Greetings, and welcome to the Harris Corporation Second Quarter Fiscal Year 2019 Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr.

Anurag Maheshwari, Vice President, Investor Relations. Thank you. You may begin..

Thank you, Michelle. Good morning, everyone, and welcome to our second quarter fiscal 2019 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 will also be available. With that, Bill, I will turn it over to you..

Tactical Communications, Night Vision and Public Safety.

In Tactical, international delivered another solid quarter up 11% driven by the ramp of modernization programs in Australia, standardization of Harris equipment in NATO countries in Western Europe, continued border security programs in Eastern Europe and the third technology refresh for a longstanding customer in Northern Africa.

For the first half, international revenue was up 7% driven principally by Asia-Pacific and a strong second quarter recovery in Europe and book-to-bill was greater than 1.

That combined with a solid pipeline of $2.5 billion reaffirms our expectations that international will grow low-to-mid single digits in fiscal 2019 with sequential growth in the second half. On the DoD side, Tactical revenue was up 7% for the quarter despite a tough compare and growth across the services shifting from readiness to modernization.

We started to deliver on a $90 million Army HMS Manpack LRIP that we booked in Q4 of last year; we remain on track to complete the delivery by this summer.

For the SOCOM two-channel handheld program, we successfully completed operational user assessment, delivered initial units, and expect production to ramp through the second half of the fiscal year.

For the Marine Corps, we booked $75 million order for MUOS software upgrades for Falcon III Manpack radios and recognized $24 million of revenue in the quarter with a balance to shift by fiscal year-end.

This award brings MUOS orders since its launch in 2016 to about $175 million highlighting our ability to generate additional software revenue on previously sold hardware. For the first half, DoD Tactical revenue was up 17% driven by the ramp in modernization programs and strong Q1 readiness demand and orders were up 45% with a book-to-bill of 1.7.

Pipeline remained solid at $1.6 billion and with anticipated second half modernization growth we now expect DoD revenue will be up in the low 20% range for the year versus up mid teens at the start of the year. Overall for Tactical, first half revenue increased 11%, book-to-bill was 1.3, and backlog increased 34% to over $1.1 billion.

The growth in Tactical coupled with strong revenue and order growth in Night Vision and Public Safety give us confidence to increase Communication Systems revenue guidance to up 10% to 11% for the year versus prior guidance of up 9% to 10%. In Electronic Systems, revenue increased 6%, the sixth consecutive quarter revenue growth.

This strong performance was driven by sustained growth in long-term platforms F-35, F-18, F-16, which collectively grew double-digits as we leverage technology upgrades, ramp production, and expanded our international footprint.

We also saw growth on SOCOM rotary platforms as we began to modernize legacy electronic warfare systems to address new threats and requirements. Order momentum continue to be strong growing 12% and for the sixth straight quarter book-to-bill was greater than 1 as we expand our electronic warfare and avionics franchises.

In electronic warfare, we booked $115 million in contracts from Iraq and Poland to upgrade the EW capabilities of their F-16 aircraft, adding to the previously announced Turkey and Morocco awards, and continuing the international expansion of our F-16 EW program.

With $225 million of funding remaining on the previously announced $400 million sole source IDIQ contract and several additional international opportunities in the pipeline, we remain confident in the growth trajectory of our EW business.

In addition, we've partnered with Northrop on the recently announced Next-Gen Jammer Low Band program which will significantly increase airborne electronic attack capabilities on the EA-18G Growler.

This win is the combination of a multi-year strategy to invest in adding features, functionality, and capability to our EW products to enable us to increase content on existing platforms and win new pursuits.

In avionics, we're leveraging our open system architecture technology and recent award on the F-35 mission processor to win content on two new strategic platforms, a large UAV, and a new trainer aircraft. These wins build on the F-35 success and provide significant multi-year follow-on opportunities.

For the first half, Electronic Systems revenue was up 7.4% and book-to-bill was 1.2 resulting in a backlog increase of 24%. The pipeline remains robust at $16 billion with $3 billion in proposals outstanding and we continue to expect revenue segment to be up 7% to 8% this year.

And then, finally, in Space and Intelligent Systems, revenue growth accelerated to 11% in the quarter as our multi-year investments to innovate ahead of customer needs led to high-teens growth in the classified business which more than offset the expected headwinds on environmental programs.

We continue to be successful in expanding the addressable market of our classified business by providing end-to-end mission solutions and penetrating new adjacencies.

In our small satellite franchise, we received awards of more than $350 million over the past three years to develop and produce 17 satellites with five different customers as we move from pathfinder mission to building a full constellation in space.

And on the new ground based adjacency, we have nearly tripled the program since our first win in second quarter of fiscal 2017 solidifying our position with this customer.

We see this momentum continuing with several new wins in the second quarter that extend our positions on existing programs as well as create new franchises that will have significant follow-on opportunities. Last month, we were awarded a $218 million follow-on contract from the U.S.

