Pamela A. Padgett - Harris Corp. William M. Brown - Harris Corp. Rahul Ghai - Harris Corp..

Peter John Skibitski - Drexel Hamilton LLC Gautam Khanna - Cowen and Company, LLC Noah Poponak - Goldman Sachs & Co. Robert Stallard - RBC Capital Markets LLC Howard Alan Rubel - Jefferies LLC Carter Copeland - Barclays Capital, Inc. Seth M. Seifman - JPMorgan Securities LLC Chris D. Quilty - Raymond James & Associates, Inc..

Good day, ladies and gentlemen, and welcome to the Harris Corporation's Third Quarter 2016 Earnings Conference Call. At this time, all participant lines are in a listen-only mode to reduce background noise. But later on, we will be conducting a question-and-answer session; instructions will follow at that time.

I would now like to introduce your first speaker for today, Pamela Padgett, Vice President of Investor Relations. You have the floor..

Hi. Good morning, everyone, and welcome to our third quarter fiscal 2016 earnings call. I'm Pamela Padgett, and on the call today is Bill Brown, Chairman and CEO; and Rahul Ghai, Senior Vice President and Chief Financial Officer. And first, before we get started, few words on forward-looking statements.

Forward-looking statements made today involve assumptions, risks and uncertainties that could cause actual results to differ materially from those statements. For more information on a related discussion, please see the press release, the presentation on Harris' SEC filings.

In addition, a reconciliation of non-GAAP financial measures discussed today to comparable GAAP measures is included on the Investor Relations section of our website, which is www.harris.com, where a replay of this call will also be available. And with that, Bill, I'll turn it over to you..

Okay. Well, thank you, Pam, and good morning, everybody. Third quarter results were solid with operational earnings benefiting from the continuing ramp in synergy savings. Total company orders and revenue were sequentially higher and book-to-bill was a very strong 1.12, driven by Space & Intelligence Systems, Electronic Systems and Critical Networks.

We delivered good bottom-line results despite the impact of lower tactical radio revenue from the Middle East, demonstrating that the added scale of the Exelis acquisition has broadened our business and is contributing to improved operating resiliency.

Looking to the full year, and the now slower pace in the Middle East, together with a DOD tactical radio opportunity that has slipped into next year, we're adjusting our fiscal 2016 earnings per share guidance to about $5.70, the bottom end of the prior range on revenue of about $7.5 billion.

Rahul will provide more color in a minute, but the only segment that's changing is Communication Systems where we're now expecting legacy tactical revenue to be down high single-digits with similar declines in both international and DOD. So let me start with a little color on what's driving the change.

We started the year anticipating Harris legacy international a flat to down, even though we were coming off several years of strong expansion in international, including a record fiscal 2015. But at the time, we had started to see some opportunities in the Middle East market stretch out a bit.

The first half of the year played out about as we thought with international revenue up 5%, including higher revenue from the Middle East as a result of strong FMS funding support. And while we were expecting a year-over-year back half decline in the Middle East, we anticipated sequential revenue growth.

But the combination of fiscal pressures and funding priorities, both in country and with the U.S. government, as well as a slow FMS approval process, have shifted opportunities to the right. We believe the slow pace in the Middle East is temporary.

Security issues and the need for more capable tactical communications are unchanged and the FMS funding support remains strong for the region with additional money earmarked in the GFY 2017 President's Budget request. In the U.S.

tactical market, while our book-to-bill was above one in the quarter, MUOS upgrade opportunities expected in fiscal 2016 are now unlikely to begin before the end of the year. While the MUOS capability is designed into our new two-channel Manpack for the U.S.

Army, we've also adapted the waveform so that could be easily ported through a simple download into our 117G radios, 30,000 of which are currently fielded in DOD inventory. We've demonstrated connectivity between our radio and the satellite.

We're on track to receive NSA certification shortly, and customers across several services are anxious to benefit from the mobility and higher bandwidth that the MUOS constellation provides. This is a very real and compelling value proposition for our customers and funding for this opportunity has been earmarked in GFY 2016.

We anticipate this funding converting to an order for Harris before the end of September. So while fiscal 2016 is a bit softer than expected in Tactical Communications, our outlook is solid and our competitive position has never been stronger.

In the DOD, we've won or have a position on every major tactical radio contract awarded in the last five years. The mid-tier radio, MNVR, won in 2013, the Rifleman Radio won last year, the SOCOM two-channel handheld won earlier this year, and most recently, the very large HMS Manpack awarded in February.

These are all significant wins for Harris, so let me update you on the latest developments. After more than four years of tenacious effort, the Army awarded Harris a 10-year, $12.7 billion IDIQ contract for the multi-channel Manpack radio, opening a market for Harris which had previously been closed to competition.

Qualification and customer tests are starting soon and scheduled to wrap up by the end of our fiscal 2017, with the initial production delivery order award currently scheduled in early fiscal 2018. The $3.7 billion Rifleman Radio procurement is also progressing well.

We've now completed both qualification and customer tests, receiving positive feedback on operational capabilities such as range and battery life. An initial production delivery order is expected in the second half of fiscal 2017.

