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

Robert M. Spingarn - Credit Suisse Securities (USA) LLC David Strauss - Barclays Capital, Inc. Gavin Parsons - Goldman Sachs & Co. LLC Carter Copeland - Melius Research LLC Gautam Khanna - Cowen and Company, LLC Jon Raviv - Citigroup Global Markets, Inc. Sheila Kahyaoglu - Jefferies LLC Seth M.

Seifman - JPMorgan Securities LLC Josh Ward Sullivan - Seaport Global Securities LLC Robert A. Stallard - Vertical Research Partners LLC.

Greetings, and welcome to the Harris Corporation Fourth 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.

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

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

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

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

Okay. Well, thank you, Anurag, and good morning, everyone. We ended fiscal 2018 on a high note with fourth quarter earnings per share up 19% on revenue growth of 8%, the highest top-line growth we've seen in seven years. Revenue was once again up in all segments and operating margin expanded 50 basis points to 19.6%.

For the year, earnings per share was up 18% to $6.50 on 5% revenue growth and we generated record free cash flow of $915 million, 116% of net income. Orders were up 18% and increased by double-digits for the fifth consecutive quarter, ending the year up 23% with a book-to-bill of 1.2, and backlog up 26%.

All driven by our multi-year investment and innovation, strong customer positions, high win rates, and an improving budget environment. Rahul will walk through the details of the quarter and full-year financial results. But I want to take a moment to just recap the highlights of the year on slide 4.

Communication Systems had a terrific year with revenue up 9% from strength in DoD Tactical and Night Vision. DoD Tactical revenue was up 46% in the quarter and 35% for the year driven by more than $100 million of readiness demand from the Army and the Air Force to support deployment of security forces overseas, with upgraded software-defined-radios.

Order momentum was even stronger up 81% for the year to support readiness and the ramp of modernization programs. Notable wins include the first LRIP order for the Army HMS Manpack.

Additional orders from the Marine Corps for Manpack radios with MUOS capability, and a $765 million sole-source IDIQ for Navy and Marine Corps Falcon III and next-gen radios, double the previous contract and aligned with the budget request for Marine Corps modernization efforts over the next few years.

We were also awarded a sole-source five year $130 million IDIQ by the Air Force to develop and produce a handheld video data link radio to provide airborne collected ISR information to forces on the ground, representing the successful execution of our strategy to penetrate adjacent markets like Tactical ISR.

International Tactical also performed well, with revenue up 10% for the quarter and down less than 1% for the year, as increased demand in the Middle East and Africa to support counter-terrorism activity, and the ramp of the Australian modernization program in the Asia-Pacific region offset the expected decline in Eastern Europe.

International orders were up 25% in the year, which combined with a robust and diverse pipeline gives us confidence that international will return to growth in fiscal 2019. Overall for the year, Tactical ended the year stronger than we first expected with revenue up 11%, orders up 41% and backlog up 82% to about $900 million.

Giving us confidence and continued growth in Tactical and the broader CS segment in fiscal 2019 and beyond. In Electronic Systems, after a flattish first half due to the ADS-B transition, second half revenue growth accelerated to 9%, with growth across all ES businesses and ending the year above the high end of our 5% guidance range.

The key driver with long-term platforms like the F-35, F-18, and F-16 which collectively grew by more than 20% as a result of technology upgrades, ramped production, and increased content. Two international programs; UK Robotics and the UAE Battle Management also contributed to strong year-over-year growth in ES.

Segment orders increased 33% to $3.1 billion with more than – and more than doubled to over a $1 billion on the F-35, the F-18 and the F-16 platforms. In June, we were awarded by a $400 million sole-source IDIQ to supply Electronic Warfare Systems for international F-16s.

That's a key gating item as we work towards capturing an estimated $1.5 billion opportunity. On the F-18, we had our best orders year on record, and we received two awards totaling $320 million to supply electronic jammers to protect U.S. in international F18s against electronic threats, supporting multi-year growth on this important platform.

We continue to make progress on the international pursuits, successfully delivering our first two robotic systems for Explosive Ordnance Disposal missions to the UK MOD. Achieving this milestone is important as we pursue other international opportunities in the upcoming U.S. DoD Common Robotic System Competition.

We also leveraged our FAA managed services model to capture a 15-year $141 million contract in the quarter to modernize India's air traffic management communications infrastructure, supporting growth in one of the world's largest aviation markets.

Overall for Electronic Systems, book-to-bill was 1.3 for the year and backlog increased 30% to $2.6 billion. This combined with the $17 billion pipeline and $4.5 billion in proposals outstanding, gives us confidence that revenue will continue to accelerate in fiscal 2019.

In Space and Intel, revenue was up 1% for the year as growth in Classified programs from the ramp of smallsats, ground-based adjacencies and Space surveillance programs, offset the expected headwinds on environmental programs.

Investments in R&D and innovation ahead of the customer needs, resulted in double-digit growth in Classified orders for the year as we strengthen our global leadership in hosted payloads, increased our share of wallet with existing customers, and expanded our addressable market from components to now full-mission solutions.

Orders for the segment grew 6% and book-to-bill was slightly greater than 1% for the year.