Army for wideband SATCOM operational management system network, a 35% increase over the initial order reflecting the customer's confidence in Harris's Technology and capabilities.

We also leverage our mission knowledge and secured an $80 million order from the Space Enterprise Consortium to enhance space-based position, navigation, and timing systems by providing additional capabilities to detect and mitigate harmful interference.

Technology matured on this program is expected to transition over time to future generations of GPS satellites and various other payloads. In addition, we continue to strengthen our position on [exquisite] [ph] systems receiving a $115 million contract to provide next-generation technology for a long-standing classified franchise.

And finally, earlier this month, we received a $185 million follow-on sustainment and modernization award for counter communication that will be a standard for the Air Force going forward. I'm also pleased to note that we had a record launch quarter in Q2 validating our leadership position in hosted payloads and small satellites.

We successfully launched three small satellites including Harris's first smallsat called HSAT showcasing our ability to provide an end-to-end solution including ground command and control from our Phillis facilities here in Florida.

We also witnessed for launch of the first GPS-3 satellite with the Harris navigational payload which is performing well through initial system checks.

Two international satellites were also successfully launched with Harris payloads, one for Japan's Ministry of the Environment and the other for the Korean Aerospace Institute further embedding us as the leader in environmental sensors.

And in just a few weeks ago, Iridium completed its final launch and now has a constellation of 66 satellites in space with 232 Harris reprogrammable hosted payloads on board providing persistent real time tracking of ships and aircraft globally along with a few other missions.

For Space and Intel, first half performance was better than anticipated with revenue up 8% and backlog up 10%.

With about 92% of second half fiscal 2019 revenue and backlog, and an high confidence follow-on opportunities, and a $10 billion pipeline, we now expect revenue growth of 6% to 7% for the segment, a two point increase from a previous guidance of 4% to 5%.

Overall with our strong first half performance, solid backlog coverage, new wins in a growing pipeline we are increasing total company revenue guidance to be up 8% to 8.5% versus previous guidance of up 6% to 8% with earnings per share now at $7.90 to $8 and free cash flow of $1 billion to $1.025 billion.

So let me now turn it over to Rahul to cover financial results and some more detail before we close with a few comments on the merger..

Thank you, Bill, and good morning everyone. Discussions today are on a non-GAAP basis excluding L3 deal and integration costs as well as one-time charges in the prior year.

Turning now to the total company results on Slide 5, revenue was up 9% in the second quarter and earnings before interest and taxes increased 18% on higher volume and operational efficiencies, resulting in margin expansion of 150 basis points to 19.6%.

EPS grew by 19% and free cash flow increased 25% to $323 million for the quarter as we reduced 10 days of working capital compared to last year. For the first half, revenue was up 9% and earnings before interest and taxes were up 15% with margin expanding 90 basis points to 19.5%.

Free cash flow was robust in the first half at $409 million, a 24% increase over the prior year and was approximately $1 billion over the last 12 months. Second quarter EPS bridge on Slide 6. EPS grew by 19% or $0.31 with strong operational performance more than offsetting a higher tax rate.

The $0.35 increase from operations was driven by high volume in tactical radios, avionics, and classified space and solid program execution which more than offset lower environmental volume and increased R&D investments. A higher tax rate relative to last year which included the catch-up benefit from tax reform reduced EPS by $0.04.

Segment details on Slide 7, Communications Systems second quarter revenue was $540 million, up 10% versus the prior year. In addition to strong growth in Tactical, revenue was up double-digits in Night Vision and Public Safety as the businesses converted strong orders to revenue.

Operating income for the segment was up 12% and margins expanded 50 basis point to 30% from volume leverage and operational efficiencies partially offset by program and product mix. Orders grew by 33% resulting in a book-to-bill of 1.2 for the quarter.

In addition to the order momentum from Tactical modernization programs, we continued to execute well on our strategy of expanding into the adjacent airborne segment for the $66 million order with small tactical terminal airborne radios for both domestic and international platforms.

And in the Public Safety business, orders grew more than 50% in the quarter as we strengthened our position with the utilities and state and federal agencies with orders from Nevada, AEB, and the Air National Guard.

For the first half of the year, segment revenue was up 12% with double-digit growth in all three businesses and operating income increased 16%. Operating margin was up 90 basis points versus the prior year. The segment first half book-to-bill was 1.3.

Historical information for tactical orders, revenue, and backlog is included as supplemental information at the end of this presentation. Electronics Systems on Slide 8, segment revenue was $617 million, up 6% for the quarter.

Segment operating income increased 21% to $117 million and margin expanded 230 basis point to 19% from strong operational performance and the absence of a one-time contract adjustment in the mission network's business recorded in second quarter of fiscal 2018. Orders were up 12% resulting in a book-to-bill of 1.1.

