L3Harris Technologies Inc (LHX) — Q4 2018 Earnings Call Transcript

Thank you, Michelle. Good morning, everyone, and welcome to our fourth quarter fiscal 2018 earnings call. On the call with me today is Bill Brown, Chairman and Chief Executive Officer; and Rahul Ghai, Senior Vice President and Chief Financial Officer. First, a few words on forward-looking statements. Discussions today will include forward-looking statements and non-GAAP financial measures. Forward-looking statements involve assumptions, risks, and uncertainties that could cause actual results to differ materially from those statements. For more information, please see the press release, the presentation, and Harris SEC filings. A reconciliation of non-GAAP financial measures to comparable GAAP measures is included in the quarterly materials on the Investor Relations section of our website, which is www.harris.com, where a replay of this call also will be available. With that, Bill, I will turn it over to you.

Okay. Well, thank you, Anurag, and good morning, everyone. We ended fiscal 2018 on a high note with fourth quarter earnings per share up 19% on revenue growth of 8%, the highest top-line growth we've seen in seven years. Revenue was once again up in all segments and operating margin expanded 50 basis points to 19.6%. For the year, earnings per share was up 18% to $6.50 on 5% revenue growth and we generated record free cash flow of $915 million, which is 116% of net income. Orders were up 18% and increased by double digits for the fifth consecutive quarter, ending the year up 23% with a book-to-bill of 1.2, and backlog up 26%. All of this was driven by our multi-year investment in innovation, strong customer positions, high win rates, and an improving budget environment. Rahul will walk through the details of the quarter and full-year financial results. But I want to take a moment to just recap the highlights of the year on slide 4. Communication Systems had a terrific year with revenue up 9% from strength in Department of Defense Tactical and Night Vision. Department of Defense Tactical revenue was up 46% in the quarter and 35% for the year driven by more than $100 million of readiness demand from the Army and the Air Force to support deployment of security forces overseas, with upgraded software-defined radios. Order momentum was even stronger, up 81% for the year to support readiness and the ramp of modernization programs. Notable wins include the first LRIP order for the Army HMS Manpack. Additional orders from the Marine Corps for Manpack radios with MUOS capability, and a $765 million sole-source IDIQ for Navy and Marine Corps Falcon III and next-gen radios, which is double the previous contract and aligned with the budget request for Marine Corps modernization efforts over the next few years. We were also awarded a sole-source five year $130 million IDIQ by the Air Force to develop and produce a handheld video data link radio, which will provide airborne collected ISR information to forces on the ground, representing the successful execution of our strategy to penetrate adjacent markets like Tactical ISR. International Tactical also performed well, with revenue up 10% for the quarter and down less than 1% for the year, as increased demand in the Middle East and Africa supported counter-terrorism activity, as well as the ramp of the Australian modernization program in the Asia-Pacific region offset the expected decline in Eastern Europe. International orders were up 25% in the year, which combined with a robust and diverse pipeline gives us confidence that international will return to growth in fiscal 2019. Overall for the year, Tactical ended the year stronger than we first expected with revenue up 11%, orders up 41%, and backlog up 82% to about $900 million, giving us confidence in continued growth in Tactical and the broader Communication Systems segment in fiscal 2019 and beyond. In Electronic Systems, after a flattish first half due to the ADS-B transition, second half revenue growth accelerated to 9%, with growth across all Electronic Systems businesses and ending the year above the high end of our 5% guidance range. The key driver was long-term platforms like the F-35, F-18, and F-16, which collectively grew by more than 20% as a result of technology upgrades, ramped production, and increased content. Two international programs; UK Robotics and the UAE Battle Management also contributed to strong year-over-year growth in Electronic Systems. Segment orders increased 33% to $3.1 billion with more than $1 billion on the F-35, the F-18, and the F-16 platforms. In June, we were awarded a $400 million sole-source IDIQ to supply Electronic Warfare Systems for international F-16s. That's a key gating item as we work towards capturing an estimated $1.5 billion opportunity. On the F-18, we had our best orders year on record, receiving two awards totaling $320 million to supply electronic jammers to protect U.S. and international F-18s against electronic threats, supporting multi-year growth on this important platform. We continue to make progress on the international pursuits, successfully delivering our first two robotic systems for Explosive Ordnance Disposal missions to the UK Ministry of Defence. Achieving this milestone is important as we pursue other international opportunities in the upcoming U.S. Department of Defense Common Robotic System Competition. We also leveraged our FAA managed services model to capture a 15-year $141 million contract in the quarter to modernize India's air traffic management communications infrastructure, supporting growth in one of the world's largest aviation markets. Overall for Electronic Systems, book-to-bill was 1.3 for the year and backlog increased 30% to $2.6 billion. This combined with the $17 billion pipeline and $4.5 billion in proposals outstanding gives us confidence that revenue will continue to accelerate in fiscal 2019. In Space and Intelligence, revenue was up 1% for the year as growth in classified programs from the ramp of smallsats, ground-based adjacencies, and space surveillance programs offset the expected headwinds on environmental programs. Investments in R&D and innovation ahead of customer needs resulted in double-digit growth in classified orders for the year as we strengthen our global leadership in hosted payloads, increased our share of wallet with existing customers, and expanded our addressable market from components to now full-mission solutions. Orders for the segment grew 6% and book-to-bill was slightly greater than 1 for the year. With about 80% of fiscal 2019 revenue and backlog and high confidence, follow-on opportunities, a $14 billion pipeline, continued strength in classified space, and decreasing headwinds on our environmental programs, we now expect mid-single digit growth for the segment in fiscal 2019. We continue to maintain best-in-class margins and generate a record free cash flow of $915 million, returning about $550 million to shareholders. We also achieved our post-Exelis debt reduction commitment of $2 billion and pre-funded our pension plan to about 90%, with no required contributions until 2025, creating future cash flow flexibility. But our strong operational performance wouldn't be possible without a relentless focus on operational excellence. It's a program we call Harris Business Excellence or HBX. HBX is an integral part of the Harris culture of continuous improvement, and it has contributed to successes across the enterprise. For example, in Night Vision over the last two years, we've improved yield and on-time delivery while lowering cost, resulting in significant margin expansion and double-digit growth. This business has shifted from being a watch area when we acquired Exelis to a growth driver. The improved returns give us the room to increase investment to compete on upcoming U.S. and international modernization programs. On the F-35 program, we've delivered over a million parts with greater than 99.95% on-time delivery, and we've received the Outstanding Supplier Award in our weapons release factory in Amityville. Operational performance and a commitment to innovation have driven increased content per shipset with opportunities to expand further in the future. On the F-18 IDECM program, we have received more than $1 billion in orders to date, we've cut factory cycle time by 10%, and have been recognized by the Navy for maintaining a 100% on-time delivery record over the past 20 years. In Space and Intelligence, you've heard me speak about improved execution on the SENSOR program and we continue to make progress, with on-time delivery increasing from 35% when we acquired Exelis to 90% today, driving 15% revenue growth on the program just this past year. Finally, on GPS III, we've corrected the legacy issues and established a proven and reliable production cadence, delivering the fifth payload in March with numbers 6 through 8 expected by early next year. Now with a recently developed fully digital Mission Data Unit, we're well-positioned for the upcoming GPS IIIF award and maintaining incumbency. Overall, we've had an exceptional year, in which we returned to growth and generated record earnings per share and free cash flow, meeting or exceeding the targets we set for ourselves. For fiscal 2019, we expect to build on that momentum and continue our strong performance, accelerating growth in all three segments, increasing margins, and maximizing cash. For the year, we expect earnings per share of $7.65 to $7.85 on revenue growth of 6% to 8%, and we aim to achieve our $1 billion free cash flow goal. Let me now turn it over to Rahul to walk through our financial results and provide additional details on fiscal 2019 guidance, before I close with a few comments on our medium-term outlook. Rahul?

