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Edited Transcript of LHX earnings conference call or presentation 31-Jul-19 12:30pm GMT

Q4 2019 L3Harris Technologies Inc Earnings Call

MELBOURNE Aug 5, 2019 (Thomson StreetEvents) -- Edited Transcript of L3harris Technologies Inc earnings conference call or presentation Wednesday, July 31, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Anurag Maheshwari

L3Harris Technologies, Inc. - VP of IR

* Christopher E. Kubasik

L3Harris Technologies, Inc. - Vice Chairman, President & COO

* Jesus Malave

L3Harris Technologies, Inc. - Senior VP & CFO

* William M. Brown

L3Harris Technologies, Inc. - Chairman & CEO

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Conference Call Participants

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* Carter Copeland

Melius Research LLC - Founding Partner, President and Research Analyst of Aerospace & Defense

* David Egon Strauss

Barclays Bank PLC, Research Division - Research Analyst

* Gautam J. Khanna

Cowen and Company, LLC, Research Division - MD and Senior Analyst

* George D. Shapiro

Shapiro Research - CEO and Managing Partner

* Jonathan Phaff Raviv

Citigroup Inc, Research Division - VP

* Joshua Ward Sullivan

Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst

* Michael Frank Ciarmoli

SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst

* Noah Poponak

Goldman Sachs Group Inc., Research Division - Equity Analyst

* Peter J. Arment

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Richard Tobie Safran

The Buckingham Research Group Incorporated - Research Analyst

* Robert Alan Stallard

Vertical Research Partners, LLC - Partner

* Robert Michael Spingarn

Crédit Suisse AG, Research Division - Aerospace and Defense Analyst

* Seth Michael Seifman

JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst

* Sheila Karin Kahyaoglu

Jefferies LLC, Research Division - Equity Analyst

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Presentation

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Operator [1]

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Greetings and welcome to the L3Harris Technologies Fourth Quarter Fiscal Year 2019 Earnings Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host for today, Anurag Maheshwari, Vice President of Investor Relations. Thank you. You may begin.

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Anurag Maheshwari, L3Harris Technologies, Inc. - VP of IR [2]

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Thank you, Dana. Good morning, everyone, and welcome to our fourth quarter fiscal 2019 earnings call. On the call with me today is Bill Brown, CEO; Chris Kubasik, COO; and Jay Malave, CFO.

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 our 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 where a replay of this call also will be available.

As supplemental information for investors, discussions also will include selected L3 and Harris combined financial information, which combines their historical operating results as if the businesses had been operating together on the basis of a newly announced 4-segment structure during prior periods, but excluding the operating results of Harris's Night Vision business and L3's divested businesses.

With that, Bill, I'll turn it over to you.

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [3]

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So thank you, Anurag. Good morning, everybody. I'm excited to welcome you to our first ever L3Harris Technologies earnings call. I'm also pleased to welcome our new Chief Financial Officer, Jay Malave, who joined us on July 1 from United Technologies, where he most recently was CFO of Carrier. Prior to that, Jay spent more than 20 years in the aerospace businesses including as CFO of United Technologies Aerospace Systems and working the integration of the Goodrich acquisition. Many of you know Jay from his time leading the Investor Relations function at United Technologies, and I'm thrilled to have him on board and confident he will be a strong business partner to me, Chris and the rest of the management team.

As you're aware, on June 29, in fact, in minutes after we ended Harris's fiscal '19, we successfully completed the transformative merger establishing L3Harris Technologies, and we really hit the ground running. On the first working day after closing, we consolidated headquarters activities between Harris and L3 and announced our new organizational model, creating 4 mission-focused segments that combine the top talent of both companies.

In the first week, we completed 115 town halls with senior leadership touching 80% of all employees. And then in the second week, we held a multi-day leadership meeting where Chris and I shared our joint vision, values and operating philosophy with nearly 100 executives and have set out our initial game plan. And I have to say that the level of energy and excitement across the company is extraordinary.

So we're off to a good start as a combined company, we'll talk more about that in a few minutes. But let me first begin by providing an update on Harris's fourth quarter and fiscal '19 results, followed by Chris with L3's Q2 and first half results and then Jay with combined L3 and Harris financials and guidance.

So starting with Harris on Slide 3. We ended fiscal '19 on a high note with fourth quarter non-GAAP earnings per share up 39% on revenue growth of 12%, the highest top line growth we've seen in 8 years. Overall, the company margin in the fourth quarter expanded 80 basis points to a record 20.2%.

These results cap an exceptional year in which we accelerated revenue growth and had margin expansion in all 3 segments. We outperformed on all guidance metrics, and we delivered a record earnings per share of $8.29, up 30%, and free cash flow of $1.055 billion. Total company book-to-bill was 1.1 driving funded backlog growth of 12% and setting us up for continued top line growth. All 3 segments contributed to our strong performance driven by their top line growth, which continued to exceed expectations.

Let me take a few minutes to recap some of the highlights on slide -- of the year on Slides 4 and 5 with additional segment detail in the appendix.

Communications Systems had a terrific year, with revenue up 14% from solid growth in DoD Tactical and Public Safety. DoD Tactical ended the year with revenue up 31% from last year and up 80% from fiscal '17. This strong growth was driven by nearly $300 million of modernization demand from the Army, Marine Corps and SOCOM as they embark on a multiyear upgrade cycle.

Modernization order momentum continued in the quarter with the Army awarding us a second HMS Manpack LRIP order, followed in July with the release of the 2-Channel Leader Radio RFP.

We also continue to execute well on our strategy to penetrate adjacent airborne markets and were awarded the initial prototype phase of the Air Force's airborne high-frequency radio modernization program, expanding our leadership in HF from ground to airborne.

International Tactical performed as expected, and revenue was up 3% for the year driven by the ramp of the Australia modernization program, early adoption of multichannel products in Canada and Western Europe and ongoing counterterrorism support in Africa. Overall, Tactical ended the year stronger than initially expected with revenue up 14%, book-to-bill of 1.1 and backlog up 17% to $1.1 billion. This, combined with the well-supported DoD budget request, increasing international demand for 2-channel radios and executing on expansion into adjacency gives us confidence in the continued growth trajectory in Tactical for the second half of the year and the medium term.

In Electronic Systems, revenue increased 14%, the ninth consecutive quarter of revenue growth, ending the year up 9%. This strong performance was driven by sustained growth in long-term platforms, F-35, F/A-18 and F-16 and more recently by growth on B-52 and SOCOM rotary aircraft, all of which collectively grew double digits as we leverage technology upgrades and ramp production.

Orders were strong in ES, ending the year at nearly $3 billion in bookings with 2/3 from the avionics and electronic warfare franchises as we continue to leverage our long-standing customer relationships to solidify our position on new and long-term platforms.

In April, we received a 100 -- a $340 million award for F-35 release systems supporting LRIP 12 through 14, which means all of our F-35 production content across avionics and release systems is now under multiyear contracts, which increases medium-term visibility.

We also received a $72 million production order to deliver upgraded countermeasure electronic warfare systems for the B-52 platform, bringing that program's current value to over $430 million against a $1.3 billion total opportunity.

