Why don't we get started? I'm Doug Harned, Bernstein Aerospace and Defense analyst, and I'm really pleased to have with us today Chris Kubasik, Chairman and CEO of L3Harris, and also with us is Michelle Turner, CFO. I know Chris wants to say a few words to start out, so I'll turn it over to you for a few minutes.
I'll just, I'll start with a couple of opening comments. Good morning, all. Thank you for joining us. Looking forward to all your smiles, and engaging nods through the audience. I'm already seeing it. Oh, good. Thank you for that. Just as a reminder, this is being recorded, and webcast. Chris and I will discuss certain matters that may constitute forward-looking statements. For more information on the risk,, and uncertainty in these statements, please reference our safe harbor provision on our investor materials, and our SEC filings on our L3Harris website. Thank you. Look forward to the discussion.
All right. Well, thank you, Michelle, good morning, everyone. It's always great to be back in New York. You know, it's hard to believe it's been almost four years since the merger of equals between L3 and Harris. I think when we look back over the four years, by all accounts, it's been quite a success. You know, there was a lot of questions and uncertainty when it was first announced, but everything has been tracking as planned. One of the main reasons for that merger was to create more competition, especially with the Department of Defense. I think when you look back on time, you know, back in the 90s, there was a lot of consolidation, as you well know, and we were left with five major primes.
We've been talking about creating this sixth prime, if you will. I think we'll talk about some of the success we've had, not only as a prime contractor. We continue to subcontract to major platforms, and of course, we continue to be a merchant supplier. I think what differentiates us from a lot of the other companies, we've adopted this phrase of being the trusted disruptor. Trusted in that we understand the mission of our customer, our 46,000 employees, and we've taken an approach of teaming and embracing a lot of the new entrants that have tried to get into this defense industry.
I view us, and a lot of the primes as being more hardware-defined and software-enabled. We're working with a lot of these companies that are software-defined, and hardware-enabled, and having some success. In fact, yesterday, we just announced a strategic partnership with Amazon Web Services, as we're going to be pursuing some markets together. I think that's just a great combination, and an example of how we try to work with partners, and companies that are somewhat software-centric. You know, one of the key things we're trying to do is differentiate ourselves through the way we deploy capital. I think over the mid to long term, it looks like a balanced capital approach because it is between dividends and share repurchases, and acquisitions.
In the last couple months, fourth quarter of 2022, two properties we've been looking at for a while came on the market. You have to be opportunistic, we went after, and succeeded in acquiring both the Viasat tactical data link business, which actually closed in January. The whole focus on JADC2, and resiliency, and data links was right in the sweet spot. Aerojet Rocketdyne, which I'm sure we'll talk about a little more, Doug, also came on the market, and we're in the process of getting that through the regulatory market process, the regulatory approval process. That's a unique opportunity to have a bolt-on into a new market area. I think, since we've announced, you can see that the missiles market, the DoD calls it munitions and missiles, is up 24%.
Additionally, they've been given over $200 million of DPA, Defense Production Act money, to expand the facilities, move production, and digitize engineering. Strategically, I think we've been pretty clear in our strategy, and we're executing upon it. Maybe a quick word on governance. You know, per the merger agreement, we had four board members retire in the last year or so, and we've replaced them with a couple recently retired flag officers, and a sitting chief operating officer, and chief financial officer from large public companies. I think we have a very diverse and experienced board.
On the ESG front, something we've spent a lot of time talking about, and focused on. I think by all accounts, we've been rated independently as the leader in A&D when it comes to ESG, and the progress that we've made there. Shifting quickly to operations, a big believer in leadership, and getting the right talent. I think L3Harris is viewed as one of the hot stories in defense. Since the merger, more than half of the leadership team is new. Most of those individuals have come from larger, more co-complex organizations. I think it positions us well for future growth. As we look at the new hires, two of our three segment presidents are new.
The real focus is on operational excellence, operational experience, and leadership. Obviously, interacting with customers, motivating the employees, strategic thinking are important, but we're really focused on the operations, and we've had challenges in the last year or so, driven by supply chain inflation and attrition, but we're starting to overcome that. Finally, just a quick word on financials. We started big believer in momentum. We had a good fourth quarter of 2022. I thought we had a really good first quarter of 2023. We have about a month to go in Q2 of 2022, but it looks like we're gonna have not only revenue, but earnings growth and positive cash as well. Feel the momentum is building, and, Doug, we look forward to your questions and those of you in the audience. Thank you.
