L3Harris Technologies, Inc. (NYSE:LHX) Q1 2024 Earnings Call Transcript

L3Harris Technologies, Inc. (NYSE:LHX) Q1 2024 Earnings Call Transcript April 26, 2024

L3Harris Technologies, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings. Welcome to the L3Harris Technologies First Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the opening remarks. [Operator Instructions] As a reminder, this conference call is being recorded. It is now my pleasure to introduce your host, Mark Kratz, Vice President of Investor Relations. You may now begin Mr. Kratz.

Mark Kratz: Thank you, Rob. Good morning, and welcome to our First Quarter 2024 Earnings Call. Joining me this morning are Chris Kubasik, our CEO; and Ken Bedingfield, our CFO. Yesterday we published our first quarter earnings release detailing our financial results and guidance. We also provided a supplemental earnings presentation on our website. As a reminder, today’s discussion will include certain matters that constitute forward-looking statements. These statements involve risks, assumptions and uncertainties that could cause actual results to differ materially. For more information, please reference our earnings release and our SEC filings. We will also discuss non-GAAP financial measures which are reconciled to GAAP measures in the earnings release. I’d now like to turn it over to Chris.

Christopher Kubasik: Hey, thanks, Mark, and good morning, everyone. Since the merger of L3 and Harris five years ago and after strategic acquisitions and targeted divestitures, we have built a company with a national security focus. We have critical technologies in all domains that align to national security priorities and the global threat environment. Responsive space, resilient communications, and rocket motors are critical for the future fight. The trusted disruptor strategy and our portfolio are setting the stage for L3Harris to differentiate ourselves with top line growth, while simultaneously increasing our industry-leading margins. The global security environment continues to be one with heightened tensions and regional conflict.

Domestically, Congress recently passed the 2024 appropriations bills, which included $844 billion for defense. Our programs are well-funded and we are positioned for profitable growth across much of the enterprise. Demand remains strong for our products and solutions as we started off the year with a 1.06 book-to-bill ratio. Internationally, we continue to see a strong and geographically diverse pipeline of opportunities. As an example, we were recently awarded a $150 million program to provide secure networking to Taiwan, displacing a longtime incumbent. This win is an integral part of our interoperability and supports the CJADC2 mission. Turning to tactical radios, we maintain a robust international pipeline of over $10 billion, including several FMS cases, primarily for Europe totaling more than $1 billion.

These opportunities along with a continued strong backlog give us confidence in an international tactical radio ramp in the second half of the year. Other international opportunities are supported by the DoD supplemental funding, particularly in Ukraine. Earlier this week, the President signed a foreign aid package for Ukraine, Israel and Taiwan that includes $67 billion in funding for key defense programs. L3Harris has been a key supplier in Ukraine since the start of the conflict and the need for this equipment remains strong. Our products are being used in theater and exceeding expectations. The supplemental bill will provide our allies access to needed capabilities, while at the same time support the US defense industrial base, including small and mid-sized businesses.

With the bill just recently passed, we will give you more information during the next earnings call on the incremental opportunities it provides. Our workforce is proud to support our country and its allies around the globe. Turning to 2024, our strong first quarter results reflect improvement across our diverse set of programs and products. We’re executing on our contracts and improving cost and schedule performance, which helped drive net positive EACs for the second consecutive quarter. In our product businesses, we are improving quality and driving higher on-time deliveries. Turning to programs, I see development risk abating. This is not to say that we’re out of the woods on all of our development programs, but the business is performing well and the disciplined bidding focus and programmatic rigor is starting to pay off.

LHX NeXt cost savings are also starting to contribute and we see that benefit accelerating in 2024 and 2025. Ken will cover the financials in more detail, but I wanted to highlight that revenue was up double-digit year-over-year, and operating income was up $150 million, resulting in margins expanding 80 basis points to 15.1%. Given the strong start to the year, we are raising our 2024 margin EPS and revenue guidance while reaffirming our free cash flow commitments. At our Investor Day, we committed to $1 billion in LHX NeXt gross cost savings by 2026, focused on optimizing our workforce infrastructure and supply chain. The initiative will enable us to maintain our industry-leading margins while investing in technologies, tools and systems to support our customers and employees.

