for questions. Our first question comes from the line of Sheila Kayaglu with Jeffreys. Please proceed with your question.

Good morning and good results guys. First question, I guess, more broadly speaking, revenue guidance moved up, but margin guidance was maintained. When we think about programs driving upside across the business, how does this convert to profit growth or operating leverage for standalone Harris?

Hi Sheila. So, as we look at margin expansion driven by the revenue growth, clearly we've said that before, that this year in communication systems is a transition year for us as we ramp three new products. The army handheld, the SOCOM handheld, and the army man back. So as we work up the production ramp and take out costs, which we've got a great track record previously, we took a 47% of the cost, for example, in the 117G post-introduction. We are confident that communication systems margins will continue to trend up. Same thing in electronic systems. We've done well taking out costs this year. We guided to .5% at the beginning of the year. We increased it to 19%. We had a plus sign, the guidance range. 80% of the business is fixed price. So we'll continue to drive margins in electronic systems as well. But the volume is a headwind, especially as the growth is coming from long-term platforms. So I think communication systems and electronic systems should drive margin expansion in the future years. And just if I can add here,

Sheila, we said this year we'd see a little bit of margin expansion in fiscal 19, not because of segment margin expansion, but more because of the mixed shifting to higher margin businesses, CS and ES, that would grow faster. We've even seen more of that this year on top of some margin expansion in ES. So as we look into the back end of the year, we can see ourselves touching 20% margin in the fourth quarter, and we see some expansion in margins going into fiscal 20 and beyond.

Thank you for the color. And then just on CS, strong support for the tactical business and the budget. How do we think about market share going forward given upcoming orders for Army Man Pack and handheld on a best value basis and for other implications for the overall tactical market?

Well, look, we're very pleased with the trajectory of the budgets. They continue to increase. I'm very pleased to see the Army HMS budget growing. There's over $500 million in 20 from about 300 million this past year. 7.3 billion over the next five years, which is stronger than we had expected, and the president suggested even about a year ago. Our market share has remained very, very robust. We're on all the contract vehicles. We continue to compete well. We're gonna continue to win and gain share through the investments we make to continue to advance our radios, take costs out, add functionality, improve waveforms in the radios. And that's how we expect to win and continue to have a large share in the market and DOD and perhaps gain some share over time. So the outlook is very, very strong in DOD radio, Sheila.

Great, thank you. Thank you. Our next question comes from the line of Robert Stallard with Vertical Research Partners. Please proceed with your question.

Thanks so much, good morning.

Good morning.

Bill, just a quick question on the merger situation here. When do you expect to announce the next layer of management for the combined company?

Hey, Rob, we'll be fully prepared to announce the management structure several levels down, plus our board as we get closer to the closing. So probably towards the end of June.

Okay, and then as a follow-up, again on the merger situation, you highlighted the very strong cash flow performance on the working capital days that you've seen. Do you see this achievement being applicable to the combined company? What sort of scale are we now looking at there?

Yeah, clearly, as we're all pointed out, and as prepared remarks, since we bought Excel, as we brought down working capital days by 35 days, we'll end the year at 43. Very, very positive trajectory. I think on a combined basis, assuming if we combine the end of March this past month, we think the combined days was 70 days. So we see a lot of opportunity between the two companies. We're estimating six to seven days over the next several years at $35 million a day, but clearly there's some opportunities beyond that. Chris and his team are working hard on this, are making good progress. We're really getting into the details of where that working capital happens to be, putting plans in place. So Rob, if anything, I think Chris and I are more confident today than we were three or six months ago that we've got good working capital improvements ahead of us.

That's very helpful, thank you.

You bet.

Thank you, our next question comes from the line of Carter Copeland with Melius Research. Please proceed with your question.

Hey, good morning, gentlemen. Morning. Just, Bill, I wondered if you could maybe comment on, you know, if you look at the book to Bill's, you know, obviously the most recent ones are lower than what you saw in the preceding quarters, but you know, obviously the budget activity's been strong. Just, I wonder if you could give us some color on the funnel of opportunities that you're looking at behind the bookings we've seen lately, and if there's any material difference from what we've seen over the last 18 months or so, which has been very strong.

