Greetings, and welcome to the L3Harris Technologies Second Quarter Calendar Year 2020 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Rajeev Lalwani, Vice President, Investor Relations. Thank you. You may begin..

Thank you, Michelle. Good morning and welcome to our second quarter 2020 earnings call. On the call with me today are Bill Brown, our CEO; Chris Kubasik, our COO; and Jay Malave, our CFO. First, a few words on forward-looking statements and non-GAAP financial measures.

Forward-looking statements involve risks, assumption, and uncertainties that could cause actual results to differ materially. For more information, please see our press release, presentation and our SEC filings.

A reconciliation of non-GAAP financial measures to comparable GAAP measures is included in the Investor Relations section of our website which is l3harris.com where a replay of this call will also be available. And to aid with year-over-year comparability, following the L3Harris merger, prior-year results will be on a pro forma basis.

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

Okay. Well, thank you, Rajeev and good morning, everyone. I want to start by thanking L3Harris employees for their hard work and dedication of over the last several months. The pandemic has challenged us all to find new ways of working effectively.

And our team has responded well to ensure we continue to meet the mission critical needs of our customers even as the virus spreads across southern states, where we have a large presence. And as the environment evolves, the health and safety of our employees will remain our top priority.

All of our facilities are up and running and adhering to well-established protocols such as daily health screenings, face coverings, social distancing and adjusted work schedules. Our work from home policy remains in place for about half our workforce. And we are prepared to operate under these conditions over the coming quarters.

We continue to pay close attention to our supply base and monitor our risk position daily and we've successfully implemented mitigation plans where needed, including developing alternative sourcing, providing on-site assistance and working with local authorities to secure closure exemptions.

In addition, we accelerated nearly $250 million in supplier payments within the quarter and we plan to continue that support through year end. We're also doing our fair share to support our communities' health care workers and first responders through the pandemic.

And we continue to hire aggressively to meet our growth needs, adding about 3,000# employees through June and bringing on board our largest cohort of interns and new college grads ever.

Chris and Jay will walk through the details in a minute but as you saw earlier today we reported second quarter results with non-GAAP earnings per share of $2.83, up a solid 13% against a tough backdrop. Company margins increased 150 basis points to 18.2% and adjusted free cash flow was $785 million, all above expectations.

Reported revenue was flat but adjusted for divestitures was up about 2.5% as strong 8% growth in our core U.S. government-related businesses more than offset a modest decline on the international side and a 35% drop in our small commercial businesses, consistent with what we anticipated.

Total company funded book-to-bill was 1.09 with funded backlog growing about 5% since the beginning of the year when adjusted for divestitures. Our strategic priorities have remained the same since we closed on the merger a year ago. And we're proud that our nearly 50,000 employees quickly aligned as one operating company.

And we're pleased with how well the team is executing and avoiding operational missteps despite the many moving parts. Integration continues to progress well with net synergy savings of $60 million in the quarter and $115 million year-to-date.

We have not seen a slowdown in activity due to COVID and now believe we can deliver $185 million in net savings this year, up $20 million from prior estimate, largely due to a steady ramp in savings from the supply chain, shared services and benefits.

Our integration roadmap is very methodical and rigorous with a weekly cadence of top-down reviews and we continue to expect to achieve $300 million in cumulative net savings in calendar 2021, one year ahead of original plan.

We're making good progress and driving a culture of operational excellence deep into the company and through the quarter, we continue to hold training sessions and conduct lean assessments, quality clinics and value engineering events despite the inability to travel.

As we've said before, e3savings are additive to synergies and we're a key part of the margin expansion we achieved in the quarter and year-to-date. But more importantly are essential to expanding margins beyond the integration window. Investments in technology and innovation remain at the top of our agenda and are key to long-term revenue growth.

Since the closing, we fully implemented a rigorous stage gate process called Checkpoint and cut 30% of IRAD projects to sharpen our focus on key strategic themes around spectrum superiority, actionable intelligence and war fighter effectiveness, while positioning for the shift to an integrated networked battlefield.

We are investing heavily in multi-function, software-defined, open architecture systems that allow us to deliver mission solutions independent of the platform. These investments are evident and are increasing traction on revenue synergies; we've now been down selected on 13 out of 23 proposals and continued to build on our multi-billion pipeline.

While we're still in the early innings, the collaboration we're seeing across segments is really impressive with the process to identify new revenue synergy opportunities nearly self-sustaining.

On portfolio reshaping, we are set to close today on the divestiture of EOTech, a small consumer-facing business bringing total transactions to date to four with proceeds exceeding $1 billion.

We're now about one-third of the way toward our bottoms-up estimate of divesting 8% to 10% of revenue with more progress expected in the coming quarters as we increase our focus on businesses where we're best positioned to win.

And on maximizing cash generation, we delivered $785 million of free cash flow in the quarter and about $2.7 billion on a LTM basis, growth of over 20% on a per share basis.

