L3Harris Technologies, Inc.

Greetings. Welcome to the L3 Harris Technologies second quarter calendar year 2021 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 call is being recorded. It is now my pleasure to introduce your host, Rajiv Lawani, Vice President of Investor Relations. Thank you. You may begin.

Thank you, Rob. Good morning, and welcome to our second quarter 2021 earnings call. On the call with me today are Chris Kivesic, our CEO, 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. A reconciliation of non-GAAP financial measures to GAAP comparable measures is included in the investor relations section of our website, which is L3Harris.com, where a replay of this call will also be available. With that, Chris, I'll turn it over to you.

Well, thank you, Rajiv, and good morning, everyone. I'd like to thank the entire L3Harris team for a job well done as we began our third year as a new company. We are executing the integration plan and have exceeded many of our targets despite challenges such as the pandemic. The high performance culture and leadership team we've created are set to carry this momentum forward, which is reflected in today's results. We reported a strong second quarter. Organic revenue was up over 6% with growth across our key end markets and all four business segments. Funded book-to-bill was 1.0 for the quarter and 1.05 year-to-date. Margins increased to 18.6%, resulting in EPS of $3.26, up 15%. We had solid free cash flow of $685 million, which contributed to shareholder returns above $1 billion, including repurchases of $850 million in the quarter and over $1.5 billion year-to-date. Our first half performance, coupled with our expectations for continued execution in the back half, more than offset the divestiture headwinds and supports another raise to our EPS guidance, which Jay will cover. Execution against our strategic priorities that are on slide three continue to deliver results and create value for the company's stakeholders as we make progress and build momentum with top line opportunities, operational performance, announcing and closing divestitures, and delivering on our capital return commitments. In terms of the top line, we had our best quarter since the start of the pandemic, with progress against our key end market growth objectives, while seeing data points that validate our focused R&D strategy. Our government businesses were up 6% in the second quarter, driven by double-digit growth internationally. Our international revenue benefited from increased aircraft ISR and radio sales to regions in the Asia Pacific and Europe. And on the domestic front, the growth was broad-based with our responsive space and maritime programs, as well as land modernization for night vision and SATCOM products leading the way. Our strategy to deliver end-to-end mission solutions utilizing the capabilities and scale across the broader organization continues to gain momentum. Our space business strategy is working as we grew 10% in the quarter, capturing classified awards totaling over $300 million for ground and responsive satellite solutions. These awards are also part of the revenue synergy capture efforts and bring awards to date to over $700 million on a win rate of 70% from our growing $7 billion plus pipeline. Turning to our commercial aerospace and public safety businesses, They were up over 5% in aggregate and were led by our commercial aerospace business up double digits off a low base and from strength in product sales. On the public safety side, there was a modest decline, but with sequential improvement and increased bid and proposal activity from a more stable backdrop. Our solid top line was accompanied by backlog growth as we continue to win strategic programs that include several prime roles. Backlog increased 7% organically year-over-year to over $20 billion, with notable award activity across all domains. On the space side, our revenue synergy awards came from combining electronics and optics capabilities across the company to deliver solutions for an increasingly contested environment. These are incremental to the Pathfinder programs we previously won, which have billions of dollars of potential over time. Customers are viewing L3 Harris as a trusted disruptor. They see us as a company that understands the complexity of the mission and can offer fresh and creative solutions. With a three-year space pipeline of nearly $20 billion, there's more opportunity for continued growth. Within the air domain, we strengthened our existing F-35 franchise with initial production awards for the aircraft memory system and the panoramic cockpit display electronic unit, under the TR3 program. This brings total orders year-to-date on the platform to about $500 million. We're progressing on all three TR3 systems through integration and qualification this year and in support of the planned Lot 15 cut-in of the production hardware. We are also secured a roughly $100 million IDIQ with SOCOM for infrared EO sensors on rotary platforms furthering our modernization opportunities across L3 Harris. Moving over to the land side, we signed several key contracts that touched both international and domestic markets. First, we received a $3.3 billion five-year IDIQ for foreign military sales to a range of partner countries from our new, broader portfolio of products, including radios and SATCOM terminals. This replaces our prior five-year $1.7 billion contract, which supports and validates the continued modernization across geographies and expands our product scope. Second, in the UK, we received a logistic