Yeah, I mean, good question, Carter. No fundamental or material difference. You know, the date book to Bill is very strong at 1.1. You know, we've had five consecutive quarters above one backlog, as we pointed out in our remarks, it's up 15% year over year, it's up over 20% in the tactical business. It's up 25% over the last couple of years, so the backlog is actually quite strong. You know, we expect book to Bill for the year to be more than one, so I think it's all good news. The pipeline for the Harris as a total company is at $32 billion across the three segments. It's very resilient. The budgets, I think, are well supportive of growth into the future. You know, we've raised our guidance now three times this year. We've had, we're $120 million above the S-board revenue, so every indication is we continue to see good growth opportunities into the future.

And Carter, if I may add, you know, the 1.03 book to Bill that Bill mentioned in his prepared remarks, that's the funded book to Bill. If we include the unfunded portion of the awards we received in the quarter, we are at 1.3 book to Bill for the quarter. And you know, the only other data point I would throw out there is that our backlog is up, you know, 15% year over year, as Bill mentioned, and 12% since we started the fiscal year. So good growth and backlog.

That's great. Thanks for that, Coler. And then just as a quick follow-up, Bill, you mentioned it quickly, but the thought process around revenue synergies, I just wonder as you get, you know, another quarter under your belt, and we get close to closure, just if you could share, you know, your thoughts on the intersection of Harris's capabilities and L3's capabilities and how that's evolving and, you know, what we should expect to see or places you're excited about, any color there would be helpful, thanks.

Yeah, that's a very good question. I mean, every day that Chris and I interact with the teams on as they get together and share information, brainstorm both in the open area as well as in the classified area, we're getting more and more encouraged about the set of opportunities ahead of us. It's still premature to calibrate that or quantify it or say how much time it's gonna take to achieve it. Some will require some R&D investment to occur. You know, we saw the same thing happen with Excellus. It was probably a couple of years in until we really started to see meaningful revenue synergies, but, you know, we're seeing in a couple of different areas, you know, we've got a great position now staked out in small sacks. You know, both L3 and Harris have good expertise in optical and RF payloads, SATCOM, you know, mission knowledge, you know, very strong L3 data link capabilities, SIGINT capabilities. And I think when you combine it, we think we'll have a much more holistic, much more competitive offering in small sacks. And as you guys are very encouraging, we've talked in the past about data links. You know, L3 is very strong on the airborne side. We're strong on the ground side. I think that's gonna be very interesting. You know, the other area that's been, I think, of note recently is L3 has a very strong multifunction phased array capability. You know, we've got strength in open system architecture, backend, EW processing, you know, good capabilities as well in phased arrays, but that multifunction that L3 brings and some of the open architecture that we have is really game changing in our view. And it's not just on current platforms, but also new and evolving platforms. So, you know, those are some of the ideas and some of the things we're thinking about. Obviously the small swap EW product that we've had on the market for a couple of years, it's now started to take hold. Lots of opportunities to embed that small swap EW into some of the unmanned systems that L3 has and that they're system integrator on. So there's more than 100 different ideas. Those are the ones that come to the top of mind, but you know, the energy, the excitement when people talk about these is palpable and we're very optimistic about this.

That's great color. Thanks, Bill.

Sure.

Our next question comes from the line of Gautam Khanna with Cowan and Company. Please proceed with your question.