With about 80% of fiscal 2019 revenue and backlog and high confidence, follow-on opportunities, a $14 billion pipeline, continued strength in Classified Space, and decreasing headwinds on our environmental programs, we now expect mid-single digit growth for the segment in fiscal 2019.

We continue to maintain best-in-class margins and generate a record free cash flow of $915 million, returning about $550 million to shareholders. We also achieved our post-Exelis debt reduction commitment of $2 billion, and pre-funded our pension plan to about 90%, with no required contributions until 2025, creating future cash flow flexibility.

But our strong operation performance wouldn't be possible without a relentless focus on operational excellence. It's a program we call Harris Business Excellence or HBX. HBX is integral part of the Harris culture of continuous improvement and it's contributed to successes across the enterprise.

For example, the Night Vision over the last two years, we've improved yield and on-time delivery while lowering cost, resulting in significant margin expansion and double-digit growth. This business has moved from being a watch area, when we acquired Exelis to a growth driver.

And the improved returns, give us the room to increase investment to compete on upcoming U.S. and international modernization programs. On the F-35 program, we've delivered over a million parts with greater than 99.95% on-time delivery and we've received the Outstanding Supplier Award in our weapons release factory in Amityville.

Operational performance and a commitment to innovation has driven increased content per shipset with opportunities to expand it further in the future.

And on the F-18, IDECM program to franchise with more than a $1 billion in orders to date, we've cut factory cycle time by 10% and have been recognized by the Navy for maintaining a 100% on-time delivery record over the past 20 years.

In Space and Intel you've heard me speak about improved execution on the SENSOR program and we continue to make progress, with on-time delivery increasing from 35% when we acquired Exelis to 90% today, driving 15% revenue growth on the program just this past year.

And finally, on GPS III, we've corrected the legacy issues and established a proven and reliable production cadence, delivering the fifth payload in March with numbers 6 through 8 expected by early next year.

And now with a recently developed fully digital Mission Data Unit, we're well-positioned for the upcoming GPS IIIF award and maintaining incumbency. Overall, we've had an exceptional year, in which we returned to growth and generated record earnings per share and free cash flow, meeting or exceeding the targets we set for ourselves.

For fiscal 2019, we expect to build on that momentum and continue our strong performance, accelerating growth in all three segments, increasing margins and maximizing cash. For the year, we expect earnings per share of $7.65 to $7.85 on revenue growth of 6% to 8% and to achieve our $1 billion free cash flow goal.

Let me now turn it over to Rahul to walk through our financial results and additional details on fiscal 2019 guidance, before I close with a few comments on our medium-term outlook.

Rahul?.

Thank you, Bill, and good morning, everyone. Starting with total company results on slide 5. As a reminder, discussions today are on a non-GAAP basis and exclude one-time adjustments.

Revenue was up 8% in the fourth quarter and operating income increased 11% on higher volume and operational efficiencies, resulting in margin expansion of 50 basis points to 19.6%. EPS grew by 19%, or $0.29, and excluding the benefit of tax reform was up 12%, or $0.18. Free cash flow was a record $464 million for the quarter.

Turning to the full-year EPS bridge on slide 6. EPS grew by 18%, or $0.97. The expected $0.21 headwind from the ADS-B program transition was offset by disciplined capital deployment.

Half of the EPS growth was from higher volume in Tactical Communications, Avionics, and Classified Space, solid program execution, productivity and higher pension income offset by lower environmental volume and program mix. The other half came from a lower tax rate including the benefit from tax reform.

On slide 7, Communication Systems' revenue in the quarter was $523 million, up 16% versus the prior year with growth across all the three businesses in the segment. In addition to the strong growth of 21% in Tactical, Night Vision revenue was again up double-digits as the business continued to improve execution.

Operating income for the segment was up 11% to $162 million from higher volume and operational efficiencies. Operating margin remained strong at 31% and orders were up 6%, growing for the eighth consecutive quarter. For the full-year, revenue and operating income each increased 9% with operating margin of 30%.

Segment orders increased 28%, book-to-bill was 1.3x, and greater than 1x in each of the three businesses in the segment. We continue to include historical information for Tactical orders, revenue and backlog as supplemental information at the end of the presentation.

On slide 8, Electronic Systems' revenue was $640 million, up 8% for the quarter, driven by growth in Avionics, Electronic Warfare, and C4ISR. Segment operating income increased 14% to $119 million from higher volume and strong operational performance. Orders grew double-digits for the fifth straight quarter, up 38% with a book-to-bill of 1.3x.

For the full year, segment revenue was up 5%, and operating margin was at 18.6%, as operational efficiencies partially offset the negative impact of the ADS-B program transition, incremental investment, and shift in program revenue mix.

On slide 9, in Space and Intelligence, revenue for the fourth quarter was up 0.4% and operating income was up 8% as margins expanded 110 basis points from strong program execution and higher pension income.

For the full-year, revenue was up 1% as continued growth in Classified programs was partially offset by an expected decline in the environmental program revenue. Operating margin expanded 110 basis points to 17.5%. Switching to guidance for fiscal 2019.

We have adopted the new revenue recognition standard ASC 606 using the full retrospective method, effective at the beginning of fiscal 2019.

Adopting the new standard requires adjusting the timing of recognition of revenue and associated program cost for a few contract, treatment of certain expenses, but does not materially impact our total financial results.