SOCOM's modernization is also moving forward and a protest of Harris' single award for the $390 million two-channel handheld radio program was recently resolved in our favor and work has begun. Product deliveries begin in the first half of fiscal 2018.

This radio features both communications and ISR capabilities and since SOCOM has long been an early adopter of cutting-edge technology that eventually find its way into the broader DOD and international militaries, it positions us well to compete on a number of other modernization programs.

The handheld is part of a broader modernization program that SOCOM has said could reach $900 million and include a new Manpack and HF radio. The Manpack RFP is expected late this summer and contract award before the end of fiscal 2017 with the HF radio following sometime thereafter.

On the international front, the pipeline remains about $2.9 billion, and is diverse in terms of regions, countries and customers within the country. And while the near-term velocity has slowed a bit in the Middle East, continued progress is being made elsewhere.

In the last earnings call, we mentioned that a $600 million opportunity for Australia's Phase 3 modernization had moved into the pipeline, with an award expected by the end of fiscal 2017. We've now been selected as the preferred supplier, with a significantly broader scope where Harris will now prime to deliver an integrated solution.

This is a key part of our long-term growth strategy in international to expand our addressable market, leverage capabilities from across Harris and evolve from a radio supplier to now providing entire systems.

Turning to a few highlights in other areas of the company, both Space & Intel and Electronic Systems had strong orders, higher sequential and a year-over-year organic revenue and book-to-bill greater than one. Approximately 70% of Exelis' legacy business reside in these two segments and contributed to the positive sales and orders trend.

In Space & Intel, awards from classified customers totaled $329 million, with continued strong budget support for intelligence programs and the ongoing customer focus on space superiority and protection capabilities.

On the commercial space side, there are signs of a recapitalization cycle and fleet expansions beginning, and we recently received a $37 million order to provide an 18-meter unfurlable antenna reflector for the JCSAT-17 geostationary communications satellite.

The prospects in our space antenna business are stronger today than they've been in the last decade.

Within Electronic Systems, we enjoyed another quarter of strong electronic warfare bookings, including $88 million to supply electronic jammers for the F/A-18 aircraft, an excellent example of modernization opportunities on existing platforms with a very long tail.

Electronic warfare is now on track in fiscal 2016 to double orders over the prior year and end the year with about $200 million higher backlog.

Strong free cash flow generation and deleveraging remain top priorities for Harris and at the end of the third quarter, year-to-date free cash flow stood at $425 million, supporting expectations for the year of $750 million. On April 8, we completed the sale of Aerostructures and used the cash proceeds to pay down debt.

So less than a year after closing the Exelis acquisition, we repaid $683 million of term loan debt, which is approximately one-third of the total debt we've committed to repaying over three years.

So now, before turning the call over to Rahul Ghai, our new Chief Financial Officer, to cover the detailed financial results and guidance, I want to provide a brief introduction. As you already know, Rahul joined Harris in March of 2015 to lead the finance integration team and was named CFO in early February.

By leading the finance integration team over the last year, Rahul has been essential to our integration success and has provided a smooth and natural transition to CFO. Rahul and I worked closely together for five of his 12 years at United Technologies, and again, over the past year, as we've integrated Exelis.

I'm confident in Rahul's ability to lead the Harris' finance organization and be a true business partner to me and to the rest of the management team.

So Rahul?.

Thank you, Bill, and good morning, everyone. Before starting, I'd like to remind you that our discussions today are on a non-GAAP basis. Now, turning to third quarter results and slide three in the presentation. EPS was $1.45 with acquisition savings supporting operating performance and benefiting from a lower than expected tax rate in the quarter.

Reported revenue was $1.91 billion compared to $1.19 billion in the prior year. On an organic basis, revenue was down 3%. Strong revenue growth in Space & Intelligence Systems and Electronic Systems was more than offset by lower revenue in IT services and International Tactical, in both legacy Harris and Exelis.

Sequentially, revenue was up 3.6% with higher revenue across three of our four segments, with the exception of Communication Systems where revenue was less than one point lower than revenue in the second quarter.

EBIT margin for the company held strong at 16.4%, driven by excellent margin performance across all segments and reflecting continuing focus on driving integration savings and lowering costs across the company.

Orders in the quarter were $2.1 billion, bringing year-to-date book-to-bill to 1.06 for the company and was greater than one in each segment in the third quarter with the exception of Communication Systems. Within Communication Systems, third quarter book-to-bill for Tactical Communications was 0.8 with legacy Harris business at 0.83.

And in the supplemental pages of the presentation, we have included historical order and backlog detail for legacy Harris tactical business. Public safety book-to-bill was a bit disappointing at 0.5 and reflects that while the business is slowly improving, with revenue up 15% in the quarter, we're not beyond the choppiness.

In Space & Intelligence, orders strength continued in the classified area. In Electronic Systems, orders were strong in electronic warfare and also in avionics where we received $121 million in follow-on contracts for the F-35.

In Critical Networks, FAA funding was a significant driver and both CapRock energy and maritime reported book-to-bill of more than one. For Harris overall, awards are on track to achieve a book-to-bill of one or close to one for the year.