Yes, thanks and great results guys. Thank you. A couple of questions. First, Bill, I was hoping you could expand upon the airborne radio opportunity and maybe just more broadly speak about the foreign and domestic RF tactical pipelines and how they may have changed with the airborne kind of opportunity now. Well,

the pipelines themselves are very strong. I mean, it's been very resilient for the DOD. It's still around 2.6 billion. It's kind of in line with where we were before in the last couple of quarters and it's been very stable. You know, on the DOD side, about 1.6 billion, you know, shifting more towards modernization. So now it's almost a 50-50 split between base and modernization, but up year over year by about 13%. So again, you know, given the strong orders over the course of the last year across tactical, the fact that the pipeline for that business remains as resilient as it is, I think is very encouraging. I think testament to what the team has been doing. You know, on the airborne radio side, I'm very optimistic about this. This kind of goes back three years or so. It's been a lot of investment we've made. You know, with Excellus, they had a position on airborne platforms and it was an older product offering. And a lot of the new product offerings that we're putting in place, the two channel offerings on the ground side, you know, have capabilities that can be bettered on the airborne side. As you know, we're also partnered with Viasat on the STT. We've seen some really good growth this year on airborne radios on the small tactical terminal. So, I mean, I'm very encouraged about this and the fact that we had a first opportunity here in a Middle Eastern country on a small number of Apaches, where they have a very large fleet, I think is a big win for us. It's not big in dollars, but the opportunity set ahead of us is pretty substantial. I think this will grow over time. I won't be able to quantify it today, but I think it'll grow over time. And again, it's along the path of growth beyond that simple ground business that we've been in, that we've been pushing on for the last several years.

And my follow-up would be just, if you could talk a little bit about how you've, you've mentioned how you've worked together with L3 in advance of the merger closing. But if you could just talk about what operationally maybe you guys have offered in terms of help to L3. They had a traveling wave tube issue a quarter ago that didn't seem to recur in today's results. Have you guys been kind of working together operationally ahead of the deal so that there are no surprises once it actually starts to combine?

Yeah, thanks, Gautam, for the question. Look, our integration teams are really focused on the integration value. So how we can combine our spend and leverage that and bring that down. We've done a number of should cost analyses. We've got a very good and robust listing of what we buy, who we buy it from, what we price we pay. It's done in a clean team, so we don't have visibility to that. But the clean team's coming up with great ideas and actually developing the negotiating packages so that when we close day one, we can start executing against that. We see opportunity on the indirect side, facilities, we've had our combined operations leadership teams going out and visiting many of our sites to understand what the combination of opportunities, what the facility consolidation opportunities might be. I know Chris is very, very deep in what's happening at the traveling wave two business. I'm sure he'll speak about that later on this morning. He's put a lot of resources there, a lot of focused attention. We're aware of it. We see some metrics coming out of it. We're providing guidance and assistance where we can. But Chris is doing a great job in getting his arms around this. And I think you'll see stability and eventually some improvement here. So I think together as a combined company, the operational muscle that we both will bring and I think what we've honed here at Harris over a number of years, I think we'll continue to see this L3 Harris business perform like I think we have done at Harris over the last five or six years. So I'm very optimistic about that, Gotham. Thank you. Appreciate it.

Thank you. Our next question comes from the line of Robert Spingarn with Credit Suisse. Please proceed with your question.

Hey, good morning. So I have a question, Bill, for you on growth. That speaks a little bit to what we've already talked about and then I have one for Ahu on cash. But Bill, you're now targeting 9% growth for this year. L3 is at 6%. You both had among the best numbers growth-wise this quarter and you talked about the budget supporting further growth in the medium term. But would you say that the new L3 Harris can be the sector top line growth leader well into the future? Or is this a peakish kind of year, just given those strong budgets over the past couple of years?

Look, I don't see that fiscal 19 is a peakish kind of year. Again, it's a little assumed to comment on the growth potential of the combined companies. You'll see L3's result, they've knocked the cover off the ball this quarter. They took their guidance up for the year, as did we. Between the two companies, we're $274, $275 million above the S4, even more if you look at where they're guiding to this year. So the combined, the companies independently are performing better than expected. The budget outlook is better than we have thought. Our opportunity set as we think about revenue synergies is more encouraging to us. We'll be more competitive as an enterprise because we'll take costs out, be able to bid aggressively, attack businesses, be more of a full mission provider. So if anything, I'm more encouraged about the growth trajectory beyond fiscal 19. I would not call it peakish. But I do see us doing, I think, quite well as a combined entity once we close and kind of get on with it. So I think it feels pretty good.