In addition to strength on long-term platforms strong growth in the weapons release business led to first half segment revenue growth of 7%. Operating income increased 13% with margin expanding to 19.2%. Segment first half book-to-bill was 1.2.

In Space and Intelligent systems on Slide 9, segment revenue was $513 million, up a record 11% and operating income grew 15% as margin expanded 60 basis points from higher volume and strong program execution. First half segment revenue increased 8% with continued growth in classified programs, partially offset by a decline in environmental revenue.

Operating margin remained strong at 17.8%. Moving to Slides 10 and 11 for full-year guidance. As Bill mentioned we now expect the revenue to be up 8% to 8.5% versus up 6% to 8% in the prior guidance from increased trend in Tactical Communications and classified space. We are increasing EPS guidance by $0.10 to a range of $7.90 to $8.

Higher volume in Communication Systems and Space and better than expected operational performance in Electronic Systems is expected to contribute an additional $0.13 to EPS. This will be partially offset by an increase in interest expense of $0.03 as floating interest rates trend higher.

EPS at the midpoint will now be up 25% for the year with about 60% of the growth coming from operations and the remaining 40% from lower share count and a benefit of a lower tax rate.

Total company margin is now expected to be between 19.5% and 20% an increase from the previous guidance of 19.3% to 19.7% from increased volume in high margin Communications Systems segment and improvement in margins in Electronic Systems. We had increasing free cash flow guidance to a range of $1 billion to $1.025 billion driven by higher earnings.

Switching to segment outlook, in Communication Systems we now expect revenue to be up 10% to 11% versus up 9% to 10% previously driven by strength in DoD Tactical Communication, the operating margin guidance of 29.5% to 30.5% remains unchanged. In Electronic Systems revenue guidance remains unchanged at up 7% to 8%.

Operating margin is now expected to be between 18.5% and 19.5% versus 18% to 19% previously from strong program execution. In Space and Intelligent systems, we now expect revenue to be up 6% to 7% versus up 4% to 5% previously driven by better than expected growth in classified programs.

The operating margin guidance range of 17% to 18% remains unchanged. And with that, I would like to turn it back to Bill for his closing remarks..

Okay, thanks Rahul. So overall, we're performing exceptionally well in all segments and across all metrics. Orders, revenue, backlog, margins, earnings per share, cash, and we're on track for a record year. There has been a lot of discussion around the GFY 20 Defense budget.

We continue to believe that the President supports increased funding to meet national security demands and with outlays continuing to lag budget appropriations overall as well as in the budget lines that matter to Harris, we expect growth momentum to continue in the medium term in the mid-to-high-single-digit range.

From this position of strength, we decided about three months ago to merge with L3 to create a leading global defense company. We are well into the regulatory process and continue to expect a mid calendar 2019 close.

On January 10, we received a second request for information from the Department of Justice and we continue to work cooperatively with the DOJ on its review. As part of the regulatory process, we're moving proactively to explore the possible sale of our Night Vision business.

The government shutdowns affected to team handling our merger filing but we believe we have enough slack in the schedule to absorb the near-term delay without impacting the mid-year closing.

We’re also tracking well in international approval processes including European Commission and we've held informal discussions with the UK authority should a filing be required in the event of a hard Brexit at the end of March.

Integration planning is progressing well with about 50 dedicated leaders from Paris and L3 who are leveraging Harris’s Exelis experience and skill set to develop detailed plans to achieve $500 million of cost synergies and $3 billion of free cash flow.

Chris and I are deeply involved in the integration planning and have weekly meetings with the teams to ensure that we capture the full value of the merger and hit the ground running on day one following the close.

We both have spent considerable time meeting and getting to know each other's leadership team and have made good progress in developing an organizational model that's lean, mission-focused, and leverages the best of both companies. All in all, we're tracking on or ahead of schedule as we execute this transformational combination.

So with that, let me ask the operator to open the lines for questions..

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]. Our first question comes from the line of Robert Stallard with Vertical Research Partners. Please proceed with your question..

Bill, first of all I thought we'd start with CS, very strong DoD performance both on revenues and orders in the quarter and I was wondering if it's your perception whether the DoD is adding incremental demand into your backup or whether this is pulling forward activity that you may have expected to occur in the future?.

No, I think this is just a continuation of a very, very strong ramp in the DoD business, last year, if you remember, we increased our guidance through the year, we started off in the high teens 20%, we ended in the mid-30s, we're seeing a similar trajectory this year but a shift from readiness to modernization, the modernization ramp clearly has happened, we're seeing significant growth in modernization spend as we expected and have communicated to our investors over the last couple of years..

Okay. And then secondly on the L3 Front, it looks like they had a few execution issues this quarter in their results this morning.

I was wondering if you put the two business together whether there is some, say, process expertise that you could bring to the table and maybe improve the execution of the combined business going forward?.