Thank you, Bill, and good morning, everyone. Starting with total company results on slide 5. As a reminder, discussions today are on a non-GAAP basis and exclude one-time adjustments. Revenue was up 8% in the fourth quarter and operating income increased 11% on higher volume and operational efficiencies, resulting in margin expansion of 50 basis points to 19.6%. EPS grew by 19%, or $0.29, and excluding the benefit of tax reform, was up 12%, or $0.18. Free cash flow was a record $464 million for the quarter. Turning to the full-year EPS bridge on slide 6. EPS grew by 18%, or $0.97. The expected $0.21 headwind from the ADS-B program transition was offset by disciplined capital deployment. Half of the EPS growth was from higher volume in Tactical Communications, Avionics, and Classified Space, solid program execution, productivity, and higher pension income offset by lower environmental volume and program mix. The other half came from a lower tax rate including the benefit from tax reform. On slide 7, Communication Systems' revenue in the quarter was $523 million, up 16% versus the prior year with growth across all three businesses in the segment. In addition to the strong growth of 21% in Tactical, Night Vision revenue was again up double digits as the business continued to improve execution. Operating income for the segment was up 11% to $162 million from higher volume and operational efficiencies. Operating margin remained strong at 31% and orders were up 6%, growing for the eighth consecutive quarter. For the full-year, revenue and operating income each increased 9% with operating margin of 30%. Segment orders increased 28%, book-to-bill was 1.3x, and greater than 1x in each of the three businesses in the segment. We continue to include historical information for Tactical orders, revenue, and backlog as supplemental information at the end of the presentation. On slide 8, Electronic Systems' revenue was $640 million, up 8% for the quarter, driven by growth in Avionics, Electronic Warfare, and C4ISR. Segment operating income increased 14% to $119 million from higher volume and strong operational performance. Orders grew double digits for the fifth straight quarter, up 38% with a book-to-bill of 1.3x. For the full-year, segment revenue was up 5% and operating margin was at 18.6%, as operational efficiencies partially offset the negative impact of the ADS-B program transition, incremental investment, and shift in program revenue mix. On slide 9, in Space and Intelligence, revenue for the fourth quarter was up 0.4% and operating income was up 8% as margins expanded 110 basis points from strong program execution and higher pension income. For the full-year, revenue was up 1% as continued growth in classified programs was partially offset by an expected decline in the environmental program revenue. Operating margin expanded 110 basis points to 17.5%. Switching to guidance for fiscal 2019. We have adopted the new revenue recognition standard ASC 606 using the full retrospective method, effective at the beginning of fiscal 2019. Adopting the new standard requires adjusting the timing of recognition of revenue and associated program cost for a few contracts, treatment of certain expenses, but does not materially impact our total financial results. Our guidance is based on the new revenue recognition standard, and the preliminary recasted historical financials are included as supplemental information on slide 16. For fiscal 2019, revenue is expected to be up 6% to 8% over the recasted fiscal 2018 base, which is $11 million lower than the reported numbers; thus, not a material impact. The growth in the year has been driven by continued Department of Defense Tactical modernization, as well as growth across Electronic Warfare, Avionics, Battle Management, and Classified Space Programs. We expect total company EBIT margins to be between 19.3% and 19.7% from strong growth in higher margin Communication Systems and Electronic Systems segments. Fiscal 2019 EPS is expected to be between $7.65 and $7.85, and includes a placeholder of $400 million for share repurchases and an effective tax rate of 17%. We expect to generate greater than or equal to $1 billion in free cash flow in fiscal 2019, reflecting higher earnings and cash tax benefit from pension prefunding, partially offset by increased working capital, higher capital expenditures, and the timing of tax payments. We ended fiscal 2018 with working capital of 42 days, a one-day improvement over 2017, and 2019 guidance reflects continued improvement in working capital performance. Capital expenditures grew by approximately $35 million to $170 million to support new program starts. We are expecting accelerated growth in each of the segments in fiscal 2019. Communication Systems revenue is expected to be up between 8% and 10%, with Department of Defense Tactical up mid to high teens, Night Vision up double digits, and International Tactical and Public Safety up low to mid-single digits. Modernization growth in Department of Defense Tactical will primarily occur in the second half of the fiscal year as we start to ship Manpacks for the Army and ramp up production and deliveries of handhelds with SOCOM and the Army. Segment operating margin is expected to be between 29.5% and 30.5%, reflecting the dilutive margin impact of new program starts and incremental systems work that is more than offset by the benefits from operational excellence and fixed cost leverage from higher volume in the Rochester factory. Electronic Systems' revenue is expected to be up between 7% and 8%, driven by strong growth in Avionics and Electronic Warfare as fiscal 2018 backlog converts to revenue, and the continued ramp of the UAE Battle Management program. Segment operating margin is expected to be between 18% and 19% as growth from lower margin program is offset by operational excellence. In Space and Intelligence, revenue is expected to be up between 4% and 5%. Classified business representing about two-thirds of the segment is expected to grow high-single digits, partially offset by continued modest weakness in environmental programs, which we expect to reach a trough this fiscal year. Segment operating margin is expected to be between 17% and 18%, reflecting the volume increase and operational efficiencies. Fiscal 2019 EPS bridge on slide 11. EPS is expected to grow between $1.15 and $1.35 from higher volume across the three segments; operational efficiencies, lower tax rate including the benefit of tax reform, and accretive capital deployment. With that, let me turn it back to Bill for closing remarks.

