L3Harris Technologies, Inc.

Greetings. Welcome to the L3 Harris Technologies third quarter calendar year 2020 earnings call. At this time, all participants are in listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference call is being recorded. It is now my pleasure to introduce your host, Rajiv Lalwani, Vice President of Investor Relations. Thank you. You may now begin.

Thank you, Rob. Good morning, and welcome to our third quarter 2020 earnings call. On the call with me today are Bill Brown, our CEO, Christy Basick, our COO, and Jay Malave, our CFO. First, a few words on forward-looking statements and non-GAAP measures. Forward-looking statements involve risks, assumptions, and uncertainties that could cause actual results to differ materially. For more information, please see our press release, presentation, and SEC filings. For reconciliation of non-GAAP financial measures, to comparable gap measures is included in the investor relations section of our webcast, which is L3Harris.com, where a replay of this call will also be available. And to aid with year-over-year comparability following the L3Harris merger, the first half of prior year results will be on a pro forma basis. With that, Bill, I'll turn it over to you.

Thank you, Rajiv, and good morning, everyone. So two years ago this month, we announced the merger of L3 and Harris. And thanks to the hard work and perseverance of our employees, we've been able to deliver results consistent with or better than expectations, despite market volatility and unforeseen obstacles like COVID. Their efforts have led to another strong quarter and put us in a position to raise our 2020 guidance. The mitigation plans we implemented earlier in the year to manage COVID-19 have proven effective in keeping our employees safe and our facilities open. and will remain in place for the foreseeable future. We also continue to support our supply chain through accelerated payments, totaling over $200 million in the quarter and nearly half a billion dollars year-to-date, and we expect these advances will continue in the fourth quarter. Earlier today, we reported third-quarter results with non-GAAP earnings per share of $2.84, up a solid 10%. Company margins expanded 60 basis points to 17.9% on organic revenue growth of 4.5%. And adjusted free cash flow was $726 million. Our core U.S. and international government businesses were up over 7%, including double-digit growth internationally, partially offset by COVID-related impacts on our commercial businesses that were down largely in line with expectations. With another quarter strong execution under our belt, we're improving our outlook for the year and increasing margins, earnings per share, and free cash flow to the upper end of the prior range, while narrowing organic revenue growth to the prior midpoint of approximately 4%. It's worth noting that despite the pandemic headwinds, we're back to the midpoint of our initial 2020 earnings per share guide, a testament to the benefits of the merger and our earnings power. Integration activity continues to progress well, and in the quarter, we delivered net cost synergies of $50 million, bringing year-to-date savings to $165 million and well on track to meet our $185 million target this year. At this rate, we'll exit the year with $250 million in net cumulative savings, which positions us to deliver at least $300 million net in 21, a year ahead of schedule. Our E3 operational excellence program continues to mature and become institutionalized, and alongside cost synergies was a key driver of the 60 basis points of margin expansion in the quarter and 130 basis points year-to-date. With our strong performance to date, we're increasing our margin guidance to approximately 17.75% for the year, a 100 basis point improvement from 2019, and a solid base to build on over the medium term. As we look beyond 2020, we see three primary building blocks supporting mid-single-digit top-line growth. First, we have a portfolio that is well aligned with national security priorities, irrespective of the outcome of the elections. Our broad C5 ISR capabilities are essential elements in countering the near-peer threats identified in the National Defense Strategy. Resilient communications, open architecture command and control, offensive and defensive cyber, and ISR across all spectrums, electro-optical, infrared, hyper-spectral, RF, sonar, and all forms of intelligence, signals, comms, electronic, and image. We have leadership positions in many of these areas and operate in all domains, and we've realigned our R&D efforts to extend our position through investments in open architecture, multifunction, software-defined technologies. The security threats are real, and we anticipate that future defense budgets will continue to prioritize spending in these areas where we're well-positioned and we're investing. Second, we uniquely benefit from the revenue synergy opportunities created in a merger of two complementary companies that expanded our addressable market. This quarter, we received an additional 12 revenue synergy awards, bringing the total downselected proposals to 25 out of 37 for a cumulative value of over $300 million, an initial down payment on our multi-billion dollar pipeline. Two recent wins worth highlighting are the Space Development Agency's tracking layer, which leveraged legacy Harris' strength in space payloads and integration with L3's onboard space avionics solutions. The other is SafeSIM, a DARPA program to simulate and train for future multi-domain battle that addresses the challenge of secure data sharing of highly classified sensors. And third, we see upside in international, which at about 20% of revenue is underrepresented versus peers. With a now larger international footprint, we can better leverage our scale and extensive sales channels and capitalize on our domestic position to support global modernization efforts and extend our ISR leadership in the airborne, land, and maritime domains. And as seen with recent awards this quarter to deliver missionized aircraft to both Canada and the Royal Australian Air Force, we're making progress. Our top line and margin opportunities, along with our discipline around working capital and CapEx, support our free cash flow potential as well as our ability to return capital to shareholders. We're off to a good start to date and now expect to deliver free cash flow of approximately $2.65 to $2.7 billion for the year at the top end of our prior guidance. This performance, coupled with investiture proceeds, has enabled us to return over $1.3 billion of capital to shareholders in the third quarter, which puts share repurchases to date at $1.85 billion ahead of our full year 2020 commitment of $1.7 billion. For the full year, we now expect share repurchases to be about $2.2 billion, a pace we plan to sustain through next year. On portfolio reshaping, we're about a third of the way through our bottoms-up target of divesting 8% to 10% of revenues, and activity continues to be robust. Our criteria and strategy haven't changed as a result of recent events. We continue to be patient and persistent as we look to maximize value. And as previously stated, we will announce divestitures as they occur with proceeds primarily used for capital returns. So overall, we're executing well despite the uncertain times. And with our unique revenue, margin, and cash opportunities, we remain focused on delivering double-digit earnings and free cash flow per share. So with that, I'll turn it over to Chris to discuss segment results. Chris?