Our strong performance along with divestiture proceeds drove a cash balance of $2 billion at quarter end and supports our prior commitment to return capital to shareholders in the third quarter. Longer term, we see a clear path to achieving $3 billion free cash flow in calendar 2022, driven in part by continued improvement in working capital.

In the quarter, we achieved another two day sequential improvement with solid momentum toward a calendar 2022 goal of sub 50-days from 68 at merger close adjusted for divestitures and accounting items. Slide 4 illustrates the opportunity ahead of us.

10 businesses account for about 75% of our working capital, six of which have more than 75 days on hand, driving those six the current company average of 55 days would generate nearly $0.5 billion of cash flow with the largest opportunity tied to lower inventory.

Shorter cycle times, better forecasting, product rationalization and part commonization, vendor managed inventory and improved supplier delivery performance. The levers are clear. We've done it before and the team is focused and motivated to get it done.

Finally, we're all watching carefully the progress towards a 2021 defense budget and signals from Congress, the Biden campaign and the Trump administration on the budget trajectory in 2022 and beyond.

We're encouraged by the bipartisan support in advancing the fiscal 2021 National Defense Authorization Act through the house and senate and we believe that the heightened threat environment will drive the trajectory of U.S military spending regardless of the election.

And while we're conscious of the risks surrounding elevated deficits, we believe our technological capabilities and opportunity set position as well over the coming years.

Recent house and senate marks support this as we saw ongoing strength in areas like tactical radio, aircraft ISR, F-35 and space and classified budgets are also set to be well supported.

So between budget positioning, revenue synergies, margin expansion potential and shareholder friendly capital deployment, we remain confident in our ability to sustain double-digit earnings and free cash flow growth per share in the medium term. And with that I'll now turn it over to Chris Kubasik to discuss segment results.

Chris?.

Okay. Thank you, Bill and good morning, everyone. I'd like to highlight the quarterly segment results starting on slide 6. Integrated Mission Systems increased revenue 7% from growth in our Electro Optical and Maritime Businesses with ISR relatively flat in the quarter, but expected to pick up in the back half of the year.

Operating income was up 38% and margin expanded 370 basis points to 16.8% from integration benefits, operational excellence and cost management. Order momentum at IMS was broad-based with a funded book- to-bill above 1.0 in each business resulting in an overall segment book-to-bill of 1.19 for the quarter and 1.12 since the merger.

Our highlight in recent months has been the traction we've seen in our maritime business. In the quarter, we received an order from a classified customer for an unmanned surface vehicle. And just this month, we were selected as the prime contractor for the medium unmanned surface vehicle for the U.S navy.

We're also in the process of finalizing our position on the U.S navy's frigate program as a system integrator this initial 10-ship contract has a potential value of over $300 million. So clearly, we're seeing positive momentum in this business. On slide 7, Space and Airborne Systems revenue increased 4% in the quarter.

Growth in Avionics from the production and modernization ramp of the F-35 and increased classified work at Intel and cyber were partially offset by program transition timing and a tough compare in the space business.

Segment operating income was up 3% and margin contracted 20 basis points to 18.8% as operational excellence and integration benefits were offset by program mix from increased developmental work and investments in earlier stage technologies.

Overall funded book-to-bill was 0.94 for the quarter and just below 1 since the merger, with particular strength in space, which delivered a book-to-bill over 1.0 in the quarter.

As a reminder, in our space business, we are transitioning from a legacy exquisite payload provider to a full end-to-end systems provider for responsive satellite and ground systems. A recent launch for the U.S Air Force demonstrated this capability.

We designed, developed and built satellites within a couple years and are now providing the tasking and the command and control for these on-orbit spacecraft. This speed to market is a significant differentiator compared to legacy systems that take nearly a decade to become operational.

As war fighting capabilities accelerate in the space domain, we are well positioned to participate and capture new business and have a strong pipeline that exceeds $10 billion to support growth in the medium and long term.

On slide 8, Communication Systems revenue was up 2.5% for the quarter as DoD tactical and integrated vision systems benefited from modernization demand, both were up double digits.

This strength was partially offset by international tactical radio sales timing and headwinds at our public safety business both of which were down in the mid-teens consistent with prior expectations. Segment operating income was up 11% and margin expanded 190 basis points to 23.9% from integration benefits and cost management.

Turning to orders, DoD tactical modernization momentum continued with a $95 million award for an additional low rate production contract on the US army's HMS Manpack. After completion of the operational testing early next year, we anticipate a full rate production award against the previously announced IDIQ of nearly $13 billion.

This will support continued revenue growth. Lastly on slide 9, Aviation Systems organic revenue decreased 7% in the quarter with commercial aviation down about 50% due to the pandemic in line with our expectations.

This headwind was partially offset by continued growth within the classified areas at defense aviation products, which was up in the mid-teens. Operating income was down 8% primarily due to the impact of divestitures, but would have grown 4% otherwise.

Margins expanded 120 basis points to 12.5% from operational efficiencies, integration benefits and cost actions, partially offset by COVID related headwinds. Orders significantly outpaced sales leading to a funded segment book-to-bill of 1.26 for the quarter and 1.13 since the merger.