support contract covering legacy Bowman and future Morpheus radios, positioning us well for a billion-dollar modernization opportunity in that country. And third, we want a competitive 10-year IDIQ to supply the U.S. Air Force with our T-7 multi-mission robots, further expanding our customer reach after launching the T-7 with the UK a few years back. We're now pursuing other international opportunities in the robotic area. Within the sea domain, our team was successful in extending its leading prime position in undersea sensor systems and warfare training for a range of the U.S. Navy platforms and support of distributed maritime operations. This undersea warfare training range program called USWTR has an award value of nearly $400 million and further builds our credibility to pursue additional domestic and international opportunities. In the cyber domain, while limited to what we can say due to the classified nature, our billion-dollar Intel and cyber business received over $250 million in orders for complex mission solutions and specialized communications for both domestic and international markets, leading to another quarter of book-to-bill above 1-0 for this business. We also had a key award in an adjacent market with our public safety business with a 15-year, $450 million contract from the state of Florida to upgrade and continue operating its law enforcement system for first responders. Moving over to the budgets, while the process is ongoing and we await a FIDEP, we were pleased with the initial request for the FY22 budget as a support stability in the DOD, NASA, and FAA spending, and is aligned with our capabilities and investment priorities. For the DOD, it's focused on continuing to revolve around and address near-peer threats through high-value technology, which Congress is reviewing. And when we look at the portfolio and the relevant line items, our programs are well supported. This builds on the trend we've seen in international markets, where there's a broad stability in military spending, including key countries such as the UK, Australia, Canada, Japan, amongst others. We're also seeing growing demand for the type of defensive systems we offer for our alignment with the U.S. export policies to ensure partner security. Our most significant opportunities remain for ISR aircraft missionization and other upgrades, land force modernization, and enhanced maritime systems. All in all, as we consider the trajectory of our top line over the coming years, we remain confident in our ability to outgrow the budget and deliver sustainable growth through our domestic positioning, revenue synergies, and international expansion that drive a large pipeline of opportunities underpinned by our leading R&D investments. Shifting to operational performance, we continue to surpass milestones for priority programs. For example, at SAS, the team completed a successful preliminary design review for an advanced EW solution called ViperShield that can deliver self-protection capability for Block 70 F-16s. At IMS, we advanced our unmanned maritime strategy with several customer engagements and demonstrations highlighting differentiators in predictive autonomy on USVs, as well as a submerged torpedo tube launch and recovery for our small UUVs. We also successfully completed a prototype demonstration for a SOCOM multirole aircraft in a variety of challenging conditions while utilizing the breadth of L3Harris offerings. And financially, we had another quarter of strong margins as the team continues to offset mixed impacts from early stage programs with three E3 initiatives including program excellence and factory productivity, allowing us to flow through cost synergies totaling an incremental $27 million in the quarter. In addition, the first half synergy run rate is now $350 million, driven by progress on facilities, consolidation, and IT efficiencies. We see this as the minimum level we'll deliver on this year, up from the $320 million to $350 million range we discussed in April and still a year ahead of schedule. Any upside from here will be incorporated in our E3 program, with our integration efforts blending into operational excellence initiatives. On margins for the year, this leaves us at about 18.5% for the top end of the prior guide, and a level we'll look to build on in the years ahead. Next, on capital allocation, today we announced the sale of two small businesses within our aviation system segment for $185 million in cash, and these should close before year end. When combined with the roughly $2.5 billion divested under our portfolio shaping initiative, total gross proceeds are set to be $2.7 billion. We have now divested nearly 10% of our revenues, and with the completion of a few others in process, our portfolio shaping program announced in 2019 is largely complete. Proceeds from divestitures, including those from the recently completed military training and combat propulsion businesses, will be part of our capital returns program consistent with our shareholder-friendly capital allocation approach. Our expectation now is for buybacks to be roughly $3.4 billion this year, up versus our prior guide of $2.3 billion. When combined with dividends, capital returns will be about $4.2 billion in 2021. So to wrap up, I'm pleased with the execution against our strategic priorities competent in our ability to consistently deliver double-digit EPS and double-digit free cash flow per share growth. And I'm excited about the next phase for L3 Harris. With that, I'll hand it over to Jay. Thank you, Chris, and good morning, everyone.