Okay, thank you, Bill, and good morning, everyone. Let's go to slide five. Integrated mission systems revenue increased 6.2%, primarily from growth in our maritime business, as recently awarded manned and classified programs began to ramp up, along with growth from our ISR business, driven by strength in aircraft missionization. The modest decline in our electro-optical business was due to timing of deliveries. Operating income was up 21%, and margins expanded 190 basis points to 15.5% from operational excellence and integration benefits, partially offset by higher R&D investments. Order momentum at IMS was broad-based, with particular strength in maritime, resulting in a segment-funded book-to-bill of 1.08 for the quarter and 1.22 year-to-date. Our maritime business continued to build out its pipeline of opportunities following the Medium Unmanned Surface Vehicle Award. Additionally, the team finalized its position as the largest subcontractor on the U.S. Navy's frigate program. We're playing a key role as a mission solutions provider for electrical, propulsion, and navigation systems. The current 10-ship contract could exceed $300 million if all options are exercised. In addition, the Department of Defense recently reported its long-range plan to significantly expand the U.S. Navy's manned and unmanned ship count to over 500, with the greatest increased plans for unmanned vessels. With our experience and capabilities in both platform types, we are well-positioned to support the Navy's growth. Turning to space and airborne systems, organic revenue increased 6.8%. Growth in our avionics business was driven by the production and modernization ramp on the F-35 and increased classified work at Intel and Cyber. These were somewhat offset by program timing in the space and electronic warfare businesses, which based on recent awards, including the F-18 IDECM contract, position us for growth in the coming quarters. Segment operating income was flat and margins contracted 110 basis points to 18.5%, as integration benefits and operational excellence were more than offset by program mix from recent wins. Overall funded book to Bill is 1.04 for the quarter and 1.05 year-to-date, with key awards received in our space, avionics, and electronic warfare businesses. As Bill highlighted, our space business was one of two awardees for a contract with the Space Development Agency to develop and integrate an end-to-end system of four satellites where we are providing both the bus and mission payload, validating our space strategy to become a mission solutions prime. This system will provide warning and tracking of advanced threats, including hypersonic missiles. The initial satellites will be launched within the next 24 months and support the tracking layer of the EOD's Missile Defense Network in space. Once fully operational, there could be a demand for many more satellites for the value well into the billions, leading to the next face-based franchise for our company. We expect to build on these opportunities in the near to medium term with a space pipeline of over $10 billion in opportunities. Next, communications systems organic revenue was up 6.7% for the quarter, driven by tactical growth in the mid-teens, which included international growth of about 20%. The Middle East, Europe, and Asia Pacific provided most of that growth. Both DOD tactical and integrated vision systems benefited from continued modernization demand. This strength was partially offset by our public safety business due to COVID-19, which was down consistent with expectations in the mid-teens. Segment operating income was up 17%, and margins expanded 230 basis points to 25%, from operational excellence, integration benefits, and cost management. Funded book-to-bill was about 1.0 for the quarter and 0.94 year-to-date, and was particularly strong in tactical communications at over 1.1 for the quarter. This was driven by an initial full-rate production award on the U.S. SOCOM's multi-channel MANPAC program as part of the $255 million sole-source IBIQ. an important milestone for this multi-year modernization strategy. We also saw healthy activity on the international front, including customers in the Middle East, where we continue to build out our installed base and identify new opportunities. Lastly, aviation systems organic revenue decreased 4.1% as the anticipated COVID-19-related impacts in commercial aviation were partially offset by consistent, strong performance and Defense Aviation Products, which was up high teams, and Mission Networks, which was up mid-single digits. Operating income was down 19%, with most of the decline resulting from divestitures, while margins contracted 40 basis points to 13%, as integration benefits, operational efficiencies, and cost management were more than offset by COVID-19-related market headwinds in commercial aviation. Third quarter funded book-to-bill was 0.94, following strong first half orders, resulting in a year-to-date funded book-to-bill of 1.08. Award activity was notable on several ground vehicle programs from the DOD and international customers for our power and propulsion systems, which totaled approximately $150 million. In addition, we recently announced that we're a partner with Northrop on the U.S. Air Force's GBSD program for operations and maintenance training systems, highlighting continued progress with next-generation programs and platforms. Now, over to Jay, who will discuss the financials in more detail, as well as our guidance. Thank you, Chris, and good morning, everyone.