We are accelerating our LHX NeXt activity in 2024 and earlier this month we implemented a workforce reduction that will result in about 5% fewer people than when we began the year. With these reductions, we are focused on eliminating non-core processes, streamlining our organizational structure to maximize efficiency and rightsizing our physical footprint. To summarize, our actions to date have put us ahead of our gross run-rate savings target of $400 million by the end of the year. There’s more work to do, and I am confident in our LHX NeXt leadership team and know that our collective efforts will yield the $1 billion savings target as previously committed. Operationally, we continue to make progress within our Aerojet Rocketdyne segment. Since closing the acquisition, we’ve implemented processes and tools, which has helped reduce late deliveries by 20%.

We’ve returned multiple programs back to green and we continue to work with our customers and the DoD to accelerate and improve deliveries of these critical products and to support future growth. Aligned with that growth it was recently announced that we were selected to be the primary propulsion provider for the Missile Defense Agency’s next-generation interceptor. We anticipate this to be a multi-billion dollar opportunity over the life of the program. Outside of operations, our finance team saw an opportunity to refinance some variable rate debt and replace it with fixed-rate notes saving 150 basis points. On capital deployment, we increased our dividend for the 23rd consecutive year and we were able to get back into the share repurchase market in Q1, executing about half of the 2024 share repurchase target.

We expect about $1 billion in gross proceeds from the previously announced divestitures, which will largely be used to reduce our leverage below our 3.0 target ratio. We remain focused on achieving the financial framework we laid out at Investor Day and our first quarter results are a solid step forward towards delivering on our commitments. I’ll now turn it over to Ken to provide additional perspective.

Kenneth Bedingfield: Thanks, Chris. Let’s start with consolidated results for the quarter. We reported solid bookings of $5.5 billion, including over $900 million for SDA Tracking Tranche 2, nearly $150 million for US Marine Corps and SOCOM handheld tactical radios, and an international award for a NATO country for missionized business jets that leverages our domestic ISR capabilities. Backlog remains at over $32 billion and supports margin expansion opportunity as we move forward given operational improvements and recent bidding discipline. Revenue grew 17% and 5% organically with growth in three of our four segments. Revenue at IMS reflects aircraft procurements in Q1 ’23, resulting in lower sales in Q1 2024. As Chris mentioned, operating margins expanded to 15.1%, up 80 basis points from improved operational and program performance, while also starting to see the benefits of LHX NeXt. EPS grew 7% to $3.06 per share, primarily from segment operating margin performance, partially offset by higher interest expense and lower pension income.

On a pension-adjusted basis, first quarter EPS was up over 10%. Free cash was an outflow of $156 million as first quarter cash flows are typically the lowest of the year. As you will recall, we derisked 2024 cash taxes at the end of ’23 and we remain confident in delivering free cash flow growth this year to $2.2 billion. I’d now like to turn to some segment details for the quarter. I highlighted earlier that revenue grew 17% from the acquisition of Aerojet Rocketdyne and organic growth in our SAS and CS segments, as we continue to see strong demand for Space Systems and Tactical Communications businesses. On margins, we drove operational improvements throughout each of our four segments. In SAS, we are making progress on development programs, including the recent launch of five L3Harris missile tracking satellites as part of the SDA Tracking Tranche 0 and HBTSS programs.

With these space investments and risks largely behind us, we are beginning to realize the benefits of the new growth areas and maturing processes as we move forward. These efficiencies were a contributing factor in expanding SAS margins by a 100 basis points in the quarter. We made progress on program performance, resulting in a $75 million improvement in net EACs versus the first quarter of 2023. These were driven by improvements in all segments as our focus on operational rigor continues to pay dividends. This was most prominent in our CS segment where the Integrated Vision Systems sector saw stronger results. The Tactical Data Links business continues to perform well as we realized synergy benefits of a consolidated business within our broadband communications sector.

And in Tactical Communications, which drove solid results with an increased level of lower-margin DoD deliveries, we anticipate it will continue through the first half of the year. On capital allocation, our plan remains the same. We will continue to focus on deleveraging the balance sheet before we look at opportunities to accelerate share repurchase beyond offsetting dilution. During the first quarter, we returned over $450 million to shareholders through dividends and share repurchases. Moving on to 2024 guidance. We are tightening our revenue range of $20.8 billion to $21.3 billion, while we reaffirm our free cash flow commitment of $2.2 billion. We are increasing total company margin guidance for the year to greater than 15% versus prior guidance of approximately 15%.

This increase is most notable in SAS, where we now expect margins of approximately 12%, up from prior guidance of mid-to-high 11%. Outside of operations, we are also updating our guidance for pension income. At the end of last year, we combined the acquired Aerojet Rocketdyne pension assets with our own. Our actuarial update is more positive than our initial outlook, so we have updated those figures accordingly. Lastly, on guidance, we are increasing our earnings guidance to a range of $12.70 per share to $13.05 per share, up from prior guidance of $12.40 to $12.80. From a modeling perspective, I would continue to point out that our CS segment will have a heavier DoD tactical mix in the first half that has less margin opportunity than international programs.