First, I'll provide more color on the quarter. I'll cover also the segment results and finish with our updated outlook. Starting with the second quarter, organic revenue was up 6.2% with a return to growth in all four segments. IMS led the way of 12%, followed by a return to growth at AS of 4.7%. Margins expanded 40 basis points to 18.6%, primarily from E3 productivity, program performance, and integration benefits, partially offset by higher R&D. The sequential decline in margin was also due to timing of R&D as expected. These drivers, along with our share repurchases, led to EPS being up 15%, or $0.43, to $3.26, as shown on slide five. Of this growth, volume, synergies, and operations contributed $0.18. A lower share count contributed another $0.18. And pension, tax, and interest accounted for the remaining $0.07. Free cash flow was $685 million, while working capital days stood at $0.57 due to receivables timing. And shareholder returns of over $1 billion were comprised of $850 million in share repurchases and $207 million in dividends. Of note, our last 12 months of share repurchases have totaled over $3 billion at an average price of $195 per share, well below our current share price. Now turning to the quarterly segment results on slide six. Integrated mission systems revenue was up 12%, led by double-digit growth in ISR aircraft missionization on a recently awarded NATO program, in addition to mid-single-digit growth in maritime from a ramp on key platforms, including the Virginia-class submarine and Constellation-class frigate. This more than offset the low single-digit decline in our electro-optical business that was due to the timing of Westcam turret deliveries. which we expect to increase in the back half. Operating income was up 2%, while margins contracted 150 basis points to 15.3%, reflecting expected mixed impacts, including a ramp on growth platforms and programs. Funded book-to-bill was 0.81 in the quarter and 1.06 for the first half, with strength across the segment. In space and airborne systems, organic revenue increased 3.2%, from our missile defense and other responsive programs, driving 10% growth in space, along with mid-single-digit classified growth in Intel and cyber. This strength outweighed the impact from modernization program transitions in our airborne businesses, the F-35 Tech Refresh 3 program with Mission Avionics, and the F-16 Viper Shield Advanced Electronic Warfare System. Operating income was up 7.7%, And margins expanded 90 basis points to 19.7% as operational excellence, including program performance, increased pension income, and integration benefits more than offset higher R&D investments. And funded book-to-bill was over one for both the quarter and first half, driven by space. Next, communication systems organic revenue was up 3.2% with mid-single-digit growth in tactical communications. that included international up double digits, driven primarily by modernization demand from Asia Pacific and Europe, and an anticipated decline in DoD from last year's second quarter 40% plus growth. U.S. DoD modernization continued to benefit the integrated vision and global communication businesses, leading to high single digit and double digit growth, respectively. Conversely, Broadband was down low single digits on lower volume for legacy unmanned platforms due to the transition from permissive to contested operating environments, as expected. And public safety was down 7% from residual pandemic-related impacts. Operating income was up 8.3%, and margins expanded 170 basis points to 25.5% from higher volume, operational excellence, and integration benefits. and funded booked a bill in the quarter and first half for about 1.3 and 1.1, respectively. Finally, in aviation systems, organic revenue increased 4.7%, driven primarily by our commercial aerospace business that was up 20% from recovering training and air transport OEM product sales. We also saw mid-single-digit growth in defense aviation from a ramp on fusing inordinates programs and emission networks from higher FAA volumes. Operating income was up 17%, and margins expanded 200 basis points to 14.5% from operational excellence, integration benefits, and higher volume. Funded book to bill was about 0.9 for the quarter and first half. Okay, shifting over to our 2021 outlook. Overall, organic revenue growth is unchanged at 3% to 5%, with our top-line training as expected at 4% for the first half, and supported by a 1.05 funded book to bill year to date. Our U.S. government businesses are expected to accelerate in the back half driven by space, tactical communications, integrated vision solutions, and classified growth within intel and cyber and defense aviation. On the international side, we continue to expect mid single digit plus growth for the year as a strong first half led by aircraft ISR and international tactical radios moderates. And lastly, the encouraging results in our commercial businesses in the second quarter build confidence in a flattish outlook for the year with double-digit growth in the back half. Consistent with our overall guide at the consolidated level, we've also maintained our segment sales guides as well. And as we think about the second half of the year, our key watch items will be the timing of awards, the continued performance of our supply chain, and the pace of the commercial recovery. Turning to margins, we have raised our outlook to approximately 18.5%, a 25 basis point increase to the top end of the previous range due to our strong performance to date and confidence in our ability to execute on cost synergies, E3, and program deliverables. We do continue to expect margins to move lower in the back half due to higher R&D investment and stronger growth on new, earlier stage programs. From a segment perspective, We're holding to our prior margin guidance ranges across the board, but we're expecting IMS and SAS to be at the upper end of their ranges given their strong performance to date and are holding AS and CS steady at their midpoints given divestiture dilution at AS and expected mixed pressure at CS. On EPS, we're raising our full year guide to a range of $12.80 to $13. with the midpoint now toward the upper end of our previous range and reflecting 11% growth from 2020, delivering on our double-digit commitment in spite of dilution from divestitures. As shown on slide 11, the increase of $0.05 from the prior midpoint is driven by $0.13 improvement in operations and synergies and $0.19 from a lower share count at 203 million shares, along with a lower tax rate of about 16%. all of which more than offset divested earnings of 31 cents. On a standalone basis, we expect about 15 cents of net dilution from divestitures. Moving to free cash flow, our guide of $2.8 to $2.9 billion is intact, despite divestiture-related headwinds of roughly $80 million. It continues to reflect the three-day working capital improvement from year-end to around 49 to 50 days. That's now adjusted for divestitures. CapEx is expected to be about $365 million, $10 million lower versus the prior guide due to completed divestitures. Our guidance also now reflects approximately $3.4 billion in share repurchases, an increase of $1.1 billion from our prior guide to account for net proceeds from recently closed divestitures. All told, we expect to return about $4.2 billion to shareholders this year. So let me sum it all up. We deliver strong performance in the quarter and first half, solid revenue and book-to-bill growth, further expansion of industry-leading margins, and consistent cash generation and deployment, all enabling another guide raise as we continue to execute on our strategic priorities and drive double-digit annual growth in earnings and free cash flow per share. With that, Rob, let's 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 yourselves to one single part question. If you'd like to ask a question, please press star 1 on your telephone keypad, and a 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 that are 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 Doug Harned with Bernstein. Please receive your question.