I'll begin with a quick recap of third quarter results and then shift over to our updated outlook. In the quarter, organic revenue was up 4.4%, and margins expanded 60 basis points to 17.9%, as the benefit from synergies more than offset higher R&D investment. Earnings per share grew 10%, or 26 cents, as shown on slide 9. Of this growth, synergies and operations contributed 24 cents, along with a lower share count for 13 cents, which more than offset headwinds from divestitures in pandemic-impacted end markets. Free cash flow for the quarter was $726 million, and we ended the quarter with 55 working capital days, holding a strong first half improvement of seven days. With year-to-date organic revenue growth just over 4% and margins of 17.9%, along with a 5% higher backlog, L3Harris has set up well to close the year. So let's turn to slide 10 to cover our updated outlook. Organic revenue is now anticipated to be approximately up 4% or at the midpoint of our prior range, with the top-line trending largely as expected. Our core U.S. government businesses continue to perform well, up about 7% year-to-date, and driven by DOD tactical radios, maritime, mission avionics, and classified growth at intel and cyber and defense aviation products. On the international side, the business return to growth in the third quarter up double digits, which sets up for a flattish year or better, supported by ISR and international tactical radios. And finally, this guidance reflects about a two-point impact from our commercial businesses due to the pandemic in the range of our initial assessment. Shifting the margins. We've revised our outlook to approximately 17.75%, a 25 basis point increase versus our prior expectation from better cost performance and mitigation of COVID impacts. On EPS, we are raising our full year to approximately $11.55 at the top end of our previous range and consistent with the midpoint set at the beginning of the year. As shown on slide 11, the increase of 20 cents from the prior midpoint is primarily driven by 13 cents of improvement in operations, including our mitigation efforts, plus 7 cents between a lower share count and other items. Moving to free cash flow, we now plan to deliver approximately $2.65 to $2.7 billion, or the upper end of our prior guidance driven by higher net income and CapEx discipline. This keeps us on track to deliver our 2022 free cash flow target of $3 billion, and double-digit annual growth on a per-share basis. At capital returns, we returned over $1.3 billion to shareholders in the third quarter, with $1.15 billion of share repurchases and $179 million in dividends. Year to date, total buybacks were $1.85 billion, ahead of our prior target of $1.7 billion for the year. With an elevated cash position, and solid cash generation anticipated in the fourth quarter, we now expect share buybacks for the year to be around $2.2 billion. And we expect to continue our shareholder-friendly capital framework into 2021 as we normalize our cash balance, generate healthy cash flow, and continue shaping our portfolio. Now switching to our segment outlook. In integrated mission systems, we now anticipate revenues of approximately 6% for the year from the prior range of about 5.5% to 7%, driven by growth in ISR and maritime. Segment margin is now expected to be about 15%, up 150 basis points versus the prior guidance, driven by solid program performance and cost management. At space and airborne systems, we're now guiding to organic revenue growth of approximately 7%, within the previous range of about 6% to 7.5%. as higher F-35 revenues continue to drive mission avionics. Segment margin guidance remains unchanged at approximately 18.75%. In communication systems, organic revenue growth is expected to be approximately 4%, and within the prior range of up 3.5% to 5%, mainly driven by modernization strength in DOD tactical radios. Segment margins are now expected to be about 24%, a 25 basis point increase from our prior guidance, primarily from mix related to our tactical business and cost management. And lastly, in aviation systems, we now anticipate revenues to be down approximately 3% on an organic basis versus our prior range of down 1% to 5%, consistent with our prior estimates in the commercial aero business, partially offset by double-digit growth on the defense side from classified and other programs. Summit margin guidance remains unchanged at 13.25%, reflecting the timely and decisive actions to mitigate commercial arrowhead wins. So overall, we delivered solid performance in the quarter and year-to-date, and now expect to deliver results consistent with our original EPS and free cash flow guidance set back in February. Before wrapping up, I'd like to briefly touch on our outlook post-2020. We'll provide 2021 guidance as we typically do with fourth quarter results. Though no, we remain confident in our framework of annual double digit growth in earnings and free cash flow per share as the building blocks remain the same. Mid single digit top line growth, steady to rising margins, working capital and capex discipline, and returning our free cash flow to shareholders through buybacks and dividends. With that, I'll ask the operator to open up the line for questions.

Thank you. We'll now be conducting a question and answer session. In the interest of time, we ask that you please limit yourself to one single part question. If you'd like to ask a question, please press star 1 on your telephone keypad, and the confirmation tone will indicate your line is in the question queue. You may press star 2 if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Thank you. And our first question is from Mike Walton with UBS. Please proceed with your question.

Thanks. Good morning, everybody. You increased the purchase effort by half a billion, directionally closer to your pre-COVID capital return level of $3.5 billion, but not quite there yet. I'm just curious, is there anything that would hold you back from going that much higher? And then more philosophically, Bill or Chris, as you look at capital returns through dividends and repurchase. Do you have more headroom here to maybe push the dividends a little bit harder, and do you think that would be more appealing to investors? Thanks.

So, Miles, I'll start on the second one, and maybe I'll ask Jay to come back on the first one on the buyback. You know, look, on capital returns, you know, we – you know, the philosophy really is 100% of our free cash flow coming back to owners in repurchases or dividends, and we see that through next year. You know, we've been leaning pretty heavily into share buybacks, and Jay will talk a minute about our philosophy there based on our share price. We think that that's a good value. We do see our dividend, you know, with some room to move up. We've been up about 25% in our dividend rate since close. We raised it twice once at close and once at the beginning of this year. But at about 28% of our free cash flow being paid out, it's below the bottom end of our range. And we'll expect to take a hard look at that early next year and probably lean a little bit heavier into our dividend. But broadly, all of our cash will come back to owners, plus the vestiture proceeds through at least next year. Jay, you want to talk about the buyback?