So turning to segment detail on slide four and comparisons to prior year pro forma results, as Exelis and Harris were combined for all of fiscal 2015. Communication Systems third quarter revenue was $485 million and down 10%. Tactical Communications revenue was down 16% and public safety was up 15% compared to prior year.

Higher tactical revenue in Europe and Central Asia was more than offset by lower revenue in Middle East for both Harris and Exelis legacy businesses and completion of Australia's Phase 2 modernization program. Operating income was $154 million and operating margin was a strong 31.8%. Turning to Space & Intelligence Systems on slide five.

Third quarter revenue was $489 million and up 7% compared to prior year, driven by higher revenue from a number of new classified programs, including programs in space superiority. Operating income in the third quarter was $76 million and operating margin was 15.5%.

Following the close of the quarter, Harris was awarded $81 million in follow-on contracts with $26 million order to sustain ground-based systems that support U.S. missile warning, missile defense and space surveillance missions from the Air Force for the SENSOR program. Turning to Electronic Systems on slide six.

Third quarter revenue was $393 million and up 6% compared to prior year. Higher revenue from the F-35 program and counter IED systems was partially offset by lower revenue from Commercial Broadband Satellite Program terminals. Operating income in the third quarter was $75 million and operating margin was excellent at 19.1%.

Just following the close of the quarter, we completed the sale of Aerostructures, which was part of the Exelis acquisition and reported within Electronic Systems. While not material to Harris, we have included historical financial informations of Aerostructures for fiscal 2015 and 2016 in the supplemental section of the presentation.

Turning to Critical Networks on slide seven. Third quarter revenue was $551 million and down 10% compared to prior year. Higher revenue from FAA's NextGen modernization programs was more than offset by lower revenue in IT services from the wind-down of two major programs and lower revenue in CapRock's energy market.

Operating income in the third quarter was $59 million and operate margin was 10.7%. So moving to slides eight and nine. Total company revenue guidance on an organic basis is revised from down 5% to 6% to down about 7%, driven by lower revenue in Communication Systems.

The impact of lower revenue is expected to be partially offset by cost savings across the company and lower taxes. As a result, non-GAAP EPS is now expected to be approximately $5.70 the lower end of the previous guidance range.

In Communication Systems, we now expect revenue to be down between 8% to 9% with Harris legacy tactical down high single-digits. With lower volume for the year, operating margin is expected to be about 29% (sic) [29.5%] in the segment, which is at the lower end of the previous range.

In Electronic Systems, expectations remain unchanged with the exception of removing Aerostructures for the remainder of the year. With Aerostructures removed, revenue is revised to a range of down 3% to 4% and is equivalent to the previous organic expectations of down 2% to 3%. Operating margin is unchanged at 18% to 19%.

And in Space & Intelligence and Critical Networks, expectations remain unchanged. The expected tax rate for fiscal 2016 has been revised from 32.5% to 31%, due to international tax settlements for prior years and from integration steps that have lowered state taxes.

Beyond fiscal 2016, we expect to benefit from lower state taxes and now permanent R&D tax credit. So let me turn it back to Bill for a few closing comments..

Well, thank you, Rahul. A little less than a year ago, we closed on Exelis, a truly transformational acquisition for our company. We're executing well on the integration and our results are benefiting from synergy capture.

From day one of integration, we've been tracking a little ahead of schedule in reaching integration targets, which is a great achievement from the team. So as we maneuver through pockets of revenue softness, it's evident that the added scale of the Exelis acquisition has broadened our business and is contributing to improved operating resiliency.

With less than a year into the acquisition, achieving our current expectation of about 11% earnings growth is a good outcome. Looking ahead, we expect fiscal 2016's rising trend in earnings to continue into fiscal 2017, supported by higher synergy savings and other cost reduction actions.

In the meantime, we'll continue to gain traction in our multi-year strategy to successfully integrate Exelis, lower costs and deliver accretion, shape our business portfolio, drive strong free cash flow and deleverage, all while still investing in technology and new product development to drive future growth.

And with that, I'd like to ask the operator to open the lines for questions..

Our first question comes from the line of Pete Skibitski from Drexel Hamilton. Your line is open..

Hi, good morning, guys..

Good morning..

Good morning, Pete..

Hey Bill, I guess on the Australian contract, it seems like one of the largest radio contracts you guys have won as far as I remember.

Is that through the protest period I guess number one? And number two, how much of a growth driver can that be for you in fiscal 2017?.

Well, first off is we've been named the preferred supplier, but haven't won the award yet. We expect the contract award to occur sometime late in our fiscal 2017, which means revenue from that opportunity extends into and begins in fiscal 2018. So it's still on the horizon.

We are very well-positioned, being officially notified by the Australian MOD that we're the preferred supplier, it's a very, very important step in the contract negotiation phase, but we do expect that award to happen sometime in the late of our fiscal 2017. It's very big and we're very pleased with our progress there.

And again, it's a key part of our long-term strategy to grow from a radio supplier to now a system supplier. We've talked about that for the last few years..

Oka, that's great.

Is it fair to say that $2.9 billion international pipeline still includes Australia in it?.

Yes, it does..

Okay.

And just last one, I know we're still a quarter out, but directionally, in fiscal 2017, can you give us a sense of your outlook for communications just given its importance?.