Our guidance is based on the new revenue recognition standard and the preliminary re-casted historical financials are included as supplemental information on slide 16. For fiscal 2019, revenue is expected to be up 6% to 8% over the re-casted fiscal 2018 base, which is $11 million lower than the reported numbers. So not a material impact.

The growth in the year has driven by continued DoD Tactical modernization, as well as growth across Electronic Warfare, Avionics, Battle Management and Classified Space Programs. We expect total company EBIT margins to be between 19.3% and 19.7% from strong growth in higher margin Communications Systems and Electronic Systems segments.

Fiscal 2019 EPS is expected to be between $7.65 and $7.85 and includes a placeholder of $400 million for share repurchases and an effective tax rate of 17%.

We expect to generate greater than or equal to $1 billion in free cash flow in fiscal 2019, reflecting higher earnings and cash tax benefit from pension prefunding, partially offset by increased working capital, higher capital expenditures, and the timing of tax payments.

We ended fiscal 2018 with working capital of 42 days, a one day improvement over 2017 and 2019 guidance reflects continued improvement in working capital performance. Capital expenditures grew by approximately $35 million to $170 million to support new program starts. We are expecting accelerated growth in each of the segments in fiscal 2019.

Communications Systems revenue is expected to be up between 8% and 10%. With DoD Tactical up mid to high teens, Night Vision, up double-digits and International Tactical and Public Safety up low to mid-single digits.

Modernization growth in DoD Tactical will primarily occur in the second half of the fiscal year as we start to ship Manpacks for the Army and ramp-up production and deliveries of handhelds with SOCOM and the Army.

Segment operating margin is expected to be between 29.5% and 30.5%, reflecting the dilutive margin impact of new program starts and incremental systems work that is more than offset by the benefits from operational excellence and fixed cost leverage from higher volume in the Rochester factory.

Electronic Systems' revenue is expected to be up between 7% and 8%, driven by strong growth in Avionics and Electronic Warfare as fiscal 2018 backlog converts to revenue, and the continued ramp of UAE Battle Management program.

Segment operating margin is expected to be between 18% and 19% as growth from lower margin program is offset by operational excellence. In Space and Intelligence, revenue is expected to be up between 4% and 5%.

Classified business representing about two-thirds of the segment is expected to grow high-single digits, partially offset by continued modest weakness in environmental programs, which we expect to reach a trough this fiscal year.

Segment operating margin is expected to be between 17% and 18%, reflecting the volume increase and operational efficiencies. Fiscal 2019 EPS bridge on slide 11.

EPS is expected to grow between $1.15 and $1.35 from higher volume across the three segments; operational efficiencies, lower tax rate including the benefit of tax reform and accretive capital deployment. And with that, let me turn it back to Bill for closing remarks..

Okay. Well, thank you, Rahul. I want to close with a few comments on our multi-year strategy, including the growth outlook for the medium-term.

As we recap on slide 12, in recent years we reshaped our portfolio to focus on high-growth, high-margin businesses, successfully integrated Exelis, and made disciplined investments in the business that led to several new product launches and strategic program wins. We also de-risked the balance sheet to give us more financial flexibility.

Fiscal 2018 was an inflection point for Harris as we returned to growth and grew backlog significantly. This combined with a more favorable budget environment, especially in strategic growth areas, positions us well to accelerate growth in fiscal 2019 in the medium-term.

At this time last year, I laid out the medium-term growth drivers by segment that is shown on slide 14, and over the past year we've seen the outlook improve in each of them.

Communication and Electronic Systems are now expected to grow high-single digits and Space and Intel at mid-single digits, the higher end of the medium-term range for all three segments that we indicated this time last year.

In Tactical, we're beginning to see the DoD modernization ramp across all the services, and International has stabilized and is returning to growth as we leverage our incumbency and large installed base and benefit from higher defense spending by coalition partners.

In Electronic Systems, Avionics and Electronic Warfare are entering a multi-year growth cycle, driven by our position in long-term platforms.

And in Space in Intel, Classified growth will accelerate as we maintain high win rates and expand into adjacencies in a growing budgeted environment and the headwinds in the environmental business now become tailwinds. We've been on a multi-year journey to improve margins.

And while we made progress in driving productivity and efficiency in recent years, I see much more opportunity in front of us.

We're now halfway through standardizing our systems that will reduce the number of ERP platforms from 28 to 3, simplifying our operating environment, driving productivity through growth and shared services, automating core processes, and laying the foundation of our enterprise-wide digital strategy.

By the end of this year, we will have eliminated 80% of our data centers. And by fiscal 2021, the remainder will be fully cloud enabled. We recently hired a new Chief Technology Officer who is fundamentally reshaping how we design and develop new products to get more out of every R&D dollar we invest.

We're fully deploying DevOps to streamline software development, which is going to be more than 40% of our engineering work today, and is expected to increase over time.

And we continue to squeeze more cost savings out of our supply-chain through value engineering and should cost analysis on new products, and improving supplier performance and reducing sole-source components on legacy solutions.

Taken together, this relentless focus on operational excellence combined with the leverage on incremental volume that will drive margin expansion in Communication and Electronic Systems as well as for Harris as a whole.