Sure. You know, Miles, in the third quarter, we increased a little bit relative to the proceeds, about $150 million. If you just do the math, that would say $350 million here in Q4. You can back into our free cash flow for the fourth quarter. And with the dividends, we're approaching – kind of the framework that Bill just mentioned as far as returning free cash flow to shareholders. Yeah, there could be a little bit more room there. I mean, our balance is elevated. We're at $1.3 billion at the end of September. Given where we are with the guidance we just gave you, we would expect the balance to continue to remain elevated in December. And so there could be opportunity there. We're also evaluating other items, which could include some pension contributions. So we're leaving our optionality there. open a little bit, but if it doesn't happen in this quarter, then it would carry over into next year.

Thank you. Our next question is from the line of Sheila Kayagu with Jefferies. Please just answer the question. Ms. Kayagu, I'm sure she's muted. You're live for questions.

Hi. Sorry about that. Thank you guys for the question and good morning. I wanted to ask about Just integration activity, clearly it's been performing really well. And EBIT was up $32 million in the quarter. But X synergies, your incrementals were about flat. And then the implied incremental for 2021, X synergies is 20%. So how are you thinking about maybe incrementals going forward outside of synergies and what changes with mix going forward? Thank you.

So, Sheila, it's a great question if you think about it. You know, maybe kind of a little bit bigger picture here. You know, we end the year this year, we'll be at $17.75 for the year around that ballpark. We do have incremental synergies next year of $50 million. That equates to anywhere, you know, about 25, 30 basis points of expansion. Our core E3 productivity is obviously going to be a driver for us, but we do have some mixed headwinds that we'll be dealing with, and we deal with that every year. And so our intent always is to drive more than the mixed headwinds. But I think for now, right now, as we're continuing to go through the planning phase, offsetting, you know, one for one is where we stand at the moment. The other thing I'll say is that we will see a little bit of a headwind in Q1 because of just the roll-through of the commercial, the pandemic-related impacts rolled through the four quarters. And so that'll put a little bit of pressure on Q1, which will also have an impact, obviously, on the full year. But having said that, I think, you know, mix is something we just have to keep an eye on. But our core E3 productivity is intended to offset that on a kind of run rate basis and drive. Once we get beyond the synergy period, In the integration period, our core E3 operating excellence program will continue to be a driver of margins for us.

Our next question is from the line of Christine Weig with Morgan Stanley. Please receive your question.

Hey, good morning, everyone. Bill and Chris, what drove your narrower 2020 revenue outlook? And I know it's still too early to talk 2021, but how much of your expected 2021 revenue is already in the backlog? versus what you need to go out and win.

So right now, as you'll see in the queue, our funded and unfunded backlog at the end of Q3 was about $20 billion. And you'll note there about two-thirds of it, 65%, rolls out through calendar 21. So we think that that part of our business is pretty solid. We've got a very good pipeline, $69 billion. It's come up over the last quarter. It's come up about... you know, 8% or 10% since the beginning of the year. So it continues to grow, be very robust. You know, and as we look into next year and to Jay's points about mid-single-digit growth, you know, we see good, solid growth in our core U.S. government businesses. You've heard a couple of our peers talk about, you know, low to mid-single-digit growth there. We will add on top of that with revenue synergies that we've talked quite a bit about, We see international growing. It's a growth business for us here in the back half. You know, book-to-bill was very good. The pipeline is really strong internationally. We see that being a contributor into next year. You know, and certainly, as Jay just mentioned about commercial, it'll be a little bit of a headwind until we lap one year on COVID, you know, but the other dimensions will be pretty strong going into next year.

Thank you. Our next question is from the line of Seth Seifman with J.P. Morgan. Please proceed with your question.

Thanks very much, and good morning. Maybe two areas following up there to talk about growth. You know, one is in space. I know, Chris, you mentioned a lot of the opportunities there. Is there a point in which we should see the, you know, maybe the books of Bill step up even further and the backlog start to grow a little bit more? And then, you know, Bill, you just mentioned the international opportunities. Are those principally on the tactical radio side or are they across, you know, IMS or avionics or other areas? Thanks.

Yeah, good morning, Seth. I'll take a first out of both of those. Yeah, so in space, we're going to be seeing the book to bill increase. We talked about some of the key wins we had here in the third quarter. You know, we talked about our strategy to be a mission solutions prime, and it's really taken traction here. The FDA win was a big one. There's some opportunities coming down the pike in the fourth quarter. A fair amount of them are in the classified world, but you'll be able to see that in the quarters ahead. As Bill said, on the international side, we do have a strong pipeline, a good book to build. The tactical radios are going to grow. You know, that represents about 20% to 25% of our international revenue. We're really seeing it across the board. The ISR platforms are doing well with the aircraft missionization and, of course, the maritime business. So it's pretty well spread out across the portfolio and the domains.

Our next question comes from the line of Gautam Khanna with Cowan. This is either question.

Good morning. Thanks, and congrats on the SDA win. Good morning. Guys, I was hoping you could elaborate on the revenue synergy opportunity. You know, the SDA win seems like, you know, that kind of establishes a new franchise for you guys. Are there other kind of new franchise setting opportunities within that pipeline that you could maybe elaborate on so we could – think about growth beyond 21 as well. And would you be willing to opine on where you think the top line will shake out in terms of growth rate in 22?

