Anurag Maheshwari - Harris Corp. William M. Brown - Harris Corp. Rahul Ghai - Harris Corp..

Seth M. Seifman - JPMorgan Securities LLC Robert M. Spingarn - Credit Suisse Securities (USA) LLC David Strauss - Barclays Capital, Inc. Noah Poponak - Goldman Sachs & Co. LLC Jon Raviv - Citigroup Global Markets, Inc.

Gautam Khanna - Cowen and Company, LLC Carter Copeland - Melius Research LLC Peter John Skibitski - Drexel Hamilton LLC Robert Stallard - Vertical Research Partners LLC.

Greetings and welcome to the Harris Corporation Third Quarter Fiscal Year 2018 Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Anurag Maheshwari, Vice President, Investor Relations. Thank you. You may begin..

Thank you, Michelle. Good morning, everyone, and welcome to our third quarter fiscal 2018 earnings call. On the call with me today is Bill Brown, Chairman and Chief Executive Officer; and Rahul Ghai, Senior Vice President and Chief Financial Officer. First, a few words on forward-looking statements.

Discussions today will include forward-looking statements and non-GAAP financial measures. Forward-looking statements involve assumptions, risks, and uncertainties that could cause actual results to differ materially from those statements. For more information, please see the press release, the presentation and Harris SEC filings.

A reconciliation of non-GAAP financial measures to comparable GAAP measures is included in the quarterly materials on the Investor Relations section of our website, which is www.harris.com, where a replay of this call also will be available. With that, Bill, I'll turn it over to you..

Well, thank you, Anurag, and good morning, everyone. Earlier today, we reported strong third quarter results with non-GAAP earnings per share of $1.67, up 21% on 5% revenue growth. Revenue was up in all segments and operating margin expanded 30 basis points to 19.3%.

These results extend our strong year-to-date performance with non-GAAP earnings per share over the first three quarters up 17% on 4% revenue growth and 10% higher free cash flow. The highlight again this quarter and for the year is our strong order momentum, up 27% in the quarter for our fourth consecutive quarter of double-digit orders growth.

Book-to-bill was 1.2 for the quarter and the year, with total company backlog increasing 22% over last year. So, let me start by providing some color on top line growth drivers across the segments noted on slide 4. Communication Systems' revenue grew 4% in the quarter, driven by strong growth in DoD Tactical Communications and Night Vision.

DoD Tactical delivered another solid quarter with revenue up 48% as a focus on readiness continue to drive growth across our services, especially the Air Force and the Army, as they upgrade their legacy communication equipment to software-defined radios.

The sustained readiness demand has driven a year-to-date increase in DoD orders of 62% and revenue growth of 32%, and we now expect DoD revenue to be up about 30% versus prior expectation of low 20% growth and up from mid-teens when we started the year.

International Tactical revenue was down 12% as expected on a tough year-over-year compare, as Q3 2017 included a record $150 million of Eastern European revenue.

The decline in Eastern Europe was partially offset by continued momentum in the Middle East and Africa, driven by ongoing counterterrorism support and by the ramp of these Australian modernization program in the Asia Pacific region.

Strong orders growth of 15% for the quarter and 36% year-to-date has nearly doubled International backlog, providing more visibility going into the fourth quarter and next year. For the year, we still expect International will be flat to slightly down.

As we've been communicating, our tactical strategy is to win all DoD ground radio programs, leverage platform investments to maintain International leadership and expand our adjustable market into network systems, ISR and airborne. And we continue to execute well against this strategy with several wins and accomplishments this quarter.

On DoD ground radios, Army and SOCOM modernization programs continue to make solid progress. In the omnibus bill, the HMS program is well funded at $415 million in GFY 2018, more than 50% higher than the prior year and up an additional $60 million over the original GFY 2018 President's budget request.

We delivered additional HMS Manpack test radios in the third quarter and, earlier this week, we received an LRIP delivery order from the Army to proceed with the next production phase for the Manpack radio, clearly demonstrating the Army's commitment to the program.

On the Army two-channel handheld radio, we expect to deliver the first batch of test radios soon with an award anticipated sometime this summer. For the SOCOM two-channel handheld, we delivered initial test radios during the quarter and will ramp production in the fourth quarter, accelerating in fiscal 2019.

Continuing our effort to expand into broader network systems, we recorded another win in Asia when we leveraged our radio incumbency position and were selected as the prime systems integrator to modernize and upgrade the military communications network.

This builds on prior successes in Australia, UAE and other Middle Eastern and Central Asian countries as we continue to expand our aperture and increase customer stickiness.

And then finally, just a few days ago, we were awarded a five-year $130 million sole-source IDIQ by the Air Force to develop and produce a handheld video data link device to provide airborne collected ISR information to forces on the ground, opening a new market opportunity for us.

This strategic win against the incumbent helps us increase our share of wallet of ground devices and positions us well to grow in the airborne ISR segment going forward. Overall, for the first three quarters, Tactical revenue increased 7% with a book-to-bill of 1.4, resulting in a 74% year-over-year backlog increase to $880 million.