Great. Thanks, Chris. As you have questions, I think, you'll probably know, you can enter them in the Pigeonhole link there. Just to get started, if we went back a couple years ago, at that time, we would be talking still about the completion of all the synergies, capturing synergies in the L3Harris merger. When you look at where you were a couple years, ago and where the company is now, you know, are you through everything you wanted to capture out of that merger? What are your priorities? You talked about some right there.
Yeah. No, great question. We've been consistent, for the last several years in communicating to the workforce. We have three strategic pillars, we used to talk about growth, innovation, and performance. I think when I look back on the last couple years, we were doing very well on the first two, performance was the one that was more challenging due to the headwinds that I mentioned. For 2023, we've adopted the phrase, "Performance first." Everything, every executive does is focus on performance, meeting their commitments to their customers, the financial commitments to Wall Street, and the commitments to our workforce. We give specific examples, you know, a good example, based on all the emails I've been getting, would be, like, the Paris Air Show.
We're not going to the Paris Air Show. Nobody's sold a darn thing in the Paris Air Show for 40 years, or at least I haven't. We're not going there. We're gonna do program reviews. We're gonna visit our sites. We're gonna meet with our employees. It's changing the behavior. In performance, I think we've made a lot of good progress, the biggest headwind being supply chain. We've talked about not just sitting there waiting for more and more suppliers, but we've actually engineered and developed alternative parts. We've talked about it, I think it gets to be an old story, that a lot of our products, you know, are reliant on these parts, and we book revenue upon delivery. We've had a little bit more of a headwind.
We're doing that, and to your question, specifically, we're rolling out what we call LHX NeXT, which is really the continuation, and the transformation of the business. I'd like to say the first couple years, it was easier to save the $660 million. We shut down our headquarters just a few blocks from here. We went from six segments to four. We put out new $1 billion of bids for supply chain, you know, standardized benefits. It was relatively easy compared to what we're gonna do now, which is really just challenge everything we do, look at spans, look at layers, eliminate waste, with the goal of being even more, and more efficient. That's the focus on performance. The innovation, we talk a lot about. We spend more on IRAD as a percent of revenue than most.
I think we're starting to see some payoff. We're very aggressive with our CRAD, which is our customer, R&D, over $1 billion. We've invested in venture capital shield to help bring commercial entities into defense, focused on autonomy, and space. You know, on the growth front, you know, we just continue to have record backlog, record book-to-bill. I believe the customers are embracing us when we go for these prime bids. Our focus has really been more on speed. The number one issue when I talk to our customers, schedule, schedule, which is different than 10 or 20 years ago. We're being innovative there. We're partnering with companies such as Amazon and others that I mentioned, I think we're kind of shaking things up.
Well, when you say performance, how do you measure that? In other words, what are the metrics? You know, is it cost? I mean, certainly Paris Air Show's cost. You know, how do you push performance?
I mean, that's a great question. In our business, and I think the whole industry, a lot of it is on the programmatics, and the estimates at complete, right? I will tell the team, it's not that simple, but, right, we sign a contract with a commitment to deliver a certain capability at a certain price, at a certain time. You know, the key inputs there are your direct labor, your supply chain, your overhead, and your profit. We have a process that looks at that on a regular basis. The first quarter was not great. We had more negative EACs than positive EACs.
You know, that would be, at the highest level, what we review with the board, what I look at on a, on a monthly basis, but well below that. I think what's unique about L3Harris is that I have an executive focused on operations, who reports directly to me. In addition to the programmatics, we're looking at supply chain, we're looking at continuous improvement, EHS, quality, so we have all the standard metrics there on cost of poor quality, on-time deliveries, and such. It's been a maturation, and the goal here is to identify challenges early and deploy the resources to fix them.
I think, as I said, the momentum is starting to build, but the goal would be, obviously, you know, not to have these negative write-offs as a result of having fixed price contracts and cost growth.
Well, I wanna get to the supply chain in a minute, but first, maybe you could set us up a little bit by just If you look at the Biden defense budget, how do you see L3Harris faring in that? Then, we still gotta get a real budget, right? We've got to get through the rest of this year, even if we get the debt ceiling taken care of this week. How do you see that congressional process playing out for you?
I think, last night there was a overwhelming, favorable vote by the House. Seems like the Senate will look at it this weekend, hopefully, we will get the 2024 defense budget, which is coming in at $842 billion. These numbers get so large, you just throw them out. I looked back, two years ago, it was $742 billion, three years ago, it was barely $700 billion. I think, well, it's important to have year-over-year growth rate. To go from $700 billion to $842 billion, again, this is top-line DoD as a proxy for growth, is pretty darn impressive. $842 billion is, I know you've written about, is 3.5% growth.