This order momentum, along with our investments in innovation, increased content on existing platforms and expansion onto next-gen platforms will drive a multiyear growth cycle in avionics and electronic warfare.

In Space and Intel, revenue was up 8% for the quarter and the year, well above our initial expectation of 4% to 5%, driven by mid-teens growth in our classified business.

Order momentum was even stronger as we saw continued success in strengthening incumbent positions and expanding the addressable market of our classified business by providing end-to-end mission solutions and penetrating new adjacencies.

I'm also pleased with our relentless focus on operational excellence, which drove margin expansion across each of our segments, despite the mix challenges that come with new program starts.

Our operational excellence program, called HBX, has driven net productivity savings that have more than offset the dilutive margin impact of DoD Tactical modernization and revenue growth on long-term platforms in classified space, resulting in total company margin of 20.2% for the fourth quarter and 19.8% for the year, 90 basis points of margin expansion.

Similarly, our multiyear focus on working capital has delivered terrific results. We ended the year with working capital of 41 days, a 4-day improvement over last year and a 37-day improvement since the Exelis acquisition. Our working capital reduction, combined with earnings growth, resulted in record free cash flow of $1.055 billion, exceeding the post-Exelis acquisition goal of $1 billion by 2019.

Overall, we had an outstanding year of accelerating revenue growth, margin expansion and record EPS and free cash flow, exceeding the targets we set for ourselves. And we'll continue building on this momentum as we go forward as L3Harris to drive continued above-market growth, margin expansion and cash generation, creating long-term value for our shareowners.

Let me now turn it over to Chris to discuss L3 results for the quarter and the first half. Chris?

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Christopher E. Kubasik, L3Harris Technologies, Inc. - Vice Chairman, President & COO [4]

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Okay. Thank you, Bill, and good morning, everyone. Let me take a moment to thank and congratulate the L3 and Harris teams for their hard work this past quarter. Today's results from both companies are due to everyone's focus in the uncertain times leading up to the close of this historic merger.

As Bill mentioned, day 1 was seamless. We rolled out new e-mail addresses to all L3Harris employees, launched a new website and portal that connected the 50,000 employees across the globe and installed new signage at our 50 largest sites.

On the operational side, in the first week, we issued nearly 40 RFPs to our supplier base totaling $900 million in annual spend to start leveraging the purchasing power of the combined enterprise and to work towards our cost synergies goal.

Shifting now to L3 results. We had a solid second quarter highlighted by our consolidated margin and free cash flow, both outperforming the second quarter guidance we discussed on our May earnings call. Margins expanded 160 basis points to 12.2%, and free cash flow was up 38% to $220 million. Non-GAAP EPS was up 18% to $2.91 on 2% revenue growth.

These results capped a strong first half with EPS up 21% on 8% revenue growth. Total company margins expanded 130 basis points to 11.9%, and free cash flow was $365 million or 5x last year's first half as we executed on working capital improvements that resulted in a 12-day reduction over the past 12 months. Orders were up 8%, resulting in a book-to-bill of 1.11, and funded backlog increased 16%.

Turning to the segments on Slide 6. ISR revenue grew 2%, driven by a ramp-up in WESCAM turret systems and the strength of our ISR missionization business as several key programs accelerated, including the Australian Peregrine and the Presidential Aircraft Recapitalization program. This growth was partially offset by lower deliveries of Night Vision products due to export timing. And operating income was up 50%, resulting in margin expansion of 460 basis points to 14.3%. This was due to higher volume, improved contract performance and L365 savings. In the first half, ISR revenue was up 12% and operating income grew 45% with margin expansion of 280 basis points to 12.3%.

In the Communications segment, revenue was flat in the quarter with higher production volume for UAV communication systems, offset by lower volume in the integrated maritime and microwave product sectors. Margins declined by 130 basis points to 7.9% from the dilutive mix impact of the maritime developmental program and the continued investment in unmanned undersea vehicles. For the first half, segment revenue was up 5% with margin expansion of 20 basis points to 9.3%.

Lastly, the Electronic segment's second quarter revenue was up 3% with strong growth in precision engagement systems, which includes the Fuzing & Ordnance business, F-35 display systems and airport security equipment, more than offsetting the expected headwinds in the defense training solutions due to last year's competitive loss of the C-17 training contract and lower volume from commercial flight simulator sales. Margin expanded 10 basis points to 13.6%. And in the first half, segment revenue was up 3% with margin expansion of 10 basis points to 14.1%.

Overall, L3 had a strong first half, tracking above the guidance set at the beginning of the year and ahead of the amounts disclosed in the S-4.

Looking forward, as we announced on July 1 and detailed in the appendix to the webcast slides, we have organized L3Harris into 4 segments that group technologies and capabilities to allow us to compete across multiple missions and domains.

Cutting across these segments, we have business development, operations and program excellence functions to drive further growth while achieving greater cost and operational and programmatic efficiencies. We have worked on the structure since we announced the merger in October and have assembled an outstanding, seasoned and collaborative team to lead the new organization. I'm excited to be part of it and look forward to the work ahead.

With that, I will turn it over to Jay.

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Jesus Malave, L3Harris Technologies, Inc. - Senior VP & CFO [5]

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Thank you, Chris, and good morning, everyone. It's an honor to join the L3Harris team, and I look forward to working with the analyst and investor community once again.

In a moment, I will discuss L3Harris guidance for the second half of calendar year 2019. And as a reminder, we have transitioned to calendar year reporting.

But beforehand, in order to provide context and support for the guidance, I will walk through the L3 and Harris combined financials for the first half of calendar year 2019, which we prepared on the basis Anurag described at the start of the call. And I will also note various drivers and year-over-year comparisons in those results. Similarly, all comparisons included in the guidance discussion are to the comparable prior year period L3 and Harris combined financials.

Okay. Starting with results. In the second quarter, revenue was up 7% and EBIT increased 16% on higher volume and operational efficiencies, resulting in margin expansion of 140 basis points to 16.3%. EPS grew by 27% to $2.42, and free cash flow was $487 million for the quarter.

For the first half, revenue was up 10% and EBIT increased 17%, also on higher volume and operational efficiencies, resulting in margin expansion of 90 basis points to 15.8%. EPS grew 27% to $4.65, and free cash flow was slightly above $1 billion, up more than 50% from last year. First half book-to-bill was 1.07.

Turning to our new segment structure on Slide 8. Integrated Mission Systems revenue for the quarter was $1.25 billion, up 3% driven by strong growth in electro-optical airborne imaging systems and continued strength in the ISR aircraft missionization business including the Australian Peregrine program. Operating income for the segment was up 14% to $158 million from higher volume and improved program performance. Operating margin expanded 110 basis points to 12.6%.

For the first half, segment revenue was up 12%, and operating income increased 17% with margin expansion of 50 basis points to 12.1%. First half book-to-bill was 1.16.

Next is Space and Airborne Systems on Slide 9. Revenue for the quarter was $1.2 billion, up 17% driven by double-digit growth in avionics and electronic warfare from a production ramp and new content on long-term aircraft platforms as well as continued strength in classified space. Segment operating income increased 25% to $225 million, and margin expanded 120 basis points to 18.8% from higher volume, strong program performance and operational efficiencies.