OK. And then on cash roll, the two of you, the two companies, have about $1.4 billion pro forma on the balance sheet cash. And so you've targeted $2 billion for share repurchases in the first 12 months post-closed. But given what's on hand and what you're going to generate in the meantime, it seems that you'll end that first year with a lot of excess cash. So I know you're limited in your ability to buy back even more stock in year one. So should we think about this cash build as giving you more firepower for repurchases in year two? Or might you do something else with that cash?

No, absolutely, Rob. We've said this before. I mean, post-closed, our priority, we've done the debt repayment with the sale of our night vision business as and when that closes. We're going to pre-fund the combined L3 Harris pension. And with that, Harris standalone pension is pre-funded till 2025. L3 pension should that be funded till about 22 based on the modeling that we have done. So the pension should be funded with no near term funding requirements. And that would, and we've said, M&A, only if it's absolutely critical. So all excess cash should go back to shareholders, whether in form of dividends or shared buyback. And dividends, we've kind of targeting between 30% to 35% of our free cash. So that leaves a lot of firepower for shared buyback. And we should keep, we should need to keep about $500 million on the balance sheet. So all excess cash back goes back to shareholders.

And I would just add, I think you know our debt ratio is quite low, so we don't have any debt payments in the near term either, or the medium term,

Rob. Okay, thank you both.

Thank you, our next question comes from the line of Richard Safran with Buckingham Research. Please proceed with your question.

Good morning, everybody. How are you? Good morning, Richard. You know, generally, I'd like to ask you for defense. We're seeing a lot of programs transition from development to production. And I wanted to ask you about the DOD classified and unclassified contracting environment that you're seeing versus what you may have been expecting. You know, for example, as programs transition to production, are you seeing a more favorable contracting environment? And if possible in your answer, could you comment directionally on how contracting may impact your margins going forward?

You know, look, it's a pretty broad question. I think in general, we're seeing opportunities put on contract a little bit faster than it would have been a year or two ago. You know, in terms of the way things are being done, it's not changing all that much in terms of mix, you know, cost plus, fixed price, encouragement to industry to invest in IRAD. As you know, Richard, there's been a conversation around contract financing. You know, that still is out on the horizon. You know, I think there was an attempt to, you know, change contract finance structure back in September of last year. This is still an open discussion, but I don't really see, you know, substantive changes in terms of anything that's kind of generalized with the classified or non, you know, that would impact, you know, margin structure going forward. Our margins on the classified side, they're typically, more typically, they're cost plus, and they can come with cost plus margins. You know, so I think that's what you'd see on the cost plus side. That's not really, or the classified side, but I don't see that changing much here at all,

Roll. I don't know if you have any other kids. No, I think you're right, and I think even with, you know, everything else that's going on, I think the growing margins this year, all segment margins are expanding in all three segments, and you know, in response to Sheila's question, you kind of provided a little bit of forward-looking statements on our, you know, expected margins going forward.

Okay, thanks for that. Just a quick follow-up here. Just on the classified backlog growth, I thought I'd ask if you could comment on how quickly you see classified revenues growing relative to unclassified part of the business, and on that part of the business, are you finding margins for classified wins at or above standard margins, and do you think that the trends that you're seeing in the classified programs are gonna impact you positively in 20?

Well, first of all, the classified business over the last couple of years has gone very, very well for us, and our bookings continue to be very strong. You know, the mid-teens' rate book to bills over one, revenue up in the double-digit low to mid-teens' level has been very, very good, and it's been over the last couple of years. It's in exquisite systems, it's in, you know, small satellites, it's in ground adjacencies. You know, it's in these areas we really can't talk much more about, but it's pretty broad-based, and I think it reflects, you know, a drive that we've had over the last number of years to invest in technology and to move from providing components to subsystems to now more complete mission solutions, and that's been a multi-year journey for us, and we're seeing our growth, our position, our share increasing as the budgets are inflecting. I think that's what's driving positive growth for us. In terms of the margins on that business, you know, a lot of it, some of it is fixed price, but much of it is because you're pushing the envelope of technology. Much is gonna come more in a cost plus side. They come with slightly more compressed margins, but as I look out at the next couple of years, you know, I see our space business, where a lot of the classified business happens to be, it's also in the S, but a lot's in space. Now, I see it's holding the margins in that area as we continue to drive productivity, take out cost, take out cost in the pieces that are not classified or are fixed price, you know, and absorb the mixed differential as the classified business, you know, grows a bit. So, you know, I'm not terribly concerned about that. I think it's very good business, in fact. Some of the technology that you develop in the classified world does help your business over time in non-classified. So, you know, it's terrific business, and you know, we're pleased to be a strong player there. Thanks very much for that. Appreciate it. You bet, you bet.