This growth in Tactical, coupled with another strong quarter of double-digit growth in Night Vision, has enabled us to raise Communication Systems revenue guidance to an increase of 7% to 7.5% for the year versus the prior guidance of 5% to 7% and 3% to 5% when we started the year.

In Electronic Systems, revenue growth accelerated to 10% for the quarter with growth across all ES businesses, as the first half ADS-B headwind subsided.

This strong growth was driven by long-term platforms like the F-35, the F/A-18 and F-16, which collectively grew more than 25% as we leveraged technology upgrades, ramped production and expanded our International footprint.

In Avionics, we continue to generate double-digit growth in weapons release systems, even excluding F-35 growth, with new content awards and increased production of both domestic and International platforms. Segment order growth accelerated in the quarter to 56% for a book-to-bill of 1.4 and orders are now up 32% on a year-to-date basis.

We booked more than $300 million in orders across F-35, F/A-18 and F-16 platforms, including a $184 million contract supplying electronic jammers to protect U.S. Navy, Australian and Kuwaiti F/A-18 aircraft against electronic threats.

Orders across the three platforms, F-35, F/A-18, F-16, have more than doubled this year to over $900 million and are on track to hit $1 billion for the year. Overall for ES, solid third quarter results have mitigated the first half ADS-B impact with year-to-date revenue now up 4% and a book-to-bill of 1.3, resulting in a backlog increase of 21%.

This combined with an $18 billion opportunity pipeline and $4 billion in proposals outstanding gives us confidence that revenue will grow 4.5% to 5% this year and that the growth will accelerate in the medium-term.

In Space and Intelligence Systems, revenue was up 1% as Classified programs continue to grow mid-single digits from the ramp up of smallsat, ground-based adjacency and space surveillance programs, offset by expected headwinds on environmental programs.

Order momentum also remained strong in the Classified area with additional customer funding for long-standing programs and new adjacencies.

In addition, we were awarded an approximately $500 million multi-year contract to provide payloads for an exquisite classified space system, reflecting continued success in leveraging technology to not only expand as a full mission solution partner in smallsats, but also to strengthen our position as a partner of choice on large exquisite platforms.

I'm also pleased to note a few accomplishments that strengthen our competitive position on important missions. In the environmental solutions business, the launch of NOAA's GOES-S satellite in early March included our second Advanced Baseline Imager, or ABI, which improves fire detection and severe weather forecasting.

This follows a successful launch of GOES-R in November of 2016, which has provided unprecedented imagery of recent hurricanes with four times the resolution and five times the download speed, providing forecasters with 30-second updates of the entire Western Hemisphere.

Harris ABIs are also on the last two of NOAA's latest generation of geostationary weather satellites, GOES-T and GOES-U, with the entire Constellation controlled by Harris' enterprise ground system.

We continued to execute well on GPS with a proven and reliable production cadence that included delivering a fifth GPS III navigation payload in early March, 26 days ahead of schedule. Strong execution along with a developed and fully tested 100% digital mission data unit positions us well for the upcoming GPS III 11 Plus award.

Year-to-date, Space and Intel revenue was up 1% and orders were up 6%, resulting in a book-to-bill of greater than 1. Our pipeline has grown by 14% to $13 billion over the past year and with the recent success of expanding into new adjacencies, we're confident this business can be a growth driver in the medium-term.

In summary, with our strong year-to-date performance, continued order momentum and an improved outlook on the back of a favorable GFY 2018 budget resolution, we're tightening our fiscal 2018 guidance and now expect revenue to be up approximately 4% from the previous guidance of 3% to 4%.

This growth, combined with our strong operating performance, gives us confidence to tighten our EPS guidance to $6.45 to $6.50 at the high end of the previous range and increase free cash flow to a range of $900 million to $925 million. And with that, let me turn it over to Rahul..

Thank you, Bill, and good morning, everyone. Starting with total company results on slide 5. As a reminder, (11:57) today are on a non-GAAP basis and exclude one-time adjustments. Revenue was up 5% in the third quarter, with growth across all three segments.

Operating income was up 7% on higher volume and operational efficiencies, resulting in margin expansion of 30 basis points to 19.3%. EPS grew 21% and was up 12%, excluding the benefit of tax reform.

Adjusted free cash flow was $121 million as higher revenues and order momentum in the backend of the quarter resulted in $120 million increase of receivables and inventory, which will unwind in the fourth quarter.

Year-to-date revenue was up 4% and operating income was up 3% despite a $36 million unfavorable impact from the ADS-B program transition in the first half of the year. Year-to-date, adjusted free cash flow was $451 million, a 10% increase over the prior year as we enter our strongest cash generation quarter.

We have returned a total of about $400 million to shareholders, including approximately $200 million in share repurchases. In addition, we prefunded the pension by $300 million in the third quarter. On a last 12-month basis, adjusted free cash flow was about $900 million. Turning to the third quarter EPS bridge on slide 6, EPS grew by 21% or $0.29.