Well I think you'll hear from Chris later on this afternoon on his business and his performance last year, his expectations for this year I think overall Chris and I have worked well together, we're working well with the team.

One of the key focus areas of integration is on operational excellence and certainly L3 as L365 we have our HPX program and putting them together we think collectively we will find a way through the combined companies to continue to execute, execute better, capture our revenue and cost synergy.

So Rob I think it's all good stuff and I think the company's going to benefit from both our programs in 2019 and beyond..

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

Bill, you mentioned MUOS and the opportunity for software upgrades, is there any way to think about how big this opportunity is both domestically and internationally?.

Well, it's a good question because just on specifically on MUOS, we made an investment a few years ago to customize that waveform, so it's easy to download and just a software download onto our 117 G, we have about 30,000 out in the field U.S.

DoD, International not all of them will be upgraded, some will be replaced with a new radio particularly in the Army. So we think the opportunity for us is something around 70,000 radios maybe a bit more than that.

I think we've already installed about 10,000 in the Marine Corps, a few in the Air Force, so we still see some upside, in DoD, we see some upside in just specifically in MUOS and international markets like particularly in Canada, in this part of the long run plan for the company and we've seen that shift in how we're spending IRAD moving from hardware development to software and waveform development, we think that's going to be a differentiator for that business in the future..

Okay.

And then just on ES, performance have been better just on execution, any color around what was driving that and how sustainable do you think it is to reach that 19.5% margin?.

So I think the question was on ES. It was a little bit difficult to hear. But we're very proud of what they've done; they're growing very well for the first half up 7.5% about the same for the back half.

So again 7%, 8% for the year, margins are good and actually getting better in the year, we feel really good about long-term platforms, we've talked about our avionics business, electronic warfare across those three platforms I mentioned before F-18, F-16 and F-35 we're really excited about the wins we've seen in F-35, the future is very, very bright in that business, we see over the course of the back end of the year continued growth in orders particularly around developments in the UAE and we see a lot of optimism going into fiscal 2020.

So yes the whole team I think has done exceptionally well in managing their investments, positioning their business very well, growing the pipeline and you're seeing the results of that hard work comes through in fiscal 2019..

Okay, thank you..

On the margins, Sheila, we've guided to even in our medium term guidance that we have laid out back in August, we had said that we expected upside from the 18.5% that we’re guiding to this year.

We've had guided there was a plus next to it and we have seen some of that kind of coming to this year but as we continue down the path of cost reduction, the business is 75%, 80% cost that is fixed price, so as we continue to take cost out of that in that business they should be margin upside there as well in the outer years..

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

Hey, good morning.

Bill, I wanted to follow-up on Rob Stallard's question before with regard to L3 and some of the margin pressures that they showed, this morning I think investors are very excited and intrigued by your $3 billion free cash flow target that you and Chris have laid out but maybe they are a bit skeptical on how you get there since that seems to be more lift of their margins and I wanted to talk about that $0.5 billion in gross synergies, $300 million in net, how much that is process improvement where the Harris model once overlaid on the L3 assets helps to lift that or does it have to do with other obviously there's going be day one costs and so forth.

So I wanted to chop up that that number and see if we can understand where it's coming from and over and how it plays out over the let's call it three year horizon?.

Yes, okay. So no change today in terms of our expectations or in cost synergies, still $500 million gross, $300 million net, over the next three years. In the building blocks that haven't changed either about 50% is coming from direct and indirect spend and facility rationalization.

We see about 25% from the consolidation of the headquarters functions and segments, and the other 25% from functional efficiency shared services, it really comes from both companies, there's not initially more coming from one or the other we see about 40% of that or so happening in the first year mainly from segment and headquarter consolidation, we will see some indirect spend coming through as well but look we've been through this path before with Exelis.

We've spent the last six or seven years at Harris developing an operational excellence agenda, a rigor around that it extends well beyond supply chain, it goes into our factories, it goes into our engineering function, it's permeated across all of our administrative functions, we've leveraged a shared service center.

So today we have all of our IT across the company centralized in one location, 15 other processes, financial and others that are now centralized in a shared service activity. I think L3 is further at the front end of that journey and you'll see some margin upside that will come simply because that's the path that they were on themselves.

So we'll see that -- we'll see margins grow in the combined company through both what they have laid out in the rest for us about a point of margin growth on their own not a point on Harris side plus another 150 or so, 200 basis points on synergies. So this is a great story that's playing itself out.

I think the story is really compelling, that translates into free cash. I think I've got a lot of confidence in hitting $3 billion of free cash in three years, we're starting from about $2 billion we will see some organic growth. In the back part of it is really the after-tax cost synergies but also keep in mind working capital performance.

This is something that we've been able to achieve pretty well at Harris post Exelis, we took about 20 days out of working capital, we're only assuming six or seven days out of the combined company which will have 70 days. So I feel very optimistic about generating additional cash coming out of the combined company, Rob..