Good morning. Thank you. Good morning, Doug. I wanted to understand a little more about the outlook for communication systems. I mean, you already had strong growing positions on radio modernization and night vision, and then you got some big awards in Q2, and those should add to growth. And I would expect those should be high margin as well. And so when you look at the longer-term growth here, you know, look at the revenue trajectory over the next three to five years, how do you see that now? And is there potential to take margins up above their current 25% levels here?

Yeah, Doug, this is Chris. Thanks for the question. Yeah, you absolutely got it right. We've been quite successful in the communication segment of late with some of those wins, not only here domestically, but internationally as well. So I think what we're seeing is some upward pressure for revenue growth and margins over the longer term, like we've talked about before. We had a great quarter when you look at the book-to-bill, and – You know, the continuation for modernization of the land forces, whether it's the radios, the night vision goggles, SATCOM, we're really in a good position. So maybe I'll throw it over to Jay to give you a little more color.

Sure. Maybe just another quick comment on revenue growth over the medium term. Doug, if you recall, if you look at the future, it's somewhat similar to what we had this year. If you look at our segments, we had SAS at 4 to 6, IMS at 4 to 6. and now it's followed by CS and AS. If you look to the future, we would expect those two top segments to continue to be the leaders in growth. I will say, as Chris mentioned, that this gives us more confidence in the CS outlook, but we probably expect those two to drive a little bit higher growth than CS in the medium term. On the margin profile, you see this year we are taking from the first half, we are going back a little bit, and that's really a reflection of the mix on the new programs. We have the Army The HMS modernization programs, we also have in our broadband communication, the NextGen Jammer program. So we have some pretty sizable programs that are actually margin diluted. The good thing about that is the team has a track record of being able to take costs out, drive the margins better over time. So if you look at the first half, that shows you what the potential of the segment could be. And so when we end the year this year, we'll be in that, say, 24, you know, right now we're saying 24.5% at the midpoint. We delivered over 25 in the first half of the year. That gives you kind of a view of what the median term could look like over time.

And I'll just chime in that yesterday we signed a contract with the Mideast country for the first phase of a multi-year next-gen SDR standardization program. And this has the potential, you know, for up to a billion dollars over the next several years. So a lot of good positive momentum.

Our next question comes from the line of Christine LeWag with Morgan Stanley. Pleased to see you with your questions.

Hey, good morning, guys. Good morning. Chris, in space, can you provide more color on the competitive landscape, the available programs for bid, and how you're performing?

Oh, absolutely. Now, we've had a good run in space, and as I mentioned earlier, You know, we had a good quarter. Book to bill in space was 1.2 so far this year. And, you know, we've been successful in winning 10 of 18 prime positions just in the last 18 months. So that's something that we're quite proud of. And we've also moved into the missile defense arena recently. So, you know, maybe a little longer answer. The approach we're taking in space is similar to what we've done in all five domains, and it's really understanding the customer's mission. You know, we have 47,000 employees and 20,000 engineers and 20,000 employees with clearances. So we're looking at our capabilities. We're looking at how we're spending our IRAD, and we're trying to develop solutions and alternatives that meet their needs. We've talked a lot in the past, as you know, about our responsive SATs, where we were able to develop and launch satellites within 20 months. So that's helping us win a lot of these prime positions. We understand the mission. We have innovative solutions. The focus is on the payload and the integration and speed. So strategically, I think that has been a needle mover. When I look at the exquisite satellites, you know, we continue to have some of the best payloads out there. So we're working with partners usually the larger primes, and that's contributed to some success, and we have some awards coming up in the next few months that are classified. And then we're working collaboratively, you know, with some of these new entrants, just like we do with the traditional primes, and find where we can partner, where we can compete, and it seems to be working. So very proud of that team, and the outlook is quite positive in space. And the budget's clearly supporting this growth as well.

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

Hi. Thanks. Good morning. Good morning. Chris, just wanted to ask about the margin side. You know, you're hinting at the idea for further margin upside from here. Can you just talk about the different drivers you see? How much of the margin upside that you see from here is dependent on volume versus kind of what's under your own control from an E3 perspective? And then also what you're assuming for pension when you say higher margins from error. Thank you.

No, thanks, David. I mean, a small part of the margin improvement does come from volume. And, you know, we've talked about organic growth trajectory, so that's a contributor. But the big driver is ultimately E3. And, you know, we talked about the synergies, which are a year ahead of schedule. And, you know, we're committed to a $350 million run rate. A lot of this takes more than just the two or three years that we've talked about, and each and every function is developed in executing a transformation plan. It takes investment sometimes in systems and processes, but we believe there's continual upside. We've proven it. We're focused on this, something Jay and I review on a regular basis. So we see no reason why the E3 program can't continue. I'll let Jay jump in on the pension. assumptions. But again, the execution has been what's helpful in driving the margins. We're able to control our EACs and the commitments that we sign up to with our customers. So, Jay, a little more color?

Yeah, sure. Just to confirm right on the margins, the absorption is a little benefit That's typically factored in when we talk about the mixed headwinds, and that's usually coming in these new programs with thinner margins. As Chris mentioned, E3 is the key driver. It's going to drive us, and we've talked about 20 to 25 basis points per year over the medium term of being able to continue to drive expansion, and we feel pretty confident in that. The pension, if you think about this year, all in between FAS and CAS, it's a benefit of about $470 million on an absolute basis. We expect that next year the CAS element to decline a little bit as a result of the ARPA legislation that was enacted earlier in the year. As that pushed out funding requirements for pension, our recovery for CAS will come down a little bit. But that should be offset by some fast income. So net-net, I would expect the year-over-year pension to be pretty much flat.

Thank you. Our next question is coming from the line of Robert Stallard with Vertical Research. Please proceed with your question.

Thanks so much. Good morning.

Good morning.

Chris, it's probably one for you. You mentioned that the disposal process is now pretty much done. I was wondering how the prices on the assets that you've sold have compared versus your expectations. And do we now see maybe a shift in strategy and perhaps start to look again at acquisitions? Thank you.