We saw considerable traction on the defense side for airborne radars, ground vehicle systems and training solutions, as well as within the classified arena. One of the key wins in the quarter was the $900 million single award IDIQ to develop and manage simulator requirements and standards across the Air Force's training portfolio.

This solution will leverage open systems architecture and set common standards for the Air Force and aligns with the DoD move towards multi-domain operations and ties to the program direction of JAB C2. It will also position us well for future military training offerings.

So before handing it over to Jay, I'd like to echo Bill's comments and thank our employees for their dedication, focus and hard work during the pandemic. We'll continue to prioritize your health and safety as we move forward. With that over to you Jay..

Thank you, Chris, and good morning, everyone. I'll begin with a recap of second quarter results then provide an update on the impact of COVID and then wrap up with guidance. In the quarter, organic revenue was up nearly 2.5% as 8% growth in our US government business more than offset the commercial decline.

EBIT increased 9% on 18.2% margins resulting in EPS growth of 13% or 0.32 as shown on slide 10.

Of this growth $0.22 came from synergies, $0.15 from operations including cost management and $0.13 from share count, pension and other items including divestitures, partially offset by pandemic related headwinds of $0.18 mainly from our commercial businesses.

Free cash flow for the quarter was $785 million and we ended the period with 55 working capital days or two days better sequentially after adjusting for divestitures and purchase accounting adjustments, versus the prior year and our expectations we benefited from accelerating customer collections and ongoing inventory management, while continuing to support our suppliers.

Margins in the quarter came in at 18.2% or 150 basis points higher than last year and ahead of our internal views. Most of the expansion or 140 basis points came from the $60 million synergies drop through. We also saw benefits from our cost management efforts and tailwinds from reduced expenses such as for travel and trade shows.

Along with operational efficiencies which more than offset 60 basis points of COVID headwind. While some of the expense tailwinds are temporary, our margin performance highlights the portfolio's resiliency during a tough environment and our future earnings potential. Next let's turn to slide 11 for details on the guidance outlook.

Organic revenue is unchanged at up 3% to 5% % with top line trending as expected. And overall COVID impacts still sized within our prior range. For our core US government business representing about of 75% sales, we expect the 8% first half growth to carry over to the back half as well.

And for our commercial aerospace businesses, which were down about 50% in the quarter, it's generally tracking to our previous forecast for the year and in line with broader industry forecasts.

In public safety, the business was down in the mid-teens in the quarter and we now expect that business to decline around 15% from 10% previously, reflecting the slow pace of new awards. On international, we're holding our flattest view for the year based on our second half visibility with upside opportunity in ISR.

So overall relatively minor changes with a clear line of sight to our sales outlook, which is supported by a funded book-to-bill of 1.1 in the first half. Shifting the margins. We've increased our outlook to 17.5% plus with the plus indicating potential upside of 10 to 20 basis points versus the prior guidance of 17.5%. Due to performance to date.

cost synergies, E3 progress and expense management. Margins step back in the second half versus the second quarter due to higher R&D investment as well as a placeholder for higher COVID related mitigation costs or disruptions, but still continued margin expansion progress on the full year of nearly 100 basis points.

On EPS, we're holding the full year guidance range of $11.15 to $11.55 with the contingency at the midpoint from the margin up side to account for the uncertain backdrop amid to pandemic's progression.

On capital allocation, we're in a strong cash position and should remain so after completing our committed repurchases with divesture proceeds here in the third quarter. Beyond that we'll continue to monitor market conditions for deployment opportunities such as capital returns and employee pension plan contributions.

Moving to free cash flow, our guide of $2.6 billion to $2.7 billion remains intact with similar upward pressure from earnings upside, working capital traction and lighter CapEx. Finally and briefly on the segment outlook. We've maintained our guidance for all line items but for margins at IMS, where we see likely upside.

The improvement is coming from synergy drop through and operational excellence via E3 productivity. Both year-to-date and going forward. So a great example of the merger benefits. So to put it all together, a solid growth outlook supported by our year-to-date performance and forward visibility. With an upside bias assuming a stabilizing environment.

And with that I'll ask the operator to open the line for questions..

[Operator Instructions] Our first question comes from the line of Seth Seifman with JPMorgan. Please proceed with your question..

Hey. Thanks very much and good morning, everyone.

Bill you talk in the slides about the potential for cash flow growth beyond 2022 and you mentioned your working capital, just wanted to confirm a; is that the chief source of cash flow growth in those out years number one? And b; are there others and if so, kind of what are they? And if you could speak a little bit maybe qualitatively to the magnitude and relative importance of those other drivers?.

Yes. So Seth thanks for the question. So between now and 2022 time frame mid single digit plus type of revenue growth that we expect because we're seeing good visibility in the 2021 budget, which we think is going to get passed sometime in the next six months or so. Our programs are very well supported there.