In summary, we expect higher revenue, higher margin, double-digit earnings per share growth, and sustained cash generation through the medium-term. 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 Robert Spingarn with Credit Suisse. Please proceed with your question..

Good morning..

Good morning, Rob..

I just had a couple of program-related questions. First, on the ES segment, the midpoint of your margin guidance would be flattish with 2018. And I think you call out some lower-margin programs perhaps being offset by operational improvement.

What are some of these lower-margin programs, or the mix shift that you see here?.

Well, I think, first I'd say on 2018, we ended the year at 19.2% and we were guiding to 19.3% to 19.7%. So, at the center point we're up about 30 basis points before the Rev Rec goes in place, it's 50 basis points including revenue recognition.

But as we've seen growth in our segments, especially in our Space, in environmental, in our Electronic Systems' business, some new wins like a Classified business is coming in at a lower than average segment margins and that's growing pretty healthily, and that will bring down the SIS segment a little bit, again offset by operational excellence.

And of course, over in the Communication Systems segment and Tactical, as we see the ramp of modernization programs, as we've said before on this call, we'll see those programs coming at slightly lower than segment or normal Tactical margins, but improving over time as we continue to take costs out of the products, as we've done many times in the past..

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

Are there further opportunities or risks for your packages on the aircraft?.

You know, Rob, we see more opportunities than risk, so there are some risks that remain today. We're about $2.2 million per shipset. Either we provide the mat (26:09) or we provide the common components. We have the bomb-release system, the carriage-release system. We recently won, over the last year, the PCD EU as well as the Aircraft Memory System.

You know one of the things that's coming up is the ICP, the Integrated Core Processor, or the Mission Processor and that'll be awarded probably sometime later on this year. We're one of three companies are in the hunt on that. And over time, I think, you've heard Lockheed talk about what they might do on the ICNI as well as on the EW platform.

And given our progress so far on EW and the work we've done through software-defined EW, a big investment over the last several years, a small size, weight and power systems, really improvements in cognitive in the algorithms we have. You know we think we'll be a player there if they decide to move down the path and re-compete that.

So, as I look at F-35, is both going to grow from a volume perspective, but I think net-net I see opportunities to increase our content per shipset over time..

Okay. Thanks very much, Bill..

You bet..

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

Thanks for taking my question. Good morning..

Good morning, Dave..

Bill, you talked, I think, again about $4 billion in outstanding bids at ES.

Could you just talk about, obviously, the big ones, the chunky ones and the timing around those when you would expect to hear on those?.

Yeah, there's some – certainly a big piece of it is going to be some opportunities, we have with the FAA, which is a bridge contract on the FTI program. We should expect that over the next couple of months that's going to be an important one, but there's a lot of other activities including some of what I just mentioned on the F-35.

There's opportunities on F-16. You know there's opportunities in the near-term pipeline on robotic systems, especially as we extend that platform beyond the UK into other international markets as well as U.S. DoD. So, it really goes across the gamut of what's in the Electronic Systems business.

I don't know, if you have any other color, Rahul?.

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

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

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

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

Okay. All right. Bill, you outlined the potential for margin upside between volume and productivity and various other things. Currently, the businesses as a whole are running around 22%.

Would you care to frame kind of the margin upside potential you're thinking about here?.

Yeah, when I look at it – let me take it from the Harris-wide perspective, you're talking about the seg Op margin or segment EBIT margin..

Yeah..

This year, we're going to be – again, center point of our guidance is 19.5%. So that's up on an average about 30 basis points over reported 2018, a little bit more than that when you look at the revenue recognition restatement in 2018. But if I go out in the 2019 – into fiscal 2020, I think we should be approaching, if not hitting 20%.

So, we believe with the maturity of our operational excellence program, some of the actions, the steps we're taking today and the way we're going to take cost out of new product launches like in Tactical over the next 12 to 18 months, we're pretty confident of margin expansion in 2020 and beyond..

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

You bet, David..

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

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

Hey, Gavin..

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

When we look at going into next year, again, we're guiding to 6% to 8% revenue growth. We ended the year with very strong backlog growth.

And as I look into next year, Harris as a whole – and I'll really keep my comments specific to fiscal 2019, we have about two-thirds of our revenue that's covered either in backlog or in high probability follow-on opportunities, which is up from where we were last year.

And it's up pretty substantially in the CS business, as well as the Space and Intel segment. So, we think just based on where the backlog is, the pipeline we have, the bids that are outstanding, I see more visibility on revenue in fiscal 2019 than we would say going into 2018 a year ago..

Okay. And then on the long-term outlook for Manpack, I'm just curious if you could update us on how much you think of the IDIQ might be exercised.

Do you think you can get more than 50% share, and if so, what do you think your share could ultimately be on that program?.

Look, we've been running historically over the last five to 10 years at a much higher share than 50%. So, we would aspire to have our fair share of that market, which would be more than 50%. Look, first of all, the funding lines for Tactical as a whole are actually quite strong.

They're up in the fiscal 2019 NDAA from 2018, and 2018 was up about 17%, 20% from fiscal 2016, and they're growing to about $1 billion or $1.2 billion a year over the next several years. So, the funding that's supporting the overall Tactical business is very, very strong including the HMS Manpack. We're doing well.