No, thank you for the question. No, we've had numerous transactions that comprise the $2.7 billion, you know, and went back and looked at our original estimates, and we've, generally to answer your question, been able to meet or, in some cases, slightly exceed what we had projected. You know, we talked way back about, you know, maybe about $2.8 billion of gross proceeds from all these divestitures. We're at $2.7, and as I mentioned, a couple small ones. So we'll will clearly get within the range of our expectations. You know, on the M&A front, we did come out of the box two years ago and said we really were going to stand down on M&A and focus on the integration and the divestitures. And as I've highlighted, that's gone very well or maybe even better than expected. But even during that two-year period, we watched the market. I'm highly confident we didn't miss anything in that two-year period. So we'll continue to survey the market. We're looking at anything that is, quote, a must-have, as we call it. And, you know, when I look at the portfolio, as we've said over the two years, we're in all five domains. I don't really see any glaring needs or gaps. So, you know, we'll either proactively approach companies or respond inboundly. but we're really going to continue to hold the discipline, look at things strategically, look at them operationally, make sure the financial hurdles make sense. So not really in a rush and very pleased with what we've been able to win organically. So hopefully that gives you some insight, Robert, and we'll let you know as things progress.

Our next question is from the line of Miles Walton with UBS. Please proceed with your question.

Hey, good morning. I was wondering if you could comment a bit on the second half implied step down in SAS margins. I think you've talked in the past about R&D and mix, and maybe just quantify those. And also, Chris or Jay, could you just update us on Next Generation Jammer? I know the second protest has been, you know, or is being adjudicated, I guess, by GAO, and I guess that's due for decision here in the next couple weeks. Would that have a swing factor on this year's top line or guidance in any way?

Yeah, I'll take the next-gen jammer one first and then ask Jay to chime in on SAS. No, you're right. It's going to be mid-August when we hear the results. We're very supportive and confident in the process that the U.S. Navy ran, and we're assuming that we begin work in in August, and that's built within the model and the guidance. So no additional upside from that, but a huge win, and we're looking forward to getting started and delivering those capabilities.

Yeah, and the SES margins, Miles, you know, this first half, about 19.5% in that ballpark. The back half of the year does step down to 18, maybe 18-plus in the guide range at the high end, at 18.75%. The key drivers is really mixed on the new programs, particularly in the space. We've got to step up on these missile defense programs. There's a number of other classified programs that we've already won and that are, you know, we anticipate winning here in the back half of the year, which will continue to put some pressure on the margins in the back half. But again, those are things that we had contemplated coming into the year when we set the guide originally. And we're, you know, we're pretty impressed by the fact we're able to go to the high end of the guide now based on these same new programs.

Our next question comes from the line of Richard Safran with Seaport Global. Please proceed with your question.

Hey, good morning, everybody. How are you?

I'm doing fine. How are you doing?

Great. You know, the international market for defense is always dynamic, and I thought I'd follow up on some of your opening remarks here. Could you give us an update on the overall international outlook, the opportunity set, where you're seeing demand coming from, and for what types of systems, you know, et cetera. In your answer, Chris, you have this reputation for being able to drive and improve relationships with government customers. And I was just wondering in your answer if you could discuss where you see the opportunities for L3Harris.

Okay. Well, there's a lot of questions there. I'll go backwards. Yeah, I mean, I try to encourage my team. you know, that we've got to spend time with our customers and listen to their challenges and such. So actually this evening I'll be headed to D.C. and have three days of meetings in the Pentagon with a whole variety of customers from OSD and the services and obviously bringing the key P&L leaders with me. So, you know, we like to listen to our customers and see how we can help them and work collaboratively with them on the budget process and such. So, I think everybody does it, but that's something I'm focused on. International, you know, we came out of the shoot and said this was one of the areas we thought we could do better. And I think we said we were underperforming as a combined company. And we were probably right around 19% of our revenue, maybe 20 on a pro forma basis back in 2019. You know, so far this year, we're at about 22% of our revenue coming from international. So we're seeing a little little positive movement. As you know, it's a little lumpy. You know, as I mentioned, you know, maybe somewhat surprising, you know, the budgets have really been stable across the globe, consistent with the U.S. So I think that was a pleasant surprise given the threat environment. And you think of U.K., Australia, Japan, Canada. And, you know, so our approach and strategy that I've talked about is really twofold. We have the 10 focus countries where we have executives, either local country nationals or expats there day-to-day, understanding the process, the threats, and bringing in our P&L leaders, at least when the borders open, to try to close on deals. So that seems to be working well. And then more on the traditional product side, we use the distributors and the reps, and we've been able to use previous relationships to expand the portfolio. I mentioned that IDIQ for FMS is an example that now allows all the products of the new company to come through, not just the traditional radio. So I think that's a positive. A lot of what we do is focused on more defensive systems. We're hearing from our international customers because ultimately they want situational awareness and the ability to communicate in a contested environment. So I look at our portfolio and the things we're doing on ISR aircraft, whether it's something like a rivet joint, to a business jet, and in some cases to a single prop aircraft. We have a broad portfolio that allows them to get situational awareness. You know, we've talked quite a bit about our resilient comms capability, our waveforms library, which is second to none. And, you know, relative to the regions, it's the usual place, the Mideast, the Far East, and Asia Pacific. And we're seeing growth opportunities in all those areas. That's probably a longer answer than you wanted, but we're optimistic and I think we're in good position and executing on the strategy we laid out two years ago.