A lot of unspent dollars from prior years, good opportunities on revenue synergies, growth opportunities international. So we see the top line continue to improve, margins coming up, we're doing very well in margin progression this year.

Jay just talked about some of the upside drivers here in calendar 2020 we see continued momentum on margins over the next couple of years. It's certainly not going to end as we get to 2020. There's going to be opportunities even certainly beyond that. Working capital is a driver, we've made great progress down 13 days since the close to 55.

We see getting to about 50 days or below 50 by the time we get calendar 2022. But that way we look at this from a bottom up perspective, Harris was at 41. We can see our ability getting down into those 40-41 days. So even as we had 50 days in 2022 an extra 10 beyond that's about $350 million worth of cash, which has great opportunity to deploy it.

In the near term certainly next year or so towards share buyback that will reduce our share count. So overall you put all those pieces together, we continue to see double-digit growth in free cash per share..

Our next question comes from the line of Robert Stallard with Vertical Research. Please proceed with your question..

Thanks so much. Good morning. I think it's a question for both Bill and Chris. I mean I'll see a lot of talk out there about what the trajectory of the DoD budget could be over the next few years. But I was wondering if both of you could maybe frame how different the merge company is today versus what you saw in the last defense downturn.

And how things could play out?.

Well, I mean I'll start and I'll let maybe Chris jump in here, Rob. So that's -- it's a great question, look, I think part of the reason why almost two years ago now Chris and I contemplating putting the company together was really to build a more scaled mission solutions, priming Chris talked a lot about becoming a sixth prime.

When we sit there in fact when we talked about our merger back in October of 2018, we talked about our presence connecting across all domains a CP or ISR powerhouse company mission solutions prime company. And you can see based on the progression we've seen to-date clearly moving in that direction.

Certainly as the DoD moves towards connecting all of their platforms, all sensors, all shooters across all domains. I see us be really being in the sweet spot of that. We've won 7 IDIQs on ABMS.

There's a lot of players on the team, but I think it's testament to the capability that this organization has overall in spectrum superiority, spectrum dominance across what we do in electronic warfare, waveforms, communications, ISR, all those pieces come together to help realize that vision of where the DoD needs to move to in order to fight the next fight.

You can see really across all domains. The progress in space, the progress in unmanned both airborne and maritime. So we're really I think realizing that vision and I think we're a much more resilient organization today we would have been several years ago with a tremendous opportunity to gain share in a market that may flatten or come down over time.

So I think we're just a fundamentally different position today we were a number of years ago. I don't know, if you want to add, Chris..

Yes, maybe I'll just add a little bit, Rob. We talked a lot about leveraging the scale of the enterprise and I think in this industry scale matters and you look at this new company with close to $700 million of R&D that positions us well for these new markets and NextGen opportunities. So we're starting with the clean sheet.

I believe we're pretty agile and responsive. The national defense strategy talks about disaggregation. Bill mentioned autonomy and some of the capabilities we have there fit nicely with these large platforms and then the ability to connect them.

And you look at our ability to attract and hire college grads and others, there's a lot of excitement with this new company. People see that we're growing 8% in the government business and I think we're ahead of schedule and going better than I would have expected after 13-months..

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

Hey. Good morning, gentlemen. Thanks for the time. I hope everybody's well. Bill, I wondered or Chris, I wondered if you might tell us a little bit more about this comments on trimming the IRAD pipeline or narrowing the focus of that IRAD pipeline, just help us think through the price prioritization and that thought process.

Are you looking to prioritize capabilities or ROIs or customers, any granularity you can give us on how you're thinking through that process? Thanks..

Hey, Carter. It's a great question and it really I'm glad you asked it because I think it's a fundamental part of the value creation story that we have in front of us.

We've been talking about this for a couple of years of taking, as Chris just mentioned $700 million worth of IRAD that previously was distributed very deeply and broadly across the company not centrally coordinated, no clear business rationale across the individual investments and through the work that CTO Ross has done here to really get at and categorize where all that money is going.

We looked at it; we saw 30% of the projects that were -- didn't have a business case or were overlapping were duplicates.

And we've provided two investors some examples of that, so allows us to focus that firepower that's pretty potent on a smaller set of opportunities really around the areas around multi-function, open systems architecture, software-defined everything that really is the heart of what we're trying to do in spectrum superiority, sensing solutions, delivering actionable intelligence.

That's where we're really focused and as I think about this that's -- that is going to enable us to continue to invest in these new opportunities that we're seeing coming through in revenue synergies. We've won quite a few here. They're small today in terms of revenue impact.

They'll grow over time but the pipeline is large, is getting bigger and really positions us and I think in a fundamentally different way. So when you think about value creation, a potential into the future for a technology company we call L3Harris, this is fundamental to the value creation story..

And I'll just chime in Carter, I mean; this is what we've been talking about for almost a year and internally and externally. This is about optimizing the enterprise the greater good of L3Harris versus optimizing the divisions and this is part of the transition from more of a holding company to an operating company.