We had a delivery order, an LRIP delivery order for 1,129 units out of (32:31) delivery in fiscal 2019. We expect that we'll see another LRIP order probably in the back half of our fiscal 2019 of some size, leading into operational testing in fiscal 2020. So, it is all playing out, I think, very well. It's moving forward as we'd expected.

The budget is there. The Army is moving the program. So, I think, it's all very good news on not just the Army Manpack, but really all the Tactical Radio programs as a whole..

Great. Thank you..

You bet..

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

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

Hey, good morning, Carter. Thank you..

Bill, I wondered if you might expand a little bit on the – just the thought process around the R&D pipeline.

Obviously, your IRAD investments have had a lot of payoff, a lot of attractive payoff in the last couple of years, and I just wonder if you think about the incremental dollars and opportunities that you have in that pipeline, is your thought process around these things changing? I mean, you've obviously had a lot of success, just help us with the mindset around what else may be out there given the success you've seen already..

Well, it's a very good question, Carter, thank you. In fact, having a new CTO on the team over the last year is really helping us dig in a lot more into where we're spending our money and where we shouldn't be spending our money going forward. I mean, you're right, over the last couple of years we've raised our investment in IRAD.

This year we closed at just over 5% of revenue, which is above where everyone else in the segment, the peers happen to be. It's going to go up again a little bit in fiscal 2020. When tax reform was enacted, we took our fiscal 2018 number up about $20 million, because we saw new opportunities in things like robotics that we invested in.

So, we continue to look at how we spend money, we look at the return on different programs, we look at how we leverage capabilities across the company. Lots of places around Harris invest in various features of software or waveforms, and we're thinking about how do we leverage the investments we have across the company in a more productive way.

So that's one of the things our CTO is helping us think about. As I go out a year or two or three from here, I don't think we'll be substantially higher than as a percentage of revenue. So, I see it neither as a margin drag nor tailwind on our margins.

But if we continue to find good opportunities to invest, invest ahead of the curve, invest ahead of where the customer is going to go. And I think as you look at the results we're pointing out today and very good growth, it really does come from some of the IRAD investments we've made in the last three or four years..

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

Well, that's certainly something that we're looking at very, very carefully and something that we're focused on as an organization. Certainly, as you deploy tools like DevOps, it's going to help you develop products which have significant software content faster.

The concept is basically being able to integrate your – continuously integrate and test software builds so that you always have a software feature that you can field in market, and that is something that we have not developed – a lot of the defense companies have not, and that is going to compress the cycle time for software pretty substantially.

We've seen that in multiple cases where we deployed DevOps. As we go out the next two years to three years, you know by fiscal 2021, we think 85% or 90% of our new starts will be on DevOps, I think that's going to be a key thing to compressing our overall cycle time in developing and launching new products, Carter..

Awesome. Thanks for the color, Bill..

Carter, I just wanted to add to what Bill said. So just to give you an example or a couple of different examples, a lot of – like if you take Communication Systems as a segment, we've been investing a lot in hardware over the last couple of years with SOCOM and the Army all the products coming on.

So even that is kind of coming to an end at this point, with SOCOM Manpack is a one big program that is going to work on next year. So, a lot of the attention now is going to shift to waveforms and the software that goes onto those radios, and how do we monetize that revenue stream as we've done previously with the MUOS waveform.

So, there's a shift of where we're spending the dollars are happening as well within our R&D space..

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

Thanks. Good morning, guys..

Hey, Good morning, Gautam..

Just a couple of questions.

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

Sure. Yeah. First, on the international side, pipeline is actually still very good. It's about $2.3 billion, it's still about the same where we were last quarter. You know, the makeup really looks about the same about 50% is Middle East and Africa. You know, Iraq remains a big opportunity. It was pretty substantial in 2018.

It will be a substantial amount in 2019 and beyond. So, there's really good opportunities there. About 30% is in Europe and we're starting to see a little bit of a shift from Eastern Europe to Western Europe from countries like Poland and Romania to NATO countries, so in Western Europe still a little bit of a shift.

And then the balance is going to be in Asia, in Central and Latin America, a little bit in Canada. In Asia, we see Australia some additional opportunities on the rise and other smaller countries in Asia. And we see in Central America, we see Mexico being a bigger opportunity in 2019 than we had in 2018.

So, overall the trends I think are very positive in the International. We ended up having a good year in fiscal 2018 in International, a little bit better than we thought, down less than 1% and a little bit better in Europe than we had anticipated at the beginning of the year. So, played out a little bit better than we had thought.

And I think we'll be back to low-mid-single digit growth in fiscal 2019.

Do you want to cover the DoD?.

Yeah, the DoD, Gautam, the DoD Tactical, it's right, it has actually grown since we last spoke.

The DoD Tactical pipeline is now $1.7 billion, which includes about $400 million, $450 million of the modernization pipeline and about $1.2 billion, $1.25 billion on the base side so that's – so it's – I think last time we spoke, it was around a $1.5 billion if I remember correctly..

Right..

Okay, that's very helpful. And just curious if you've seen any sort of potential blowback from some of the more challenged relationships the U.S.

has with NATO allies, is there any – can you talk about your incumbency there and how much of a – how difficult it is for some of the NATO allies to switch away from the Harris radios that they've already purchased in? I'm just curious like is there any potential blowback from the friction we're seeing where they may prefer European suppliers or what have you instead?.