Well, first on 22, it's a little bit further out in the future, but I might maybe answer the first part of the question as Chris thinks about if he wants to give any guidance on 22. You know, but we're making really good progress on the revenue synergies. And I think this has been you know, a pleasant surprise to all of us in terms of the pace and magnitude of getting that revenue opportunity. It points to the strategic rationale, the combination, and the complementary nature of the technologies that we're working on. You know, so again, we're about 80 proposals that have been submitted. You know, it's come up from Q3. You know, we're winning, you know, quite a few of them. 25 out of 37 is pretty healthy with $300 million of awards. We talked about a couple of them. These are some of the, certainly the SDA win is one of the bigger ones, but Generally speaking, they're going to be in the space domain and electronic warfare, some in maritime. And there's quite a lot that's happening in the classified domain. You know, as we said over multiple calls, you know, one of the things that was unique here is as we put our companies together, we got a lot of input and feedback from our classified customers who really see across our portfolio and across other missions, across other companies, And we're really giving a strong guidance as to where there might be opportunities to combine capabilities within L3Harris. And the team has worked very hard to put together some compelling proposals, and we continue to win. So, you know, it's modest growth this year. It'll start to grow next year and be a good contributor in 21 and certainly more beyond that. It'll grow to hundreds of millions over the next year or two, which I think is a very positive thing. signed for not just winning them but actually seeing them come through in revenue opportunities. So I'm really, really pleased here, Gotham, on sort of the revenue synergy. And I'll let Chris maybe answer the question on 22 if he wants to take a stab at that one.

Absolutely. No, I agree with Bill. We're really outperforming here on the revenue synergy. And, you know, over time and probably by 2022, you know, the business development pursuits and as the business integrates, These things are really going to be merging and part of our overall strategy. So I'm thinking by the time we get to 22, 23, I'm not sure we're going to be calling these out. What it is going to do is give us higher confidence in our growth rate that we've already talked about. So I'm looking for good opportunities in year-over-year growth improvement relative to revenue synergies. But over time, it's just going to be merged and part of our normal processes.

You know, and I think JJ's comment about the mid-single-digit framework kind of expands more than one year. Thank you, Gotham.

Our next question comes from the line of David Strauss with Barclays. Please receive your question.

Thanks. Good morning. Morning. Bill, I get this question a lot from investors, so I thought I'd give it to you. You know, there's this perception that your portfolio is shorter cycle than your peer group. I guess, you know, how much of your portfolio is, you know, short cycle, you know, converting from backlog into sales, you know, I guess within 12 to 18 months? And do you view, you know, your portfolio as shorter cycle and I guess more at risk than your peer group to, you know, to lower budgets? Thanks.

So, David, thanks for the question. You know, look, as I mentioned earlier, about two-thirds of our backlog coming out of Q3, which you'll see in the queue, is around a little over $20 billion funded and unfunded, you know, rolls out over the next year. You know, and what I've seen over time is, you know, it's hard to compare our portfolio to sort of short, long cycle versus peers, but certainly it has lengthened over the last several years as some of the program's you know, that we've worked on, specifically in tactical radios, have moved from sort of book and ship, you know, a quick turn to replenish, you know, spares or radios in Iraq and Afghanistan to now being fundamental long-term programs of record, which a lot more, longer visibility in terms of the buying pattern, the spending outlook. So we certainly see our portfolio being longer term than we were several years ago, and certainly combining with L3, I think, puts us in that position as well. So, again, I think our portfolio is very sound. It's robust. We're well-positioned, and we're well-positioned to grow into next year.

Thank you. Our next question is from the line of Pete Skibitsky with LMB Global. Please pursue your question.

Hey, good morning, guys. Phil, can you maybe talk at a high level about these new concepts of ABMS and JADC2? I think you have some bids in there, and they seem pretty well-supported in DOD. I'm just wondering if you can maybe size the opportunity set for you there. It's still a little nebulous, and maybe talk about timing. Just maybe level set us on your expectations.

So, Peter, very good question. Look, you know, and I took some pains in my comments to talk about the broad set of C5 ISR capabilities we've had across the company. And when you break down C5 in ISR into its components and domains, you know, different sensing technology, we've got a very strong position across all of them, you know, all of which are essential in enabling, you know, this JADC2 or Joint All-Domain Command and Control vision of the future. You know, we are a strong player there. I think on ABMS, we've, you know, lots of players on the IDIQ, but we are across all seven business areas, which is somewhat unique. You know, we had content on Project Convergence, which is sort of the Army version of that in partnership with the Air Force. We had a lot of content there, and we'll hope to see more as it gets into the next version of it next year. You know, we're very strong in maritime and distributed maritime operations. So, You know, we believe this is a strength of ours. You know, we've got very strong capabilities in comms resilient communications, which is developing very strong resilient waveforms. L3 had a strength there. We had certainly a strength there. You know, very strong ISR. So, to me, we're right in the middle of this. You know, and I think it's fundamental that, you know, JADC2 or that vision, that concept is going to be required here. in a near-peer competition. It's going to be more about the capabilities on platforms and how they interoperate as opposed to the platforms themselves. And when I think about this powerhouse that we've created here at L3Harris, you know, Pete, I think we're right going to be in the middle of it. It'll grow over time. There's funding there, and, you know, we're confident that's going to be a driver for the company over time. It's hard to size it today, but we believe it's going to be pretty important, Pete.

Thank you. The next question is from the line of Richard Safran with Seaport Global. Please proceed with your question.