And when we look at things holistically from the top down, we're able to prioritize those to get the greater growth and the greater returns. Same process applies to CapEx and everything else that Bill, Jay and I look at on a regular basis. So that's the origin of the 30% that Bill referenced..

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

Hey. Good morning, everybody. Can you hear me, okay? Great. I'd love to get a little more specific on the capital deployment plan and specifically the intent to buy back stock, just given the large cash balance at the end of the quarter and how much free cash you're set to generate moving forward here.

And if there's going to be even more proceeds from divestitures. One, will you restart in the third quarter on an underlying basis even before the Leidos proceeds like are we just buying back stock again now or not. And when I add up all those pieces, it looks like you could be buying back several billion dollars a year going forward.

Is that a reasonable assumption?.

Yes. So, Noah, look in Q3, we will use the proceeds we received from the sale of SDS to Leidos, was $1 billion we closed that out in Q2. We'll deploy that back to owners as we've always said we would in Q3 we sold an asset and we're buying back an asset, happy to be our stock.

As we look to the back end of the year with a $1.3 billion, 3 billion four-ish in free cash generation in the second half. We'll end the year with a pretty strong balance of cash in the [one seven one eight] kind of $1 billion range. So still opportunities beyond that for deployment as we've been talking a lot we see that growing $3 billion by 2022.

There's no debt pay down requirements at all, we'll refinance some debt but at 1.7 going to1.5 leverage ratio. We've got, I think a good leverage basis we don't see any significant M&A on the near term horizon. So it gives a lot of opportunity to deploy that upward to $3 billion a year in free cash generation back to owners as we said we would.

And that just to remind everybody is after significant investments in development internally hiring people, training people, spending investment on capital driving IRAD at close to 4% as Chris mentioned a couple of minutes ago significant investments inside the company even with that gives us an opportunity to deploy that cash effectively with shareholders..

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

Thanks. Good morning, guys. How you doing good? Hey, I wanted to ask Bill if you could maybe numerically express the revenue synergy opportunity in some reasonable time frame.

So whether it's 2022 and 2023, what should we be anticipating, so what you're going to get incrementally from some of these captures you're pursuing that combine the capabilities of L3 and Harries. And how do you see that playing out over the next 5 or 10 years.

Could give a quantification of it?.

Yes. So again we won 13, it's in the tens of millions of dollars and it's actually growing it's -- we're seeing good traction there. You'll see it a little bit in the 2020 results will start to grow in 2021, little bit beyond that. The pipeline itself is north of $5 billion and it's growing every time we meet with the team. And it's pretty substantial.

The opportunities that we want are in the $1.5 billion to $2 billion of lifetime revenue. So I would expect I don't commit Chris and Jay to something here, so maybe I'll let Chris jump in here but I would expect that it'll be something growing north of $100 million a year, but Chris maybe you could add..

Yes, no. I'll sign up to at least $100 million a year and would you say 10 years from now, no, it's as Bill said it's going better than we expected. And we have a very strict definition of what we're calling revenue synergy. These are bids that neither company would have submitted had we not merged together.

So we're getting the momentum, a lot of these are the initial wins some from DARPA, some from rapid capability office and then we got a win from four to two to one but we like the momentum. And I would expect that this will contribute to our top line growth for the foreseeable future.

And we'll quantify it for you as we start to move up and get some of these wins..

Thank you. Our next question comes from the line of Doug Harned with Alliance Bernstein. Please proceed with your question..

Good morning. Thank you. If I think back to Chris to what L3 looked like not that long ago and you had all of more than 80 or so businesses with overlapping overhead functions and the sense of need to rationalize the supply chains and facilities.

And if we roll forward where does--where do things stand today in terms of addressing a lot of the opportunities and costs that you had before because I'm just -- you continue to find new cost synergy.

So I'm trying to figure out what the pathway looks like in terms of the things you've gotten done, the things that are still to go here and where you can potentially be?.

Yes, no, that's a great question, Doug. And I say we made a really good progress in the last 13 months but a lot of the progress we made was a result of starting early even the pre-merger.

I'd say we're ahead of schedule on the synergies that we talked about, but everything that we've looked at shows continued margin upside and cost take off opportunities well beyond the initial three-year period. The facility consolidations are ongoing. Those will take the most time as you would expect.

I think we've made great progress on the supply chain and that's just something we're going to continue to work on year after year. And also not only on the value capture but improving the resiliency given some of the recent challenges in the COVID environment.

So if this were a baseball game we're probably in the second or third inning as I see it holistically. And really hitting the ground running on day one. The benefits and the HR and all those initiatives were done on the first cycle which was pretty impressive.

So I think there's a lot more to go and we see this as part of our culture of operating excellence and it's just going to go year after year and I think there's a lot more to go..

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

Hi. Good morning, everyone and thank you.

Bill, I think you mentioned six businesses with high working capital and you quantified the opportunity which is quite big at $500 million, I'm guessing the size of these businesses might be fairly large, but is there anything structurally different about them and how do we think about that working capital drive down contributing to intermediate results?.