Gautam, it's interesting. I see – we've seen no blowback in fact, I would say it's going in the other direction we're seeing more opportunities than we've seen in the past with NATO countries. I think it's turning out to be a little bit more of a positive than a negative in lots of ways.

We are seeing coalition partners, NATO partners stepping up with more defense spending. And we do see opportunities that are increasing for Harris on the Tactical Radio side not decreasing..

Okay. And just one last one from me, you guys have been repurchasing quite a bit of stock, raising the dividend, repaying debt.

How does this M&A fit into your medium-term plans, if at all?.

Well, look, I mean I think you pointed out. I mean I think we've done a lot of good things on the balance sheet, we'll generate a $1 billion dollars of cash this year. We've been paying a dividend that's just under $300 million, we'll evaluate that at our August board meeting and decide if there's an increase and to what extent.

We have a placeholder out there for $400 million worth of buyback, we have $300 million of debt that's due at the backend of the year. And over the course of 2019, we're going to evaluate that $400 million share buyback placeholder as to whether it's the best places to buy back our stock or to look at M&A.

Certainly, as we get beyond 2019 when you really step up more on free cash that you see any – in fact any drag on debt repayments go to zero. We're going to generate more free cash and more optionality on that cash for M&A. So, look, we're going to – we're building our strategic pipeline on M&A.

We're looking at a variety of different opportunities all within core segments and that will bolster our ability to compete.

But nothing more to report on today, certainly, with the way we execute on Exelis and how we transformed the business at Harris, I'm very confident that any deal we do would be accretive and would be effective when we execute it and would be strategic to the company..

Thank you, guys..

You bet, Gautam..

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

Hey, good morning, everyone..

Hey, Jon.

How are you doing?.

Rahul, can you step us through some of the cash building blocks heading into next year? You went through a couple of them in your prepared remarks, but can you just sort of narrow in on things like working capital, cash flow, headwind versus tailwind? And then also, I know you mentioned CapEx, so a little bit more on cash building blocks towards the $1 billion?.

Yeah, absolutely. Jon, so in 2019, our net income is up about $140 million. And we get the cash tax benefit of about $90 million from the pension funding that we did or prefunding that we did back in 2018 and that's getting partially offset by increase in working capital of about $30 million to $40 million.

As I mentioned in the prepared remarks, our days come down by one day, but we still because the revenue growth – we still see some drag on working capital. So, there is about $35 million of CapEx growth and it's primarily to fund new program starts like the FTI India win that Bill mentioned.

Our ERP investment is a multi-year investment, it's a little bit of step up in that as well. Classified wins that we got in Space this year that required a little bit of CapEx. So, it's about $35 million growth in CapEx.

And then there's some cash tax refunds that we got in 2019 from old payments in fiscal 2018 that we discussed earlier and that's a headwind as well and that won't repeat.

So, you put all that together we feel good about the $1 dollars, but as we look further out Jon and look into fiscal 2020, you know the big one-time item that we have in fiscal 2019 is this $90 million of cash tax benefit from pension prefunding.

And as we look at fiscal 2020, we think there's several offsets to that, the biggest being we have not yet recovered the Exelis restructuring outflows that we had from the government.

It's a proposal (44:03) restructuring proposal, it's a multi-year approval process and we start recovering all the money that we have previously spent and we recovered that through our cost-plus program. So, there's a little bit of outflow in Exelis restructuring that still happening in the $10 million to $15 million range that kind of goes away.

We do think that CapEx is a tailwind in fiscal 2020, because a lot of the program CapEx will be kind of behind us also the ERP implementation starts winding down. And then we're working on several other cash tax saving projects that we've kicked off this year and that will start delivering results in fiscal 2020.

So, put all that together there's enough to offset the $90 million of one-time benefit that we'll get in fiscal 2019 and then earnings drive cash flow growth in 2020 and beyond..

Got it. That's very, very helpful. And then just on the investment decisions. And then Bill, thank you for all the color you offered earlier in the call.

Can you just offer some perspective on what role the customer is making or playing in driving those decision? Do you sense that customers are desiring to see more investments upfront that you can then deliver a more mature product at the other end? Just kind of curious what the customer conversations like when it comes to approaching CapEx and also R&D investments..

Well, it's a very good question, man. It's been a multi-year push by our DoD customers for industry to step up in R&D. And I think we heard that message that demand signal. We started to step up on this four years or five years ago. And I think that's paying some dividends today.

We don't make investments in R&D internally without really understanding the business case, and understanding where the customer is going. The messages that we're hearing from them and we shape our internal investment pipeline accordingly. So, it's all very well connected to where we believe the customers are going.

Input from them and I think, the fact that we've been willing to step up internally has paid dividends for us. And you see that very clearly upon what's happening on Electronic Warfare, with an area that was underinvested in by Exelis we stepped up dramatically in Electronic Warfare.

And now, we've not only positioned ourselves to retain our strong platform position on F-16, F-18, B-52 but also now we're starting to get into the mix for re-competes on fifth-gen aircraft and proprietary platforms that are being envisioned down the road.

So, I think one good example of where we're hearing the message, shaping our investments and I think we're investing smartly on behalf of shareowners. So, I think it's all pretty tightly connected. And again, our new CTO is going to help us shape it even further in the next couple of years..