Our addressable market is really the investment accounts, and they're actually growing faster. I like the fact that it appears to be a two-year deal, so we don't have to go through this drama again. When they resolve this, I think it cuts down the probability of a year-long CR. In fact, you would think that this should be ideally approved by October 1, but my guess will be December, because it always takes a few months into the year. I think that's a huge positive. When we look at the details, you know, and I mentioned the L3 and Harris merger of equals, we're in all domains. On the space front, that's our fastest growing business. A lot of money for the Space Force.
We're priming contracts for the Missile Defense Agency, for the SDA, classified. Actually, a lot of work for NASA and NOAA for the weather satellites, so I think we're well positioned there. On the airborne, you know, we've had a long legacy of doing work for Rivet Joint, ISR capability. Last year, we won the Armed Overwatch, which was kind of a pretty cool innovative idea, taking a crop duster, and putting all sorts of avionics and cameras, and such on it for special ops. We support the F-35 program, you know, with Lockheed on the Tech Refresh. Maritime, we're on Columbia, we're on Virginia class. Those programs are going to continue. We're working on unmanned, autonomous naval platforms. They seem to be lagging more than I would like, but they're still part of their strategy.
Of course, on the ground, tactical radios is kind of what we used to be known for before the merger, and is a key part of our business. I'll actually be up there next week for a few days, and we just won a majority for the HMS Manpack, about just under $200 million, and yesterday, we got a $200 million order for Ukraine. That, that is all growing, and then our cyber business, we don't, we don't talk a whole lot about. Probably like everyone you talked to yesterday, and everyone that you're going to talk to today will say, "We're well positioned based on the budget.
They was it.
You know, what else are you gonna say? No, I really think when you look at all those domains, more and more money is going to space, then, you know, I mentioned the Aerojet acquisition. When you look at what the DoD calls munitions and missiles, but most of that is missiles, you know, it's growing 24% year-over-year. I look at Standard Missile 6 as an example. It was $800 million in the budget. It's $1.6 billion now, and Aerojet obviously has a piece of that with the propulsion. You know, I like the growth, I like the trend.
Well, you know, you're right, everyone will say they're well-positioned, I am sure. You know, that budget increase you're talking about, which is a little more for the investment accounting of 4% and 4.5%. The problem here is, and I'm sure you even heard Lindsey Graham's commentary, inflation is pretty high. Last year, we saw in the 2023 budget, $50 billion added by the Senate for inflation. This year, yes, the budget is up, but I look at this in a sense of trying to fit, you know, 15 pounds of potatoes in a 12-pound bag here. Not everything's gonna fit in there. Do you think you're going to get more money from Congress as this goes forward for the overall?
No, I think. No, it's a great point. I think what, you know, where it suffers is the DoD is on the buying power, right? If they're historically buying 10,000 whatever, you know, as the price increases due to inflation, and everything we've talked about, you know, they're probably gonna have to get 9,500 or find more money. You know, it always comes down to the defense industry, and how we all handle these things. You know, we're seeing more, and more fixed price development contracts coming out. We decided not to bid on two so far this year under the theory that I'm not gonna bid fixed price on a development/production program where we have not agreed on the specs and such.
You know, I appreciate the DoD's occasional attempt to get industry to bid, and use the wrong contracting vehicle, and we will continue to pass on those opportunities. 'Cause when you look down the road three to five years, everybody's taking these write-offs, and the reason they're taking the write-offs is they bid fixed price development, and they can't get the contract mods or contract changes as the scope and technology changes. You know, I think that's their attempt, on occasion, to try to handle this issue, and I think the industry as a whole is gonna continue to no-bid these contracts until they use the right vehicles.
Well, for L3Harris, among the major primes, you have the highest % of fixed-price work. A lot of ways, that's really good, but.
True.
In an inflationary period, it's been interesting because when we've looked at inflation in defense, we've found over, you know, 20, 30 years, no correlation with defense margins because you get repricing, you have cost plus work. This time around, inflation's gone higher, faster.
Correct.
When you look at your businesses that are under fixed-price contracts, how should we think about them evolving through this period, how repricing might occur, and how you can support margin expansion?
Yeah, it's a great question, and I looked at it the same way. Now, in our case, our backlog as a percentage of our annual revenues is the smallest in the industry 'cause it's been perceived, rightfully so, as being more short cycle, whether it's the radio, the night vision goggles, the WESCAM turrets. We have some long term, some short term. We're a little over 70% fixed price. What I think I see is most of this is flushing through the system, and it was more than people just tend to correlate inflation to supply chain, you know, which I think for the whole industry and major primes is 50%-60% of the cost of a program. It's also impacting the labor, direct labor, indirect labor.