Well, first of all, we're not going to provide today any guidance. We're not – we'll come to that in early August. But I think when you talk about communications, you sound – your question seems more directed towards the tactical side, which, as we know, has been more of the important earnings driver.

So we're not going to provide some guidance today, but there are several things that are on our radar screen that we'd like to see happen in the near term that will help to shape some of the guidance we'll provide in early August.

In the DOD side, both MUOS and the MNVR radio, the mid-tier radio, together will contribute to higher earnings, higher revenue in fiscal 2017. MUOS, which did slip out of the quarter, we expect to receive certifications on that this summer, NSA certification. We've already demonstrated on air performance of both voice and data. It's well supported.

Funds are allocated. And it's a very strong and compelling business case and we're very confident that's going to happen over the next several months. On the mid-tier side, on the MNVR, that will be in the tens of millions of dollars. It's well supported in the President's Budget request, as well is in the NDAA that just came out.

The network assessment is going on as we speak. And we expect a production award towards the end of the government fiscal year 2016, so around the September timeframe.

I think on the international side, which has become a bigger part of our business and it's a very large pipeline, we're looking at what's occurring in Eastern Europe and the Ukraine where we've been very, very strong in fiscal 2016. We need that to continue. We need to see the opportunities that we've seen very well in Iraq in fiscal 2016.

We expect that to continue at the same level as we see in 2016, and again, opportunities in Iraq, to us, as we speak today, seem to be well supported. One of the opportunities in the international that slipped out of fiscal 2016 into 2017 is in Iraq, but it's well-funded. We think that that's going to happen in 2017.

There's another country in the Middle East we can't name where an opportunity did slip out and we expect that will happen in early 2017 as well. And then, finally, in Central Asia, meaning specifically Afghanistan, we've had a very strong year this year. Opportunities there seem well supported.

And we do expect Afghanistan, and more broadly, Central Asia, to be the strong contributor to revenue into next year. Now, outside of Tactical Communications, we have a broader – outside of legacy tactical, we've a broader communications business, including Exelis, the radio business from Exelis, which is mostly international.

We've been tracking an opportunity in Saudi Arabia for quite some time. It's about $40 million, $50 million in size for SINCGARS radios for vehicles. It's been hung up in the Saudi Royal Court for a number of months, and we need that to break free as we get into 2017 as well.

So maybe, Pete, just a little bit of shape and color around what we expect going into next year..

Yeah. I appreciate it very much. Thank you..

Sure, Pete..

Thank you. Our next question comes from the line of Gautam Khanna from Cowen and Company. Your line is open..

Yeah, thanks. Good morning, guys..

Good morning..

Good morning, Gautam..

So to follow up on Pete's question, when we look at the absolute level of backlog at legacy tactical, $419 million, it's a pretty low level, obviously, that captures domestic and foreign.

Why should we not be concerned about another down year in fiscal 2017 at tactical RF? Or are you willing to say directionally it's going to be flat, up, down? What's your sense, because a lot of what you talked about look like fiscal 2018 sales opportunities?.

Well, most of what I talked....

(24:32)..

Yeah, yeah, we're not going to comment yet on 2017 in the shape up, down, flat at this point. We provided some additional information on the backlog in the document. I know some of the math that some of the analysts have done on funded backlog. Where we're at today? It's low, it's lowest as it's been in sometime.

As we look out over the next 12 months and how much is covered in backlog, it's not all that different from where we were about a year ago.

But we do see a number of things that are materializing both in the DOD as well as in the international side much of which we do expect over the course of next year and it's good to see a lot of the international opportunities backstop by throwing a funding support within the U.S. DOD and state department funds..

Can you give us any color on the upcoming quarters? Do you expect book-to-bill to be – you're implying about $300 million of legacy tactical RF revenue in Q4. Do you anticipate that bookings will exceed that or coming below that? And how is it shaping in fiscal Q1? You mentioned MNVR might actually get an award in the September quarter.

Are there any other items you can point to, to help us kind of calibrate to what we should expect in the next couple of quarters?.

Yeah, Gautam, over the course of Q4, we expect to end the year with funded backlog in Tactical in line with Q3 or slightly up. So we do expect to see some decent awards in Q4 about at the level of revenue. So we don't see another step down in backlog at this point, but in line with where we are in Q3.

We're not anticipating or providing any guidance on Q1 in the 2017, although we are watching very carefully the network assessment. The funding for MNVR is in the 2016 budget. There's money allocated in the 2017 PBR. It seems to be protected in the NDAA that came out of HASC at about $20 million, $25 million.

And we do anticipate a production award occurring in the September timeframe. That could drive revenue beyond that; it may not be in Q1, but we do think that that's going to end up occurring as we get into 2017..

Okay. And last two, sorry..

Sure..

Australia, is it still $600 million with the expanded scope in the pipeline?.

Yeah. The scope of our work hasn't changed from what we've been communicating before. And this has been in the discussions with the Australian MOD for several years. We've got a very strong group of partners with us. We have a very well-defined scope providing a broader system with radios and it remains about $600 million..

And last one, and I'll turn it over, HMS Manpack, when is the final down select to two?.