Thank you..

You bet..

Thank you. Our next question comes from the line of Sheila Kahyaoglu with Jefferies. Please proceed with your question..

Good morning. Thank you..

Good morning, Sheila..

Just on the medium-term target, there's solid growth outlook across the portfolio.

I guess, how do you think about biggest risks, whether it's budget related or maybe tied to Op (47:09) pursuits in the pipeline?.

A little bit difficult to hear, but I think you're referring to the medium-term outlooks and – first of all budget is going to be an important driver to that.

What I've seen very positively in the NDAA, which passed the House, it's supposed to be at the Senate this week, it could be signed by the President, before we even get out of fiscal 2018, which would be pretty unique.

I think very encouraging to us as well as to all the people who issue procurement decisions in DoD, if the NDAA can get signed that quickly, and maybe even an Appropriations Bill by the end of September, that's even a possibility. So, I think these are all very positive indicators.

So, when you look at Harris, last time I talked about medium-term as mid-single digit growth plus, I think now it's mid-to-high single digits, you see that coming through in 2019. It's really across the segments.

I think a very important driver of that is going to be in the Communication Systems segment where we do see a very strong ramp in DoD in the Tactical Radio business, and we've been focusing a lot on commentary around the Army. We see the budgets growing pretty dramatically on the Army over the next four or five years.

But you also see SOCOM growing, you see the Air Force being strong, and you see the Marine Corps recap coming in quite substantially. So, when I look at our next five years, there's about $5.5 billion worth of budget available to Harris on the Tactical Radio side that supports our business cumulative over the next five years.

So, it's very, very encouraging to me. We also see I think great progress on some of the platforms in both Avionics and Electronic Warfare. I think we're just really starting this big growth. The IDIQ we won on the F-16 EW platform internationally was for $400 million.

So, we booked an award for Turkey in Q4, that was $60 million (48:59), we had Morocco before that. We have about a $1.5 billion opportunity that's ahead of us on international F-16s, F-18's going to grow, the F-35's going to grow, and again, I think we're on the frontend of a nice growth trajectory on the Space Classified business.

So, Sheila, really as I look at the business and I see even things that have been headwinds turn to tailwinds like environmental, really across the franchise I see really good growth prospects. Some of it's driven by – and a lot of it driven by where the budgets are growing.

But I think a lot of it's driven by how well we've positioned our portfolio and the differentiators we have in our products and our solutions..

Got it. Thank you, Bill. And then just one more. You mentioned software as a potential opportunity for yourselves and the defense primes.

I guess how do we think about software evolving as a contributor to the top-line over time and where are those opportunities?.

Well, it's going to be – today, it's more than 40% of the work content we do in engineering. So, it really is today part of the top line. Five years ago, it would've been half that or 25% of our engineering content. As we go forward, it's going to be more than 40%, it can grow to 50%, 55%, 60%.

I think where it's going to contribute to the top-line, Sheila, is how good we are at ingesting and maturing DevOps within this company so that we become strategically better than other players in the space, so we can develop software faster with lower defect rates, with better capability.

And I think the more we can do that, that is where I think it's going to contribute mostly to the top-line as I see that. To me over the next four or five years, I think it's going to be fundamental to how we and probably other players in the space develop products.

A lot of it's going to turn on software and I think the best people in this space are the ones that are going to win..

Thank you..

You bet..

Thank you. Our next question comes from the line of Seth Seifman with JPMorgan. Please proceed with your question..

Thanks very much. Good morning..

Good morning, Seth..

You mentioned that Space driving the higher CapEx, and I wonder if you could talk about, if you can at all, what's underlying that.

And then just the – that's an area of the budget where we've seen a lot of additional resources, and maybe how you're seeing that play out in terms of what contracts are coming up so far, what areas are most exciting for you guys.

And then maybe to bring it back around to the CapEx, when we look out to fiscal 2020 and beyond where you see CapEx overall for the company kind of shaking out..

Well, yeah, I mean, look, on the Space side, it's very exciting, a lot of stuff that's happening. We talked the last quarter about a $0.5 billion exquisite win that we have to a prime on a mission are that we've had some experience on. It's going to deliver over the next five, six years.

Our piece of that is probably more front-end loaded, there's some capital associated with that program. We've talked over the last year about our positioning on smallsats. We have multiple contract awards on that. That's going exceptionally well. There is some capital associated with that.

And as that matures over the next 12 months or so, there's lots of other mission areas and components and capabilities that will be augmenting that smallsat mission that we're positioning ourselves on. It's all, I think, very exciting. Space superiority is a huge growth driver for the company.

I talked about our growth in that area being more than 15% this past year. We see that continuing to grow, we think we're well-positioned for opportunities for – on ground control systems as well as space situational awareness. So lots of different ways we're competing on, on space superiority. And the last one is on the optics side.

With Exelis, we acquired a great capability up in our Rochester facility for optics and there is a recap of a lot of different capabilities in Space, some are RF related and some are optics related. And those recapitalizations sometimes requires some additional capital investment.

So that all goes together in some of the things we're spending our growth capital on in 2019. As Rahul mentioned, we're up to about $170 million in 2019. We'll see that mitigate itself a little bit going into fiscal 2020, probably down around $15 million or $20 million as we get through a lot of this sort of one-time growth capital we see in 2019..