You factor all those items in, I think we believe we've flushed most of this through. Then as we go through, and review, and bid new work, you know, it's on Michelle and I and the executive team to say, "This is the cost of the new product. This is what we're gonna bid. If it's fixed price, and it's development, we're not gonna bid it, because we don't wanna take a loss." The impact is on the buying power that our DoD has. We try to come up with creative systems or approaches that are maybe more cost-efficient, easier to get into the field. No, that is clearly the challenge and the headwind.
I think the whole industry has kind of flushed through that in 2022 and early 2023, and, you know, our backlog turns rather quickly.
I look back a couple of years before we really got into this heavy inflation. I know you all had been talking about this incremental margin expansion path year-over-year, clearly, a lot of the things that happened in the interim made that much more difficult, with inflation, with supply chain. Do you see yourselves going back to that kind of a path with this annual margin expansion?
Yeah, let me give a high-level answer. I'll ask Michelle to give more details. The answer is yes. We're gonna see margin improvement as I look at it sequentially, quarter-over-quarter, throughout 2023. I made the conscious decision with the team in late 2022, with our attrition, which, you know, I think we were all dealing with double-digit attrition. We're down below 9% in March. I'm feeling better about that. We spent $200 million, you know, that we would not have planned for a year earlier on the workforce. We held all the employee benefits flat year-over-year. You know, when you get your envelope or email that says, "What is my healthcare and dental?" It is the same number, which was viewed very favorably.
We increased the defense or the annual wage budget. We did a few other things with spot awards, really to get the workforce engaged and stop leaving and stay with us. It seemed to pay off, but I think it was, like, $200 million.
Yeah.
that we absorbed, which I thought, and the team thought was in the best interest of the company. The other option is they leave, and then you spend all sorts of money recruiting new people. You want to give a little more color on the margins?
Yeah. I think to your point, Doug, really, we've been impacted by two headwinds: the supply chain challenges that have permeated over the last 18 months. Where we sit today, the takeaway is, the worst of that is behind us, right? When you think about 2021, electronic components really became an acute issue across the industry. We entered 2022, we saw a lot of hiccups in the first half of the year. As we got into the second half of 2022, we started to see improvement. Albeit, it wasn't linear, but we started to see the continuity of supply start to increase. Where we sit here in Q2 of 2023 is we have a lot more insights in terms of the electronic components, mostly driven by the proactive actions that Chris talked about, right?
The macro environment is improving, but the overall supply chain is not back to where it was in, say, 2019. What is better, however, is the actions that we've taken to allow us to be agile and really pivot as we start to see these disruptions within the supply chain. To Chris's points around part redesign, when we started at the beginning of this, we had a couple hundred parts that allowed us to use alternate sources in our products. That number is over 1,300 at this point. We've built in a level of resiliency within our supply chain that's allowing us to meet the demands of our customers, even while the macroeconomics around supply chains and ecosystems continue to be a challenge. Then to the point around inflation, right?
You know, the heightened inflation environment has permeated from about the middle of last year to where we sit today. We're starting to see that dissipate. Chris knows I like fun facts. A fun fact around inflation is if you look at the earnings results over the last three quarters, the number of times the word inflation has been used has sequentially decreased every quarter. Now for in Q1, it's at the point that it was in 2021. I think across industries, inflation is starting to be at a place where it's manageable, it's controllable, companies are taking action. We are taking action to offset that.
The final point I would make is around our short cycle of portfolio. This is unique to L3Harris, and we have been criticized for having a more short cycle portfolio in comparative to our peers. However, in a heightened inflationary environment, that actually works to our favor. If you assume that the middle of last year was the height of the inflationary environment, our average program performance period is about 12 to 18 months. We will have worked through most of those programs by the end of 2023. As we head into 2024, that should be a bit of a tailwind for us as we've worked off all of those programs that were priced in advance of the heightened cost environment.
I'll just chime in. Those are all the operational things. We're also looking strategically, and portfolio shaping as well. I've talked about the need to divest in some form or fashion, sell, spin, whatever, our non-core assets. I think that's an important part of the margin story as well, to get a more focused portfolio in these acquisitions, via, you know, Viasat, Aerojet, get us right in high growth, high margin opportunities, and we will get rid of the non-core, which tends to either be overly capital intense or lower margin. As we go through that process, I think we come out the other end with a higher growth, higher margin business. You know, a lot of people sometimes were questioning these acquisitions relative to scale.