For the first half, segment revenue was up 16% and operating income increased 19% with margin of 18.2%. First half book-to-bill was 1.13.

Switching to Communication Systems on Slide 10. Revenue for the quarter was up 6% from strong growth in DoD Tactical and Public Safety partially offset by lower deliveries of L3 night vision products due to timing and the transitional impact to full operational capability of the UAE Land Tactical System program. Segment operating income was up 10% and margin expanded 80 basis points to 21.6% as strong program execution offset the mix impact from the ramp in tactical radio modernization programs.

The first half, segment revenue was up 12% and operating income increased 18% with margin expansion of 100 basis points to 21.5%. First half book-to-bill was 0.96 and that's coming off a book-to-bill of 1.27 in the last 6 months of 2018.

And lastly, in Aviation Systems on Slide 11. Revenue for the quarter was up 2% as growth in precision engagement, airport security equipment and FAA programs was partially offset by the expected headwind in defense training solutions due to last year's loss of the C-17 training contract and lower volume for commercial flight simulators. Segment operating income was up 11% and margin expanded 90 basis points from better cost management.

For the first half, segment revenue was up 1% and operating income increased 9% with margin expansion of 90 basis points to 10.5%. First half book-to-bill was 0.99.

Okay. Now turning to guidance for the second half on Slide 12. The strong year-to-date performance gives us confidence that we will continue to outperform markets in the back half of the year.

Starting with the top line. We expect second half revenue to be up in the range of 9.5% to 10.5% with strong growth across segment -- all segments. This is supported by high visibility sales coverage from our backlog and high probability follow-on opportunities.

Second half total company EBIT margin is expected to be up approximately 170 basis points to 16.7% from higher volume, operational efficiencies and cost synergies.

EPS is expected to be in the range of $4.95 to $5.05, which reflects higher profit and share repurchases, which we will initiate over the next few days.

As announced on July 1, the Board has approved a 10% dividend increase and a $4 billion share repurchase authorization program, of which, we will utilize $2.5 billion over the next 12 months.

In the second half, we expect to generate free cash flow in the range of $1.3 billion to $1.35 billion reflecting higher earnings and a 1- to 2-day reduction in working capital from June 2019.

Capital expenditures are expected to be $190 million or 2% of revenue in the second half.

For the full year, revenue is expected to be up in the range of 9.5% to 10.5% with EBIT margin of approximately 16.2% and EPS in the range of $9.60 to $9.70.

Full year cash flow -- free cash flow is expected to be in the range of $2.3 billion to $2.35 billion.

Turning to the EPS bridges on Slide 14 and 15. Expected second half EPS at the midpoint of $5 reflects an increase of $0.94 driven by volume -- by higher volume across the 4 segments, operational efficiencies and cost synergies partially offset by the impact of a higher tax rate of about 18%.

Expected full year EPS at the midpoint of $9.65 reflects a total increase of $1.65 with $1.70 driven by operational improvement and cost synergies, an additional $0.17 coming from the elimination of L3 intangible and pension amortization and lower interest and share count partially offset by a $0.22 tax headwind.

Switching to the segment outlook. In Integrated Mission Systems, we expect revenue to be up approximately 10.5% in the second half driven by continued strength in airborne imaging systems and growth in ISR aircraft missionization and maritime platforms with operating margin of approximately 12.5%.

Full year segment revenue is expected to be up approximately 11.2% with operating margin of approximately 12.3%.

Space and Airborne Systems revenue is expected to be up approximately 11.5% in the second half driven by continued double-digit growth in avionics and electronic warfare and strong growth in classified space. Segment operating margin is expected to be approximately 18.7%.

Full year segment revenue is expected to grow approximately 13.9% with operating margin of approximately 18.4%.

Communication Systems revenue is expected to be up approximately 9.5% in the second half driven by strong growth across all sectors with operating margin in the range of 22.1%.

Full year segment revenue is expected to be up approximately 10.7% with operating margin of approximately 21.8%.

Lastly, Aviation Systems revenue is expected to be up approximately 7% in the second half driven largely by continued double-digit growth in precision engagement. Operating margin is expected to be up -- I'm sorry, expected to be approximately 14% from improvements in EDD and productivity initiatives across the segment.

Full year segment revenue is expected to grow approximately 4% with operating margin of about 12.3%.

So to summarize, we expect the first half momentum to carry over to the second half in addition to the benefit from cost synergies, resulting in a strong 2019.

I'll stop here and turn it back over to Bill for closing remarks.

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [6]

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Well, thank you, Jay. I know that's a lot to take in, so let me wrap up with a few comments on the budget and our strategic priorities going forward.

With regard to the budget, I'm very encouraged by the recent bipartisan deal raising the BCA caps over the next 2 years and removing the threat of sequestration. We continue to believe the House and Senate will support increased funding to meet national security demands which are well aligned with our core franchises. And with budget outlays continuing to lag budget appropriations, we expect growth momentum to continue in the medium term.

A few weeks ago, Chris and I aligned with our leadership team on our top strategic priorities, first and foremost being integration and accelerating the capture of cost synergies. We now expect to hit a gross run rate of $150 million by the end of calendar '19, putting us on track to meet or exceed 40% or $200 million of gross savings in calendar 2020.

We're off to a great start on segment and headquarter consolidations and supply chain activities, and we're growing increasingly confident of exceeding $500 million gross cost synergies in calendar '22.

Other priorities include driving operational excellence through our new program called E3, Excellence Everywhere Every Day; establishing a new performance culture building on the strengths of both companies; investing smartly and aggressively in technology to grow revenue and increase share; reshaping our portfolio to focus on high-margin, high-growth, technology-differentiated businesses; and maximizing cash flow that will be returned to shareholders through repurchases and dividends.

Overall, the progress and alignment in the first 30 days has exceeded our expectations, and we feel even more confident in the strategic combination and our ability to deliver shareowner value.

So with that, let me turn it to the operator to open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Robert Stallard of Vertical Research Partners.

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Robert Alan Stallard, Vertical Research Partners, LLC - Partner [2]

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Maybe a quick first question for Bill. There was some commentary at the Paris Air Show that the combined company might be looking at some post-merger disposals, and I wonder if there had been any further thought or development on that front?

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [3]

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Well, Rob, thanks for the question. Yes, it's definitely a key priority, as I mentioned in my closing remarks, in terms of the top priority for the management team. Certainly, as we've talked about before on this call and other venues, a broader mix of businesses gives us an opportunity to take a fresh look at the combined company portfolio and really think about what fits, what doesn't fit. It certainly gives us an optionality to do some things with businesses that we no longer consider strategic. We continue to look at this through a couple of different lenses. Certainly, one is does the business have technology that's required by differentiation? Can we deliver good returns? Can we grow and win, gain share, et cetera? And we're going to evaluate what businesses we're in based on those metrics. We continue to have this dialogue. Chris and I are working very hard on this. We're engaging our new Board on this as well. We're not going to deliberate decisions and discussions in public, but it's really top of mind to us, Rob.