Of this, $0.11 of EPS growth came from higher volume in Tactical radios, Avionics and Classified space, solid program execution and higher pension income. This was partially offset by lower environmental volume and increased R&D investment. Lower share count and reduced interest expense contributed $0.06.

Lastly, a lower tax rate, including a benefit from tax reform, added $0.12 to EPS growth. Segment details on slide 7. Communication Systems third quarter revenue was $481 million, up 4% versus the prior year.

In addition to strong growth in DoD Tactical, Night Vision revenue was also up double digits, as the business continued to improve execution and increase its share of wallet with the Army. Operating income for the segment was up 5% to $147 million and operating margin expanded 20 basis points to 30.6% on higher volume.

Orders grew for the seventh straight quarter, up 20% with a book-to-bill of 1.1. In addition to strong bookings in Tactical, PSPC orders grew 28% on increased demand for legacy system upgrades from state and local agencies. Night Vision orders grew 10% with continued momentum from the U.S.

Army and we received a $30 million award to support increased logistics readiness. Year-to-date segment revenue increased 6% and operating income was up 8%. Operating margin of 29.6% was up 50 basis points versus the prior year.

Year-to-date segment orders have increased 36% with a book-to-bill of 1.3 and it's greater than 1 in all three businesses in the segment, Tactical, PSPC and Night Vision. We continue to include historical information for Tactical orders, revenue and backlog as supplemental information at the end of this presentation.

On slide 8, Electronic Systems' revenue was $609 million, up 10% for the quarter. In addition to the growth in Avionics and Electronic Warfare that Bill mentioned, we saw solid revenue increase from the ramp of UK robotics and UAE battle management programs.

Segment operating income declined $3 million (16:11) was more than offset by increased R&D investment and program revenue mix. Year-to-date segment revenue was up 4% and operating margin was down to 18.6% as operational efficiencies partially offset the negative impact of the ADS-B program, R&D investment and program revenue mix.

On slide 9, in Space and Intelligence Systems, segment revenue was up 1% and operating income was up 8% as margins expanded 100 basis points from strong program execution and higher pension income. Year-to-date segment revenue was up 1% with continued growth in Classified programs, offset by a decline in environmental revenues.

Operating margin expanded 120 basis points to 17.7%. Moving to slide 10 for full year guidance, as Bill indicated, given a strong year-to-date performance, we now expect revenue to be up about 4% for the year, reflecting strength in DoD Tactical and Avionics.

We're tightening the EPS guidance at the high end of the range to $6.45 to $6.50 from drop through on higher volume. Tax rate guidance is now 22.5% from 23% previously. The $0.04 benefit from lower tax rate will be offset by higher than expected share dilution and an increase in interest expense from the additional debt raised or pension prefunding.

In Communication Systems, we are increasing the revenue guidance to be up 7% to 7.5% versus up 5% to 7% previously from improved DoD Tactical outlook and Night Vision readiness demand.

In Electronic Systems, we are narrowing revenue guidance to the higher end of the range to be now up 4.5% to 5% versus up 4% to 5% previously as strong orders in Avionics convert to revenue. In Space and Intelligence, we are narrowing the revenue guidance to be up approximately 0.5% versus flat to up 1% previously.

For each segment, margins are still expected to be around the midpoint of the guidance ranges, at about 30% in Communication Systems, 18.5% in Electronic Systems and 17.5% in Space and Intelligence. We are increasing the adjusted free cash flow guidance from approximately $900 million to a range of $900 million to $925 million due to higher earnings.

And with that, I would like to turn it back to Bill for closing remarks..

Well, thanks, Rahul. We are now in the final innings of fiscal 2018 and we feel good about our year-to-date results and our expectations for the balance of the year.

The passage of the GFY 2018 Omnibus Bill and the trend line in the President's Budget in 2019 and beyond are real positives for Harris and the programs we support, especially in strategic growth areas where we have invested in R&D over the past several years and our strong customer positions.

Tactical radio budget have increased by an additional $1 billion over the next five years compared with where they were this time last year. F-35 and F/A-18 aircraft quantities have been increased, Classified space and other IC budgets are trending up and F/A programs are well-funded.

Overall, our bid and proposal activity remains high, our win rates are solid and our order rates – our orders and backlog continue to grow, setting us up for accelerating growth in 2019 and in the medium-term as we execute against our strategic priorities and deliver shareholder value.

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

Thank you. We will now be conducting a question-and-answer session. Our first question comes from the line of Seth Seifman with JPMorgan. Please proceed with your question..

Thanks very much and good morning..

Good morning..

Bill, maybe if you could talk a little bit about I think overall the boost in the budget was much higher than expected and a lot of it comes in areas that should be attractive for Harris.

And so, when you think about the framework for growth, kind of the multi-year framework that you guys outlined, is it possible at this time to think about how much acceleration there might be relative to that framework?.

Yeah, Seth, thanks for the question. For us and for everybody in the space, the budget was very positive as I mentioned in my remarks. Tactical radio is pretty good.