Just to clarify, we're not trying to be the largest defense contractor. We're trying to be the most valuable, and that's the strategy. We'll add a couple billion of revenue through acquisitions. We'll probably divest a couple billion. At the end of the day, we'll have a really nice, crisp, focused organization that I think we'll all be proud of.
On the two most recent acquisitions, TDL and then the in process-
Right.
Aerojet Rocketdyne, can you First, on TDL, you've got Link-16. Can you talk about how you're using that capability within communication systems to ultimately, I assume, produce some real revenue synergies?
Absolutely. I think that was the acquisition that had more revenue synergies than cost. There's questions about the integration. This fits nicely into one of our 14 sectors, which reports up to one of our three segments, so it's a very discreet operation with dedicated resources. We're actually, on the cost side, we are migrating a lot of the production from Southern California into our Salt Lake City facility. That will be done by the end of this calendar year. It's actually progressing quite well. Even the attrition that you would expect is below our target. I think that move is gonna save money, and allow us to continue to produce and meet our on-time deliveries with higher quality products. We've had a unusual amount of.
You know, in our business, you spend a lot of time in D.C., in the Pentagon, meeting with customers. We were getting calls, you know, back in November, December, after we announced the acquisition from customers, and we had to say, "Well, wait. We can't do anything yet until we actually close," which we did on January 3rd. Link 16's on over 20,000 different platforms. There'll be a refresh, you know, with a more resilient, if you will, Link 16. Part of this is just having the footprint and the real estate on these different platforms. We think, you know, that there's huge opportunities. I think one of the lessons learned out of Ukraine is the importance of communications and resilient communications.
The Ukrainians have it, mainly as a result of the 15,000 radios that we've delivered. The other guys don't, and you see what's happening. I think this just reinforces the importance, a little bit of our portfolio with the ISR for situational awareness from space and aircraft and the ability to communicate. Everything in between is the missiles and munitions, which, of course, there's a huge shortfall and why this acquisition of Aerojet strategically makes a lot of sense to me.
On that, before you weren't a player really in that market. How did you think about this? Clearly, there's growth here right now, no question about it, and there's even more growth than when you originally announced it. You know, it seems different. It doesn't seem to fit into a lot of the other things you do. How do you think about this in terms of synergy?
Yeah, we don't see a lot of revenue synergy, to your point. It's probably not a lot of difference in the last five months. Michelle mentioned the short cycle business, right? This comes with $7 billion of backlog, with a annual revenue of about $2 billion, so it'll give us more visibility, and a longer term view of our backlog, and forecast, kinda offsetting that short cycle business. You know, when you did the merger, you know, it really was to get into all the domains. We look at the budget, we look at the strategy, you know, I'm well aware of the people that question these things, but, you know, we have a process.
You know, the likelihood of two of the things that we wanted to buy come to market in the same quarter, you know, we view it as, having been in this industry for almost 40 years, you have to take advantage of these opportunities. There aren't that many opportunities to make acquisitions. I will go on record again and say, I don't foresee any acquisitions for the next several years. Like I said, I can only say it so many times. Yeah, ideally, would I have liked one to come into market in 2022 and one in 2023, or one in 2023 and one? Absolutely, but they were both for sale in the fourth quarter. You know, we're fixing our operational challenges through supply chain. I think that story's almost done.
Viasat will be basically integrated and ready to roll by the end of the year, we'll take on Aerojet Rocketdyne. I'm well aware of the feedback, "How can you do three things at once?" One thing is being done, the other is being done, and the third will be done, so they're really spread out. Again, you listen to customer, you look at the strategy, you're trying to get in high growth markets. This is a high growth market. It's well documented. It's one of the biggest risks of anyone you talk to in the DoD, is there are not enough munitions and missiles, and this is gonna take years, if not decades, to replenish the supply and to prepare for the threats that are out there.
I think there's margin opportunity, and, you know, it's further backed up by the DoD, you know, giving Aerojet Rocketdyne $215 million for, you know, Defense Production Act. I think that's a huge focus on the importance of manufacturing. There's only, you know, since I'm sure I'll answer the question before you ask it, we're going through the regulatory process, and the fact there's no revenue synergy confirms, you know, that we don't compete with them, and they're not a customer of mine, and I'm not a customer of theirs. Terms like vertical and horizontal competition do not exist, which is why we're confident this deal will close in the second half of 2023.
One thing about this, I mean, as I'm sure you've heard, you've had some vocal customers who have not been happy with the performance in Aerojet Rocketdyne, which appears to be an opportunity for you.
Yes.
There should be some upside here. How do you think about that in terms of how you plan to manage this, integrate it, you know, post-close to improve performance?