Well, we expect the customer test for the Manpack to occur between January and May of 2017, and we expect the first delivery order with an August of 2017 decision and delivering around October of 2017. That is our expectation. As we've said before, we see the Manpack as a revenue driver in fiscal 2018 not in fiscal 2017..

Thank you very much..

Sure, Gautam..

Thank you. Our next question comes from the line of Noah Poponak from Goldman Sachs. Your line is open..

Hi, good morning, everyone..

Good morning..

Good morning, Noah..

So the MUOS slip, is it possible to quantify how much revenue that took out of the fiscal 2016 revenue outlook today?.

Yeah. It's in the tens of millions of dollars that slipped beyond Q4 into Q1, Q2. It's possible to receive the order late this quarter. It more likely is in Q1 of our fiscal 2017. Over time, it's a pretty substantial opportunity; it's across a number of different services, and we feel very, very good about the capability.

As I said in my prepared remarks, the business case on that is really very, very compelling, and we've demonstrated on-air performance of the 117G with MUOS already, and I think it's a great opportunity for us and we're confident it's going to go forward. It may not happen this quarter..

Okay.

I guess, I'm sort of wondering more broadly, when I looked at the revenue outlook reduction, especially in Comm Systems, kind of, how much of that is general softness across many areas, especially international versus the prior forecast, as opposed to it being one or two or three bigger specific items that slipped into 2017?.

Yeah, it really comes into three specific opportunities. One is MUOS on the DoD side, which again is tens of millions and drop the guidance down to high single-digits for the DoD side tactical radio in fiscal 2016. That did slip to the right, but we're very confident that's going to happen.

On the international side, we saw two opportunities slip to the right. One is in Iraq. It does have funding, but we do expect that to be a first half 2017 event, not in Q4 of 2016. And the other is an opportunity for another country in the Middle East, which we can't name.

The funding for that opportunity has been reprioritized, but the customer is working with us on a number of other projects, which we believe will be funded in the first half of our fiscal 2017. So it's relatively isolated to three different specific opportunities that generally just moved out of the quarter..

Okay, great. That's really helpful. On slide 10 where you've given this historical data on Harris legacy Tactical, you've broken out revenue by domestic and international.

Can you tell us what orders were by domestic and international in the quarter?.

Well, we're going to stick with the splitting of the revenue for right now, but I would say that the relative mix, Noah, of the ending backlog, between international and DoD is reflective of the balance between international and DoD in the revenue base. So kind of on the order of two-thirds, one third – international, two thirds; DoD, one third..

And why not give those order numbers on that slide? Just competitively or...?.

Well, it's just something that we're not necessarily prepared to provide today. We'll give that some more thought over the – for the next call that we have, Noah..

Okay. It would be helpful..

Okay..

And then what were – specifically, what was the book-to-bill in the other segments where you've quantified it as being over one, can you tell us how far over one or specifically what they were by segment? It sounds like they were pretty good..

Yes, we were at about in the Space & Intelligence business just over 1.3. In the Electronic Systems business, we were at about 1.25, and in the CN business, we were at 1.21..

Okay, thank you..

You bet..

Thank you. Our next question comes from the line of Robert Stallard from Royal Bank of Canada. Your line is open..

Thanks so much. Good morning..

Good morning..

Good morning..

On the Manpack award, some of your competitors have been talking about what they have to offer there. I was wondering if you could frame for us where you think Harris is positioned and why you think you're going to win..

Well, we think we've got a very, very strong and compelling offering. We've been working on it for a number of years. We have a very strong, very high share today in the Manpack market within the U.S.

DOD and we've developed I think a very good radio in a very large factory where we've got tremendous scale that through the R&D investments we're able to continue to bring features and functionality of the radio over time and use our scale to make sure we're competitive on the cost side.

So we think we've got a very, very strong offering for the Manpack..

Okay. And then, secondly, you highlighted the debt repayment year-to-date, and you're about a third of the way to your target..

Yeah..

What do you think the profile of debt repayment will be going forward from here?.

Good morning. This is Rahul. So we think we had said that we will be about $2 billion in the first three years. So we are tracking to that, and in the first quarter of our fiscal 2017 or just after the first quarter of fiscal 2017, we have about $250 million of debt repayment on one of the old Exelis notes that we will prepay.

So I would say between, so it may be a little bit kind of the same pattern between 2017 and 2018 and we'll evaluate as we get into fiscal 2017 if we need to alter that, but I would just spread that equally between 2017 and 2018 at this point. Maybe a little bit lower in 2017 and more in 2018..

What we said is that also over the next three years, we'll bring our leverage ratio down into the 1.5 range and we're tracking well towards that..

Okay.

And then, just a final one from me, I was wondering if you could size how large your Middle Eastern export sales are in the Communications division?.

Middle East for us and broadly Middle East North Africa is about 40%, 45% of our international tactical business..

Okay. That's great. Thank you..

You bet..

Thank you. Our next question comes from the line of Howard Rubel from Jefferies. Your line is open..

Thank you very much..

Good morning, Howard..

Good morning, Bill. I wanted to address maybe a strategic question. You talk about continuing to optimize the business portfolio. Clearly, the sale of the Aerostructures business was spectacular outcome, but optimize means lots of different things.

So could you elaborate on that please?.