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Robert Alan Stallard, Vertical Research Partners, LLC - Partner [4]

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Okay. Then maybe as a follow-on for Jay, and welcome back. In the free cash flow guidance, there's around $400 million worth of adjustments, and I was wondering how many of these are one-off items in 2019 and won't be repeating themselves in 2020 and beyond.

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Jesus Malave, L3Harris Technologies, Inc. - Senior VP & CFO [5]

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Are you talking in the back half, Rob?

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Robert Alan Stallard, Vertical Research Partners, LLC - Partner [6]

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Yes. It's in the release. There was a reconciliation of the guidance for the full year. We've got $1.875 billion to $1.925 billion and then a number of adjustments that gets you to $2.3 billion to $2.35 billion adjusted free cash flow for the year.

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Jesus Malave, L3Harris Technologies, Inc. - Senior VP & CFO [7]

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Right. So when you look at that, there will be -- we will continue to expect some of the deal -- or integration costs we'll still see going into next year from a cash basis. But let me just take you back to the second half of free cash flow because we expect an uptick in net income. There'll be a little bit of an outflow related to our working capital with a 1- and 2-days improvement, but we're going to try to hold that flat. And we'll see a little bit of a benefit in cash taxes. So feel good about the second half.

And specific to your question in terms of what we see going next year. As I mentioned, there will be some continued costs on -- related to the integration, restructuring-type level costs and those type of items. But beyond that, I don't expect there to be other significant items that will repeat going forward.

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [8]

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I mean, just in a nutshell, I think, for the year, Rob, $260 million of free cash impact from deal and integration costs. We had about $25 million or so in the first half. The $235 million will be in the back half. About $100 million of that, $95 million are going to be deal costs, that's going to be behind us by Q3. The balance is integration costs, we'll see some little drag forward into calendar '20 on integration costs as well.

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Operator [9]

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Our next question comes from Sheila Kahyaoglu of Jefferies.

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Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [10]

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On the deal closing, you guys increased share repurchases and your dividend. How are you maybe thinking about your overall free cash flow target and targeting return to shareholders?

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [11]

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Well, I think, as Jay was alluding to, we feel good about this year in terms of cash generation. We're still targeting $3 billion 3 years out. That's calendar '22. We'll certainly ramp to that. So I think we're off to a really good start in terms of the cash we generated in the first half, LTM cash, what we're going to do this year. So all that's looking pretty good. We ended June on a pro forma basis with $1.7 billion on the balance sheet. We're going to generate about, say, $2.5 billion, more or less, in the next 12 months. So that puts us about $4.2 billion, more or less, of cash available for deployment. Our dividend is about $700 million, $680 million. That's including the 10% increase we did -- that we announced in July 1, that will be enacted here in August. We'll reevaluate that in January, about $700 million in dividend. We have about $300 million worth of deal and integration costs, we just spoke about that, over the next 12 months. We had to fund the SERP and deferred compensation programs. But what that means, it leaves you about $3 billion over that period of time for things to do, $2.5 billion on buyback and about $0.5 billion, Sheila, that's going to be held on the balance sheet just because that's what we require for normal working capital needs.

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Sheila Karin Kahyaoglu, Jefferies LLC, Research Division - Equity Analyst [12]

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Sure. And then maybe just on the margin, the pro forma margin guidance for the total company implies second half margins are up 80 basis points over the first half but just a decent acceleration. Can you maybe talk about the moving pieces? How much of that is coming from synergies versus the underlying business profitability?

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [13]

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Yes. So you're right, Sheila. The first half, on a pro forma basis, up 90 basis points, the second half up 170. So it's up sequentially as well, 16.7%. For the year, about 130 basis points of margin expansion. So at 16% to a little bit better than we had thought when we put the deal together in the S-4. So we feel good about the trajectory.

As we mentioned on the call, about $40 million in the back half is coming from net cost synergies. There's a road map in the back on the EPS bridge, which indicates the absence of L3 intangibles and pension amortization, about another $40 million, $43 million. We see an operational improvement year-over-year in a couple of businesses from L3 including EDD. We see operational excellence savings, which offset some mix, growing some investment in the back half. All of which gets us to about 170 in the back half and we feel it's pretty well calibrated.

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Operator [14]

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Our next question comes from Carter Copeland of Melius Research.

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Carter Copeland, Melius Research LLC - Founding Partner, President and Research Analyst of Aerospace & Defense [15]

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Just a couple quick ones. One, I realize it's hard because we don't have a Harris guide for the next sort of fiscal year out there, but it looks like, on a pro forma basis, the top line that you've put forth for that second half is a little bit ahead of where we may have been on a pro forma basis coming in. Could you just verify that and maybe help us size it?

And then as a follow-on, I wondered as part of the many decisions you made in getting the deal closed and whatnot, where you shook out on things like incentive compensation, not necessarily for the executive team but as you go a layer down in terms of driving the sort of behavior that you want, if there was anything useful or notable to speak about there that will help us understand where your points of emphasis are.

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [16]

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Yes. Sure, Carter. Thanks. So really on the first point, on a combined -- first of all, Harris is trailing a little bit, backtracking a bit better on our calendar '19 in terms of -- versus the S-4 on a combined company basis. For calendar '19 we're about $0.5 billion better. So it's quite a bit stronger than we envisioned late last year when we put out the S-4. But again, as we mentioned at that time, the S-4 was related to strategic plans, which were put together earlier in the year over the summer. And the market has gotten it a bit better. We've won some strategic opportunities. So we feel good about where we're at in calendar '19, a bit better than we started. '20 is looking pretty good as well, certainly with the budget backdrop, strong funded backlog at the beginning -- at the midpoint of the year, so up 15%. So a lot of it's tracking, I think, for really good top line progress.

On the comp program, we're still in discussions with our Board in terms of what we do going forward. But Chris and I -- obviously, there's a short-term plan and a longer-term plan. On a short-term basis, it'll be some combination of revenue, op income and free cash. And since we all know the importance of cash generation, the importance of driving working capital improvements, there's probably going to be a slight tilt towards free cash much like we did a number of years ago at Harris. You'll note, Chris mentioned about the big step-up in the first half in free cash generation, up 5x over the first half of last year. I think 50% of the short-term comp for the L3 executives came on free cash. And we all know, when you incentivize for something, you get results. So that's kind of our thinking on a short-term basis. Longer term, it'll be performance-based equity, that'll be tied to the targets we're discussing with shareowners.

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Operator [17]

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Our next question comes from Peter Arment of Baird.

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Peter J. Arment, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [18]

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A question, Jay, I guess, on CapEx, you mentioned $190 million for the second half of the year, about 2% of revenues. Just thinking about longer term as we think about the forecast period and thinking about your integration period, is that still a good number to go off of, about 2% of sales?

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Jesus Malave, L3Harris Technologies, Inc. - Senior VP & CFO [19]

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Yes, I believe it is, Peter. I mean, 2% this year on a full year basis, that's $380 million, $190 million the first half, $190 million the second half. I think going forward, it feels like that's the right place to be to fund and be prepared for the growth. And yes, I think 2% is what you should go with.