Absolutely. Great, great question. There's only so much we can do before the deal closes, you know, under the gun-jumping rules. You know, I've been to a facility or two. They, you know, the team's been out there. We can only observe and get ready for the integration. You know, with 46,000 employees going to 50,000, we have the tools, we have the skill sets. I mentioned our focus on operations. We view these as factories, not programs, right? When you look at the flow of production, you look at the lead times, you look at the quality, rolled throughput yield, we just see lots of opportunities where our experience, our tools, and our systems can help step up the quality and the on-time delivery.
We're well aware of some of the feedback. I generally don't use other companies' names other than Amazon in my presentations, but, yeah, I'm well aware, and I think that's why it's in the best interest of national security, and the national defense to get this thing closed quickly. I'm hoping those same companies that are concerned about Aerojet's performance are supporting this deal because it's in their interest for us to own it sooner rather than later, so that we can move forward with the execution.
As I am sure you know, when you do deals like this, the process before close, you can often see the loss of key people, you can see performance issues in the company that's being acquired. I mean, how do you manage that? Obviously, you're not directly involved in what they're doing, but how do you reduce the risk?
Yeah, I mean, that's always the challenge. We've met, as you would imagine, the key leaders. You know, a majority of the people, you know, will be staying and want to, you know, perform well and be part of L3Harris. I did a video back, I think, in December, you know, which was reviewed by 100 attorneys and went to the workforce. The feedback has been very positive from the Aerojet Rocketdyne employees. They wanna be part of a bigger company. There's more opportunities, right there. It's tough to be a $2 billion company going up against, you know, companies 20 times larger than you on a level playing field.
I think a lot of the key leaders who we've met, you know, they wanna be part of the new company, so their performance during this period is important to them as well. You know, it's a clear acquisition, so the board won't come. Eileen Drake won't be part of the company. A few other corporate execs won't be, but, you know, where the rubber meets the road at the facilities in Huntsville, Camden, you know, out in California, they're all working hard. We get regular updates, but again, you know, as you said, during this period, like any acquisition, you can only observe and get the data, and I think they had a pretty good first quarter, right?
No, they did.
Right.
If I could just add, in terms of Q1, they did report really strong results. 11% growth within Q1. This was actually a record Q1 from a revenue perspective for them. EPS and cash, when adjusted for one-timers, 'cause they had some integration, merger work that they had to adjust for, was in line with expectations. They're performing well and consistent with what they've been sharing. The only other thing I would add to Chris's point around the integration work is we are spending a lot of time understanding the portfolio, the processes, but particularly the people. To your point, Doug, we haven't seen a lot of attrition. We did a 3-day roadshow.
We went to three of their sites, spent a lot of time, what I call doing a listening tour, really trying to understand the care about, the concerns, and really how do we tap into creating value expeditiously post-close. The team is excited about being part of this journey, so we're excited about getting this behind us.
Yeah, I mean, they've had a rough two years...
Yeah
... for all the well-documented-
Yeah
items I'm not gonna repeat. I think there's excitement, and as Michelle said, their attrition is less than ours. I guess when there's a duopoly, there's only so many places you can actually go, so you know, it's a very-
Right
... engaged workforce. Again, that, $215 million of, DPA money, the sooner we can get in there, and work collaboratively with the existing team to optimize that, I think that's a game changer, a real game changer.
If we switch over to some of the individual businesses, communication systems, fantastic, high-margin business. You've got great radio contracts. Going back to the supply chain issue, this has been an area where semiconductors have been an issue, and it looked like you were finally, in Q4, reducing inventory, and getting some of that backed up, back up in radios out there. It was hard to see that much in Q1 on that line, but can you help us understand how the, what I would call, almost finished inventory, the work in process there, how you see that flowing out to the customer over the next couple years, given the supply chain challenges you faced?
Yes, I'll start, and then, Chris, feel free to jump in. Just for the audience's benefit, our communications systems, part of our portfolio, is about a $5 billion business. To your point, Doug, we do enjoy really nice margins within this business, north of 20%. This has been the area that's been the most acutely impacted in terms of supply chain, and electronic components. We are starting to see that abate, however, based on those proactive actions that I talked about earlier. I'll also note that this is the business that has also seen really strong demand as a result of the current conflict in Ukraine. To your point around inventories, Doug, as we purposely grew our inventories, that was aligned with demand increasing as well.