Thank you, our next question comes from the line of Miles Walton with UBS. Please proceed with your question.

Thanks, good morning.

Good morning, Miles.

Bill, I think it sounded like you're kind of confident on the turn in the environmental headwinds at Space and Intel, and so I'm just curious, can you size kind of what you had to absorb this year in your fiscal 19 that you grew 7% in spite of that, and then just confirm that you don't see that as a headwind year on year into 20, and maybe what that outlook is from there.

Yeah, look, we've, this year, our environmental business, I mean, it's kind of in the range of 270 million or something, a little less than 300, it's down, you know, mid-teens in size, you know, we do believe it's cropping here this year. The book to bill, as I mentioned in my remarks, was about 1.4, so the book to bill has been good. The backlog is obviously up. You know, we see 20 to at least be flat with 19, and perhaps a little bit of growth there and beyond, and we've gone through some budget pressures here over the last couple of years. You know, we continue to see things put on order for, no, it's the goes our ground modernization that we're seeing some opportunities there. We're seeing opportunities in, over time, in US and international sensors. We've launched five satellites, five instruments in the last 12 months. These things go in phases, so as they launch, you'll have both US and international customers starting to look at developing the next generation instruments. You know, we sell into Japan, Korea as well, South Korea as well as here in the States. So, you know, we're seeing opportunities to grow in adjacencies on RF spectrum management, DOD weather, you know, thermal detection. So we're seeing a number of different things here that indicate to us that, you know, 20 should not be another step down, and perhaps there should be opportunities beyond that, and that basically sizes that business.

So could Space and Intel be your fastest growing or at least the business that's accelerating the most into 2020?

You know, I think it's probably, it's too soon to say right now. We're gonna come back and give you some guidance in early August as we close the year. It has been, as you can tell, it's been a headwind for us over the last couple of years, and certainly in fiscal 19, but we've gotta look at the whole portfolio and the outlook on the budgets and how it's gonna roll into our business. I wouldn't say it's gonna be the highest grower, but I think it should be a pretty healthy grower over the next several years. Last time we provided medium-term guidance, we said it would be mid-single digits, and we'll come back and revisit that come early August.

That was good. Thanks, guys.

You bet.

Thank you. Our next question comes from the line of Seth Seisman with JP Morgan. Please proceed with your question.

Thanks very much, and good morning. Good morning, Seth. So I wanted to ask a little bit about the tactical radios, and it looks like probably on the DOD side be up to somewhere in the 660 million or something like that range for this year. When you think about what the growth drivers are in terms of the key programs that we know that are on, the key growth drivers in 2020 within DOD tactical.

Well, like I think as we go from here, the growth drivers are gonna be modernization. It's gonna be the Marine Corps ramp, army ramp, both on the handheld and the man pack. We'll see SOCOM continuing to grow. Those will be the principal drivers. I mean, your numbers are in the ballpark here in fiscal 19 on DOD. You have to go back just two years in 17. It's up about two thirds. The budget's been up about two thirds, in that period of time. But what's interesting and what's I think very encouraging here, Seth, is you go out the next two to three years, the budgets grow by another two thirds. So they touch 1.5, $1.6 billion a couple of years out. And when you just look at it, even holding constant share, if those budgets happen, we would see that business continuing to grow pretty substantially and probably touch on a billion dollars three years out. So if anything, we remain very encouraged about the growth outlook in DOD tactical.