Good morning, everybody. How are you doing? Good morning, Richard. Just a very quick question here on R&D. I wanted to ask you about your opening remarks on research and development. Given the number of wins and the fact that your win rate has been increasing and your remarks, I want to know how you're thinking about R&D longer term. If you think it could be ratcheted back a bit, do you need to spend more R&D to support the increasing win rate on programs, or are you really just about the right level right now?

Hey, Richard, thanks for the question. Again, I think you're hitting on a very important topic, and that is the power of the IRAD that we spend and the work that's happened over the last five quarters. You know, we're spending in the 3.6%, 3.8% of our revenue in that range. We think it's sized well. And I think more importantly, what What the team has done is worked very hard over the last five quarters to make sure it's spent on the best, highest value, highest return opportunities, and focusing that sphere we call IRAD. You know, we've reduced the number of projects by about 30%. We moved about 10% of the dollars around to really be placed on the technologies, the areas that we think have the best returns or align to revenue opportunities, revenue synergies, And the second element of it is not just making sure we're spending on the right projects, but also doing it efficiently. So we've got good opportunities to drive operational excellence skills into the way we develop products. We're pushing hard on digital engineering, on DevOps, and a lot of our work is software development. There's lots of ways to improve the effectiveness of our R&D spend. And to me, this is going to be a very powerful driver of growth in the future. I don't see it stepping up materially from where we're at. I think it's a good amount. It'll come up with revenue in terms of a dollar perspective, but I think we're spending a healthy amount on R&D.

Thank you. Our next question is from the line of Doug Harned with Bernstein. Please proceed with your question.

Good morning. I want to go back really to the budget here. When you look across the portfolio here, trying to understand how your businesses are affected by in-strength and forward deployed in-strength. And, you know, changes really aren't in the plans right now in terms of at least basic number of, say, Army troops. But, you know, we're about to have an election. So if we were to see military personnel reduced in the coming years, you know, how would that affect you? And I'd ask the same thing for changes in forward deployed troops, such as moving the troops out of Afghanistan, Iraq, or elsewhere. So when you look across the businesses, how are you tied to those levels?

So, Doug, I'll start here. Maybe you're going to ask Chris to jump in. I don't think we're going to be much affected by redeployment of overseas troops back on shore. I don't think that's going to be a big driver of growth, either top headwind or tailwind. On end strength, You know, it would come back to things like, you know, businesses like Night Vision Goggle or radios where, you know, those are distributed out to individual soldiers. You know, but frankly, we're on the front end of a modernization ramp even through the next five years. We're not even 40% through the modernization ramp with radios. So even if end strength comes down, as I expect it likely will, you know, I don't think it's going to affect anything. the growth rate in our radio business. I think you are so far underpenetrated with new technology, both night vision as well as radios, that we still see good growth opportunities there. So, if anything, you know, reduced end strength might actually free up some dollars to be put onto modernization investments that, you know, really affect the broad part of our business. I don't know if, Chris, you wanted to add to that.

Yeah, and if there is a reduction in the forward deployed troops, I mean, you look at the rest of the portfolio, Doug, and Situational awareness is going to be critical. So you look at the ISR assets that we have both in space and air and the need, as Bill talked about, for the multi-domain comms. It strengthens the rest of the portfolio. So I look at it as kind of a net-net push or maybe a slight positive when you look across all four segments. And the same theory applies internationally. There's just a lot of need for communications and situational awareness. So our ISR capabilities, both in space, air, land, and maritime, are well positioned.

Thank you. Our next question is from the line of Noah Hoppenack with Goldman Sachs. Please receive your question.

Hey, good morning, everyone.

Good morning, Noah.

Hey, guys, so kind of every quarter since the merger, we sort of all get on these earnings calls and question you on the sustainability of your growth rate and ask about short cycle and the O&M exposure, and I think those are sensible questions, and you guys provide decent answers to those that have some conservatism but are mostly qualitative in nature. And, you know, after every one of those conversations, the stock just derates, you know, moving sideways while you're performing well and the numbers are going up. And so I guess I wonder, you know, how much are you all talking about that internally in terms of a different way to start from scratch and reframe this for investors? I mean, you talk about the – handful of franchises you have, you know, the defense budget is broken down into a handful of franchises. Is there a way to sort of, you know, while still giving detail, like super simplify this so that people can see on a legit three to five year basis, you really can keep growing mid single digits. Because otherwise it just feels like we're just sort of circling back to the same things every quarter.

I don't know.

I mean, maybe there's no good answer to that and you just have to keep performing and the stock eventually matches to the numbers. But I was pretty curious if you guys talk about that or think about that internally and if you could share any thoughts with us.

Well, yeah, go ahead. Well, you know, I think a comment on some of the new awards that we talked about, I think a demonstration is illustrative of our positioning for the modernization trends that we're seeing going forward. And so while, you know, people may want to focus on O&M budgets and historical tactical radios, the new awards that we're winning are really positioning us well for the trends that we're seeing in terms of defense priority spending. And so I think you should, as Bill mentioned, think about our portfolio and our revenue potential more in that broader context. And that's what gives us confidence in our mid-single-digit growth over, and we're seeing this in our new awards right now.

Our next question is from the line of Robert Stallard with Vertical Research Partners. Please proceed with your questions.

Thanks so much. Good morning.

Hey, good morning, Rob.

Bill, you've mentioned defense exports a couple times this morning, and I think earlier this year you were suggesting this area could be a bit slower, but that doesn't seem to have happened. So I don't know if you could comment on what changed there. And also looking forward, and maybe to follow on Noah's question, how big could defense exports be as a percentage of sales going forward?