No. There's nothing structurally different about them. They -- what's happening is we're getting into a lot of detail what's driving the working capital to be where it happens to be.

And as I mentioned a lot of it is inventory, sometimes inventory is north of 100 days and it's about just prudent management, improving forecasting, improving the performance with suppliers because a lack of confidence in when a supplier is going to deliver a component drives management to increase buffer stock.

It's managing better the development of new product so that you're leveraging components that exist across other products. So you reduce sort of both SKUs as well as the parts that go into the SKU.

So it's really across all of those fundamental pieces, Chris and I and Jay have a weekly evidence just right next to our integration meeting is the focus on working capital. We've been doing this since day one. We've got dedicated teams focused on this, is driven by the general managers themselves. The teams are incentivized to improve cash.

We incentivize and drive working capital. So we expect to make a big achievement in those six businesses but the reality is we have 19 different sectors all of which have opportunities to improve working capital and we're going after every single one of them.

That's what gives us confidence of taking the 55 to below 50 and hitting 40 over the next couple of years..

Our next question comes from the line of Richard Safran with Seaport Global. Please proceed with your question. .

Hi. Good morning, everybody. I hope everybody's well. So Bill and Chris, I thought I had another question on your revenue synergies. I thought you might try to explain the driver of the revenue synergies. And if they continue why the potential is north of $5 billion.

And why they've come so much earlier than expected? To me Pentagon's giving awards to non-traditional players in major platform markets, you have space with launchers.

And you recently with Maritime, so is that the driver here, why you stand to benefit? Is the Pentagon looking for more competitors? And bringing in non-traditional players? And I guess is there room now for moving LHX to the next level as a sixth prime?.

I think the DoD is looking for more competition, more company suppliers that can bring unique mission solutions that can simplify what they're doing bring additional capabilities it’s driven through technology investment. I think what we've proven is the ability to a; invest the technology dollars.

And then find ways of delivering new capability from those investments. So I think that's clearly the direction that the DoD happens to be moving into, but I think we have just a great opportunity across our portfolio. We've had from day one, people getting together in classified spaces and open spaces sharing ideas.

And when you have a good sense of what the mission need is, and you put technologists in a room. To try to look at what we can do differently. There are just lots of great opportunities that, that come from the capabilities that being brought by this new entity. So, we're still early days.

This is only one year and it's moving faster than we had expected. There's been a lot of resonance with the customer as you could see by the winds we've had so far.

We've got to follow through; we've got to win some of the down selects, move some of the studies that Chris mentioned here with DARPA into actual programs of record but that happen over time with continued focus and investment. And if anything that the opportunity said is getting bigger than smaller.

A lot of it's coming in the classified side as well. I mean keep in mind too in the classified domain a lot of these things are relatively stovepipe and the larger companies have a broader view across multiple different programs.

So what we're now doing is getting more visibility across multiple different types of programs, classified programs and we're bringing different mission solutions..

Our next question comes from the line of George Shapiro with Shapiro Research. Please proceed with your question..

Yes, good morning. This is probably for Jay. I was curious as to how much incremental cash you got from the change in progress payments? I noticed that accounts payable were down $328 million. So, you obviously gave some of that back at the same time receivables, inventories and contract assets were down $447 million. So maybe just expand on that.

And then what you would expect it to be for the year and is that a potential increment to the cash flow guidance that you have? Thanks..

Okay, George. So I'll just go to the quarter and then the year. In the quarter the progress payment benefits were in the range of $100 million. And that was pretty much flowed down through to the suppliers.

Separate from that we did have customer payment accelerations that also we benefited from in the quarter, you're in the range of say $150million or so. The flow through of that to the full year is really dependent on what the customers do.

If the customers continue to on that type of prepayment schedule on the non-progress payment type of a payment schedule. Then we would see a potential upside in the year if it's, if not and then they go back we'll probably see a snap back and it really would just be pulling into the second quarter.

So, it could be upside, we have to kind of just monitor the customer behavior over the back half for the year as far as these accelerated payments. I mean if the progress payments right now we're expecting those will continue but those could shift as well but as I just mentioned that's been basically flowed down to the suppliers..

Our next question comes from the line of Peter Arment with Baird. Please proceed with your question..

Yes, good morning Bill, Chris, Jay. Bill I want to circle back on the budget kind of topic. We get a lot from investors about maybe L3Harris as exposure to kind of the OEM, O&M side of the budget? And I think it's reasonably high.

How should we think about that part of the budget if that, if the overall budget starts to compress how that impacts you? I know there's a lot of ISR missions and activities that flow through there but maybe just some color on how we should think about that?.

Well, it's sound -- I think we size it in the 40 percentage range of our of our business, it’s O&M funded. I think this year the DoD is under running the spending on O&M, so it does create actually some additional opportunities for O&M dollars and you mentioned exactly right some of that does fund some of the ISR missions that we happen to have here.