We see additional aircraft quantities and we're very encouraged about the trend line on the intelligence budgets, including the areas that we've been able to stake a position like in smallsats. So, we're very encouraged by that.

At the beginning of the year, we set out a framework which showed mid-single-digit growth across the medium-term and while we're not providing any guidance today, I see it today being incrementally better than when we started the year. And you could see that in sort of the trend lines based on what we've seen over the course of our fiscal 2018.

In CS, we started the year at 3% to 5%. We went to 5% to 7%. Now, we're in a 7% to 7.5% range. DoD Tactical, we started the beginning of the year at mid-teens. We went to 20% growth year-over-year. Now, we're about 30%. We're seeing much greater traction in the Electronic Warfare in Avionics segments.

So, when I sit and look at it, it feels better incrementally than it did before, so maybe mid-single-digit-plus in 2019 and beyond. Clearly, the CS segment, we said was at the time I think mid-single digits is probably mid to high. I think Electronic Systems was mid to high and it's probably at the high end of that.

And I would say also on the Space and Intel business, which we were thinking was low to mid-single-digit growth at the beginning of the year, feels closer to mid-single-digit growth principally because of getting the traction in smallsats, as well as the very significant win that we recently received on an exquisite payload.

So, that all is very encouraging and I see us being a bit incrementally better in 2019 and beyond than we thought at the beginning of the year..

Great. Thanks. That's great color.

And, Rahul, if we ended the year today, what would happen to the pension income in fiscal 2019?.

So, for every 25 basis points of increase in rates, it reduces our pension income by about $8 million to $10 million. And the 10-year is up about 50 basis points since we set the rates in June. So, there is some headwind from increase in rates.

However, we did make a voluntary contribution of $300 million to our pension fund that will generate 7.75% rate of return and it should also reduce our PBGC premiums. So, while the increase in rates will be a headwind, we should be able to manage through that and the benefits of incremental contributions will more than offset it.

But it will all depend on where the rates are as of June 30, but we don't see any year-over-year change in our pension income at this point..

Great. Thanks very much, guys..

Thank you. Our next question comes from the line of Rob Spingarn with Credit Suisse. Please proceed with your question..

Good morning..

Good morning..

Bill, the Army has been restructuring its network and I'm wondering if you can talk about on a forward basis, I'm talking beyond the existing business, the radios and so forth, but what interactions Harris is taking with the Network Cross-Functional Team at the Army? What kind of IRAD investments are you making?.

Well, it's a good question, Rob. We're very tightly partnered with the Army and have been for quite some time. As you know, they're forming this Futures Command. There's fixed investment modernization priorities, or eight CFTs, or cross-functional teams, one of which is on the Army network. We're very closely linked to them.

They've been to our facilities. We have detailed conversations with them and they help us think through how we can invest our IRAD spend both on radio but probably more importantly on next-generation waveforms that are low probability of intercept, low probability of detection, anti-jam waveforms that can operate effectively in contested environment.

So, we're very tightly linked with them. As you know, they've decided to separate the decisions around the upper Tactical network, which is around WIN-T – we've got a radio and a waveform that's positioned there – from the lower Tactical, which is around the radios. And I'm very pleased to see them moving forward and placing orders for the Manpack.

They're moving forward on the handheld. I think this is all very, very encouraging. So, long way of saying we're very tightly connected and I think we continue to adjust and adapt our strategy and our investments, given where the Army happens to be moving..

Do you see the competitive environment changing here? Are any of your competitors withdrawing perhaps, giving you essentially an opportunity for a larger share of everything?.

Well, it is shifting around. I mean, through the JTRS program, we had one of our large competitors in the space dropped out. One of their partners has a particular role on a program. There's another that's a competitor on the low end radio or the handheld radio. We're sole source on a SOCOM opportunity.

There's different players that are evolving and developing unique waveforms that are getting some traction in certain parts of the DoD community. So, yeah, it's shifting around, but I feel really good about our competitive position. We've been able to sustain high share in this area and high margins in this area.

Despite these shifts that are occurring across the services between DoD and International with some new competitors in, older competitors out, I think we continue to kind of keep the course and invest heavily and I think we'll end up continuing to be successful in this area..

Okay. And then just – this is a little bit based on Seth's question a moment ago, high level question.

But given the budget environment and the fact that we've got a pretty clear look at the – given 2018 and the 2019 budget, how do you think about industry growth for defense for the next, call it, three years? Is there an average kind of top line growth number we could think about?.

I really don't think about what the average industry growth is because everybody individually is going to be affected in a different way. Harris, even within Harris, we've got some shorter cycle and some longer cycle businesses. But I think overall, it's going to be positive. The budget trends are clearly up, at least for the next several years.

It all depends on how fast the appropriations get flowed down into contracts and awarded to companies and how fast they can execute on it.

So, there's lots of dimensions here that are going to drive top line growth, including making sure that all the things you need to provide to satisfy that contract, the supply chain, your own asset structure, your own employment, all needs to adapt to a much better budget environment.