And just to quickly add to that, Richard, you know, our growth framework, we had laid out a target of mid-single digit plus growth over the medium term for international. We feel very comfortable with that. Obviously, we're going to be doing that this year, if not a little bit better. And it's kind of what Chris said, some of these capabilities, The ISR aircraft missionization, if you recall back in our March investor briefing, we had talked about taking the exquisite rivet joint capability, bringing that to business jets, is also bringing it to pod capability based on customer affordability. And there's a significant amount of demand around the world for that. You look at tactical communications, we see a lot of these foreign countries following the same DOD modernization path. And so we see opportunities there. And I'd say the other areas is in maritime, both in manned and unmanned, you know, requests for support and the capabilities that we provide, both in, say, electrical distribution and power control, as well as things like autonomy. And so we just continue to see a growing pipeline, and we're pretty comfortable with our growth objective over the medium term.

Our next question is from the line of Gautam Khanna with Cowan. Please proceed with your question.

Yes, thanks. Good morning, guys. Morning. I wanted to ask just to follow up to an earlier question on RF tactical and sort of the prospects for growth in 22 and beyond. Maybe if you could explain for us the international and domestic pipeline and then what you expect kind of rates of growth to be beyond this year. And then I have a follow-up on IVAS. If you could talk about, you know, what your view of that program is as an potential, you know, threat or opportunity to the legacy night vision. Thank you.

Okay. Let me do a high level on the first question. Jay can give you some more color on TACCOM, and then I'll come back and answer the IVAS question. So specifically, you know, domestically, we've talked about some upcoming awards that should be occurring here domestically, the HMS MANPAC, HMS LEADER. Those are coming forward here. Hopefully in the third quarter, you know, in the fourth quarter, the Marines have a handheld competition that we're also looking forward to getting the results of. And then, of course, internationally, we have a pretty good increase here later in the year. And again, the focus there is going to be in Europe, the Mideast, and Asia, the Asia-Pacific region. Again, we've had good success in the Mideast that I just mentioned from yesterday. some Australian orders, and really a pretty strong pipeline. But I'll let Jay give you a little more color and numbers as it relates to TACOM.

Yeah, I think overall, probably in both cases, both DOD and international, you're looking at probably low to mid-single-digit growth over the medium term. Part of the reason, particularly in DOD, is that while we have strong growth on the modernization programs, it does cannibalize a piece of our base business. And so you have a little bit of a reduction there. with growth, solid growth on the modernization programs, Army being the largest program that's really in the early innings. And we've got the start of full rate production here coming in the back half of this year. Internationally, Chris mentioned that before, there's just demand around the world for some significant upgrades as far as modernization. And but again, I would put the growth rate right now in that low to mid single digit as new countries come on, other countries fall off. And so, you know, obviously we're going to drive that to more of a mid-single digit, but for now I think that's the best way to think about it and look at it.

And then going back to IVAS, you know, I think when you look at our ENVGB program in IVAS, I would say that they're kind of going head-to-head, maybe battling a little bit for budget money, although both were funded. And, you know, our focus is clearly to deliver, which our team has done a great job on schedule and meet all of our commitments I think ultimately it's going to be a question of how these get split. I think there's several hundred thousand devices needed, and they have slightly different capabilities and mission sets. So I would think over time there's going to be a split between the two. You know, we've been talking a little more publicly about some of the augmented reality capabilities within the ENVGB, you know, the real focus on the night vision. So different capabilities, different mission, and I would think the two converge at some point, and we'll see how the Army wants to play that out. But right now we're just focused on delivering and making sure we meet our commitments.

Thank you. Our next question comes from the line of Sheila Caligo with Jefferies. Please receive your questions.

Hey. Good morning, guys. Thank you for the time. On IMS, maybe can you talk about some of that deceleration? You're saying you're forecasting 5% growth for the year, and you had 9% robust growth in the first half, and it implies flat for the second half. So what are some of the puts and takes?

Yeah, Sheila, what's happening with IMS in the back half of the year is they had strong growth in the ISR business, which was mostly these international customers. That will moderate and abate a little bit here in the second half of the year. And so the growth rate is just going to normalize back to what we were expecting really for the full year. That's really the key driver. Really strong international in the first half. That moderates really in the second half for the business back to a normal rate.

Yeah, I think of all of our segments, Sheila, this one, you know, is a little more lumpy based on the large significant, you know, procurements of aircraft or deliveries. And so you kind of get these – up and down quarters, but I'd much rather be coming out of the chute strong than having a fourth quarter hockey stick. So, you know, that's what happens in the IMS, mainly in the ISR sector.

Our next question comes from the line of Rob Springard with Credit Suisse. Please receive your questions.

Hi, good morning. Good morning.

Good morning.

You know, Chris, it's kind of funny how things change, because now we're actually reading about commercial pilot shortages. And I think Jay talked about recovering training sales, but I'm curious if you can quantify how big the increase was, either year over year or sequentially, and what the latest overall recovery expectation is, and whether or not this business is core or non-core. Thanks.