Okay. Well, thank you, Rahul. I want to close with a few comments on our multi-year strategy, including the growth outlook for the medium-term. As we recap on slide 12, in recent years we reshaped our portfolio to focus on high-growth, high-margin businesses, successfully integrated Exelis, and made disciplined investments in the business that led to several new product launches and strategic program wins. We also de-risked the balance sheet to give us more financial flexibility. Fiscal 2018 was an inflection point for Harris as we returned to growth and grew backlog significantly. This combined with a more favorable budget environment, especially in strategic growth areas, positions us well to accelerate growth in fiscal 2019 and in the medium-term. At this time last year, I laid out the medium-term growth drivers by segment that is shown on slide 14, and over the past year we've seen the outlook improve in each of them. Communication and Electronic Systems are now expected to grow high-single digits and Space and Intelligence at mid-single digits, the higher end of the medium-term range for all three segments that we indicated this time last year. In Tactical, we're beginning to see the Department of Defense modernization ramp across all the services, and International has stabilized and is returning to growth as we leverage our incumbency and large installed base and benefit from higher defense spending by coalition partners. In Electronic Systems, Avionics and Electronic Warfare are entering a multi-year growth cycle, driven by our position in long-term platforms. In Space and Intelligence, classified growth will accelerate as we maintain high win rates and expand into adjacencies in a growing budgeted environment, and the headwinds in the environmental business are now becoming tailwinds. We've been on a multi-year journey to improve margins. While we made progress in driving productivity and efficiency in recent years, I see much more opportunity in front of us. We're now halfway through standardizing our systems that will reduce the number of ERP platforms from 28 to 3, simplifying our operating environment, driving productivity through growth and shared services, automating core processes, and laying the foundation for our enterprise-wide digital strategy. By the end of this year, we will have eliminated 80% of our data centers. By fiscal 2021, the remainder will be fully cloud-enabled. We recently hired a new Chief Technology Officer who is fundamentally reshaping how we design and develop new products to get more out of every R&D dollar we invest. We're fully deploying DevOps to streamline software development, which is going to be more than 40% of our engineering work today, and is expected to increase over time. We continue to squeeze more cost savings out of our supply chain through value engineering and should-cost analysis on new products, and improving supplier performance and reducing sole-source components on legacy solutions. Taken together, this relentless focus on operational excellence, combined with the leverage on incremental volume, will drive margin expansion in Communication and Electronic Systems, as well as for Harris as a whole. In summary, we expect higher revenue, higher margin, double-digit earnings per share growth, and sustained cash generation through the medium term. With that, I'd like to ask the operator to open the line for questions.