Interest expense will also remain elevated in the second quarter. Both trends should reverse as we make our way into the second half of the year, along with the second half weighted free cash flow profile. Overall, a good start to 2024, and we remain focused on executing to deliver on commitments to our customers and our shareholders. With that, let’s open the line for questions. Rob?

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Q&A Session

Operator: Thank you. We’ll now be conducting a question-and-answer session. [Operator Instructions] Thank you. And our first question is from Noah Poponak with Goldman Sachs. Please proceed with your question.

Noah Poponak: Hey, good morning, everyone.

Christopher Kubasik: Hey, good morning, Noah.

Noah Poponak: Hey, Chris, I wanted to ask you, you have the trusted disruptor strategy and you’ve talked about trying to prime more and kind of growing the profile and the size in the sector and that’s been working to a degree. We’re seeing — now that we’re seeing, I think some new entrants in the space try the same thing. And maybe have a little more success than they’ve had in the past. How do you think about that? I mean, does that crowd that effort for you or is the pie big enough for multiple companies to do that? And then, Ken, just one clarification on the LHX NeXt, will you — will all of that be adjusted out of earnings, and is all of that cash or some of that non-cash? Thank you.

Christopher Kubasik: All right. Hey, Noah, thanks for the question. Yeah, I think our strategy is working, as I said and the portfolio is well-aligned. Relative to the pie between the supplemental and the fiscal year ’24 budget, we’re well over $900 billion. So I think there’s plenty of DoD funding relative to the new entrants, which sometimes I like to think of us as one since we’re five years old, but I know where you’re going with your question. We’ve taken the approach to team and work collaboratively with these new entrants at the highest levels. So a lot of the new entrants tend to be a little more software-focused. I think the traditional, including ourselves are a little more hardware-focused. So we’re working collaboratively.

There has been some recent awards in Q1 where we are actually a subcontractor to a new entrant that won a significant program and sometimes they work under us. So I would say we’re embracing them and working collaboratively with them. And of course I’ve talked about our shield investments in the past and working with those venture capital companies who are much smaller, but also have great technology. So I think it’s working and that’s been our approach. Ken?

Kenneth Bedingfield: Yeah. Noah, from an LHX NeXt perspective, we are adjusting out the implementation costs of the program and certainly then trying to leverage the benefits of LHX NeXt in the businesses. We talked about what that target looked like for 2024 and the businesses are off working hard to operationalize that and reflect that benefit in their performance. And I think you’re starting to see that here in the first quarter. And then from a cash perspective, we’re primarily just adjusting out the cash severance costs related to the program. And you’ll see all that reflected in the schedules to the earnings release.

Christopher Kubasik: Yeah. Look, we’ve gotten the feedback relative to our disclosures. So under Ken’s leadership, we’re trying to cut back on these one-time non-GAAP adjustments and be much more transparent. So I think it will be all laid out clear for you to analyze.

Operator: Our next question comes from the line of Pete Skibitski with Alembic Global. Please proceed with your question.

Peter Skibitski: Yeah, good morning guys.

Christopher Kubasik: Good morning, Pete.

Peter Skibitski: Hey, Chris, how does the win on NGI with your partner, how does that impact your outlook for Aerojet? And also considering, as you mentioned, the fiscal ’24 supplementals, do you get more bullish about your ability to hit that $26 billion target or $23 billion, I should say?

Christopher Kubasik: $23 billion and $26 billion? Yeah, absolutely. No, you know, NGI, which is designed to protect the US against evolving long-range ballistic missile threats is a huge win for the OEM. We were a merchant supplier, as I’ve talked about before on both teams. So this definitely gives us a tailwind. When we looked, I went back and looked at our deal model, this really was not factored in when we made the acquisition of Aerojet Rocketdyne. So from that perspective, it’s going to be accretive at least to our own internal goals. Aerojet Rocketdyne is a great technology, especially with the large solid rocket motors. The quantities are still to be determined. It’s going to start as a development program. We’re in discussions obviously with the prime.

We haven’t actually been awarded and signed the contract yet, but as you saw in the media, we were selected as a propulsion provider. So it’s very exciting. And again I think it will be a slower ramp as you would imagine, but ’25-’26 timeframe, I think we’ll start to see the revenue hit our financials.