Within our product-based portfolio, which is about 25% of our overall portfolio, we saw our demand grow, our backlog grow by over 20% in 2022. Those inventories, we were purposely growing, recognizing that we were going to be growing our product, revenues in 2023, and that is what you were seeing. To your point around Q4 versus Q1, we benefited from a lot of our suppliers trying to meet their year-end objectives in Q4. We typically have our largest, deliveries within fourth quarter. Within Q1, however, we did see double-digit growth within our product deliveries in comparative to last year. Where we sit here, to Chris's point, we expect sequential improvement within Q2, and we expect that's going to continue into the second half, depleting some of those inventories.
Yeah, and, you know, during that whole COVID, seemed like forever, you know, one more quarter, one more quarter. You know, when you're actually running the businesses during that, you're making your best estimate. At that point, we took the approach, you know, every part at any cost, right? Because we were out there buying everything we could to meet the demand, and to meet our commitments, and making alternative parts and such. I alluded to it, and we said it, and I know it gets old, but, you know, you can't deliver a radio, think of your iPhone, unless you have every single part.
You know, I know guys in the Navy, they, you know, they delivered ships, and 40 years later, you're retiring ships, and it still has a punch list because, you know, airplanes, ships, you can deliver those, and it's kind of like building a house. My house in Florida still has a punch list. I've lived there four years. Radios, it's all parts. We went back early on, three years ago, you know, list the critical parts, and, you know, we'd get the critical parts, the battery, the antenna, whatever. It turns out every part is critical. I mean, we were holding up for a $1.32 part. We couldn't deliver the damn radios without this, and it's like: All right, I'll pay $2. They didn't have them, right? Because the production was actually in India, of all places.
All these things you learn about, and I think the whole industry, or I'll speak for ourselves, we learned a lot about supply chain, and we've really increased the talent and the focus. You know, I've said this before, three years ago, I'd say we had 9,500 suppliers, and today I'd say we have 525,000, because we have the visibility into the second, third, fourth tier, and any one of those, you know, can basically hold us hostage and put us behind the eight ball. We're taking a whole different approach. This concept of people saying, "I can't wait till things get back to normal," we're like: There is no normal. We're not going back to the way we used to do things.
It's the new norm. Right now, we want to burn down this inventory. We're being much more selective. We've actually changed our supply chain approach. We have some strategic alliances with some microelectronic parts. It's just a different way. Instead of, you know, reverse auctions and trying to get the lowest price, you find your key suppliers, you share the technology roadmap, they co-invest in developing new products. You know, especially on the chips, we use a lot of 28 nanometer chips. All the growth is in 3, 5s, 10s. How do we develop our products using some of the new modern chips versus the older ones that are not getting the resources from the big companies like TI, Intel, and others? You know, we feel optimistic about the future.
We've learned a lot about it, and, you know, we'll Like I said, we're gonna have a decent or a really good second quarter, and we'll continue building the momentum.
Well, I think of this as a, you know, it is particularly the radio program is particularly interesting because, I mean, Harris, essentially, a long time ago, came in the back door of the JTRS program to, you know, provide the waveforms that you could have commonality across the Army, across the Marines. That is always implied, as we've looked at this, that there's a long runway here in terms of rolling out these radios, 'cause if you don't get commonality, you've sort of not accomplished the whole point of this.
Correct.
When you look at rolling the radios out, how far along are you in modernizing the Army and the Marine Corps?
I think we're maybe about a third of the way through. We have these rather large IDIQs. I think the indefinite delivery, indefinite quantity. Yeah, you look at our backlog, it looks light, but to your point, you have high confidence in, you know, the fact that you get these annual purchases and competitions. I mentioned the Manpack HMS just the other day, like $186 million. There's a leader follower. We got the majority, another company got, you know, the minority. I think it was a 60/40 split. You have confidence and visibility into that. We.
You know, talking about the new norm, in the old days, you know, we'd be proud of the fact we had common parts through all of our radios, which sounds like a good thing until that common part isn't available, right? Those are the types of things, as we will invest in a new radio. Do you want it to have the same exact parts as the others? You may actually come up with, "No." You know, let's have some common parts or at least have dual supply. It's just rethinking everything in the way we do it. You know, we have a lot of confidence in that business, and internationally, it continues to grow as well. You don't see it in the backlog, but, you know, you do see the opportunities year after year.
One of the things that's part of this, what I consider kind of an interesting story about how you get this high-margin radio business that kind of came in through the back door, is that you did your own R&D.
Right.
That's, as you referred to at the beginning, you spend more money on R&D, on IRAD than really any of the other major primes, as a percent of revenues. That really delivered here. It really delivered on the night vision goggles. You get these commercial contracts, that's great. When you think about those investments today at higher levels of IRAD, do you have the confidence that you can do more of this kind of work, that you can get high-margin commercial work in the future?