So, yeah, as we talked earlier this year, right after I think it was Q1, maybe Q2, you know, as we looked at the international business, we saw it being more flattish for the year. We saw the first half being down a little bit, the back half growing and being about flat for the year. Q3 came in strong like we had expected it would, a little bit better than we had thought. You know, so it could be up a little bit, so flat to up low single digits internationally, so a little better than, you know, we saw a couple of months ago. International tactical has come in almost exactly as we had expected. You can see the numbers up 21% in the third quarter. You know, we expect the fourth quarter up a similar amount. So we see good recovery in that business. You know, a lot of Middle East, Europe, Asia Pacific, mostly Australia, New Zealand. So there's pretty good growth in tactical. And we've got a nice pipeline of opportunities. I think the number is about $20 billion of international opportunities. The book to bill year to date is over one, about 1.06 or so. You know, we see the fourth quarter looking – shaping up to be pretty sizable in terms of book-to-bill. It's pretty good. You know, about $3 billion of those proposals that are out there, of our pipeline, is in proposals. So it's actually getting to be more nearer term. So it's looking a little bit more encouraging than we thought just a couple of months ago. I think Chris and the team are putting a lot of focus on this. We have resources in place going after 10 focused countries. And we're starting to turn the corner. So we're at 20% roughly in terms of our revenue. We expect it's going to grow several points over the next number of years. I don't know, Chris, if you want to state a goal there, but it's going to come up from where we are because it's underrepresented in our portfolio today.

Yeah, I think ultimately the next target would be closer to the 25% of revenue over several years. And what I like about our company is the portfolio and the demand for our products and You know, when you export, there's always a focus on offensive versus defensive products, especially, you know, as administrations look at approving these exports. And when you look at our ISR capabilities, the maritime capabilities, the radios, the comms, those are generally easier to export and approve, regardless of which administration is running the country. So I think that gives us a lot of confidence. And, you know, we've been able to – stay in touch with our customers. We have executives forward deployed full-time in the focus countries, and all of us have been using new technology to call Zoom and stay in touch with our customers really on a weekly basis, and that's working well. We're negotiating contracts via Zoom and continuing to keep the business running. So very optimistic on international.

Thank you. Our next question is from the line of Peter Arment with Baird. Please proceed with your question.

Yeah, good morning, Bill. Chris Jay. Nice results. Hey, Bill, I guess on the working capital, you've given us a lot of details. Just kind of a clarification, is the seven-day improvement year-to-date the number? And is that a good kind of, I guess, pacing item as we think about your goal to get to the low 40s as we think about, you know, next year and into 22 to hit that kind of $3 billion pre-cash flow target? Thanks. Thanks.

Yeah, thanks, Peter. Yeah, so seven days year-to-date. It's about 13 days operationally since the close. So we put out divestitures and purchase accounting. We'll see towards the back end of the year, we'll probably stay right on 55 days. So you won't see seven days improvement over three quarters as they continue to pace into the future. You know, we see the 55 dropping below 50 over the next couple of years, three to four days per year. That gets us to the $3 billion goal in calendar 2022. You know, we still see an opportunity to get down to the low 40s or about 40 days. You know, certainly that's where Legacy Harris was. We've seen our peers at that point. So even after calendar 22, you know, 47, 48 days, we see opportunity to continue to prove working capital beyond that. As I said last time, and we've talked about this a number of times, a lot of it's going to be on inventory. So we've got a lot of opportunity here. We know where it's at. You know, we've got 10 businesses that we're really focused on. that drives 75% of our working capital, six with more than 75 days. So we know where we're focused. We're driving it hard. We review these every single week. And you can see the progress and trajectory that we happen to be on. So, again, about three to four days a year, you know, beyond calendar 20.

Thank you. Our next question is from the line of John Raviv with Citi. Please proceed with your question.

Good morning. Thank you. I know we've talked a lot about margin going above 18% with a synergy drop through offsetting the mix. But I think there's been some conversation over the last month or so about a long-term opportunity for 20% margin. What's your perspective on how you get there? Is it all in your control or do you need some customer behavior to change? And then also if we're going to get there, is it linear or could there's something, you know, could something big pop up in a given year such that you have to make a big investment, margin could step back for a year or two? and then kind of hitting that margin expansion growth trajectory again. So more of a long-term question there on margin. Thank you.

Hey, John, look, it's a good question. I mean, I think we're really performing better than we had expected on margins, even through this year. Keep in mind, we started the year, I think, guiding to 17 to 17.5, and now today it's 17.75. So in an era of COVID, which actually dinged us about 40 basis points this year. So you know, we're performing very, very well. It comes through, you know, the synergy drop through. It comes through operational excellence, which is maturing at a fast clip. You know, Jay's talked about 18% or so next year. He gave you some of the drivers. You know, will it go up beyond that? It'll likely move up. I don't know if, when it'll hit 20%. I think the key thing to be thinking about is we've got to make sure that we're leaning in to go after and drive revenue growth, capturing some opportunities, which might have a near-term, short-term impact on margins, but long-term be good businesses for the overall enterprise. We've got to make sure we continue to invest at the level required to grow the business on a long-term basis. Anyone could easily pull back investment like I read and drive margin up in the near term, but be detrimental in long-term value for the owners. I think you have to work the pedals here, and I think we do this very, very effectively. So we can't commit to something beyond next year, but we will commit to continue to work the agenda to drive hard on technology investments, which drive differentiation, and good cost management, lean productivity across the whole company.