Right,

okay. And then in the, I guess in the electronics, in electronic systems, maybe, if you could talk a little bit about the, do you observe any changes in the competitive environment? I mean, that's a place where just about all of the defense primes and some others play. There's a lot of new work out there. Some are growing really fast, some less fast. Everybody wants to grow. Can you talk about any changes you've observed in the competitive environment, if there are any?

Well, look, I mean, yeah, things are shifting. It's not over weeks or months. It's over several years. And I think what we've tried to point out here in various investor meetings is that we've invested in new technologies over the last three, four, five years in open systems architecture. And that has matured itself to such a place where we've won the open system mission processor for the F-35, the brain of the F-35, which is a very, very big win. It's a multi-year platform, and we feel very good about that. That was a competitive win. We're also leveraging our open systems technology into other new platforms at Boeing, the TX and the MQ-25. You can imagine in the drive towards non-proprietary solutions, there are other platforms that are looking at this. Certainly, next-gen platforms will be open system. Even some opportunities on the F-18 to drive open systems. We've done that a couple of years ago. We've also made a lot of investments in electronic warfare over the last three or four years, moving to software-defined EW with better capabilities. And those investments, I think, are positioning this company in a spot where we're growing on those long-term platforms. And we're growing, and we're growing at a faster rate than I believe others in areas because I believe we're taking share. We continue to perform well. The team's working hard, driving, making sure we're successful here that we continue to execute well. And as we merge with L3, if anything, the combined capabilities will open up some new opportunities on some areas that we're not really on today. So it is competitive. The dynamic is shifting, but I think we're well positioned here. Great. Thank you very much. Sure.

Thank you. Our next question comes from the line of John Reveve with Citigroup. Please proceed with your question.

Good morning, everyone. This is Colin on for John. Thanks for taking the question.

Good morning.

Could you just update your thoughts on the $3 billion free cash flow target, what you're seeing in existing budgets, and a combination international that could either bias growth, either upwards or downwards?

You know, I think we're feeling as good today as we did before on $3 billion in three years. You know, as Raul mentioned, we're sort of, over the last 12 months, over $2 billion in combined cash between us and L3. You know, we see organic growth opportunities, both internationally and domestically. We didn't really split those pieces, but we see organic growth, you know, driving cash generation. We see that the cash effect of cost synergies kicking in and another six or seven days worth of working capital, all of which gets us to that $3 billion range. And if anything, sitting here today, we're more confident about that than we would have been six months ago. Just given the trajectory since the merger announcement on growth in the company, on working capital improvements, you know, on the things that we're all talking about in terms of pre-funding pension, which eliminates cash flow contributions several years out. So if anything, we feel better today on achieving $3 billion three years out.

Got it, thanks for the color. And then if you could just talk a little bit about modernization trends that you're seeing among NATO partners in terms of both the NATO and US interoperability. The social forces comment points to a pretty constructive trend there. I just wanna see in terms of the larger forces, what you're seeing.

Well, it's a very good question because we're seeing really good positive trends here. And I think what we see typically is is our international partners, starting with the Five Eyes and then moving to others, modernize and upgrade capabilities as they see the DOD upgrading with products. And those same products, for example, the two channel handheld, eventually starts to find its way into allied nations and starting with their special forces and then working into the regular services as well. And that's the trend that we've seen here in the first couple of quarters of the year, very recently in the last quarter, into Canada, a couple of NATO countries in Europe. We see it in Australia as well. So there's a positive momentum behind modernization. As you know, a year and a half ago, we won a very large contract in Australia. We're executing well under modernization. So these things are all kind of going in waves. I believe the US DOD, if you see the funding with the front end of a multi-year modernization ramp, and we're seeing the same thing now starting to occur in various countries around the world. UK is a little bit further out. It's probably two or three years out with the Morpheus program, which is the upgrade or modernization of the Bowman program. Just given some of the Brexit concerns, I think that might've moved a little bit, but the reality that's still out in the horizon and we'll be a good player in all of those different competitions because of the strength of the product offering and the maturity of the product offering that we have here with

the DOD. And Colin, the only thing I'd add there is that, if you look at our radio business, our Western Europe is up more than 50% this year, primarily driven by the modernization and some of the allied nations buying our radio products.