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Peter J. Arment, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [20]

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Okay. And just as a quick follow-up, and I know you're not talking about quarterly guidance here, but just thinking about the second half guidance that you've put out. Is there anything you'd call out regarding 3Q versus 4Q either on the EPS or free cash flow? Just thinking from a modeling perspective for The Street.

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [21]

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Nothing material, Peter. There'll be additional non-GAAP charges in Q3 because of some of the deal and integration expenses. But on a non-GAAP reported earnings per share, revenue growth should all look pretty stable Q3 versus Q4.

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Operator [22]

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Our next question comes from David Strauss of Barclays.

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David Egon Strauss, Barclays Bank PLC, Research Division - Research Analyst [23]

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Welcome, Jay.

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Jesus Malave, L3Harris Technologies, Inc. - Senior VP & CFO [24]

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Thank you, David.

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David Egon Strauss, Barclays Bank PLC, Research Division - Research Analyst [25]

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Bill, you used to have -- in the Harris deck, you had a slide that showed the medium-term outlook by segment. I wanted to see if you might offer -- since we're new to the combined company segments, I wanted to see if you would offer your thoughts on kind of how the growth rates relative to each other among the segments might look going forward and also from a margin opportunity beyond what we're looking at for the second half of '19?

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [26]

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Well, David, I mean it's still a little bit early. I mean we're -- obviously, we just put the company together. It took enormous work to put together pro forma guidance in the back half. So it's a little bit premature to get out beyond that, but maybe just some high-level comments without getting into the segment-by-segment looks here.

For us, I mean, looking at 10% growth in a calendar year in the industry that happened to be in is pretty special. You follow us, you follow others in the space. Looking at 10% in the back half feels pretty good as well. So I mentioned the S-4 is a little dated. We're doing a lot better than the S-4, about $0.5 billion stronger this year. So we're coming off a stronger starting point. In the S-4, I think L3's numbers were growing at 5% to 6%, in that range. We were a little bit higher than that. I see us continuing to grow in that mid- to high single-digit range into '20 and maybe a little bit beyond that. Comes from a good bipartisan budget deal. The top line budget is not growing that much, 3% and basically flat the year after. But the certainty that provides, the funding lines that we see, Tactical, F-35, other places that affect the business look very good and very positive. I think there's a $122 billion worth of appropriations that are out there that -- exceeding the outlays, so those outlays have to catch up. There's just a lot of dry powder in the system that should keep all of the boats moving in the water. And we feel pretty good about the medium-term outlook.

On the margin side, look, ending at 16.2% this year would be a great result. We're on the front end of our ramp on synergies, only $40 million this year, getting to $300 million several years out. That's another 170, 180 basis points. So you can kind of run the math and get to 18% pretty quickly a few years out. And we'll ramp to that as quickly as we can. So as I look out on the back end of the year, we feel great and I think the outlook into -- in calendar '20 also looks pretty good, too.

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David Egon Strauss, Barclays Bank PLC, Research Division - Research Analyst [27]

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Okay. That's helpful. As a follow-up, wanted to ask about the free cash flow cadence beyond this year. So you're guiding to the full year adjusted free cash flow number around $2.3 billion. You've got this $3 billion target for 2022 -- I guess, calendar 2022. And it implies like a little less than a 10% CAGR between here and there, which just seems a little light given what you were talking about from a working capital upside opportunity and synergies. Can you just help square that why it's not a higher growth rate between here and there?

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [28]

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Look, we feel really good about where we ended on an LTM basis on cash. And just for referencing a couple of data points, I mean, Harris, over the last 12 months, was better by 4 days of working capital. So we went from 45 to 41, a day or 2 better than we thought a couple of months ago. L3's results were 12 days better year-over-year in the June-ending quarter. So we're making good progress. Over the balance of the year, we're only looking at another day or 2 between June and the back end of the year, but we're starting from about 75 days pro forma at the end of June. Harris is sitting at 41. I think we got a lot of opportunity ahead of us. Let's get through the next couple of quarters. We'll give you guidance on calendar '20. And certainly, as I look at Chris and Jay, we're all over trying to figure out a way to make sure the cash gets accelerated. That's certainly what we're trying to do.

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Jesus Malave, L3Harris Technologies, Inc. - Senior VP & CFO [29]

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Yes. David, keep in mind working capital is going to want to grow with the increase in volume, so our challenge is going to want to be to take out the productivity in working capital and hold it flat over that period of time.

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Christopher E. Kubasik, L3Harris Technologies, Inc. - Vice Chairman, President & COO [30]

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Yes. I'll just chime in there. We're clearly focused on this, Dave. You've seen the progress, as Bill mentioned, the 12 days. Good news, a lot of that is coming out of inventory, a little bit out of days sales outstanding. So we haven't even really focused on the payable lever. So the teams are working it hard and we're allocating targets right down to the program manager level. Everybody knows what they need to do to achieve these targets.

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Operator [31]

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Our next question comes from Gautam Khanna of Cowen.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [32]

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I may have missed this, but could you talk about maybe some sort of ballpark of what to expect in divestments now that the deal is closed in terms of size, maybe by sales? And I have a follow-up.

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [33]

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No. I don't think we're going to sort of size it today, only because the decisions aren't yet made and we're at the front end of the process. It's going to take some time to get alignment, work the process. And what I'll do, Gautam, as I've done before and I know Chris has done before, is rather than talking about something that we're going to do, I'll talk about what we have done when that is done.

So we don't have a predetermined target for what we're trying to do. Again, what we're looking at is we want to make sure the management team is focused on the businesses that are strategic, ones that are technology driven, have great returns and we can win. And Chris and I have spent a lot of time in the last few months on this. We've worked with our Boards, we've got a meeting coming up in a couple of weeks on this. So we're on it, but I'm not going to size how much the divestiture might be until we really get around to making some decisions around that.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [34]

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I appreciate that. Just a quick follow-up. Tactical Comms book-to-bill ratio looked pretty strong. I was wondering if you could give us some flavor on the 12- to 18-month outlook, the pipeline, international, domestic, and just any commentary you can give around the profit view.

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [35]

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Look, I mean the international pipeline remains pretty good at about $2.5 billion, and the shape of it has not changed a lot. So we had a good finish on international, a good -- basically flattish in Q4. But we had a good year, about 3%. DoD pipeline is around $1.7 billion, so it's up a little bit.

What's interesting is the mix. It's about 50-50 now between base and modernization. As we would have expected, modernization has started to grow. We see that over the course of fiscal '19, it basically tripled in size in terms of modernization. The pipeline is now half modernization and that's backstopped by what is a pretty good budget outlook.

So I've got to tell you, Gautam, we had a good year in Tactical. The guys just did a great job. We were up about 13% this year in calendar '19. It's going to be about 10%, 12% or so, low double digit in the back half. DoD is going to continue to grow pretty well. We see international in the low to mid-single-digit range. So we see continued momentum in this business, and it goes beyond the back end of the year based on what I'm seeing in the budget. So the Tactical business is performing very well as expected.

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Gautam J. Khanna, Cowen and Company, LLC, Research Division - MD and Senior Analyst [36]

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And last one for me, Bill. Any major recompetes you need to be monitoring over the next 12 months?