So we think we're well positioned on that. I don't think it's a major concern as we go into 2021. I don't know Chris or Jay if you have any thought on that but--.

I think it's just good diversity and various sources and colors of money. I think is actually strength. So yes I echo what Bill says I think we're in good shape..

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

Thanks. Good morning, everyone.

Bill, I want to follow-up you mentioned E3, if you could maybe talk about what kind of organic margin upside you've seen so far from E3, how much further you think it can go? And then on the synergy side, you said a bunch of times there's upside to $300 million any sort of quantification of how much upside there could be beyond that? Thanks..

So David, look, we're making really good progress on E3 in fact at L3, Chris instituted a program called L365. We had our own program here at Harris HBX the combination of that I think has yielded a process internal process that's been driven deep into the organization.

We typically would expect something like 2% to 3% net of inflation, net of giving back to the customer as well of costs coming out and we're seeing E3 in that range over the course of the year is getting a little bit better. I think we would sustain that in 2021 and 2022. So it sizes it a bit.

As we get beyond the calendar 2022 time period and integration starts to wind down in terms of that focus process the drive to achieving cost savings will continue. It all merges into what we now call E3. So we do expect to hit $300 million net in 2021.

We do see opportunities beyond that some of the -- I think that Chris mentioned a minute ago about facility rationalization. They do take a bit longer. They won't be fully completed in 2021. So we'd see a little bit of step up in beyond 2021 on just this consolidation of the facility.

So we can't really size it today as we get further down the path, we'll continue to update investors on this, but as you think about where we've been over the last six months we started out the year guiding to about $115 million net. We went to $165 million now we are at $185 million in an environment that's very uncertain with the COVID pandemic.

So we continue to make great progress here, great progress on E3 and all of this is going to drive us north of 18% margins next year with some upside beyond that..

Our next question comes from the line of Pete Skibitski with Alembic Global. Please proceed with your question..

Yes. Good morning, guys. Hey just on the really strong second quarter margin rate at IMS was there any one-off benefit in there and it looks like guidance is assuming kind of a lower rate sequentially in the second half of the year.

Jay kind of touched on a little bit but any color that you could add there?.

Sure, Pete. It's really strong synergy drop through over 200 basis points. They do have a benefit of pension running through because that's a predominantly legacy l3 business, but they also had strong productivity E3 productivity dropping through which pretty much offset any mixed headwinds.

And a little bit slower on R&D there and as I mentioned we expect R&D to step up in the back half of the year. For the full year, they're just --they're doing well.

We originally 13.5%, it does step down as I said for the R&D as well as a little bit of a mix as we induct some aircraft, but bottom line there you're going to see some solid margins around 14.5% for the year..

Our next question comes from the line of Michael Ciarmoli with SunTrust. Please proceed with your question..

Hey. Good morning, guys. Thanks for taking my question. Maybe just to stay on that R&D looking at the second half margins they obviously come down a bit, you talked about that COVID placeholder and I think you called that out maybe as a contingency in the earnings bridge.

So maybe that's $10 million or so, but how big -- how do we think about the R&D step up? and I guess I'm thinking about it too in the context you're talking about of 30% IRAD but it sounds like cutting 30% that IRAD but it sounds like some of that's just going to be reinvested.

Is that the right way to think about sort of the reprioritizing of the IRAD and kind of funneling it back into higher areas of opportunity?.

Yes. A lot of the reprioritization occurred as part of our planning process for the year. We're going to step up around 3.5% to about 3.7% in the back half of the year and what we're talking about is as part of the checkpoint process is really just a process for defining prioritizing those projects.

There might be some timing differences here and there and we continue to monitor them as part of that process. But there's not been any type of effort to actually reduce R&D spends as we dealt with some of the headwinds with COVID that's really been more other expense type of discretionary spends items that we've been dealing with.

And so our goal has been to hold our R&D and protect the investment and for all the items and revenue synergies that the Bill referenced before..

I'll just chime in with a 1.19 book-to-bill and IMS specifically. A lot of these as you know start out as more developmental programs and then over the course of the life of the program you get into low rate production and ultimately production of the margins increase.

So a little bit of the second half pressure is coming from some of these recent maritime wins which are good margins but dilutive in the near term but we'll ramp up as we continue to deliver on them..

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

Hi. Good morning, everybody. I wondered if we could disaggregate the space group, space and airborne a little bit just the primes are having such strong growth there. And I'm wondering if you're seeing a higher growth in space than airborne if you could talk about that a little bit.

And then if longer term on the space side, you think you can potentially outgrow the market just given the share gain opportunities if you have in front of you..

Yes. So, we feel very encouraged by the space business as a whole. Just in the quarter, we had a couple of programs that are transitioning and just the year-over-year comp was particularly difficult in the second quarter last year in 2019 Q2 which as you recall was Q4, the last fiscal quarter of Harris.

We had sort of 18%-19% growth in that space segment. So it was quite strong and the comp was kind of difficult just on a year-over-year basis. So, a little bit of impact on just calendarization pretty good book-to-bill in the first half of the year just over one.