Yeah, we feel very good about where we ended on the Aerostructures business and completing the sale in early April. It's on top of what we did last year on the Commercial Healthcare business and before that Broadcast.

So I think we've been – I think pretty dispassionate and pretty aggressive in looking at what is in our portfolio, what strategically fits, what's a better value to Harris versus to an outside party. We also look at the performance of the underlying business.

That's actually an important factor, but Howard, as I step back, we are at the heart a technology-based company, really in defense electronics, mission-critical communications. And we want to be in businesses where technology is a discriminator, add some competitive advantage.

We spend quite a bit on IRAD, more than 4% as well above our peers, 4% of our revenue. We have about 40% of our population are engineers or scientists and we want to be in businesses where technology can allow us to win and that's a key factor in how we evaluate the portfolio.

We've been, again, aggressive and doing something with Aerostructures, and we continue to look at what's in our base to that broader business that we have today..

That makes a lot of sense. And then, just to build on that, can you talk – we can see the cost synergies from Exelis.

Can you talk about a little bit on the sales synergies or where your – where the organization is able to go to market with a package that can somehow accelerate some growth? I mean you did – just to finish on that, you did a nice job I think of outlining what you're doing in radios, but the other markets are very large as well and important as we look at that (37:28)..

Yeah, our focus has been, Howard, really around the cost take-out and we've done I think a very good job. We get at it very, very quickly. And we still feel good about hitting our run rate savings as we exit 2017 in that $140 million, $150 million net range, which is more aggressive than we thought.

We're closing about 15% of our floor space and that's tracking very, very well. So that has been our number one focus. And that's how we justified the acquisition was really on cost take-out. On the revenue side, yeah, we've got our teams really focused on this.

Dana Mehnert who's been over here at Harris for more than 30 years and really built our tactical radio business into what it is today, has now taken on a role as Head of Global Business Development, really with an eye towards how do we grow in major markets around the world where the opportunities might be a little bit outside of the horizon or between businesses or might involve bringing together, strapping together some technology from Exelis with Harris and his focus is really on that.

And it's across the gamut, it's across technology, across platforms, across geographies or channels to market. In all of those things, we're starting to see some opportunities. And as we get beyond this year and start to shape 2017, we'll talk a bit more about where they start to – where we're starting to see those opportunities come to fruition.

What I'd rather do is talk about the ones that we are actually achieving as we achieved them as opposed to speculating about where they might be. One last point on this, Howard, because I think this is very important and I want to make sure investors don't miss this, it's not just about applying common technology is going after channels.

The part of what we're doing in driving operational excellence and integration into cross Exelis is improving program performance. This is very important. The best way to grow a business is performing well on what you're doing today. And in the note that in Rahul's prepared remarks, he talked about the SENSOR program.

The SENSOR program was being recompeted, because the performance wasn't quite up to snuff with the Air Force and through a lot of work, the on-time delivery of that program has improved dramatically, and now, we're starting to get awards back on SENSOR and the competition has been canceled going to one of the pieces of SENSOR because of the improved performance.

So I feel that we just keep focused on performance and executing very, very well, that will help us grow our business into the future as well..

And then, one last item..

Sure..

You've got again, sort of focused on the top-line a little bit. You've got an enormous amount of data you provide to the FAA and some of that can be remarketed and sold in a value-added manner.

How far along are you with that?.

Well, our focus right now with the FAA is executing on NextGen programs and FAA today is probably our largest customer. We're on four or five NextGen programs and, of course, we've got the FTI, the telecommunications infrastructure that we're working on.

But through Exelis, they had the ADS-B network more than 640 radio towers operating very well long-term contract with the FAA very strong position, and they have unique access to data and that data can be used in other forms for other uses including supporting the integration of UAVs into the North American air traffic control system that is a key part of our strategy.

That's an opportunity, it's likely beyond the next couple three-year planning horizon, but clearly, through both technology partnerships and legislation, all of which need to be worked on today to make sure we've got a strong position there over time.

So Howard, that is an important focus of ours, and as we get clearer around what our particular strategies there, we'll share that more with investors that's a little bit beyond the planning horizon..

Thank you very much, Bill..

Sure, Howard..

Our next question comes from the line of Carter Copeland from Barclays. Your line is open..

Hey, good morning, Bill, and welcome Rahul..

Good morning..

Good morning, Carter..

Maybe this horse isn't quite dead yet, so I'll beat it again.

But I want to talk tactical really quickly, and I know you're not ready to provide 2017 guidance, but you talked about several of these opportunities, which clearly layer in later in next fiscal year and beyond, and you made a comment in your prepared remarks in the closing remarks about sort of short-term movements in revenue.

But when you look at that business on a long-term trend line basis, is it your expectation that that trend line is upward sloping when we look out over the next two years, three years, five years because of all of the opportunities that we've been looking at and you've executed on in recent years?.

Yeah, I think it's a good question, Carter, and clearly, on the DOD side, I think the answer is yes. It is clearly on an upward slope, and I think as I went into some detail on the programs that we won on the DOD side.

And the fact that even in the President's Budget, they're well-supported in the DOD, they're well-supported, the procurements are moving forward at a reasonable pace. I feel very confident that the DOD business will be a growth driver for us, certainly, as we get into 2018 and beyond. 2017 is a little bit too soon to call.