Thank you. Our next question comes from the line of George Shapiro with Shapiro Research. Please proceed with your question.

Yes. I wanted to know... What's the progress payment benefit you've gotten this year and then how much benefit from payroll deferral? And is that inhibiting getting to the $3 billion of free cash flow next year? I'm assuming CapEx probably is no higher next year than what you're saying this year. Thanks.

Sure, George. Thanks. The progress payment benefit this year is in the range of, say, around close to $100 million in that ballpark. maybe a little bit lower than that. You know, that one we basically have offset with small supplier payments, and so it's just one for one as it's come in. We really pushed supplier payments out. On the payroll tax benefit, that's kind of $150 million plus in that ballpark. Similar type of effort. We've kind of put a placeholder there to support supply chain there as well. That, as you know, will be paid back over two years, 2021 and 2022. But I would say as it relates to kind of longer-term targets and our $3 billion target, there's a number of puts and takes. There's risk and opportunities. We've got that factored in. We feel good about our ability to generate continued working capital improvement, and we don't see that getting in the way of us getting to $3 billion in 2022.

Thank you. Our next question is from the line of Ron Epstein with Bank of America. This is you.

Hey, guys. Good morning. Good morning, Ron. Bill, just following up on one of your earlier comments, you gave us some color on the growth in classified. Can you give us more detail on that? I mean, you mentioned that that's a big area for synergies. And then I realize it's classified, right, so it's difficult. But can you give us some more feel around that? And then also, how many more opportunities are there out there? Can you share the growth profile? And what percentage of the overall business is classified today?

Okay, so let me hit on a couple of points there, Ron. But you're right. A lot of it's classified in terms of its nature. But about 20% of our total company revenue is classified. And as you know, the classified budgets, both military and national intelligence programs, those budgets have come up over the last five or six years. They're at a very healthy level. And that does offer some some cushion, if you will, as you go into the next several years, if there's more pressure on a non-classified DOD budget, money tends to move and be well-supported in the classified domain. And even the elements of that, of what's in the classified budget, which is around $85 billion plus or minus between military and national intelligence programs, the elements are actually moving in a direction which we believe supports a lot of the investments we've made. So a lot of what we focus on is in the space domain. you know, various new technologies for optics, RF systems, you know, driving to larger constellations from prototypes, you know, running a full end-to-end mission solution. I think what's an interesting element of this is historically a lot of the space domain was dominated by the intelligence community. But because of the lower cost, faster time to market, more onboard processing of our small satellites, it's opening up new markets within the DoD. So the addressable base for us is actually expanding. So that's helping us quite a bit. So that's really on the space domain, but there's plenty of other classified opportunities on the land in maritime domains as well. We've got a strong position really across all of them. So it's hard to shape them, but it gets back to the common innate on the strength of C5ISR. And a lot of the things that we do in the classified domain leverage off of that. We hone technologies, advance technologies, and then you can leverage that that benefit into the non-class environment. And that's been a strategy of the company for a number of years, Brian, and I think it's worked pretty well.

Thank you. Our final question comes from Rob Spingarn with Credit Suisse. Please proceed with your question.

Hi. Good morning, and thanks for squeezing me in. So, Bill, just following up on that, it seems like the competitive landscape for some of your work is changing a bit. There are some public companies in government services that are increasingly moving into comms and EW. And then you have some private companies, especially out on the West Coast, like Andrel and UAVs and SpaceX and Smallsats. And the Air Force is also encouraging new contractor formation, business formation. So ultimately, would you accept the premise that the competitive landscape is changing? How do you negotiate this in a potentially flattening budget? And how much will M&A factor in?

That's a very, very good question. So the landscape is changing. We are seeing greater penetration of some of the, you know, Western companies, Silicon Valley companies, SpaceX you mentioned. You know, as you know, they were one of the awardees of the SDA tracking layer. You know, we could follow what they've done in commercial launch and with Starlink and other things. So they are playing more. There's a number of other companies. You mentioned a few of them. You know, there are some more typical government contractors who are looking to expand what they do into from services to other components. You know, so the market's moving around, and we get it. The way we stay ahead is basically running our strategy, running our game, which is really strong investments and performance in R&D and technology, you know, moving quickly. You know, there's really nobody that's put up a small sat with the capabilities we had in the timeframe we've done it just in the last couple of years. I think that's the way we stay ahead. We continue to drive cost out, drive operational excellence, improve quality, and meet our program objectives. And I think if we do that and we continue to accelerate the pace at which we can execute on our programs and technologies, we're going to stay ahead. And I think that's what we need to do. You know, will M&A play a role in that? Maybe over time. Right now we're focused on integration, on portfolio shaping. You know, but as you go out in time, there could be pieces – of other companies or things on the market that could become available to fill a gap in our portfolio. We don't see that today, but that's very possible. In fact, it's probably likely it's going to happen over time. You know, but today we're focused on running our game, and I think that's been an effective strategy. So, Ron, thanks for the – Rob, thanks for the question. It was very good. I really appreciate that. Let me just wrap up from here. And I want to thank, again, the L3 Harris team. They've done a fantastic job. of staying focused and meeting our customer commitments. You know, they worked very, very hard, and that hard work has led to another quarter of very strong results. We're well positioned coming into the year end and into the coming years, and I look forward to our next update. Thank you very much, everybody, for joining us today. Thank you.

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.