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [37]

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Any major recompetes? Any recompetes, that was the question? Okay. I think, if it was the major recompetes, we don't really see a lot over the next 12 months. I mean, there's always places that we're bidding and there's opportunities out there, but there's nothing that's really significant.

The one that's really coming to mind is what we call our SENSOR program. It's when we do maintenance for ground-based telescopes, it's about 12 sites around the world. It's a legacy Exelis program. It's $150 million, $200 million a year of revenue. It's under a recompete. But it's one of those programs I feel very strong about from way back when we bought Exelis. It was 35%, 38% on-time delivery. We closed the quarter at around 94%, 95%. Very, very good reputation with the customer. So that's the only one that's jumping off my mind as a recompete that certainly I've got my eye on, but nothing more than that, Gautam. So thanks for the question.

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Operator [38]

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Our next question comes from Michael Ciarmoli of SunTrust.

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [39]

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Nice results. Just on the second half margins, specifically the Aviation segment, I think you've got pretty strong margin expansion in the second half of the year there, looking at 14% versus 10.5%. You gave some initial comments on what's driving that, but can you be a little bit more specific there on the sharp margin expansion in that segment?

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Christopher E. Kubasik, L3Harris Technologies, Inc. - Vice Chairman, President & COO [40]

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Yes, this is Chris. We see an up-ramp from a couple main drivers. If you recall, we have the EDD business in there, which, of course, is a tough compare for '18 compared to '19. So we talked earlier in January about a significant improvement, 40 basis points, from not having the same issues at EDD, which we don't expect to have in '19 that we had in '18.

We have some E3 savings that are pretty significant in the $40 million range and we have a pretty good road path to execute upon those. And we have some growth opportunities in the commercial aviation sector, specifically avionics, that has higher margins in addition to some Fuzing & Ordnance opportunities. All that contributes to the guidance we gave

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Michael Frank Ciarmoli, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [41]

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Got it. And then just bigger picture on the defense budget, I know we've got the 2-year budget deal. But any thoughts on sort of what's taking place now with the expansion of this Night Court process that Mark Esper looks to be implementing. Do you guys see this as a risk or opportunity as you look at the potential pipeline of business versus modernization, legacy? I know funding lines look good now, but it seems like what we saw take place at the Army could be expanding now into the Navy and the Air Force. I'm just wondering how you guys are viewing that process.

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [42]

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Well, look, I think it's still very early. It was only confirmed very recently, but through -- what he did when he was Army Secretary was actually very positive, very productive. I think it's notable that E with Ryan McCarthy, with the chief got together and really prioritized where they wanted to spend limited Army dollars and focused on key priorities and started to move away from things that weren't all that critical. The fact is, I think, between what we do, what L3 does on a combined basis, the fact is we're working on important programs and I think we ended up being -- doing very well through the Army process.

I'd envisioned the same thing over -- across DoD, what he's now going to work on. So the discipline of looking at where they want to spend dollars is important. And I think, based on the things that we're working on, we're going to be -- I think we're going to end up being pretty strong here.

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Operator [43]

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Our next question comes from George Shapiro of Shapiro Research.

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George D. Shapiro, Shapiro Research - CEO and Managing Partner [44]

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I was wondering, Bill, if you could provide a breakdown of your revenues between the O&M budget and the investment budget because L3 had a high percentage from the O&M budget.

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [45]

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Yes. No. On the DoD side, so we're about 55%, 60% DoD and about -- it's about 50-50 O&M versus procurement.

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George D. Shapiro, Shapiro Research - CEO and Managing Partner [46]

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Okay. And then with some of the shorter-cycle businesses that you're in and the flattening of the budget, is there any concern that your growth rate can slow somewhat quickly or more quickly than others with longer-cycle businesses might have? Or you think that you're gaining enough share that we keep going on with better-than-industry growth rates?

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [47]

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Yes. I mean the short-cycle business that we really have talked about in the past, George, is really around the tactical radio business. And that has become -- when we merged with Exelis, it became a smaller piece of the overall company certainly as we improved in the other segments. So it was like 35%, 36% of the legacy Harris company. It's now even smaller as part of L3Harris. But the fact is it is a relatively quick-turn business, but it's a little bit different today than it would have been a few years ago, where today, a lot more of the business is driven by modernization. And modernization has a lot more visibility into it than these quick-turn O&M funded orders than we would have gotten in the past. So I'm not terribly concerned. We had a very, very strong fiscal '19. We had a really extraordinary first half of calendar '19 in DoD Tactical. That will naturally mitigate itself or slow down a little bit in the back half, but it's still very healthy growth, north of 20%. So look, it's a great business. We're across all of the different platforms, different contract vehicles, all the services that we're on the front end of what we believe is a multiyear ramp here, George.

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Operator [48]

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Our next question comes from Rob Spingarn of Crédit Suisse.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [49]

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And congrats on the deal. I just wanted to go back to the guidance, and this really could be for anybody. But Jay, this is the guidance you gave. If I look at the second half revenues, it looks like, in everything but AS, we have a slight decrease in growth. Is that just comps? Or is there anything else going on there?

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Jesus Malave, L3Harris Technologies, Inc. - Senior VP & CFO [50]

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Yes, Rob, some of it is comps. We had -- up -- in the last half of last year was some pretty significant growth rates. But you're talking -- you're kind of splitting hairs. In the Integrated Mission Systems business, it was 12% growth in the first half, and we're expecting around 10.5% growth. So a real slight reduction there. In Communications Systems, we were nearly 12%, we're going to be 9.5% there, close to 10%. And so, yes, I'd say more compares than anything else, but the growth rates are still pretty substantial and pretty significant to support the 10% in the back half. As I said in my comments, high visibility with the backlog. We have 90% visibility in the backlog to the back half, and so we feel really good about going into this next 6 months.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [51]

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And then I guess for the increase in growth in AS, does this go back to the comments that Chris just made about some new programs? Or are there things ramping there?

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [52]

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We're seeing what Chris called the precision engagement systems business ramps a bit more in the back half than the front half. It grew really nicely in the first half, be even stronger in the back. And it's just a lot of classified work that Chris and his team have solidified themselves on plus a lot of Fuzing business for munitions and that op tempo there is pretty high.

We're also getting a little bit better comps on the commercial training business. The defense training business looks a little bit better. The C-17 carries for the full year, but there's F-16 wins that have happened that's going to help mitigate the C-17 loss in the back half.

So really across all the pieces of AS, it just gets better and that's why we're seeing better growth in the back half than the front half.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [53]

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Okay. And then just a clarification, just on the proceeds from the Night Vision sale, just the L3 pension prefunding that I think you were going to direct those proceeds toward. Has that happened? Is that in the op cash flow guidance for this year?

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [54]

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What's going to happen is -- so we're still on track for that. The net proceeds will be about $325 million we expect to get through the process in Q3. It's deep in the [Sitheus] review, and that will be used to prefund the pension. That will basically mitigate any cash contributions on the L3 side to the pension through the next couple of years, I think through calendar -- into calendar '22. So that's like a $70 million, $80 million improvement, if you will, in cash. But remember, Night Vision generated some cash, so there's a bit of an offset. On an annualized basis, that's sort of a $50 million, $60 million net benefit to us on the free cash side, and that is in our guidance.