Thanks for the call.

Thank you. Our next question comes from the line of Pete Skibitzky with Alambic Global. Please proceed with your question.

Yeah, good morning, guys. Nice quarter. Hey, thanks, Pete. Couple quick questions. Bill, just to follow up on international radios, you gave a lot of great qualitative color. Any view directionally on how that business goes in fiscal 20? It's always kind of opaque for us, I think.

Well, it's a little bit too soon to kind of call what 20 is gonna look like. I'd like to complete fiscal 19 and we'll provide some deeper guidance as we see some trends evolving beyond that. Just this year, it's evolving as we had expected. We're gonna be up low to mid-single digits. The first half was up seven, the back half is flat. We're up 4% year to date. On the full year basis, we see Asia Pacific up mid-single digits, mainly because of the Australia ramp. We see Europe up mid-single digits, which is a positive outcome. Laurel just mentioned about what's happening in Western Europe. It's offsetting a decline in Eastern Europe as we had thought would happen. MEA, Middle East Africa is about flat. Africa has been a strong market for us this year. We likely will see continued trends that are strong in Africa going into next year. Cala and Central Asia have both been relatively weak, but they're relatively small base. We do expect in 20 and beyond, they'll start to rebound. We see some good signals coming out of Brazil and Mexico about growth outlooks. We're seeing more positive news come out of Afghanistan because of the US pullout, anticipated pullout and the need to build their forces and equip their forces. There's some more likely we'll see growth in Afghanistan. So we'll see some things shift around. This year, again, playing out as we expected, and I think we'll see some of the same trends in the next year.

Okay, that's awful, thank you. And then just my last one. How are you guys thinking about the length and magnitude of the headwind from this UAE program transitioning?

Well, this year it's down quite a bit, because it was expected it would be down. There's a gap between initial operating capability and full operating capability, which is moving from the one brigade to now another four, so a total of five, and then there'll be other services. There'll be radios coming along. So we expect that to be a growth driver in fiscal 20, but we saw a little bit of a headwind here this year because of that particular transition. The good news here is that the team has been doing exceptionally well here. The program has gone very well. The mission readiness exercise that was done with this one brigade towards the beginning of our fiscal year was very successful. Our reputation in UAE is very, very strong. If anything, we're more encouraged today about a billion dollar total opportunity in the UAE than we would have been a year or so ago. So a little bit of a transition here in fiscal 19 that we're absorbing, and we'll see the turnaround and drive to growth in fiscal 20.

Got it, thanks very much.

Sure.

Thank you, our next question comes from the line of Josh Sullivan with Seaport Global. Please proceed with your question.

Hey, good morning. Hey,

good morning, John.

Bill, you mentioned more open systems competitions going forward. Can you talk about your historical win rates on open platforms? Maybe JTRS comes to mind, but as the market evolves in that direction, just be curious to hear Harris's historical win rate in that environment.

Well, it's hard to call a win rate because they're very different markets, and really it's just an evolving one. I think the big open system competition, the one that's truly notable because of how sizable it was, was really on the F35. In winning that, that was a multi-year process started with eight or 10 different competitors who was down selected to three. It was a -to-head competition, and we won that competition over

very,

very formidable components and competitors in the space. And the team has just done such a great job with that. We've brought great technology, great execution, good cost structure. That also has allowed us to bridge into other new platforms. It started with some open systems work we had done over some time on F18 with Boeing. So I think it's been several years. I think we're winning, the ones that we're in, I think we're winning the ones that we happen to be on. If you consider the JTRS platform as an open system, which you can because it's a common protocol in the waveforms, as you've seen over the last five years, we've become exceptionally well-positioned on JTRS programs. To take you back six years or five years ago, we weren't even the program of record. We weren't even able to compete for the program dollars. And now we're actually competing. We're on contracts, we're on programs, we're delivering radios, we're executing well. So I think this company has demonstrated an ability to find a way to win when it goes towards non-proprietary solution. That points to the agility of the company, but also to the willingness to invest ahead of the curve in R&D. And I think they all kind of go hand in hand together.