But, I think overall, it's clearly a positive sign and most companies, including Harris, would be up in the mid-single-digit-plus range 2019 and beyond..

Thanks very much..

Sure..

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

Good morning. Thank you..

Good morning..

Bill, wanted to ask you about CS margins. You had a little bit of year-over-year improvement, nice sequential improvement. It looks like in Q4, despite forecasting higher revenues year-over-year, you're guiding to down margin.

Just if you could walk through the different moving pieces there and how it might set up for margins in 2019 on the growth that you're talking about?.

So, David, this is Rahul. So, the margins for CS, we've – it's been really good year-to-date. Last year, we were at 29.1% through the first three quarters. This year, we are at 29.6%, so up 50 basis points, and so really strong growth year-to-date. And there is typically a step up in the fourth quarter on the margin side in Communication Systems.

And we – last year – this year, the same thing we are expecting a slight step up from where we are year-to-date and that's going to come from increased volume and some mix shift of products. So, we feel good about the approximately 30% that we've kind of guided to this year. Now, going forward, there are a few things that will drive CS margins.

But, overall, we feel that we can stay around the 30% range. There should be benefit from higher volume and as that drops through the factory, but the modernization products are coming with slightly lower margin and there is – all the system wins that we're getting, we also typically come in at less than the product gross margins.

So, you put that all together and we feel that 30% is a sustainable rate for this segment..

Okay.

And any update on where you are in terms of the capacity utilization in Rochester?.

Sure. Our capacity utilization is around 60% in the factory right now..

Okay. And, Rahul, a follow-up on working capital. So, you've had some working capital growth this year, but below the level of your sales growth.

How are you thinking about working capital from here, either as a percentage of sales or days working capital? Where do you think that can get to?.

Yeah. So, we've done well with working capital, David. I mean, when we bought Exelis, Harris was around mid-40s. Exelis was well north of 80% or whatever – sorry, 80 days. And so combined, we were probably in the 60ish range – 60 days range. So, last year we ended at about 43 days and that was six days lower than where we ended fiscal 2016.

So, we've shown sequentially better working capital improvement. And this year, we're targeting about a two-day improvement in working capital. So, we think we'll end at around 41 days. The opportunity for us going forward is around two areas. One, advance payments. Our advance payments are typically much lower than industry average.

So, we see there's an opportunity to improve that and reducing our inventory. We've done well so far, but there are incremental opportunities. So, it's not going to be – we're not going to see another six-day reduction, but there is an opportunity to bring that down under a couple of days over the next two to three years.

So, we'll keep making progress on working capital..

Great. Thanks a lot for the color..

Thank you. Our next question comes from Noah Poponak with Goldman Sachs. Please proceed with your question..

Hey, good morning, everyone..

Good morning..

Bill, should it be in my scenario analysis, not my base case, but in my range of potential outcomes of what is spinning out of my model that total company organic revenue growth next year is 10%?.

That's certainly not what we're guiding to today. We're not providing guidance to 2019. But, again, it all comes down to how fast the budget plus-ups that we've seen and the higher budget in 2018 flows onto contract vehicles. We have seen very fortunately the Army move a little bit faster than we had expected on the HMS Manpack.

Receiving the delivery order this week was a good positive. I think they were indicating previously it would be perhaps mid-summer. So, they're moving faster on that. That will deliver in 2019. That's a good sign. But, I think it all comes down to how fast money can flow into contract vehicles and then how fast we can execute on that.

So, there's a scenario out there that gets you higher than we are at today at mid-single-digit-plus in next year. But, we'll tell you more about that once we close our fourth quarter at the end of June and provide some guidance in late July or early August..

Okay.

With ES being up 10% organically in the quarter, but you're simultaneously spending some incremental R&D there, making some new investments there, is there a correlation between that growth rate and the investments or is the growth rate today from business already secured and the investments you are making now are hoping to win you more new business beyond today?.

I mean, they don't correlate on a day-to-day or month-to-month basis.

But clearly, the investments we've made over the last few years in a couple of areas, certainly, in Electronic Warfare, we've talked about that to quite some extent, is really paying a lot of dividends as well as investments in a variety of technologies in the Avionics side, especially in open mission systems, and that's paying some dividends.

We're sort of starting to see that flow through in the order raised and the revenue in Avionics and Electronic Warfare and I would expect as we continue to invest that we've stepped up very recently again, even from where we were before in investments in these areas and I think that will help us in 2019 and beyond.

There's also some new franchise we are investing in that includes robotics. We've seen some – a very important win. That contract in UK is executing and we see a lot of opportunities to grow from that.

So, there is a correlation between the step up in the investments we've made over the last few years in IRAD and the growth rates today, but I'd say what we're spending on today is going to help us in 2019 and beyond..

Got it. And then, just one more on the International piece of Tactical radio in Comm Systems. Your tone maybe sounded a little more positive there speaking to what the backlogs are.