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

Bill, could you comment on your forecast that were contained in the S4 relative to your medium-term outlook, it doesn't seem like the forecasts in the S4 splits with what you're talking about in terms of the medium-term?.

Yes, the -- what was in the S4 was generated in our strategic plan earlier last year. We've seen a little more -- little more tailwind in the budget, a little more tailwind in our numbers, you see we are taking our revenue guidance up this year, so we still see our growth in the mid-to-high-single-digit.

I think in the S4 it was around 3%, 6%, 7% CAGR over the next three, four, five years. We're probably a little bit better than that today based on what we're now seeing in fiscal 2019 and again this is we're seeing really good growth trajectories, our pipelines are strong, they're getting replenished quickly they're growing, our backlog is growing.

So I feel certainly better today about 2019 and beyond than what we would have been feeling six to 12 months ago..

Okay.

Could you talk about how you see your short cycle exposure I think there's some concern in the market if the budget does kind of flatten out that you're more exposed given your higher degree of short cycle exposure, could you just address how much of your business you see is kind of short cycle exposure that could turn quickly?.

The short cycle part of our business probably relates mostly to our Tactical business and principally the DoD business.

But in that area we're seeing growth in orders backlog is way up, the budgets look very, very strong, certainly what we've seen over the next four to five years, they essentially have doubled their last two years, it's kind of pretty substantially there's a lot of opportunity ahead of us.

We see the budgets growing in the tactical line items by another 30%, 40% in next three or four years. A lot of it’s been driven by Army modernization SOCOM modernization but also the Marine Corps is coming in as well. So we've seen a great trajectory here.

When I look at just the budget even if it does flatten off a little bit as I mentioned in my prepared remarks, appropriations are running well ahead of outlays overall and in our line items as well and I think that's going to provide some nice tailwind for us. So I don't see our short cycle business tailing off at all.

In fact if anything in the first half, we saw getting a bit stronger..

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

Just a couple of quick ones, one we haven't talked about in a while but obviously the PSPC numbers were pretty strong, is that market finally growing a lot or are you taking share I just wondered if you could clarify that a little bit for us? And then, a second one for you, Bill, just as you continue to work through and think through integration with L3 on the transaction, how are you thinking about internal R&D spending is that -- is that being influenced at all by updated views on revenue synergies, any color you can give us on how you're thinking about that and the combined entity and how it may influence your development spend and mindset? Thanks..

Okay, good, thanks, Carter.

Two good questions, I'd love to say that we're gaining share in public safety, I can't really say for sure we've had two very good quarters, we've had a series of quarters four or five in a row where we've seen backlog growing book-to-bill during very positive, the first half revenue was up double-digits which is in my seven years here have never happened.

We still seen very good strong order momentum, some, some good bookings. I think it comes back to where we've been over the last couple of years, quality is getting a bit better, we’re seeing a great reception on new products.

Adding Nino and the team there are doing a very good job in building our sales force, improving our channel performance, and we're starting to win a bit more on utilities, couple of big state contracts penetrated federal bit better.

I think the market is up, it's certainly not up double-digits but the market is a bit stronger but I think we're on a good trajectory here too early to claim success.

We've had two good quarters, we're expecting a good year, we are expecting the PSPC to be up high-single-digits which I don't think I've ever thought to be able to say but that's actually a great trend. And I'd love to be sitting here in six months from now looking back on just fiscal 2019 and saying we had a really good year.

So off to a really good start, I'm proud of what the team has done in turning that business around and growing the margins, growing the top-line but too soon to say whether it's officially turned around in a great business. So we'll see. On the piece on the IRAD, it's a very good question we're just starting to hit into that between us and L3.

Collectively we will spend a little north of $600 million in IRAD maybe $640 million something like that $640 million probably little north of 3% of our revenue combined and we're just now looking at what we spend, what they spend is still very early in this process and we will shape that based on where we see growth opportunities both on organic basis or independent of one another but also on a combined basis, the teams have started to get together and discuss revenue synergies of probably more than hundred ideas that they've come up with, some very interesting ones and over the next six to 12 months, I think the team will start to shape what the IRAD budget will look like in our priorities.

And I would imagine it will get shaped, it will shift a bit, based on revenue opportunities that we hadn't seen before between the two companies. So I think more to say probably in the next six months but not much more I can say on that today..

Hey, Carter. So going back to the public safety, one additional point I just want to add to what Bill said, the other thing that's helping us we have the only radio that has both the legacy technology and ERP technology on a single radio and that is helping us gain some additional customers.

So just introduction of reference introduction of new products, that radio is helping us get some momentum in the market..

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

Hey, thanks guys. Great results..

Thank you..

Couple of questions.

First you mentioned you are exploring and potentially exiting Night Vision at least the Harris Night Vision business, could you again quantify what that expected sales level is in fiscal 2019’s guidance for Harris Night Vision?.