Right, Rob. Great questions. We did see some good Good recovery, double-digit in the second quarter, driven a little more by the products than the actual training. I think there's a slight lag there. You know, we have a variety of training models from academies, you know, where the cadets actually come into our facilities for an 18, 12- to 18-month period. That's been a little challenged due to some of the border closures, so that's a little lagging, I think, as the borders open up. We'll see an uptick there. Of course, the Delta virus is kind of throwing a curveball in everything compared to what we thought it would be. So the recovery is lagging a little bit. You know, the simulators, as you said, there's a pilot shortage. People either need to get the training refreshed or a lot of pilots may have retired and there's now going to be some new pilots that are going to need the simulator training. And then, of course, for the actual manufacturing, you know, we had a slow start to the year, as you would expect. Not a lot of people buying simulators. But so far in the third quarter, even though it's early August, we've already been awarded two simulators, and we'll be converting those to contracts here in the next 30 to 45 days. So we are seeing an uptick, and, you know, it's going to drive growth in the second half. We're assuming, I'll have Jay give the exact numbers, double-digit growth in commercial aviation. It is a good market. It's got good technology, and we're going to continue to run that business and, you know, evaluate and determine strategically what we want to do with it. But it's part of the company now, and it's contributing, and we're excited about the uptick. Jay?

Yeah, you know, we step up in the back half of the year to about 30% growth in the commercial business from 20% here in the second quarter. This is consistent with what we had expected, you know, coming into the year. The trends that we've seen or have seen thus far really in the month of July support that. And so we've got some pretty good demand and a lot of activity going on in terms of simulator sales. And we're also seeing just increased leads as far as new cadet training in our academies. And we're also seeing it in the simulator training. You know, as Chris mentioned, the one thing to keep an eye on for us, just more maybe company specific, is that we do operate our simulator training in these regions that have been a little bit mixed as far as lockdowns, opens up and lock back down. But that's the smallest piece of our business. Overall, we're pretty confident with this 30% growth based on what we're seeing.

Our next question comes from the line of Michael Cimaroli with Truist. Pleased to see you with your question.

Hey, good morning, guys. Thanks for taking the question. I don't know if this is Chris or Jay, but is it possible to quantify, you know, either kind of this year on the top line organic growth or even breaking down your bookings kind of year to date? How much of the growth is coming from new programs? And I guess what I'm getting at is what kind of dilution on either new start programs are you trying to offset or deal with? And I guess Gotham kind of hit on it, you know, are you seeing any more pricing pressure, competitive pressures from new start commercial players, you know, like what we're seeing in the IBAS program.

Yeah, Michael, thanks for that. It's a great, great question. I mean, as I said, 6%, 6.2% organic growth. You know, I look at, as we go through the planning process and build up our annual operating plan, you know, we start the year and we usually have pretty good visibility into what's already in backlog. You know, so a lot of it's kind of in the 70% range as we look forward. So, you know, go back to December of 2020 when we put out our guidance for 21. Pretty good visibility, 70%. You know, there's maybe 10-ish or so of follow-on. So, you know, to answer your question, I guess you could say maybe 15%, maybe 20 at most. IS REVENUE DERIVED FROM NEW BUSINESS, TO GIVE YOU SOME IDEA. YOU KNOW, ON THE DRIVEN BY NEW PROGRAMS OR NEW CONTRACTS IS KIND OF HOW I LOOK AT IT. AND AS YOU SUGGEST, SOME OF THOSE, YOU KNOW, ESPECIALLY WITH THE DOD, START OUT AS COST PLUS CONTRACTS, YOU KNOW, THEN MIGRATE INTO LOW RATE PRODUCTION OR FULL RATE PRODUCTION. You know, it's no secret that the cost plus margins tend to be lower than what we're currently realizing. So it's dilutive on that front. And then even on the fixed price contracts, I think we're generally pretty conservative in how we start booking those until we retire and mitigate the risk. So maybe that answers your question there. As far as competitive pricing pressures, you know, nothing new or different. than what we've had over the last decade or two in this industry. You know, the selection criteria varies by program and I think our customers are very sophisticated and they look at the technical solutions, they look at past performance, they look at the management team, they look at cost, they look at schedule. So, you know, they're taking all those things into consideration. Like I said earlier, to an earlier question, you know, we try to find ways to work collaboratively with these new entrants, when and if they can add value and increase our probability of win. So, I don't know, Jay, anything further?

Yeah, you know, it's really, yeah, I mean, it varies year to year. I'd say on the mixed headwind, maybe at a gross level, you're talking, you know, anywhere around 25 basis points or so of headwind from year to year. And our challenge is really to offset that with about 50 basis points. of productivity and so that we have a net 20 to 25 basis points of improvement year to year. But again, it just, it'll vary. I'd say that probably be, that's like an average to think about.

The next question comes from the line of Seth Seifman with JP Morgan. Please receive your question.

Hi, guys. It's Tyler on for Seth. Good morning.

Good morning.

Good morning. Just have a couple quick ones here. Can you just speak through the remaining schedule on maybe the execution risk on TR-3 and just touching on the F-35 growth ramp ahead?

Yeah, let me give a quick F-35. We've talked about before we're a top 10 supplier. We've spoken at it just the other day. We deliver about 1,500 parts per jet, but the main focus has been TR-3 where we have three I mentioned two of those three. You know, we were successful in getting a production contract, which I think is indicative of the progress we've made. You know, where we are right now is going through the safety of flight on these three products. One has completed the test. One is just about to start later this week. And the third starts in October. So it's all per schedule. We're committed and focused on making sure we're ready for the Lot 15 cut-in. That's a big focus of both Lockheed and the JPO. And I'd say over the last six months, the teams have made a lot of good progress. We're communicating. We understand the schedule. We understand the risks. So, you know, I feel good about our piece of that great program and contributing to Lockheed and allowing them to deliver their jets. So, yeah. As usual in any development program, there's directed change. There's government dependencies and stuff that we're used to and accustomed to and manage and work around. So I'd say I probably feel better about the program now than I did in April.