I do see it coming off the bottom in 2016, in 2017, but I think 2018 is really the growth year, and I think it really relates to the flow in from some of these modernization programs where we're very, very well-positioned including in SOCOM. So the DOD, I think, clearly is a growth driver.

On the international side, we've seen fantastic growth over the last few years. We've seen a little bit of softness this year. The pipeline is still very robust. We are still well-positioned. Competitively, we're very strong.

Where we are going out to compete, we win almost all the places that we are competing in around the world where we have a position.

I think the opportunity in Australia where we become the preferred supplier for a very large contract, which include systems and products, it's an important part of our strategy, because we need to increase the size of the addressable market we're going after in international in order to continue to see growth in that international base over time.

But I do see on the DOD side, yes, that that will be a longer-term growth market for us..

Okay, great.

And on a couple others, just looking at the bookings trend and the revenue trend at CapRock, does that business look like it's bottomed now from your perspective?.

Well, I think the good news, Carter, is that we haven't adjusted in our outlook for 2016. We haven't changed it based on what's going on in the CapRock business. The energy business is still under a lot of pressure. I know oil prices have recovered a little bit, but still well down.

A lot of the energy majors are reporting some pretty terrible numbers right now. For the year, we still expect CapRock energy to be down about 25%. We were down in the 20% range-ish in the first half; it will be worse than that, obviously, in the second half.

As we get into Q4, we see the revenue in Q4 in CapRock energy to be on the order of about $60 million in the quarter. So if you just annualize that, you're sort of around $240 million for the year as we exit fiscal 2016. And for perspective, in fiscal 2016 overall, revenue in CapRock energy was around $290 million.

So the math would imply that we'll see a little bit of another downturn on an annual basis in 2017 over 2016. 2016, again, is down about 25% from fiscal 2015. So we are seeing another step-down as we get into next year, but it's not different than what we described last time and built into our guidance for this year.

I guess, as you saw, the CN margins were down a little bit sequentially. We did lose money in energy in Q3, but we've done quite a bit of restructuring as we laid out to investors back in February, and we do expect the energy business to go back to profitability in Q4, and be less of a profit driver as we get into fiscal 2017..

When you say less of a profit driver, you (46:13)..

Less of an impact on profit. Yes, exactly. Yes..

Okay. And then, one final one, just a clarification.

The increase in the synergies clearly benefits the fourth quarter this year, but does that imply any change to the run rate synergy target on Exelis that you laid out before or this is just faster capture?.

It's faster capture. We still expect to be at $140 million, $150 million net – $140 million to $150 million net of what we give back to the government, as we exit fiscal 2017. So it's really just a faster capture this year at $80 million, $85 million.

We see next year, in year fiscal 2017, integration savings or synergy savings in the $130 million to $135 million range, Carter. So that implies an extra $50 million in the in-year 2017 from 2016..

Great. Thanks, Bill..

You bet, Carter..

Thank you. Our next question comes from the line of Seth Seifman from JPMorgan. Your line is open..

Great. Thanks very much, and good morning..

Good morning..

Good morning..

I have to apologize in advance for asking another 2017 question, but not in terms of numbers, but just very broadly, outside of Communications, when we think about the DoD budget and investment account outlays should be up pretty nicely in government fiscal 2017 when we think about Space and Electronics, and let's say, Critical Networks putting CapRock aside, with DoD investment account outlays growing nicely, is there any reason to expect that any of those segments won't grow?.

Well, we see very good trends through the year in our Space business as well as in the Electronic Systems business. It's kind of encouraging to be through the year here in Space and pretty good backlog growth, pretty good book-to-bill through the year, same thing on the Electronic Systems business.

It's good to see electronic warfare to be pretty strong, it turns out, over the course of the year and ending a couple of hundred million dollars higher in backlog. At least that bodes well for not another step-down as we get into 2017. But yeah, the budgets look pretty good.

There's still a long way to go between where we are today and appropriations bills. But we feel pretty good about the overall outlook. The only cautionary points I would give is on CapRock. We do see again another step down as we get into 2017, just based on where the exit rate happens to be.

In our Mission Sustainment business, which was down this year in the 20%, 22%, 23% range mainly because of a couple of big program roll-offs, we've got some work to do there to make sure that we hold that business as we go into next year. It's a very, very competitive landscape. We have about a third of that business that's up for recompete.

As we go into next year, the Mission Sustainment or Services business, and we've got to do a little bit of work to make sure that we win on those recompetes. It's something that this management team is pretty well focused on today..

Okay. Thanks. And maybe as a follow-up on cash flow, you maintain the free cash flow guidance for the year, but the CapEx guidance came down.

I was wondering if you can talk about the driver there? I mean, was it basically that the uppers in the EPS guidance were kind of non-cash versus the decline in the Communications revenue?.

Yeah..

And then, you still got a pretty big jump in the CapEx in Q4 and what specifically is driving that?.

So – yes, you're right. I mean there's no change to our fiscal 2016 guidance on cash flow. Reduction in CapEx is basically offsetting the change in earnings. So, that's where – that's kind of the math we're doing.