We were very confident about that business, very strong pipeline of opportunities coming at us in space as we transition from an exquisite provider to end-to-end responsive mission solutions prime, Chris talked about that in his remarks that's both ground -- both space capability and ground support for space capability.

The pipeline in those businesses is quite large. It's about $10 billion. We have about a $1 billion of proposals outstanding that are pending awards.

So, as we look at this, we expect towards the back end of this year, we'll see some recovery but overall through the technology investments we've had, some of the revenue synergy opportunities that'll come through in the space domain, we feel very good about the opportunities in space.

So that space segment also has airborne and airborne has been quite strong for us. That's a lot of the F-35 growth; it's modernization, it's production, it's some sustainment growth there as well. So, we see in our classified part of that space business is growing quite well.

So look, we feel very confident about space, it'll come back towards the back end of the year and be a driver getting into 2021..

Hey, Robert, I'll just chime in, one of the things that were very exciting about this merger was space and of course pre-merger, you couldn't look at it due to clearances but once we got all the clearances set up. And I got into the program several months back. I got to say I'm even more impressed now than what I thought was suspected that we had.

So I think we're in good shape. We just got to continue to win and perform and I think there's some long-term growth here that's going to be pretty impressive..

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

Thanks. Good morning. So, I wanted to ask other guys in the space and people in the space have size the R&D tax amortization in 2022. I'm curious if you can do the same. And then secondarily on the segments, I know that the pension adjustment being made there was a [$98.9] million in the quarter.

Bill, is there any assumption about how much pension helps or hurts that you have to absorb going forward over the next couple of years? And your comment about 18% margin next year and beyond..

So, on taxes the impact in 2022 is north of $500 million if the law stays as it is. As you know, others as well as us believe that wasn't necessarily, the intent of the legislation to penalize R&D investment and so that's something obviously we're continuing to work, but just to answer your question specifically. It will be north of $500 million.

On pension, if you look at gross pension this year it's about $300 million of benefit; year-over- year it is about $60 million. There's a $100 million in the FAS pension benefit that's offset by about $50 million of lower cash recovery and so net-net you're talking about $50 million - $60 million.

Right now, we're not expecting any significant changes in pension benefits next year. If we were to strike it right now would be generally in line with that. I mean a little bit worse obviously on the returns but that gets amortized.

So right now we're pretty much holding in line there for what I told you about $300 million FAS and $60 million of cash..

Our final question comes from the line of Jon Raviv with Citigroup. Please proceed with your question..

Thank you very much for squeezing me in here. So, when you're talking, Bill and Chris, you're talking about transition obviously to an operating company while the industry itself has been in some transition. We know what the NDS wants for capabilities.

Can you talk about how it's acquired? How those things are changing like investment requirements, business models, partnerships, leveraging commercial. You've got a big prime out there with new leadership talking about new ways of doing business like 5G, some of it sounds like stuff that you do.

So, you can just expand on what the next generation of defense industry you think looks like here?.

Well, Jon, I'll start and maybe Chris can jump in here. But the way I look at this without commenting on what other players in the space happen to be doing. We're very unique in a sense that we've got this opportunity that can only be created by this significant transformation driven by a merger.

It's a seminal event allows us to drive a clean sheet and take a fresh approach about how you drive connectivity, cooperation, collaboration across the enterprise and that's what we talk about when we drive towards an operating company is from a technology perspective making sure all of the pieces are connected across the enterprise.

We believe success in the future is going to come from driving our business as operating entities not as disconnected pieces of an [indiscernible] organization like a holding company would have. So, we have an opportunity to drive that as part of the DNA that's being created in the organization that we're building.

We're not trying to start from an existing large position, but we've got good momentum that's built here and we feel pretty good about our ability to compete and win based on that particular model. .

And I'll just say from the customer perspective. And I will throw out the customers have been great here during the pandemic. I mean Bill and I have had unfettered access to them and there's been a lot of creativity accepting a lot of our products using video and virtual means and inspecting the products.

But the customer talks a lot about speed and they have rapid capability offices. They're using OTAs as an example. And I think we've been pretty good in responding and quick turns and winning some of these new business opportunities, several of which are revenue synergies.

And again I think the mission systems are becoming more and more important and the customers are looking at maybe procuring those directly from companies like us and there are several initiatives in that regard ABMS and others. So, I think we're well positioned and we can adjust to the customer as they change their buying patterns.

And if there's new business models, I think we're more than capable to support that so..

And certainly there's not -- we're not beholden to a platform. There's not a loss risk -- risk of loss of revenue from moving from proprietary to open systems. We're building the organization from the start with a focus on open systems architecture, which we believe is an opportunity for us and certainly what we're here to do.

So, I want to thank everybody for joining the call today. And I'd like to close by again thanking our employees as well as the leadership team for their hard work, for their dedication as we wrap up our first year as L3Harris. And for continuing meeting customer commitments during these very challenging times. So, thank you to everyone and be safe.

Thank you..

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..