And I know, you talked about that being flat to down this year and then, I think maybe refresh my memory, but I think, you've kind of said maybe flat to maybe even down slightly again next year just because you had the European recap that takes more than a year to normalize.

But, are you now thinking International can grow in 2019 or what's the latest view there?.

Yeah. I mean, again, we haven't given any guidance in 2019, but there are certain things that we're looking at that would indicate that the International business can grow modestly in 2019. Right now, in fiscal 2018, we are still guiding to flat to maybe down slightly. That implies a growth quarter in Q4.

What we have seen this year different than last year and the prior years is less lumpiness. It's more level loaded and even loaded across the quarters, which is good. We always see Q4 being a bit stronger than the others, but a little more even loaded.

Our pipeline, despite the good order rate that we've seen so far this year, our pipeline remains very robust at about $2.3 billion. It's about the same as has been every quarter over the last year practically.

So, even though the orders are coming up, the pipeline is replenishing itself relatively quickly and we feel good about the position that we happen to have. So, I think we'll deliver Q4 and as we get into 2019, we'll give you a little bit more guidance on that. But, I don't see a step down in fiscal 2019 International.

If anything, it will be probably slightly up..

Thanks so much..

You bet..

Thank you. Our next question comes from the line of Jon Raviv with Citi. Please proceed with your question..

Hey, thanks, guys. I was wondering if you could expand on David's question about margin just in a growth environment you're talking about some potential acceleration in each segment.

How do you think about mix, R&D spending investments in each segment going forward? We understand that CS stays around 30%, but how about the other two?.

Yeah. I mean, I think, we're looking at margins being about flat in the next year or so in each of the segments, so CS around 30% and the others about where we happen to be guiding to in fiscal 2018.

But, as I – my comments on mid-single-digit growth plus over the near-term, clearly, CS and ES are going to be growing a little bit faster than the Space and Intelligence business.

So, the businesses with slightly higher margins and higher margins certainly in the CS side will grow faster, so there's a company level going into 2019 and beyond just because of the mix across the franchise, across the company, we could see some margin growth at Harris overall in 2019 and beyond..

Understood.

And do you care to update us on just thinking about multi-year free cash flow targets in terms of dollars in light of again better budgets or some of the working capital opportunities you've highlighted?.

So, our guidance this year, the revised guidance is about $900 million to $925 million. So, to get on these kind of – we see a path to get to $1 billion next year and that's $85 million to $90 million, several puts and takes. About tax reform, it's probably half of that growth.

So, we got – since we are a fiscal year company, kind of June fiscal year, we got half of benefit of tax reform this year, the remaining benefit is coming next year. So, there is a tax reform benefit next year. And then, we have about $15 million to $20 million of cash outflow from Exelis integration in fiscal 2018.

That should wind down by 2019 and there will be incremental benefit from increased earnings. So, there is a clear line of sight to getting to $1 billion by 2019.

And then, beyond that where cash flow should grow with earnings, there is – we do see opportunities on working capital improvement and we'll deal with that when we get there in terms of how that all mix changes between revenue growth and working capital.

But, we see line of sight to $1 billion next year and then grow through the earnings beyond that..

Great. Thanks, Rahul..

Thank you. Our next question comes from Gautam Khanna with Cowen and Company. Please proceed with your question..

Thanks. Good morning, guys..

Good morning..

I was hoping you could expand upon your comments on the pipeline. You mentioned the $2.3 billion in the foreign side Tactical RF.

What are the big opportunities, if you could maybe give us an update on Australia? Is it still $60 million of revenue this year, ramping next year and the year after? Maybe just give us some perspective on big campaigns that are underway by region or by country?.

Yeah, I mean, I'll start on that and maybe Rahul can jump in. Yeah, so the International Tactical pipeline is around $2.3 billion and again it's about where it's been over the last number of quarters and I think it's good news that despite the orders, it's holding relatively stable.

About 55% of that is in Middle East and Africa and that's a little higher than it was last quarter. So, we continue to see opportunities flowing into the pipeline in the Middle East as we've talked about Iraq in the past. Iraq is a very big important opportunity. It's well funded. There's lots of opportunities for us to grow in Iraq.

We see opportunities in Kuwait, some opportunities evolving in Saudi Arabia, in the UAE especially as we continue to execute well on the Emirates Land Tactical System, the network system that we're installing there which is going to be going through an IOC very, very soon, hitting a key milestone.

So, we see good opportunities continuing in the Middle East. Europe is about 20%, more or less, of the pipeline. Again, we continue to see opportunities in the Ukraine that looks fairly, fairly good as well as other NATO countries. And we're starting to see more opportunities in Western Europe evolve in Europe as well.

In Asia, that's about 10% of the pipeline. So, Australia is a key part of what we're executing there. That $260 million systems opportunity is going well. It's about that revenue opportunity in fiscal 2018. It will grow in 2019 and 2020 as we continue to work and complete that program. It's going well so far with the front end, but going well.

But there's a lot of follow-on opportunities in Australia as we execute well on that particular program. So, I'm very encouraged about what's happening in the Asia Pacific region.