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Robert Michael Spingarn, Crédit Suisse AG, Research Division - Aerospace and Defense Analyst [55]

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The timing is in the guidance for this year?

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [56]

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It's not in the back half. It's in the outlook as we get into '20 and beyond.

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Operator [57]

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Our next question comes from Richard Safran of Buckingham Research Group.

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Richard Tobie Safran, The Buckingham Research Group Incorporated - Research Analyst [58]

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First, I had a bit of a top level kind of philosophy question here. For lack of a better term, commercial business model has really been at the core of Harris. So what I wanted to ask was how you -- how long you might think it might take to apply that model to the new combined company? How long do you think it might be before we see tangible results? Just interested in any color you could provide there on how you're thinking about implementing that.

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [59]

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Well, it's a great question and it's less philosophical, more financial in the sense of what we've tried to do. And I'll relate back to where we were 3 years ago with Exelis. Exelis manufactured radios in Ft. Wayne. It was under a sort of normal model with cost disclosures, and we moved that up to Rochester. It took us some time, but that's now a full commercial-model business. At L3, WESCAM, the WESCAM business they have is very profitable, nice-sized business, growing very well, great positions around the world. That's a commercial-model business much like what we do on the tactical side. There's a possibility to take the SATCOM business that L3 has, which is very strong, and over time, migrate that to a commercial model. It's something that we'll work on. It may not be a needle mover in the next couple of years. It's something that obviously we're focused on, but I wouldn't say that that's going to be the key driver to margin expansion. It's going to come through operational excellence. It's going to come through synergies. It's going to come through basic better performance in our company. So I mean we're certainly on it, Richard.

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Richard Tobie Safran, The Buckingham Research Group Incorporated - Research Analyst [60]

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Okay. Now just quickly then on the F-35 program, just following up on your opening remarks. Just generally, we've seen a lot of changes among suppliers on the F-35 program. So I just wanted to know, are there still incremental opportunities out there for you on that program? And if possible, in your answer, could you just discuss how your content on that platform has evolved?

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [61]

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Yes, sure. Now, I'm going to quote the number, this is probably just legacy Harris, I'm looking to Anurag and Jay to confirm this. So there's like $2.2 million per shipset today. So we do the common components, we do the MADL system, we do the release systems. So about $2.2 million, that we know is going to grow to about $2.7 million over the next several years. We won 3 different pieces of what they call Tech Refresh 3. So one is the mission computer, called the ICP. There's the Aircraft Memory System as well as the electronic unit, the Panoramic Cockpit Display, PCD EU. And all of those things add together over time to give us another $0.5 billion of content for F-35. So that's going to grow in terms of content per shipset. And it's going to also grow with the ramp, which is why it's an important one for us to keep talking about. As the number of the shipset continues to grow plus our content continues to grow, it's going to continue to be a growth driver for the company.

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Christopher E. Kubasik, L3Harris Technologies, Inc. - Vice Chairman, President & COO [62]

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And Richard, on the legacy L3, as you know, we have the crypto, we have the display. So think of another [$500] or [$600] per shipset as well. And when we put the merger together, we talked about the benefit of scale. I think Lockheed Martin would acknowledge we're one of the top suppliers. It gives you better access to the management team to be a part of the strategy, and we would expect to bid on other components in the years ahead given our scale and investments.

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Operator [63]

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Our next question comes from Noah Poponak of Goldman Sachs.

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Noah Poponak, Goldman Sachs Group Inc., Research Division - Equity Analyst [64]

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In the 3, the $3 billion 3-year free cash flow target, what is the underlying organic business segment? So before -- putting aside anything below the line, putting aside the working capital opportunity and the synergies, just the core newly combined business segment EBITDA growth rate on that 3-year basis that you are assuming in the $3 billion.

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [65]

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Yes, I think top line is around 5%, 6%, a little bit higher than that on EBITDA growth. When we -- it yields about $0.5 billion of incremental net income, thinking about the cash coming from growth over the 3-year period.

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Noah Poponak, Goldman Sachs Group Inc., Research Division - Equity Analyst [66]

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Okay. The 500 -- I guess, $500 million on the new guide -- should I be thinking about that relative to the $2.3 billion, to $2.35 billion. So it'd be kind of 20% of that but over 3 years, so call it a 6% CAGR?

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Jesus Malave, L3Harris Technologies, Inc. - Senior VP & CFO [67]

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Yes. It was off like a $2.0 billion to $2.1 billion free cash basis. So it's going to be maybe a little bit less than that. But yes, it's in about that range, 6%, 7%.

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Noah Poponak, Goldman Sachs Group Inc., Research Division - Equity Analyst [68]

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Okay. And then just to make sure I have the bridge correct working off of this year. In the $2.3 billion to $2.35 billion, how much working capital and synergies in that? It sounded like the 1 to 2 days of working capital is maybe $50 million. And then I thought I saw $40 million of synergy in the deck, but then, Bill, I heard you saying $150 million. I didn't know if maybe that was a run rate number. Can you just clarify those for me?

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [69]

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Yes, sure. So there's $40 million of net synergies in the back half, so it's net synergies in the full year as well, and that drops through into generating cash on an after-tax basis. The $150 million is the run rate we'll be at in terms of cost synergies by the calendar year. So that's the run rate we'll be at, which gives us confidence that we can be at $200 million or so in calendar '20 gross savings dropping through. So that's how we talked about it.

Over the course of the back end of the year, we were -- I think we were around 75 days on a pro forma basis in June. And as Jay pointed out, we're expecting 1 to 2 days of improvement sequentially through the back end of the year on working capital, so ending around 74, 73 days.

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Noah Poponak, Goldman Sachs Group Inc., Research Division - Equity Analyst [70]

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Okay. So I should be kind of in the zone of maybe, call it, $100 million of the $500 million that you had for the -- in that free cash flow bridge of net after-tax synergy plus capital efficiency, maybe $100 million of the $500 million is happening in 2019?

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [71]

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I'm not sure. We're looking at each other here. I'm not sure where we're at maybe...

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Noah Poponak, Goldman Sachs Group Inc., Research Division - Equity Analyst [72]

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Well, if it's $40 million to $50 million of synergy and then 1 to 2 days of working capital, I guess that would be...

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [73]

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One to 2 days of working capital on a full year basis is probably on the order of $30 million to $60 million, in that range, so it'll be half that over the course of the back end of the year.

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Noah Poponak, Goldman Sachs Group Inc., Research Division - Equity Analyst [74]

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Okay. And then just bigger picture on the margins. Clearly, the margins will expand if you achieve the synergy plans. But should we be giving consideration for margin expansion in the underlying business before synergies? Harris kind of had incremental margins from the partially commercial model. Legacy L3 had plans to continue to improve the operations and the margins of the business before the deal. Is it fair to assume the margins are expanding independent of the synergies and then synergies in addition to that?