Yes, Night Vision for us this year will be in the $150 million to $160 million range, it's probably mid-teens margin there about..

Just broader context you looked back at the Tactical Comps business and it wasn't just two years ago when the backlog things were -- there was an air pocket and what have you. Backlogs were up more than 2X. I'm just curious you mentioned the DoD, the international pipeline is $2.5 billion.

Where is the DoD pipeline and do you think there is any risk over the next couple of years that we'll see a similar air pocket are we sort of in order frenzy and we're not going to see much in the way of backlog growth, what's the -- what should we be tracking because it's been a pop up in a way for a while now and I'm just curious if we're ever going to see any erosion in backlog over the next year or two and what should we be prepared for?.

So it's so good question. So the pipeline is about $1.6 billion on the DoD side, it's up about 12%, 13% year-over-year.

A lot of it's coming out of modernization, so we're starting to see this long awaited modernization trend, we're really at the front end of it, modernization revenue for this year we think is in the $270 million to $275 million range. It's up substantially from last year. We see continued support, continued momentum in special operations.

We're now shipping into second half of the 2-channel radio, the army we're shipping a 2-channel radio we're down the path of the Manpack or SOCOM, we're heading down the path on delivering on the first LRIP for Manpack, we will see another LRIP coming at the back end of this year probably a third one next year.

OT will be next summer, the Marine Corps is now starting to position for their own modernization by. So we're on the front end to what I still believe is a really important ramp, couple of years ago the budgets were about $650 million this year $950 million, according to last year's FDAP they peak around $1.3 billion, $1.4 billion.

So I think we've got a lot of headroom in front of us and as I look at that and just see what's happened over the last three years in our business we've grown about two-thirds in that business.

There could be another substantial uptick in our revenue in DoD in the next three years just based on what we see in the budget, the momentum in the business, even with some expectations of a little bit more share gain in that DoD side, the business could be in the range of $900 million to a $1 billion in three years.

So we continue to see very good momentum and no hiccups whatsoever but right now in the DoD business, Gautam..

Okay. And just a last one from me, if you could update us on some of the milestones we should be tracking related to the merger.

So in terms of when the board is going to be announced the new 10 member board, anything you can give us that we can track in advance with the close?.

I think the next thing that we will be talking about probably is once the S4 is approved by the SEC, and we issue you a proxy there will be a shareowners meeting, I can't tell you exactly when that's going to be, that's not the long pole in the tent, it's really getting HSR approval from the U.S.

DoD, we probably won't announce anything on the new board structure until after the shareowners meeting.

So that'll probably be in the spring timeframe, I'm not sure what other milestones or events we'll be announcing but we still believe based on what we've seen that we'll be able to close by mid calendar year and again should we see any change from that, we will communicate with investors appropriately..

Thank you. Our next question comes from the line of Myles Walton with UBS. Please proceed with your question..

I was hoping to go back to the synergy in particular the working capital synergy commentary because it’s pretty, pretty impressive number as you achieve it, I'm just curious when you juxtapose the current environment of mid-to-high-single-digit growth for yourselves and mid-single-digit growth for L3 versus what was a flat organic environment and working capital savings are being more difficult, I'm just curious if growth is constraining kind of your six to seven days of reduction in combined company or if that's a baseline you think you could outperform against?.

Well, I think I was hearing most of that Myles but look I think the way I look at that opportunity is combined at the end of calendar 2018, we had about 70 days of working capital, so L3 ended around 80, we are about 50 on a comparable apples-to-apples basis to about 70.

We're sitting at 50, we took 20 days out with Exelis, we're only was assuming six or seven days out at about $35 million per day more or less, I do think there's opportunities to go beyond that.

We have -- we've assigned a consultant team a clean team to kind of look at working capital both Harris and L3 look at the specific entities where we have higher than normal working capital of specific items, some of it is payables, locked inventory, lot of unbilled, those opportunities certainly on the inventory side do take time to action and to achieve that's why we say over the course of three years, we'll be bringing that down.

But I believe that there's anything six to seven day improvement is probably, probably on the conservative side, I think there's probably an opportunity to do a bit better than that.

And top of that we do see organic growth and just on normal sort of drop through in our business in a 20% tax rate, we do see cash growth simply coming from organic growth.

And the other we don't really talk much about is on the capital spending side where we do some of our facilities there might be a little opportunity on capital spending, there is probably a little opportunity on cash taxes, so we've got a lot of things that I think are trending as tailwinds for us that gives us Chris and I a lot of confidence to be able to get $3 billion three years down..

And then your 40% of that cost synergy target in year one, what do you think that is in terms of percentage for your working capital synergy in your one, how quickly does this come off?.

So on the 40%, I wasn’t sure I heard all the question 40% of the $500 million of gross synergy will happen year once about $200 million that's going to basically be segment and CHQ consolidations and some indirects. And that's really where that is going to come from.