Good morning.

Good morning, Rob.

I just had a couple of program-related questions. First, on the Electronic Systems segment, the midpoint of your margin guidance would be flattish with 2018. I think you called out some lower-margin programs perhaps being offset by operational improvement. What are some of these lower-margin programs, or the mix shift that you see here?

Well, I think, first I'd say on 2018, we ended the year at 19.2%, and we were guiding to 19.3% to 19.7%. At the center point, we're up about 30 basis points before the revenue recognition goes in place, and 50 basis points including revenue recognition. But as we've seen growth in our segments, especially in our Space and Environmental and our Electronic Systems business, some new wins—like a classified business—is coming in at lower-than-average segment margins, and that's growing pretty healthily, which will bring down the SIS segment a little bit, again, offset by operational excellence. Of course, over in the Communication Systems segment in Tactical, as we see the ramp of modernization programs, as we've said before on this call, we'll see those programs coming in at slightly lower than segment or normal Tactical margins, but improving over time as we continue to take costs out of the products, as we've done many times in the past.

Okay. And on the F-35, you talked a little bit about higher content as one of the drivers there. Lockheed's been doing some things with the suppliers in order to pursue lower costs and better value, at least on things that are not life-of-program. Are there further opportunities or risks for your packages on the aircraft?

You know, Rob, we see more opportunities than risks, though there are some risks that remain today. We're about $2.2 million per shipset. Either we provide the material or we provide the common components. We have the bomb-release system and the carriage-release system. We recently won, over the last year, the PCD EU, as well as the Aircraft Memory System. One thing that's coming up is the ICP, the Integrated Core Processor or the Mission Processor, which will probably be awarded sometime later this year. We're one of three companies that are in the hunt on that. Over time, I think you've heard Lockheed talk about what they might do on the ICNI as well as on the EW platform. Given our progress so far on EW and the work we've done through software-defined EW—a big investment over the last several years, with small size, weight, and power systems, and real improvements in cognitive algorithms—we think we'll be a player there if they decide to move down that path and re-compete that. So, as I look at F-35, both volume and content per shipset are set to grow over time.

Okay. Thanks very much, Bill.

You bet.

Thanks for taking my question. Good morning.

Good morning, Dave.

Bill, you talked, I think, again about $4 billion in outstanding bids at Electronic Systems. Could you just talk about, obviously, the big ones, the chunky ones and the timing around those when you would expect to hear on those?

Yeah, there's certainly a big piece of it is going to be some opportunities we have with the FAA, which is a bridge contract on the FTI program. We should expect that over the next couple of months; that's going to be an important one. But there's a lot of other activities including some that I just mentioned on the F-35. There are opportunities on F-16. There are opportunities in the near-term pipeline on robotic systems, especially as we extend that platform beyond the UK into other international markets as well as the U.S. DoD. So, it really goes across the gamut of what's in the Electronic Systems business. I don't know if you have any other color, Rahul?

The only other thing I would add to that, Bill, is we've been talking about the UAE program, David, and a lot of bids that are outstanding to expand that program further not only with the land forces but even beyond that within the country.

That was a $189 million program in the UAE, and we're coming up very close to a mission readiness exercise in the next month or two which has gone exceptionally well. As that goes well in the August-September timeframe, I would also point out that there's a big opportunity ahead of us in the UAE.

So, in terms of percentage, are you going to hear—on the $4 billion, would you hear 75% of that this year, or is—kind of ballpark how much are you, what percentage you expect to hear on this year?

I think the bulk of it we should hear within the next year, yes.

Okay. All right. Bill, you outlined the potential for margin upside between volume and productivity and various other things. Currently, the businesses as a whole are running around 22%. Would you care to frame kind of the margin upside potential you're thinking about here?

When I look at it—let me take it from the Harris-wide perspective, you're talking about the segment operating margin or segment EBIT margin. This year, we're going to be—again, the center point of our guidance is 19.5%. So, that's up on an average about 30 basis points over reported 2018, a little bit more than that when you look at the revenue recognition restatement in 2018. If I go out in the 2019—into fiscal 2020, I think we should be approaching, if not hitting, 20%. We believe with the maturity of our operational excellence program, some of the actions, the steps we're taking today, and the way we're going to take costs out of new product launches like in Tactical over the next 12 to 18 months, we're pretty confident of margin expansion in 2020 and beyond.

Great. I'll get back in the queue. Thanks.

You bet, David.

Hey, good morning. It's Gavin on for Noah.

Hey, Gavin.

So, having taken up the revenue guidance in all three of the segments, just how should we think about how much visibility you have into that over the next few years? How much of that is already in backlog given you've had bookings well above revenue in the past few years, or how much of that is contingent upon further budget growth?

When we look at going into next year, again, we're guiding to 6% to 8% revenue growth. We ended the year with very strong backlog growth. As I look into next year, Harris as a whole—and I'll really keep my comments specific to fiscal 2019—we have about two-thirds of our revenue that's covered either in backlog or in high probability follow-on opportunities, which is up from where we were last year. It's up pretty substantially in the Communication Systems business, as well as the Space and Intelligence segment. We think just based on where the backlog is, the pipeline we have, and the bids that are outstanding, I see more visibility on revenue in fiscal 2019 than we had going into 2018 a year ago.