Yeah, that's the key question going forward. We have confidence in those businesses. We also have it in WESCAM, you know, where we have the turrets or the cameras.
Mm-hmm
that we put on various rotary and fixed-wing aircraft that have the higher margins. Even in your more traditional businesses, where you start with that cost plus development program, as you move into production, you know, you look at the weighted guidelines, you have the opportunity, you know, to get 15%, and then, you know, ideally, you move in international. We're up to 21% of our business international. There was a focus at the date of the merger. It's increased significantly, and I think our international customers and allies look at our portfolio of products. All those work in unison to grow the margins year-over-year, and I think that's unique.
I will not shy away from, you know, cost-plus development programs that might be 10% or 12% because you need those, you know, to set yourself up for the low rate production, the full rate production, and ultimately, the exports. It's really a portfolio, but we think we have pretty good visibility to improve those margins. I mentioned our LHX NeXt initiative. I mean, that's gonna start paying off maybe in late 2023, but early 2024 as well.
Well, one of the places where you do have a lot of cost plus is in the space and airborne world with space. Can you talk about... I think that's your highest growth kind of-
Right
... subsegment.
Right.
As you look at it today, I mean, you're heavily participating in sort of, what I refer to as new space, you know, large LEO constellations, things like that. You're now doing your own bus manufacturing. I know you've got a new factory, I thought, in Florida. Can you talk about how that business is likely to change over time from initially, a lot of development work on these new programs, to one with a lot of satellite production later on?
Right. Right. I probably wish I had more cost plus in space than you would think. There have been a lot of fixed price space programs, especially in low Earth orbit, with SDA and MDA. Again, you know, we have existing programs where we can use the reuse. The what's interesting about the space business, you know, is really consistent with our strategy and changing the mindset. For years, I think I mentioned, you know, like, at the time of the merger, we had no satellites in orbit where we were a prime.
You know, my simple way of looking at it, you have the bus, which is an important part of a satellite, and then you have the payload, and we were basically the payload provider, which I would argue is more valuable. The industry flipped, where the company with the payload became the prime, and then you know, the bus becomes the commodity, which was different than 20 or 30 years ago, where the bus provider was always the prime and the integrator. We've flipped that model. A lot of what we do are these smaller sats, low Earth orbit, and, you know, in the old days, you could take five years to build a $1 billion satellite, and launch it to last 15 years. Now, it's more of this factory mindset.
On SDA, we've been successful, you know, on the tracking for Tranche 0, Tranche 1, the bid, RFP will come out for Tranche 2. We're taking that type of approach, and, you know, the buses have become the commodity, and the payload is where the value resides. We have launches coming up later this year, and, we'll see how that plays out. I made comment at the beginning about the importance of speed. That's the number one goal. Let's get these demos up there. Let's get these satellites. They're gonna have a three to five-year life, and they're gonna be a replenishment.
I think it's pretty darn exciting, and a fair amount of these are classified, and that's an area where we have a lot of talent, 20,000 cleared employees, and, you know, things are progressing very well.
Well, well, staying in space and airborne, one area that has been a challenge has been Technology Refresh 3 on the F-35. Can you, two things on that? One is, maybe you can update us on how that's going. I know you're getting there, it sounds like.
Yep.
Can we see actual top-line growth there as you know, even if we're delivering, say, a flat number of F-35s, there are upgrades, you have more content. What's the growth path?
Yeah. I'll I know we're running out of time. TR-3 has been a continual improvement. There'll be others up here in the next few hours, you can ask them their opinion. We think we're doing well. The most important thing is I think there's good collaboration and teamwork, not only within industry, but, you know, there are meetings now in the Pentagon that has the Air Force, and the Marines, and the Navy, and the prime, and the subs, and us, all in the room agreeing on a path forward. First flight was a key milestone. We had that back in January. We're producing the ship sets, and Lockheed's the prime, as you well know. They're in the process of integrating, and I think it's very collaborative and working quite well.
Relative to growth, you know, it's gonna come back to what the DoD decides to do relative to the already delivered aircraft, you know? Will there be an opportunity to refresh those?
Mm-hmm.
-with TR-3 capabilities? If there are, which I think they'll need, you know, for strategic purposes, that's where the growth for a company like ours and maybe others will exceed the primes. You know, we kinda go quarter by quarter on that one, and comes back to the budget and what our customer ultimately wants.
Well, good. Well, I think we've got to wrap it up here.
Okay.
Chris and Michelle, I wanna thank you for joining us today.
No, thank you. Good to be here, Don.
Good.
Appreciate it.