Operator: The next question comes from the line of Kristine Liwag with Morgan Stanley. Please proceed with your question.

Kristine Liwag: Hey, good morning, everyone.

Christopher Kubasik: Hey, Kristine.

Kenneth Bedingfield: Good morning.

Kristine Liwag: You know, since you formed a new business review committee back in December, can you give us any color on how progress has been? What are the key areas that have come under focus and how this compares to your LHX NeXt type initiatives as well? Do they overlap?

Christopher Kubasik: Yeah, Kristine, it’s Chris. We did set up the ad-hoc business review committee of the Board comprised of four Board members as you saw. We’ve been meeting a couple of times a month for a few hours each. And we brought through a variety of topics that have been laid out in the charter that we filed in the 8-K. I would say from anything from operations, we’ve looked at the programs. They reviewed the program, review process, the bidding process, the LHX NeXt strategy and goals. They’ve reviewed the portfolio, our capital deployment strategy. And we’re just kind of checking through the items in the charter. Some topics are one meeting, some topics are two meetings. I feel like we’re about halfway through the process, maybe a little more.

And then probably middle of the year or so, the BRC will report out to our Board of Directors with observations and recommendations and findings. So I’d say it’s been a very collaborative process. I think it’s an — it’s been good for the company and it’s a good way to orient some new Board members quickly about the company and what we’re trying to accomplish. So I’d say all is going well to this point. So more to come.

Operator: Thank you. The next question is from the line of Gavin Parsons with UBS. Please proceed with your question.

Gavin Parsons: Thanks. Good morning.

Christopher Kubasik: Good morning.

Gavin Parsons: I wanted to ask on the nearly 100 basis points of year-over-year margin expansion. If there’s a way to parse that out between the drivers, I know a lot of them go hand-in-hand, but how much of that is NeXt versus EACs, repricing for inflation, mix, so on, just if there is a way to think about what the drivers were in buckets?

Kenneth Bedingfield: Yeah. Hey, Gavin, it’s Ken. I would say that, we’re seeing improvement in the kind of the high-level buckets across the Board. I would say we’re seeing some mix benefits in terms of, as Chris mentioned, kind of moving out of some of the development of phase of contracts and into some of the more mature phase. From a mix perspective, we are seeing some of the areas of the business that are higher mix of cost-plus growing. So as an example, a space within SAS was a strong grower and has a bit of a higher-cost plus mix. So that kind of works the other way a little bit. But we are seeing some of the disciplined bidding start to come through in terms of confidence in our ability to perform as well as price discipline and then just performing on our programs and certainly LHX NeXt contributing.

And I wouldn’t want to put numbers on each of the individual buckets, but largely as we think about kind of how you bridge from last year to this year, for the most part, each of those major buckets are contributing.

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

Peter Arment: Hey, good morning, Chris and Ken. Hey, Chris, you’ve made a lot of progress already on starting on LHX NeXt. And I think about a third of it is tied to your gross saving targets, it’s tied to labor reductions. You recently made an announcement there. Maybe if you could just give us a little more color on how you think things will evolve on what’s optimal for LHX and then related to all of the actions that you’ve been taking, also on portfolio shaping, just in terms of any future kind of thoughts that you’ve had on further shaping the portfolio? Thanks.

Christopher Kubasik: Yeah. No, thanks, Peter. So, yeah, the workforce was probably the quick hitter for what we need to do for LHX NeXt. And as you said, that got us about a third of the way there. The next part is going to be a little more timely and a little more complicated. And you know the facilities, I think, are going to be a key part of it. Looking at the infrastructure, we have a goal of getting from 275 facilities down to 200. We have about seven or eight that we’ve identified that will start the process here in the second quarter. So that will have a little bit of cost to move and relocate and consolidate. But these would be smaller — smaller entities that — the business case is better to consolidate into a larger facility.

We’re continuing to reduce our ERP systems. We’ve invested in some technology called the unified data layer to get us access by laying on top of all of our systems to be able to get data more quickly. And then, of course, we talked about the initiatives in IT ultimately getting believe it or not from 98 data centers, I’m sorry, 85 data centers down to two. So that’s the infrastructure, that’s going to take some time and that’s why it’s going to lead into 2025 and 2026. We’ve already kicked off with the indirect procurement. We’ve effectively outsourced that, taken advantage of the buying power of that enterprise. So that’s both a combination of price and quantity. So we’re tracking to that. And then ultimately, we called it the supply chain, but it’s really beyond the supply chain.