Okay. And then on the long-term outlook for Manpack, I'm just curious if you could update us on how much you think of the IDIQ might be exercised. Do you think you can get more than 50% share, and if so, what do you think your share could ultimately be on that program?

Look, we've been running historically over the last five to ten years at a much higher share than 50%. So, we would aspire to have our fair share of that market, which would be more than 50%. The funding lines for Tactical as a whole are actually quite strong. They're up in the fiscal 2019 NDAA from 2018, and 2018 was up about 17% to 20% from fiscal 2016, and they're growing to about $1 billion or $1.2 billion a year over the next several years. The funding that's supporting the overall Tactical business is very, very strong, including the HMS Manpack. We did have a delivery order, an LRIP delivery order for 1,129 units out of a 32-unit delivery in fiscal 2019. We expect to see another LRIP order probably in the back half of our fiscal 2019 of some size, leading into operational testing in fiscal 2020. It's all playing out, I think, very well. It's moving forward as we'd expected, the budget is there, and the Army is moving the program. I think we have very good news not just on the Army Manpack, but on all the Tactical Radio programs as a whole.

Great. Thank you.

You bet.

Hey, good morning, guys, and nice results again.

Hey, good morning, Carter. Thank you.

Bill, I wondered if you might expand a little bit on just the thought process around the R&D pipeline. Obviously, your IRAD investments have paid off, and I just wonder if you think about the incremental dollars and opportunities that you have in that pipeline, is your thought process around these things changing? I mean, you've obviously had a lot of success; just help us with the mindset around what else may be out there given the success you've seen already.

Well, it's a very good question, Carter, thank you. In fact, having a new CTO on the team over the last year is really helping us dig in a lot more into where we're spending our money and where we shouldn't be spending our money going forward. You're right; over the last couple of years we've raised our investment in IRAD. This year we closed at just over 5% of revenue, which is above where everyone else in the segment, the peers happen to be. It's going to go up again a little bit in fiscal 2020. When tax reform was enacted, we took our fiscal 2018 number up about $20 million because we saw new opportunities in things like robotics that we invested in. We continue to look at how we spend money, we look at the return on different programs, and we look at how we leverage capabilities across the company. Lots of places around Harris invest in various features of software or waveforms, and we're thinking about how do we leverage the investments we have across the company in a more productive way. So, that's one of the things our CTO is helping us think about. As I go out a year or two or three from here, I don't think we'll be substantially higher than a percentage of revenue. So, I see it neither as a margin drag nor a tailwind on our margins. But if we continue to find good opportunities to invest, to invest ahead of the curve, invest ahead of where the customer is going to go. As you've looked at the results we're calling out today and the very good growth, it really does come from some of the IRAD investments we've made in the last three or four years.

Is there a way to increase the velocity of the opportunities that you're identifying down at the segment level so you can deploy more dollars in that direction?

Well, that's certainly something we're looking at very carefully and something that we're focused on as an organization. Certainly, as you deploy tools like DevOps, it's going to help you develop products which have significant software content faster. The concept is basically being able to continuously integrate and test software builds so that you always have a software feature that you can field in the market, and that is something that we have not developed; a lot of the defense companies have not. That is going to compress the cycle time for software pretty substantially. We've seen that in multiple cases where we deployed DevOps. As we go out the next two years to three years—by fiscal 2021, we think 85% or 90% of our new starts will be on DevOps, and I think that's going to be a key thing to compressing our overall cycle time in developing and launching new products, Carter.

Carter, I just wanted to add to what Bill said. To give you an example or a couple of different examples, a lot of—like if you take Communication Systems as a segment, we've been investing a lot in hardware over the last couple of years with SOCOM and the Army all the products coming on. So even that is kind of coming to an end at this point, with SOCOM Manpack being one big program that is going to work next year. So, a lot of the attention now is going to shift to waveforms and the software that goes onto those radios, and how do we monetize that revenue stream as we've done previously with the MUOS waveform. So, there's a shift of where we're spending the dollars occurring as well within our R&D space.

Thanks. Good morning, guys.

Hey, good morning, Gautam.

Just a couple of questions. I was hoping you could kind of update us on the pipeline at Tactical RS, DoD International and if you can call out any larger campaigns that you’re pursuing?

Sure. Yeah. First, on the international side, pipeline is actually still very good. It's about $2.3 billion, it's still about the same where we were last quarter. The makeup really looks about the same, about 50% is Middle East and Africa. Iraq remains a big opportunity. It was pretty substantial in 2018. It will be substantial in 2019 and beyond. So, there are really good opportunities there. About 30% is in Europe, and we're starting to see a little bit of a shift from Eastern Europe to Western Europe from countries like Poland and Romania to NATO countries, so in Western Europe there is still a little bit of a shift. The balance is going to be in Asia, Central and Latin America, and a little bit in Canada. In Asia, we see Australia with some additional opportunities on the rise and other smaller countries in Asia. In Central America, we see Mexico as a bigger opportunity in 2019 than we had in 2018. Overall, the trends I think are very positive in the International. We ended up having a good year in fiscal 2018 in International, a little bit better than we thought, down less than 1%, and a little bit better in Europe than we had anticipated at the beginning of the year. So, played out a little bit better than we had thought. I think we'll be back to low-mid-single digit growth in fiscal 2019. Do you want to cover the DoD?