I don't think we really guided anything in terms of working capital improvements in the first year but I know we'll see something, we'll see something in calendar 2019, we'll see more in 2020, we'll see more in 2021, so I don't think it will be -- it's probably a couple of days I guess, we'll see this year.

But I think we're really suggesting more than that, we're still seeing six to seven days over the next three years..

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

Hey, good morning everyone.

Bill on the call, so on your prepared remarks, you talked a little bit about readiness demand versus modernization, readiness being a big driver last year now for modernization, can you talk about this kind of those two buckets more broadly and across the business not just CS both this year and going forward in terms of what you've seen your backlog, your pipeline and what you expect out of budgets both here and abroad?.

Actually, Jon, I missed the front part of your question, I'm sorry..

I’m sorry, as you parsed between readiness and modernization, you mentioned how there's a real shift now towards modernization which one would think would give kind of stick your piece of business than readiness which could flex up and down more rapidly?.

Yes, so, thank you, Jon, that's a great question.

So we had a really good year last year in terms of readiness demand, remember there was a couple of security forces, systems brigade that we fielded that was with the Army, we may see another one this year, we saw a lot of opportunities with the Air Force last year, we saw a little bit more this year on their TAC piece as well as their base support.

So readiness now we are starting to shift over this year into modernization, I think you're exactly right there's a lot more stickiness on that there's a discrete budget that's specific to the HMS program to the SOCOM handheld programs the SOCOM Manpack in the Marine Corps, they are specific budget items.

So I think there is a lot more stickiness to that, there's IDIQ vehicles both all the services are buying off of those IDIQ vehicles. So we feel very good about what's happening this year-end and really the expectation that that's going to continue into next year.

There's a very clear plan that SOCOM in the Army have laid out as to how they want to buy, how they want to feel based on those radios when they want to test, the budgets are coming off of so all of that seems to have a lot more predictability than what we saw in readiness.

So to your point I think that's exactly right, we'll see a little more stickiness and predictability on modernization..

And as the customer seems to as always focuses on getting more for less saving money in this case in light of deficits, I think would you will be able to characterize what your customer conversations have been over the recent weeks and months as you prepare for an FY 2020 budget which is supposed to reflect some, some changes in how the DoD is approaching both how they do business and what they want to focus on in the five-year plan?.

Well, look I think the conversation is not a lot different recently than it might have been a year or two ago which is you're right, they do want more for less that that makes sense, they drive the budgets are coming up but affordability is key.

They want innovation; they should industry to step up on innovation, spending our own money we have done that, L3 also has done that in significant way.

There has been conversations around contract financing that's still a live wire still a live switch but these are the things are sort of going on in the background but at the end of the day, it's a -- according to National Defense Strategy, there's a lot of opportunities to continue to invest, develop new capabilities, field capabilities faster to the war fighter, so every conversation is around innovation, speed to feel the capabilities, affordability those are incentivizing industry to perform, these are all the basic parts of our conversation with DoD including some meetings we had last week..

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

Thanks very much and good morning.

Bill, I wonder if you could talk maybe a little bit more about the space business, obviously very strong performance in the quarter to the extent possible maybe talk about the degree to which you have visibility on future growth, space has been an important area of the budget and the extent to which that's driven by small versus exquisite? And maybe the last point the meaning of -- you pointed out the first HSAT and kind of the meaning of that and where you sort of see that, that platform going?.

Well look at, this is our classified business in space has been very, very strong and call space in general, it's space ground other parts of the different domains that we participate in but the trends have been very, very good.

We had a really good start, orders are good, the pipeline is very strong in that business, we've had good success in growing our smallsat franchise. This is something that we've been investing towards for the last four or five years or longer.

Certainly the initial work we've done on hosted payloads it is an investment to get ahead of the curve on smallsat are now paying dividends, it's not just with one customer, it's multiple customers both in the IC as well as within DoD. So it's all good news. We launched HSAT with couple of months ago, it's performing very well.

The purpose of that investment was simply to demonstrate Harris ability to drive and manage an end-to-end mission. So to be able to build a satellite itself provide all the components, secure launch and do all agreement ground command-and-control and downlink all from our facilities and that is now sort of proven some credibility there.

There were another two classified smallsat that launched at the end of last year as well they are also performing well. So again this is a great momentum that's being built and I see continued growth in that particular domain, it's all this drive towards more resiliency in our space architecture.

That being said there are still investments to recapitalize on exquisite side, we've also seen good growth on exquisite space, that's a big driver of our growth in 2019 from 2018 and will continue into 2020 and 2021.

So that's also quite good and on the ground-based adjacency that program over the last two years has tripled in size, again it's moving from providing a component to now a full mission solution on a whole different mission.