Our next question comes from the line of George Shapiro, Shapiro Research. Please receive your question.

Good morning.

Good morning, George.

Jay, if you could go through the working capital days you expect for the end of the year. The goal, I thought, had been 52 days. This quarter, it looks like working capital actually was up like about $135 million on a sequential basis. So just looking where you're going there. And then just to verify, the $400 million reduction in sales was all due to the divestiture?

That's exactly right. I'll take the second question first, George. The two businesses, the multiple businesses that we divested at the end of the quarter were about $800 million of combined sales. We'll have here about $400 million impact for the second half, and that's what's driving the reported sales to come down by that amount. On the working capital, it's also a good observation. We reset again with the impact of these divestitures. George so at the end of the second quarter on an adjusted basis were 57 days and We're trying to get now to around 50 ish days Part of this was was planned where we had some program deliverables in the first half of the year and Those receivables will turn into billings and collections in the back half of the year we also had in the second quarter just high receivable balance and with the timing of sales. And so that will just normalize. We'll collect that cash here in the third quarter. And really for us, the working capital reduction is the same as it's always been really for the year. It's really driving down the inventory. Two elements, as I mentioned, one is just delivering on our key program milestones. So we can turn those into billings and into collections. And then second element is really delivering on our working capital initiatives. And these are the things that we've been talking about as far as reduced cycle time, improving our forecasting process. So, you know, a big second half for us, but it's essentially the way we had planned it, and we believe that we're on track for that. And I'd say that end of the year, George, is really kind of 49 to 50 days on this new adjusted basis, taking out these divestitures.

Our next question is from the line of Carter Copeland with Mellius Research. Please proceed with your question.

Right in under the hour. Thanks, guys. Good morning. Good morning, Carter. Chris, I want to kind of end here with a higher-level question on just strategy. When you came to L3 five years ago, and think about where you've gotten now in terms of organic growth, inorganic growth, the divestitures, the simultaneous integration, you're now at a point where you said you're done with the divestitures. You're not in a hurry on M&A. When you look at the next – you know, five years and try to maintain that internally disruptive mindset, you know, what's going to drive the next leg of the value creation formula? Is it about R&D and development and customers and products more so than the value creation elements we've seen over the last five years? You know, how do you continue to have that kind of mindset in creating value over the next five?

All right, Carter. Well, you've got a good memory, so thanks for that. And clearly it was a great team effort to get to this point. You know, I've talked somewhat about where we're trying to position L3 Harrison. If I listen to all the questions throughout the day, you know, I'll try to explain the vision here. We have our traditional primes, which are some great companies with a lot of cash and employees and processes. There was a couple questions about these new entrants. which are maybe a little more commercial mindset, a little more agile, maybe a little more creative. And what we're trying to do is put L3Harris right in the middle of those two and take the best of the both and position ourselves to listen to our customers and be a trusted disruptor. I don't want to underestimate the importance of understanding the mission. So we know the mission, we know the customers, and can we take that with our industry-leading R&D investments and position ourselves for growth. You know, JADC2 is something that's out there that we can talk about more in future calls, but we really want to position ourselves to help our customers solve their problems and focus on the organic growth, focus on the margin improvement, the double-digit free cash flow per share metrics. I think we're all going to drive value. So, look, I ultimately want to be the most valuable organization defense technology company in the mind of our shareholders, in the mind of our customers, and that's not necessarily the largest, and that's what the team is off executing on.

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

Yeah, good morning, Chris and Jay. Nice results. Hey, Chris, just thinking about your E3, I guess it's becoming kind of ingrained in the culture now. Outside of kind of the operational excellence you're driving, is there any kind of other buckets that still you see as the greatest opportunity to kind of show, you know, incremental savings?

Yeah, Peter, thanks for that question. You know, we've actually taken E3 to be our operating model in the broadest sense. So a lot of times, you know, people think of it as just on the continuous improvement initiatives. But, you know, the approach we've taken on E3 is much, much broader. It encompasses EH&S. It encompasses the supply chain, ESG, continuous improvement, all those aspects, quality, growth throughput yield, everything that drives our performance, including our performance on our programs. where we look at our customer ratings, we look at award fee scores, we looked at earned value management. So when you look at all those things holistically, each and every one contributes to our cash flow and our profitability. So if we can bring down lead times or cycle times, improve the quality, we look at cost of poor quality, get the yields higher. Each and every one of those is part of our E3 umbrella, and that's really what's driving the success we've had to date and the optimism we have for the future. So with that, I think I'll just kind of wrap it up. I appreciate everybody taking time to call in today. Hopefully, as you heard, we have a strong corridor, and the performance and the operational momentum is all positive. Obviously, it wouldn't be possible without my great leadership team and the 47,000 employees, so thanks again to them. We feel good about the opportunities ahead. We're going to continue to execute and look forward to talking to everybody in the months ahead as we focus on growing L3 Harris. Again, thanks for joining the call.

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