Yeah, the DoD, Gautam, the DoD Tactical, it has actually grown since we last spoke. The DoD Tactical pipeline is now $1.7 billion, which includes about $400 million to $450 million of the modernization pipeline and about $1.2 billion to $1.25 billion on the base side.

Right.

Okay, that's very helpful. And just curious if you've seen any sort of potential blowback from some of the more challenged relationships the U.S. has with NATO allies; is there any—can you talk about your incumbency there and how difficult it is for some of the NATO allies to switch away from the Harris radios that they've already purchased in? I'm just curious, is there any potential blowback from the friction we're seeing where they may prefer European suppliers or what have you instead?

Gautam, it's interesting. I see—we've seen no blowback; in fact, I would say it's going in the other direction. We're seeing more opportunities than we've seen in the past with NATO countries. I think it's turning out to be a little bit more of a positive than a negative in lots of ways. We are seeing coalition partners, NATO partners stepping up with more defense spending, and we do see opportunities that are increasing for Harris on the Tactical Radio side, not decreasing.

Okay. And just one last one from me; you guys have been repurchasing quite a bit of stock, raising the dividend, repaying debt. How does this M&A fit into your medium-term plans, if at all?

Well, look, I mean I think you pointed out. We've done a lot of good things on the balance sheet. We'll generate a $1 billion in cash this year. We've been paying a dividend that's just under $300 million; we'll evaluate that at our August board meeting and decide if there's an increase and to what extent. We have a placeholder out there for $400 million worth of buyback, we have $300 million of debt that's due at the backend of the year. Over the course of 2019, we're going to evaluate that $400 million share buyback placeholder as to whether it's the best place to buy back our stock or to look at M&A. Certainly, as we get beyond 2019 when we really step up more on free cash, you won't see any drag on debt repayments go to zero. We're going to generate more free cash and have more optionality on that cash for M&A. So, look, we're going to build our strategic pipeline on M&A and are looking at a variety of different opportunities, all within core segments, and that will bolster our ability to compete. But nothing more to report on today. Certainly, with the way we executed on Exelis and how we transformed the business at Harris, I'm very confident that any deal we do would be accretive and would be effective when we execute it and would be strategic to the company.

Thank you, guys.

You bet, Gautam.

Hey, good morning, everyone.

Hey, Jon. How are you doing?

Jon, can you step us through some of the cash building blocks heading into next year? You went through a couple of them in your prepared remarks, but can you just sort of narrow in on things like working capital, cash flow; headwind versus tailwind? And then also, I know you mentioned CapEx, so a little bit more on cash building blocks towards the $1 billion? Yeah, absolutely. Jon, so in 2019, our net income is up about $140 million, and we get the cash tax benefit of about $90 million from the pension funding that we did or prefunding that we did back in 2018, and that's getting partially offset by an increase in working capital of about $30 million to $40 million. As I mentioned in the prepared remarks, our days came down by one day, but we still—we still see some drag on working capital. So, there is about $35 million of CapEx growth, and it's primarily to fund new program starts like the FTI India win that Bill mentioned. Our ERP investment is a multi-year investment; it's a little bit of a step-up in that as well. Classified wins that we got in Space this year required a little bit of CapEx. So, it's about $35 million growth in CapEx. And then there's some cash tax refunds that we got in 2019 from old payments in fiscal 2018 that we discussed earlier, and that's a headwind as well and that won't repeat. So, you put all that together we feel good about the $1 billion, but as we look further out, Jon, and look into fiscal 2020, the big one-time item that we have in fiscal 2019 is this $90 million of cash tax benefit from pension prefunding. As we look at fiscal 2020, we think there are several offsets to that, the biggest being we have not yet recovered the Exelis restructuring outflows that we had from the government. It's a proposal restructuring proposal, it's a multi-year approval process and we start recovering all the money that we have previously spent and we recover that through our cost-plus program. So, there's a little bit of outflow in Exelis restructuring that still happens in the $10 million to $15 million range that kind of goes away. We do think that CapEx is a tailwind in fiscal 2020, because a lot of the program CapEx will be kind of behind us also the ERP implementation starts winding down. We're working on several other cash tax savings projects that we've kicked off this year and those will start delivering results in fiscal 2020. So, put all that together, there's enough to offset the $90 million of one-time benefit that we'll get in fiscal 2019 and then earnings drive cash flow growth in 2020 and beyond.

Got it. That's very, very helpful. And then just on the investment decisions. Bill, thank you for all the color you offered earlier in the call. Can you just offer some perspective on what role the customer is making or playing in driving those decisions? Do you sense that customers are desiring to see more investments upfront that you can then deliver a more mature product at the other end? Just kind of curious what the customer conversations are like when it comes to approaching CapEx and R&D investments.