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [75]

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Yes. It's fair to assume that, yes. Both independent businesses had talked about margin expansion. In both pieces, it was on the order of 100 basis points. And certainly, the synergy that we had talked about that would be incremental to that, which is going back when we first talked about the deal on a pro forma basis, the margin -- EBIT margin was around 14%, we said that would get to around 17% through 100 basis points of organic growth on margins, another 200 basis points on synergy to get to 17%. Obviously, as we're coming here into calendar '16 we're doing a bit better than that as starting off here. So yes, it is incremental to the benefits of synergies, Noah.

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Operator [76]

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Our next question comes from Seth Seifman of JPMorgan.

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Seth Michael Seifman, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [77]

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Apologize if I missed it in the prepared remarks, I know there was a lot going on, but the profitability in the Communications business at L3 in the quarter, just nearly 8%. Maybe if you can address that? And it kind of seemed like we were moving past last year's issues and kind of -- what kind of risk that presents going forward.

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Christopher E. Kubasik, L3Harris Technologies, Inc. - Vice Chairman, President & COO [78]

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Yes, Seth. This is Chris. Seth, that was driven, as we'd put in the prepared comments, mainly by the maritime sector. We have a pretty strong international focus in maritime. We have some steady cornerstone programs as I cover them on -- as I call them, focused on sensors and control systems. But there are some new developments going on, one in the unmanned arena, both surface and undersea, and that requires investments. And then we have some new programs for the Columbia and the destroyer and some laser weapons. Those were slowed in the quarter by some additional costs to get those development programs on track, and those will have long 10- to 20-year legs once we get going. So it was focused on maritime development, to answer your question.

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Seth Michael Seifman, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [79]

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And then, Bill, in legacy Harris, the Space and Intelligence segment, it seems like the book to bill for fiscal '19 was probably around 1.0, which is pretty solid and obviously there's some good growth there, but there's also a ton of growth in this space budgets. Maybe if you could talk a little bit about the visibility you have there and the confidence you have that you guys are taking your fair share on the space side.

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [80]

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Yes. Look, Seth, I mean we feel very good about the Space business. You're right, I mean in the year, the book-to-bill is a little over 1. The backlog came up a little bit. So there's a good trend there and we've talked about that pretty consistently over the course of fiscal '19 with the classified business being up mid-teens, orders looking pretty good.

That comes from a couple of different areas. When we talk about our classified business, it's not just space. So there's opportunities in space, both exquisites as well as moving to smallsat. And the team has just done a great job maintaining a strong position on exquisite components while, at the same time, taking the lead on the full end-to-end mission solutions with smallsat. But our classified business in that area also relates to other domains, and that business continues to go well. Again, same philosophy, moving from providing components to subsystems to now full mission solutions, whether they be terrestrial systems, nearshore systems, deepwater systems. And that business has gone very well. And it's really this philosophy, the budgets are coming up, and we're expanding our ability to compete on more a full end-to-end mission solutions. And you can see the trajectory happening in the back end of the year. We continue to see strong growth in the classified business.

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Christopher E. Kubasik, L3Harris Technologies, Inc. - Vice Chairman, President & COO [81]

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I'll just say that Bill and I spent a fair amount of time last week reviewing the classified business, and I was thoroughly impressed with the technology and the opportunity. So we're excited about the Space business going forward and other classified work.

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Operator [82]

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Our next question comes from Jon Raviv of Citi.

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Jonathan Phaff Raviv, Citigroup Inc, Research Division - VP [83]

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Now that we had some more time pass, any sort of additional perspective on industry M&A would be appreciated by you guys as others talk up more scaled investments to increase their probability of wins, and by definition, taking some market share. What do you consider the impact to be on LHX going forward besides bagging you a nice CFO?

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [84]

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Look, I think we -- I think -- so Chris and I started this conversation quite a long time ago with a goal of creating a very large-scaled mission solutions prime, and that's exactly what we've done. We continue to assess implications of what other people in the space do. But from what I look at, just the company that we have created and the opportunities ahead of us, I think we're very well positioned. When you talk about scale, I think we are scaled in places where we need to be scaled. We're scaled in tactical radio, we're becoming scaled in the Space business. We're scaled in lots of different areas of the company and we feel great. The company is a technology leader. Our strategy is to continue to invest significantly and aggressively in innovation. We've been running about 4% of our revenue in IRAD, and we continue to see that continue to go up. We've got a great set of people who are great technologists and business leaders to drive our business. What's going to require for us to win is continuing to accelerate the deployment of technologies into the marketplace, into the field as a warfighter and continue to execute well on our programs. That's what we can do. And no matter what happens in the market and the changes in the structure, we're going to keep focused on what we do well and the things that we can control, and it's the technology and the way we execute. So I think we're in a good spot here, Jon.

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Operator [85]

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Our final question comes from Josh Sullivan of Seaport Global Securities.

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Joshua Ward Sullivan, Seaport Global Securities LLC, Research Division - Director & Senior Industrials Analyst [86]

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Just given the success with the Exelis combination, maybe using that as a benchmark, can you talk about how the experience so far with L3 has been maybe similar to that integration and then maybe where it's been a little more dynamic?

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William M. Brown, L3Harris Technologies, Inc. - Chairman & CEO [87]

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Well, certainly, it's a much bigger scale, clearly, and there's a lot of complexity within L3. It was a company built over 20 years through a lot of M&A, and Chris has talked about the desire to move from a holding company to an operating company. And we're sort of on that journey. So getting information, getting it consistently across businesses is a bit of a challenge. But the reality is we're out of the gates very, very quickly. We've got a great, seasoned integration team, people that are very experienced. They've done this before. There are a lot of people from the Exelis integration. We're getting data very quickly. The enthusiasm and energy across the company is very good. It's gone, from my vantage point, certainly better than we would have imagined and better than we did with Exelis. We're going faster on supply chain. That was an area that took us a little time to ramp up to on Exelis, and we're at that a lot faster this time. Obviously, with the segments and the headquarters, we made those decisions, we execute on that on day 1 here, which is very important.

The revenue opportunities ahead of us are quite significant, something that Chris is spending a lot of time on. And we're very encouraged, so we're going to get on that probably a lot faster this time than we did with Exelis. Keep in mind we're in a different market space. We're in a different sort of part of the cycle. Back with Exelis, we were still coming out of sequestration, the visibility of the budgets weren't very strong. So we focused much more on cost side. This time, it's different. And Chris and the team are really putting a lot of time and effort into making sure we understand where the revenue opportunities are and then making sure that we fund them.

So I'm optimistic about the trajectory that we're on here. And clearly, we're on a great path to deliver $0.5 billion of gross cost synergies, and hopefully, a bit more than that over time, Josh.

So that wraps up our call. So thank you very, very much. Chris and I are very excited about the company that we've created and getting to the closure of this historic merger on exactly the minute that we thought we would be, in middle October of last year. There's a lot of precision in that, as you'd expect from us in this team. We're very excited. We're confident we'll create a lot of value for owners. But importantly, Chris mentioned this in his comments, we have 50,000 employees in this company. We're working very, very hard to deliver results, keep their focus on the customer. And we want to thank them for all their efforts. And we look forward to updating you again on the merger and the progress we're having at the end of October for our next earnings release. So thank you very much.

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Operator [88]

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