We still need to get the working capital improvement in the fourth quarter to get to our full year number, but historically, 50% of our cash flow for the year has come in the fourth quarter, and this year we're expecting slightly less than that. So we feel good about that.

I mean we have some projects going on and the timing of CapEx kind of differs from quarter-to-quarter and there's just variability within the quarter. So we have some projects going on that need some step-up in CapEx, but we've calculated our outlook for the year. And we think we'll be close to that number that we've guided to..

We feel pretty good, Seth, about the progress we've made over the last several years and just making ourselves a little more capital efficient, and it includes the approval thresholds in the company.

On a pro forma basis, a couple of years ago, the companies together would've been around $260 million, $270 million or in the range of 3% of sales and this year, we'll be about 2.3%. We still see some opportunities to continue to be a little more judicious on capital spending going forward.

So we feel pretty good about where we stand so far this year in capital..

Okay. Thank you very much..

Operator, we'll take one more question, please..

Thank you. This last question is from the line of Chris Quilty from Raymond James. Your line is open..

Bill, just a follow-up on Australia, and the focus on systems.

Can you give us an idea of what you end up bundling in, in a system sale in addition to radios and what kind of a revenue multiplier or, I mean does it increase the size of the potential order by 10% or 15% or double it?.

Well, the radios would also include a lot of antenna systems, it's the battle management system, the software systems. There is a variety of other things that we package in to a systems offering to a customer. Every end market is going to be a little bit different.

We've had $700 million with a systems opportunity being booked and sold in other markets in the past.

If I member right on those markets, because I don't want to talk specifically about Australia, it's probably in the order of around maybe two to ones, with two parts of non-radios to one part radios, in other words, about a third of the opportunity would be radios, thereabouts, and the two-thirds would be other things you package around that..

And when you look at your opportunity pipeline down the road, broadly, what percent of those international opportunities might you convert to more of a systems versus a traditional radio sale?.

Yeah. It's a good question. It's something we've been working on for quite some time in the U.S. The U.S. military tends to do their own systems integration. They manage each of the suppliers and the components and then integrate it together, and then test it through what we're seeing today in these network evaluations, these NIEs.

On the international side, more and more customers are moving towards buying an installed solution, an integrated solution, and that's I think a good trend and that's heading in our direction.

We feel very good that the radio itself is very, very competitive and provides a key source of value and we think we can broaden that and bring other partners on to our team, and in fact, that's exactly what we've been able to do in Australia. Some very important large global players are on the Harris team in Australia, providing components to us.

And what that does is it not just provides the radio, but software and other components around that, it does continue to build more stickiness into that and customer coming back to Harris Corporation over time. So we feel very good about the trajectory we happen to be on, on the systems and integrated solutions side internationally..

And who would be your big competitors that are adopting the same approach?.

Well, I don't like to get into the competitor, because some of the competitors have found their way on to our team in Australia, and it really varies by market. But I would just say that we've got a lineup of very good suppliers, good partners with us in Australia, and again, we go compete against different people in different markets..

Okay.

And a clarification on the MUOS, is that a one-time revenue opportunity on the software upgrade or is there any kind of tail?.

Well, there's going to be a – we've been investing quite a bit of IRAD into developing the ability to easily port this MUOS waveform into 117Gs. It sounds more simple in the way I explain it than it really was.

It was quite a bit of magic to make this happen and not require any sort of firmware, hardware change out for these radios which I think is absolutely amazing, amazing what the team has done.

And what we're now doing is working with our service partners to provide them software licenses that would allow them to once they buy the license to then download that software into their radios, into the 117Gs.

As that MUOS waveform is changed or advanced over time, there may be opportunities for that to kind of get readvanced or other licenses or other opportunities revenue opportunities to occur. But we see that, over time, this is a pretty substantial opportunity, and I think as each service picks it up will drive some revenue event for us on MUOS..

And just a final follow-up question..

Sure..

You said the outlook on your reflector businesses, the best you've seen in 10 years and yet last year was a pretty crappy year for Commercial SATCOM orders and this year is not looking any better year-to-date.

So is that primarily reflecting just a higher value for the type of and reflectors that you're developing or is it a market share gain?.

No, I think what we're seeing here is over the last five years, in our business that we've got, as you know, a pretty high share of the hoop reflector or space reflector market. We've only sold two commercial reflectors. So far we have this JCSAT order for $37 million. We have four proposals out.

We have 15 prospects in the pipeline and what's driving this, Chris, our new entrance, it's the increase in high throughput satellites. It's recapitalizations. It's a surge that is occurring in small sats for both the U.S. government as well as the commercial sector.

We see that as a pretty good opportunity in the near to medium-term and it's both on the reflectors side as well as sensors and payloads for these other small sats, both again commercial and U.S. government.

So I think we're on the front end of what it appears to be a recap cycle and we feel it's a very important recent event, and again, with the prospects we see and the proposals we have out, we will feel pretty good about this business, Chris..

Great. Thank you..

You bet..

All right. Thank you everyone for joining us today..

Ladies and gentlemen, thank you again for your participation in today's conference. This now concludes the program and you now disconnect your telephone lines at this time. Everyone, have a great day..