Well, it's a very good question, Jon. It's been a multi-year push by our DoD customers for industry to step up in R&D. I think we heard that message and demand signal. We started to step up on this four years or five years ago, and I think that's paying some dividends today. We don't make investments in R&D internally without really understanding the business case, and understanding where the customer is going. The messages that we're hearing from them shape our internal investment pipeline accordingly. It's all very well connected to where we believe the customers are going. Input from them, and I think the fact that we've been willing to step up internally has paid dividends for us. You see that very clearly upon what's happening in Electronic Warfare, which was under-invested by Exelis, we stepped up dramatically in Electronic Warfare, and now we have not only positioned ourselves to retain our strong platform position on F-16, F-18, and B-52 but also now we're starting to get into the mix for re-competes on fifth-gen aircraft and proprietary platforms that are being envisioned down the road. I think that's a good example of where we're hearing the message, shaping our investments, and investing smartly on behalf of shareholders. So, I think it's all pretty tightly connected. Again, our new CTO is going to help us shape it even further in the next couple of years.

Thank you.

You bet.

Good morning. Thank you.

Good morning, Sheila.

Just on the medium-term target, there's solid growth outlook across the portfolio. I guess, how do you think about biggest risks, whether it's budget-related or maybe tied to operational pursuits in the pipeline?

It's a little bit difficult to hear, but I think you're referring to the medium-term outlook. First of all, the budget is going to be an important driver of that. What I've seen very positively in the NDAA, which passed the House, is supposed to be in the Senate this week, which could be signed by the President before we even get out of fiscal 2018, which would be pretty unique. I think that's very encouraging to us as well as to all the people who issue procurement decisions in DoD. If the NDAA can get signed that quickly, and maybe even an Appropriations Bill by the end of September, that's even a possibility. These are all very positive indicators. When you look at Harris, I last talked about medium-term growth as mid-single-digit growth plus, I think now it's mid-to-high single digits. Those indicators come through in 2019. It's really across the segments. Very important driver is going to be in the Communication Systems segment, where we see a very strong ramp in DoD in the Tactical Radio business, and we’ve been focusing a lot of commentary around the Army. We see the budgets growing pretty dramatically on the Army over the next four or five years. About $5.5 billion worth of budget available to Harris on the Tactical Radio side to support our business over the next five years. So, this is a very, very encouraging trajectory. We see great progress on some of the platforms in both Avionics and Electronic Warfare. We're starting this big growth. The IDIQ we won on the F-16 EW platform internationally was for $400 million. We booked an award for Turkey in Q4; that was $60 million. We had Morocco before that. We have about a $1.5 billion opportunity that's ahead of us on international F-16s, F-18s, and F-35s, which we believe will grow, and I think we're on the frontend of a nice growth trajectory on the Space Classified business. There are really good growth prospects; much driven by budget growth, but I think a large part is driven by how well we've positioned our portfolio and the differentiators we have in our products and our solutions.

Got it. Thank you, Bill. And then just one more. You mentioned software as a potential opportunity for yourselves and the defense primes. I guess how do we think about software evolving as a contributor to the top-line over time and where are those opportunities?

Well, it's going to be—today, it's more than 40% of the work content we do in engineering. It really is today part of the top line. Five years ago, it would've been half that or 25% of our engineering content. As we go forward, it's going to be more than 40%, it can grow to 50%, 55%, 60%. I think where it's going to contribute to the top line, Sheila, is how good we are at ingesting and maturing DevOps within this company so that we become strategically better than other players in this space. So, we can develop software faster with lower defect rates, and better capability. The more we can do that, that is where I think it's going to contribute mostly to the top line as I see that. I believe over the next four to five years, it will be fundamental to how we and probably other players in the space develop products. A lot of it’s going to turn on software, and I think the best people in this space are the ones that are going to win.

Thank you.

You bet.

Thanks very much. Good morning.

Good morning, Seth.

You mentioned that Space is driving the higher CapEx, and I wonder if you could talk about, if you can at all, what's underlying that. Given that there's been an area of the budget where we’ve seen a lot of additional resources, can you share how you're seeing that play out in terms of what contracts are coming up so far, and what areas are most exciting for you guys? Then maybe to bring it back around to the CapEx, when we look out to fiscal 2020 and beyond, where do you see CapEx overall for the company kind of shaking out?

Well, yeah, I mean, look, on the Space side, there’s very exciting stuff happening. We talked last quarter about a $0.5 billion exquisite win that we have to a prime on a mission that we've had some experience on. It's going to deliver over the next five to six years. Our piece of that is probably more front-end loaded, and there’s some capital associated with that program. We’ve talked over the last year about our positioning on smallsats. We have multiple contract awards on that, and that’s going exceptionally well. There is some capital associated with that. As that matures over the next 12 months or so, there’s lots of other mission areas and components and capabilities that will augment that smallsat mission to which we’re positioning ourselves. It’s all very exciting. Space superiority is a huge growth driver for the company. I talked about our growth in that area being more than 15% this past year. We see that continuing to grow, and we think we're well-positioned for opportunities for ground control systems, as well as space situational awareness. So, lots of areas where we're competing. Regarding optics, there’s a recap of a lot of different capabilities in Space, some are RF-related, and some are optics-related. Those recapitalizations sometimes require additional capital investment, so that all goes together in some of the things we're spending our growth capital on in 2019. As Rahul mentioned, we’re up to about $170 million in 2019. We’ll see that mitigate itself a little bit going into fiscal 2020, probably down around $15 million or $20 million as we get through a lot of this sort of one-time growth capital we see in 2019.