So lot of this over the last four or five years is really from this trend that we've been working on moving from components to sub-systems to full end-to-end mission solutions, sometimes that takes investment in IRAD, sometimes it takes building and launching your own smallsat but that's a direction we are moving down.

And it allows us to go after a much bigger piece of the overall classified budget which by the way is growing as well. So this is the right direction that we're moving in and the team there Bill Gattle and his team have been very successful, really across all of these dimensions..

Great, thanks and last one I think when you were speaking earlier about tactical, you mentioned an airborne award and I’m just wondering just as an area that hasn't been a very big part of the franchise historically, are there awards or opportunities out there in airborne that you see as potentially over the longer-term providing opportunities for further growth in Tactical?.

Yes, this has been, just a growth agenda, growth strategy we've had for the last three years and we've been articulating that with investors.

We have principally in the Tactical business been a ground radio business and we saw two growth opportunities in adjacencies, one in the airborne side, airborne radios and the other is on systems, tactical systems, communication systems and we've been successful early on across both of those dimensions.

We've been winning business on airborne radios, it's on the smallsat terminal, it's a component with ViaSat that's been growing very, very well.

We have an opportunity to take our 2-channel handheld radio and embed it into the ARC-201 a radio we got with the Exelis acquisition as well as some capability of providing radios in the aerial tier from Exelis. We see opportunities in doing ground to air data links, that's been a very important growth business for us as well.

So this is a good growth opportunity for us as they move and merge between the airborne tier and the ground tier and connecting the two, we think this is going to continue to be sort of a growth vector for Harris in the future certainly even more so with L3..

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

Just within the space, you mentioned the classified budgets there clearly top-line defense budgets gets most of the focus but what are some of the trends within the classified budgets that you're seeing and what kind of growth is related to your programs, just give little more granularity on that?.

Yes, so the last I've seen the they call the national intelligence program, the military intelligence programs the NIP and MIP total about $81 billion, it's up couple of percent from last year, it's been growing over the last three or four years again these budgets tend to be a little bit more resilient more well funded, they are generally classified, we don't get a lot of data across the individual spending, a line item certainly not that we can talk in a open community.

But basically what we've seen are more funding going towards those things that we've been putting our money and turning on against in terms of IRAD and that is towards like things like smallsat.

That's an area that has been we have seen increasing growth in the intelligence budgets and we're getting the benefit of that, a lot more money into the broad category of space superiority.

So how we protect your brand architecture that we happen to have and we've seen over the last three or four years, our space superiority business grow, I talked a bit about some opportunity we won recently on counter communications.

So there's opportunities in that space as well and as well on our ground adjacencies, this is capabilities to find ways of gathering information where becomes harder to gather over time.

And that -- those are the kind of things that the where the budgets are moving from a classified perspective and it's the areas that we've been focused on internally within the company over the last four or five years as well..

And then just on the smallsat topic, you did three launches here, I believe you mentioned 17 orders on hand, what's the pace of launches going forward and then maybe what does the overall pipeline look like?.

Yes, so we'll see probably later on this calendar year, I know there is series of launches that still need to be determined is going to be based on when they get to the customer or when the customer secures a right for those particular smallsat that would be part of some other mission.

So that will be determined but it will happen over the next one to two years probably and as we prove out our ability to successfully launch these satellites and for them to perform and provide really terrific capabilities, I think that's going to build credibility and I think you'll see much better cadence here.

So we're starting from 10s and now going to hundreds. The constellation will be in the hundreds not in the 10s or 20s. So we do see over time that that could be a very big opportunity for the company again it starts slow and we have to prove out our ability and the customers ability to manage these capabilities on a smaller platform..

Thank you. Our final question comes from the line of Pete Skibitski with Alembic Global Advisors. Please proceed with your question..

Good morning guys, great quarter, great growth.

Hey Bill, just a follow-up on that last question, it seems like all of the big contractors are getting into the smallsat arena in some fashion, do you see you guys kind of in the leaves there or you being kind of keeping a few different competitors in the running to keep its options open, I'm just curious as to how that market is kind of unfolding given it sounds like it's going to be pretty substantial?.

Well, I think it's going to be substantial and you're right, I think a lot of other players are pushing into that area, it's not like launching a Nanosatellite or your CubeSat, there's a lot more specific capabilities that are provided we're offering.

It's not our bus we're securing the satellite bus from another vendor it's more the bus itself is more commodity like it's really around the capabilities are embedded on the platform, the response of payloads, the antennas, the capability there how you up and download information, how you manage it, so there's a lot more sophistication, so these are pretty technologically advanced small satellites, I think we're probably year or two in the lead.

We have a few that are operating, so that gives us some credibility but at the end of the day the team has to continue to work hard to advance the technology, continue to drive cost down embed more capability on to these small satellites and that's what the team is really focused on doing that..

Thank you. Thank you everyone for joining the call. Any additional questions please feel free to get in touch with me. 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..