Great. Thanks.

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

Our sales are typically a little bit backend loaded as you – and that's kind of – it's a 48%/52% split traditionally for us. DoD, Tactical, as I mentioned earlier, is a little bit backend loaded, the SOCOM and the Army handhelds are – they basically don't start till tail-end of Q2.

So, December-ish is when they start and then a ramp in the second half of the year. And then Manpack kind of starts Q2 our time. So, a little bit more backend loaded than typical. But so other than that, ES and Space should be fairly typical..

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

Great. Thanks very much, guys..

You bet, Seth..

Thank you. Our next question comes from the line of Josh Sullivan with Seaport Global. Please proceed with your question..

Hey, good morning..

Hey, good morning, Josh..

Bill, you just mentioned the hiring of a new design team, the new CTO, consolidating ERPs, changing some of the way you approach development.

What kind of benchmarking have you done for that? And then what's the timeline on some of those efforts and maybe where we would see the impact first?.

Well, I think broadly over the last five or six years, as I started to reshape this OpEx program we have at Harris, I've been talking about what I consider to be a good OpEx program is a program that delivers 2% to 3% net of cost, so 2% to 3% savings, net of what's given back to the government, net of inflation dropping to the bottom line.

And we've been running towards the high end of that 2.5% to 3% range really over the last five or six years, and I expect that to continue and maybe even go above that over the next several years. What's driving it is changing over time.

Of course supply chain is important and there's some engineering productivities, the labor productivity in our factories, but even through Exelis integration, we continue to see on top of the savings from the Exelis integration opportunities to just get better every day at what we do, and that's going to be continuation.

So that was from my experience at UTC and what I see other companies doing. So, I think that is generally pretty good. In terms of benchmarking on ERP systems, it's hard to say, but I can tell you 20 systems today is too many, and three is about the right number.

We've got a government business, we've got a commercial business, and one is – it's pretty fairly unique, which is why we're at three.

But really what we're doing is, we're bringing people into the company in senior roles either an IT or technology or other places that have experience outside of Harris to really look at what we do and bring best practices from their experiences here, and that is what's giving us some shining the light on some new opportunities that really are in front of us.

And as I said, as I look into the future, I see as much opportunity ahead of us as I've seen we captured in the recent past. So, I think the ground is pretty fertile on continuing to get better, drive efficiency and productivity really across our business in the next couple of years..

Okay. Great.

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

It doesn't, no, I mean in fact in our Rochester Tact, we've got multiple facilities up in Rochester and on the tactical side, we've been running in the low 60% – 60% utilization. You know there're plenty of opportunity to grow in that Rochester facility without any additional capital, it's about six years old.

But even there as we go to multiple shifts there's opportunities to do something different with some of the components we make there. So, I see no capacity limitations on the rise in, in our Rochester Tactical facility. And for that matter really in any other facilities we do a lot of optics work at some other things up in Rochester.

And I don't see any limitation there. I think the spike we're seeing this year on capital is really on specific programs and program capital not on basically not on infrastructure capital..

Okay. Thank you..

You bet..

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 afternoon. Good morning, sorry..

Good morning, Rob..

I'm going to Slide 13 and the medium-term guidance Bill, it may sound a bit pedantic, but your commentary said you expect the revenue growth rate to accelerate up to high-single digit. Well, you kind of going to get there in 2019, if everything goes to plan.

So, do you see the potential to go faster than what you're guiding to in 2019? And then in relation to that how sustainable do you think this sort of growth rate is, is it sort of a one or two years and it slows, or do you see this as being a sort of three year, four year, five year affair?.

Well, first, on that slide, the Electronic Systems and Space and Intel, there is an acceleration from what we see in fiscal 2019 or in fiscal 2018. So there's some acceleration there. We see CS and Communications to continue to be at a high-single digit range.

Frankly, I think as I look back on 2018 and where we started our guidance on 2018 – keep in mind we started, I believe it was 15% or mid-teens on DoD Tactical. Then we went up to 20% or low-20s% and we ended at 35%. So, I'm not so sure, I'm really sort of calling it accurately.

I think we're being more conservative than aggressive in our assumptions and hopefully with the same place today in 2019, and hopefully beyond there as well. As we see opportunities placed – put on order a lot faster than we saw over the last couple of years, and this is a pretty remarkable phenomenon.

Orders are being placed, dollars are being obligated at a much faster rate not just in DoD but also in the intelligence community, certainly from where we were a year or two ago. And that's been a very positive surprise.

And like I said the NDAA getting approved out of the House and maybe even getting approved by the President before we even hit September is pretty unique. And I think what's happening when that – when things like that happen, it gives encouragement to people who issue procurement decisions to obligate dollars faster. Their confidence goes up.

So, I continue to see opportunities in 2019 and beyond. So, what's medium-term, medium term to us is three to four years.

As I look at it and we look at our positioning, the amount of unused dollars that are not yet committed, where the budgets are growing and what we see in the budget that we can actually see over the next five years, there's a lot of opportunity to continue really robust growth across Harris, going out in that three-year, four-year, five-year period, Rob..

That's great. Thanks for it, Bill..

Okay. You bet..

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..

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..