Great. Thanks. And then just maybe as a quick follow-up, Rahul, as we go through the year, anything we should be aware of in terms of the cadence of the sales or the earnings this year?

Our sales are typically a little backend-loaded as you've noted—it's a 48%/52% split traditionally for us. The DoD Tactical, as I mentioned earlier, is a little backend-loaded; the SOCOM and Army handhelds basically don't start until the tail end of Q2. So, December-ish is when they start, and then there’s a ramp in the second half of the year. Then Manpack kind of starts Q2 on our time. So, a little more backend-loaded than typical. But other than that, Electronic Systems and Space should be fairly typical.

We should see the orders that Rahul is referencing on SOCOM handheld and Army handheld more in the front end of the year and with execution delivery, the revenue, towards the backend in Q2 into the back half.

Hey, good morning.

Hey, good morning, Josh.

Bill, you just mentioned the hiring of a new design team, the new CTO, consolidating ERPs, changing some of the way you approach development. What kind of benchmarking have you done for that? What’s the timeline on some of those efforts, and maybe where we would see the impact first?

Well, I think broadly over the last five or six years, as I started to reshape this OpEx program we have at Harris, I've been talking about what I consider to be a good OpEx program, which is a program that delivers 2% to 3% net of cost; so, 2% to 3% savings net of what's given back to the government, net of inflation dropping to the bottom line. We've been running toward the high end of that 2.5% to 3% range really over the last five or six years, and I expect that to continue and maybe even go above that over the next several years. What's driving it is changing over time. Of course, supply chain is important and there's some engineering productivities, labor productivity in our factories, but even through the Exelis integration, we continue to see on top of the savings from the Exelis integration opportunities to just get better every day at what we do, and that's going to be a continuation. So that was from my experience at UTC and what I see other companies doing; I think that is generally pretty good. In terms of benchmarking on ERP systems, it's hard to say, but I can tell you that 20 systems today is too many, and three is about the right number. We've got a government business, a commercial business, and one is fairly unique, which is why we're at three. But really, we’re bringing people into the company in senior roles, either in IT, technology, or other places that have experience outside of Harris to really look at what we do and bring best practices from their experiences here. That is what's providing some shine and light on some new opportunities that really are in front of us. As I said, as I look into the future, I see as much opportunity ahead of us as I've seen we captured in the recent past. The ground is pretty fertile for continuing to get better and drive efficiency and productivity across our business in the next couple of years.

Okay. Great. And then just with the new medium target—medium-term targets, can you update us on the Rochester facility utilization, and maybe where you see that utilization going over the next two to three years? I know you just mentioned in the previous question some opportunities in optics; does that change the paradigm at all?

It doesn't, no. I mean in fact in our Rochester Tactical, we've got multiple facilities up in Rochester, and on the tactical side, we've been running in the low 60% utilization. There are plenty of opportunities to grow in that Rochester facility without any additional capital; it's about six years old. But even there, as we go to multiple shifts, there are opportunities to do something different with some of the components we make there. So, I see no capacity limitations on the rise in our Rochester Tactical facility. For that matter, I really don't see them in any other facilities we perform a lot of optics work at some other things up in Rochester. I don't see any limitation there. I think the spike we're seeing this year on capital is really on specific programs and program capital, not on infrastructure capital.

Thanks so much. Good afternoon. Good morning, sorry.

Good morning, Rob.

I'm going to Slide 13 and the medium-term guidance, Bill. It may sound a bit pedantic, but your commentary said you expect the revenue growth rate to accelerate up to high-single digits. Well, you're kind of going to get there in 2019 if everything goes to plan. Do you see the potential to go faster than what you're guiding to in 2019? In relation to that, how sustainable do you think this sort of growth rate is—is it a one or two years and it slows, or do you see this as being a three-year, four-year, or five-year affair?

Well, first, on that slide, the Electronic Systems and Space and Intel, there is an acceleration from what we see in fiscal 2019 or in fiscal 2018. So there's some acceleration there. We see Communication Systems and Communications to continue to be at a high-single digit range. Frankly, I think as I look back on 2018 and where we started our guidance on 2018—keep in mind we started, I believe it was 15% or mid-teens on DoD Tactical. Then we went up to 20% or low-20s%, and we ended at 35%. I'm not so sure I'm really sort of calling it accurately. I think we're being more conservative than aggressive in our assumptions and hopefully with the same place today in 2019, and hopefully beyond there as well. As we see opportunities placed on order a lot faster than we saw over the last couple of years, and this is a pretty remarkable phenomenon. Orders are being placed; dollars are being obligated at a much faster rate, not just in DoD but also in the intelligence community, certainly from where we were a year or two ago. That’s been a very positive surprise. The NDAA getting approved out of the House and maybe even getting approved by the President before we hit September is pretty unique. When things like that happen, it gives encouragement to people who issue procurement decisions to obligate dollars faster. Their confidence goes up. I continue to see opportunities in 2019 and beyond, so what's medium-term? Medium-term to us is three to four years. Looking at our positioning, the amount of unused dollars that are not yet committed, where the budgets are growing, and what we see in the budget that we can actually see over the next five years, there’s a lot of opportunity to continue really robust growth across Harris going out in that three-year, four-year, five-year period, Rob.

Thank you, everyone, for joining the call this morning, and please do not hesitate to get in touch with me for any additional questions. Have a great day.