And importantly as we develop more and more credibility around installing network systems, which is a much bigger market for us, and I went through a couple of the examples of what we've done in the past and what we're working on today, including another opportunity in a Southeast Asian country that was just awarded to us in terms of a systems modernization that builds on a legacy installed base.

So, those are the major opportunities. Central Latin America is about 10% of the pipeline. It depends on what we see happening in Colombia and Mexico. Last year was a very good year for Mexico. This year is a bit softer. But we do expect to continue to see recapitalizations there.

And then Central Asia, which is Afghanistan, Pakistan, is a small piece of the pipeline, very small piece of our revenue this year. It could start to grow over time. I'm not looking at that being a growth market for us in fiscal 2019. So, maybe that's a little bit of color on the International side..

Yeah. That's very helpful. And could you give us an update on the DoD Tactical? Last time, I think the pipeline was about $1.4 billion to $1.5 billion. Is it the same and....

Yeah, it's about the same, Gautam. It's about $1.5 billion with just over $1 billion in what we call base. So, that would be readiness and resets. HF radios will be in the base and there's some opportunities on HF. And then the balance would be modernization. So, that's the HMS program, SOCOM, some opportunities for the radio for the WIN-T system.

That's a bit higher than where it was last quarter, as you'd expect. As we march off in time, more and more of the modernization opportunities will come into the pipeline, certainly that's indicated in the budget as well. So, again, about $1.5 billion for DoD and consistent with where we've been..

And, Bill, you've done a admirable job since you've become CEO. Company is in a much better position, cycle's helping, et cetera. I was just curious, your cash redeployment historically has been for share repurchase and debt repayment.

When you think about the next five years, is M&A going to be a bigger part of the story or how do you think about where you want to take the portfolio over time?.

Yeah. Look, I think our portfolio is in really, really good shape and you can see it through the solid execution over the last number of quarters. We've got very strong businesses, very strong franchises, good share. We invested very aggressively in IRAD over the last five years. Even in a difficult sequestered market, we invested in IRAD.

And a lot of the things that we're talking about today as great opportunities and how well positioned come from a lot of those strategic investments. When the market was really soft, we executed on the Exelis transaction. We integrated very, very well, and I think it's positioned us, helped us reshape the portfolio as well.

So, sitting here today, we're going to generate a lot of cash in the next couple of years, sort of north of $2 billion of cash in the next few years, less than $1 billion of that will be for dividends and a little bit of debt next year.

So, it leaves a lot of capacity for either M&A or to buy back our stock as we continue to see value in our stock both this quarter as well as going into next year. We think there's value remains in Harris stock. So, we're going to be thinking hard about this. We think that there is opportunity to continue to do M&A. That will happen over time.

I think that's going to be a key part of our long-term strategy. But, I don't see us diverting from the core business franchise that we're in today, Gautam. I see us continue to bolster the business that we're in today, which again, are performing exceptionally well..

Thanks a lot. Good luck, guys..

You bet..

Thank you. Our next question comes from Carter Copeland with Melius Research. Please proceed with your question..

Hey, good morning, guys..

Good morning, Carter..

Bill, I wondered if you could expand a little bit on the commentary around the expansion in the opportunity pipeline and the adjacencies you highlighted, just maybe some insight into the color on that expansion and what opportunities it might have both on the R&D front or the M&A front or the CapEx front to go capture some of that.

Just an understanding of what the next leg might be in terms of how you expand what you've already done..

Yeah.

I mean, as I see this, there's adjacency opportunities really across the businesses and I spoke a little bit about it in the Tactical side, as we move from a large player with high share in the ground Tactical network, ground side to continuing to grow, leveraging the platform investments we made for DoD and selling them into the International market.

That's been a proven strategy. It's worked very, very well. And it's why we've got a very high share even of the International markets we play in, where they're not restricted markets. And we've laid out a very clear strategy to investors of taking that solid base and opening up the addressable market, so going more into network systems.

So, where we have the radio packaging systems around that to make it easier to use and more intelligent to the end users like Australia, like we've done in the UAE and other places as well as get a systems opportunity in markets where maybe we don't have the incumbent radio position and use that as a way to go in and pull the radio that – maybe with another competitor into Harris.

So, that's been a clear direction that we've been on as well as take our great position on ground radios into the airborne side and clearly the ARC-201 product from Exelis allows it to go into that particular market as well as airborne ISR. And again, this is a very important win that we just received in the last week, this $130 million IDIQ.

I think it is testament to the capabilities that we have across these different domain. And, Carter, these are areas that we've been investing in IRAD in over the last couple of years. So, I don't see a big step up from here to go and penetrate these domains. I see it a continuation of the investments we have been making.

The other thing we've talked quite a bit about is some of the adjacencies that we're attacking in the intelligence community. We've talked about moving over time from being a component supplier to supplying subsystems to now supplying complete end-to-end mission solutions, like we've done on smallsat.

That has been a significant investment on our part. Our IRAD investment in our Space and Intelligence business has crept up over time and it really is going after those kinds of opportunities.

