Q4 2023 Earnings Summary
- Strong Growth in Space Business with Successive SDA Contracts: L3Harris has secured significant contracts in its Space business, including successive awards from the Space Development Agency (SDA) for tracking satellites. They have progressed from 4 satellites in Tranche 0 to 18 satellites in Tranche 2, with each contract yielding higher expected margins, indicating robust growth potential in the Space sector.
- Positive Integration and Growth of Aerojet Rocketdyne: The integration of Aerojet Rocketdyne is advancing well, with 200 proposals submitted for over $13 billion and an expected 5% top-line growth in 2024 compared to pro forma 2023. This highlights strong demand exceeding supply in the missile and space propulsion business, contributing to LHX's growth trajectory. ,
- Margin Expansion through Operational Efficiencies and Cost-Saving Initiatives: L3Harris is actively improving margins across its segments, particularly in Communications Systems (CS) and Integrated Mission Systems (IMS), through operational efficiencies, international growth, and cost-saving initiatives such as the LHX NeXt program targeting $1 billion in gross cost savings over the next three years. This is expected to enhance profitability and shareholder value. , ,
- L3Harris is experiencing margin pressure and operational challenges in its Integrated Mission Systems (IMS) segment, with margins expected to decline relative to the second half of 2023. Attrition and program performance issues have impacted results, and the segment faces lower-than-historical international mix, which is affecting profitability.
- The Aerojet Rocketdyne acquisition is facing supply chain bottlenecks at sub-tier suppliers, which could hinder the company's ability to meet increasing demand for rocket motors. Additionally, projected revenue growth for Aerojet Rocketdyne in 2024 is limited, with only around 5% growth expected, indicating potential integration challenges and slower-than-anticipated benefits from the acquisition.
- The Space and Airborne Systems (SAS) segment is projecting a slowdown in organic revenue growth, with guidance for 2024 at only 2%, down from 8% in 2023. This deceleration is due to flat performance in key sectors such as the air domain and Mission Networks, limiting the segment's contribution to overall company growth.
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Margin Improvement and LHX NeXt
Q: Which segments offer more margin improvement opportunities?
A: Chris stated they aim for at least 100 basis points margin improvement across segments by 2026, driven by the LHX NeXt program targeting $1 billion in cost savings. He prioritized segments: Communications Systems has the most potential due to its commercial model and international growth; Aerojet Rocketdyne is seeing improvements with increased volume and capacity investments; IMS has upside with international expansion and improved program performance; Space & Airborne Systems may see less impact due to cost-plus contracts. -
Aerojet Rocketdyne Integration
Q: Are there more synergies to achieve from Aerojet's integration?
A: Chris confirmed they've achieved the initial $50 million in cost synergies, primarily from eliminating public company costs. They expect an additional $20 to $30 million from further integration efforts like IT systems, which will contribute to the LHX NeXt program. Ken added that focus is shifting to operational efficiencies to drive throughput and deliver critical capabilities. -
IMS Performance and Margins
Q: Can you update on IMS attrition and margins?
A: Chris reported improved margins in the second half of 2023. Attrition is slowing down, and they've successfully hired and trained new employees. Supplier performance is improving, and bidding rigor has increased with more bids reviewed at higher levels. They've no-bid certain contracts to focus on earnings and cash over revenue. There's margin upside as they aim to increase international revenue from 25% to 30%, driven by WESCAM and international business jets. -
Space Business Growth
Q: How is the Space business progressing?
A: Chris highlighted they've won three tracking contracts for the Space Development Agency (SDA), increasing from 4 to 18 satellites. Margins have improved with each contract. Satellites have short lifespans, creating an annuity as they'll need replacement over time. They're investing in a new satellite factory in Florida to enhance production. -
SAS Growth Outlook
Q: Why is SAS growth slowing in 2024?
A: Chris explained that while Space and Intel & Cyber sectors are growing, two large sectors are flat: the Air Domain (e.g., F-35, F-16) and Mission Networks due to FAA budget pressures. Reducing costs in cost-plus contracts slightly reduces revenue. They prioritize margins and cash over revenue. -
Communications Systems Outlook
Q: What's the outlook for tactical radio sales?
A: Chris reported a record year for tactical radios in 2023. Margins are influenced by the mix of domestic and international sales. Supply chain challenges have been overcome, reducing key suppliers significantly. They've secured new market wins to be announced soon. -
Cash Flow and Tax Impact
Q: What's the impact of Section 174 on cash flow?
A: Ken noted they managed the cash impact of Section 174 by catching up on tax payments in 2023. Pending legislation could positively affect cash if passed, potentially offering retroactive relief for 2022 and 2023. Free cash flow guidance adjustments mainly include LHX NeXt implementation costs. -
International Opportunities and Margins
Q: How does international mix affect growth and margins?
A: Chris stated international sales have higher margins and are expected to increase slightly from around 22–23% of revenue. Pending supplemental defense budgets, like the $58 billion DoD portion for Ukraine, Taiwan, and Israel, could bolster growth. -
Aerojet Supply Chain Challenges
Q: Any updates on Aerojet's supply chain issues?
A: Chris acknowledged challenges with sub-tier suppliers but doesn't see bringing them in-house as viable. They've invested in these suppliers, aiding with tooling and capital. He expects improvements as new facilities become operational. Despite new competitors, demand exceeds supply, affirming the acquisition's value. -
Defense Contracting Dynamics
Q: Do you see structural contracting issues in defense?
A: Chris noted cyclical shifts between fixed-price and cost-plus contracts. They're focusing on areas like software, requiring different business models. Sometimes they choose to no-bid contracts where risk is misaligned. He emphasized balancing risk and maintaining open dialogue with customers.