Oh, well. And then I just wanted to ask one on your efforts in robotics. I believe you competed the T7 robot on the CRS program. Is this an area where you see Paris expanding its efforts? And then it would seem there might be some good cross-functionality with L3. Are they already in your supply chain on the robotics side?

Well, I don't believe they're in the supply chain on the robotics side. But there could be some opportunities here. I won't comment specifically on that, but there certainly could be. Look, I'm very pleased with what's happened on robotics from just where we were three or four years ago. As you know, we won the UK MOD program with the T7. It was 55 million pound, or about $70 million. I think we've delivered, I don't know, 10 units, I think we've delivered into the UK. They're all performing exceptionally well. We've got a very strong support by the UK MOD as we go around the world and offer the T7. They love the robot. They love the performance of what we've shown. There's another opportunity called DartRose in the UK. It's a smaller robot that we'd be competitive on. We're down selected on the Common Robotics System Heavy, the CRISH program in the US, which should be awarded sometime this summer. We think we're well positioned on that. We think globally the opportunity set could be in the close to a billion dollars here for robotics. So we're on the front end of this. And I think just the early wins with a strong, very reputable MOD in the UK, I think is very encouraging for us on robotics. Great.

Appreciate it. Thank you.

Sure.

Thank you. Our final question comes from the line of David Strauss with Barclays. Please proceed with your question.

Great. Thanks for squeezing me in. Roel, you commented on the cash progression through the year. I just wanted to circle back on that. It looks like the free cash flow guy in some prize is a pretty big step down in Q4 relative to what you did in Q2 and Q3. It looks like it assumed some sort of working capital drag. Could you just elaborate a little bit on why free cash flow is off so much in Q4?

Yeah. So there are a couple of different ways of looking at this data. I mean, clearly, we're driving more linear working capital performance through the year. And if you compare ourselves to last year Q4, where we delivered half the cash flow for the full year in Q4, we got 20 plus days of working capital, call it 20 days of working capital improvement in Q4 last year. And this year, we are only getting less than 10 days. And that's driving a huge change between what we delivered in Q4 in cash last year to what we're delivering this year in Q4. CapEx is a little bit up versus last year as well, and step up from Q3. So all in all, and there is timing of tax payments, some accrued expenses. We've got some non-executive bonuses getting paid out in Q4 as well. So you put all that in. That's why Q4 is lower than Q4 last year and slightly lower than Q3 2019 as well. But having said all that, we deliver 10 days of working capital in Q2. We're delivering 12 days of better -over-year performance in Q3. We're aiming for 10 days in Q4. So there could be some upside to Q4 cash if we drive a little bit better performance in working capital.

OK. Bill, a question on how are you thinking about, I know you've been giving consideration around how you would report the combined company in terms of adjusted EPS number and what might be excluded. Could you give us an update there? And assuming a deal will close, let's say, in late June or early July, when would you immediately come out and give guidance for the combined company? Or would this be something that waited till later?

Dave, I think if we close at the end of our fiscal year or thereabouts, Chris and I will work then in July as we close our books and report earnings early in August. My thinking at the moment, I think Chris is aligned with this, is that we would guide to the stub year, the six month back end of our calendar 19, and then maybe towards the end of the year or early in calendar 20, then guide to 20. And that's kind of what we're thinking at the moment. Again, we'll say more in the coming months. It all hinges on when we actually close the transaction. We're still contemplating a cash EPS. Likely to exclude amortization expense. But any more detail on that in terms of exactly how we're going to report that, I think it's still going to be determined. And Chris and I with the CFO of the company will certainly give some thought to that and share more about that as we get closer to the close.

All right. Thanks very much.

You bet, Dave. Thank you, everyone, for joining the call today. If there are any questions, do not touch with me. Bye bye.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.