You're winning this $0.5 billion exquisite system that we just won in the last couple of weeks, which really shows the power of the model we have in our Space and Intelligence business to both go after new end-to-end mission solutions as a prime, but also be the partner of choice for components and subsystems for large exquisite systems.

So, I think this balance is working very, very well for us, and as I see going forward, I see our IRAD in the same range we're in today as a percentage of revenue, could take up a little bit, but not materially..

That's great color. Thank you, sir..

You bet, Carter..

Thank you. Our next question comes from Pete Skibitski with Drexel Hamilton. Please proceed with your question..

Hey, good morning, guys..

Hey, good morning, Pete..

So, let me start with the F-35, just we seem to be reading more and more about cost pressures on suppliers for the F-35.

Just wondering if that's impacting you guys at all yet, and/or do you still see an opportunity to expand your content there?.

Well, both actually. I think we are a pretty significant player on the F-35. I think we're in the top 15. We have about $2.2 million worth of content per ship set on F-35 and we see that growing perhaps over time with some of the recent wins and a few things that we're working on the open mission system computer.

So, we do see cost pressure and I think we've been performing exceptionally well. Our job really is to continue to add capabilities and continue to take cost out. And when you look at the performance of the company, we're more than 99.5% on time for over 1 million components that we've delivered to date on the F-35.

So, we're a very good supplier there. We've reduced cost by more than two-thirds from the first shipset on F-35. So, I think we've demonstrated capability and willingness to work hard to continue to take cost out.

As the customer and our partners are moving to block buys, it'll help us continue to take cost out and as we move to open systems, there's lots of opportunities to both gain share and drive a more affordable aircraft for Lockheed and the end customers.

So, it's all embedded in our numbers and it's all part of what we've been doing for the last decade or more as we've worked on F-35..

Okay. That's great. And just last one from me. On Army radios, I think this will be characterized under (50:52) maybe, but a couple of programs I think in terms of demand for you. One, this whole creation of the Army Security Force Assistance Brigades.

And then the other question MUOS back-fit and my question for both of those is really how much kind of incremental demand have those two programs driven for you? How much longer will they last? I'm just wondering kind of on the timeline, how far along we are in those two opportunities..

Yeah, Pete, both. Our readiness to manage both Army and Air Force this year and it's about $100 million, maybe just a tad above $100 million. Roughly half of that is the Army and it's outfitting two SFABs. There's two Security Forces Assistance Brigades in our fiscal 2018. Not all of the content was Harris.

There was content from other players, but as was about half of that $100 million, $105 million. As we go into next year, I think the DoD has to outfit another four SFABs in the Army and then they'll decide exactly when that will be out of the mix of radio products. It's going to be legacy, it's going to be new product and all of that's being worked.

But, it looks like it'll be an opportunity for us in 2019 or 2020 based on what we're hearing from the Army in terms of outfitting additional SFABs..

Great.

And then the MUOS back-fit, are we done with the MUOS back-fit or more to go on that?.

Yeah. MUOS is going very well. In fact, as you know, we have a MUOS capability in our 117G. We've been selling that capability as software upgrades to the Marine Corps, to SOCOM, to the Air Force. It is a threshold requirement for the Army new radio.

So, one of the reasons why we've had to deliver 100 test radios to the Army for this Field-based Risk Reduction that's occurring imminently, really is to validate not just other things, but including MUOS capability in the new generation of Army radios, and again, we'll clearly be able to achieve that and develop success on that this summer and that allows that fielding to happen into next year.

So, for us, MUOS has been a good story both on thriving it back in the legacy radios, but also embedding into the new ones..

Great. Thanks very much..

You bet, Pete..

Thank you. Our final question comes from the line of Robert Stallard with Vertical Research Partners. Please proceed with your question..

Thanks so much. Good morning..

Good morning..

Just a couple of technical follow-up questions from me. First of all, your thoughts on the capital structure going forward.

What's your latest on what we can expect in terms of debt repayments or refinancing over the next couple of years?.

Well, let me start with this. I think we paid $550 million of debt in the month of April. So, that's it for fiscal 2018. We've borrowed $300 million in a floating rate note to fund the pension that we do in the year. We'll pay that in 2019. Beyond that, we don't see any further debt repayment. Any debt that's due will likely be refinanced.

We'll hit down to low 2s to 2 times to 3 times leverage by the end of this year and then even lower next year and we feel very confident and comfortable with where our debt structure happens to be in our credit ratings..

Okay. And then, secondly on the tax, there's been a lot of stuff moving around this year.

What do you expect any sort of steady run rate going forward in 2019 and beyond?.

So right now, Rob, what we're thinking is around 18% for next year. Again, part of that coming from a step down in getting half of the year of tax reform and some of the other tax planning work that we've been doing and I think that 18% is kind of sustainable going forward.

So, we see another step down from 22.5% this year to 18% and that we feel is kind of sustainable rate going forward..

That's great. Okay, thanks so much..

Thank you..

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

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