L3Harris Technologies, Inc. — Form 10-Q Summary
Reporting period: Quarter and three quarters ended September 30, 2022, compared with October 1, 2021. The request metadata identifies “2021 Q3,” but the supplied filing is the 2022 third-quarter Form 10-Q, filed October 31, 2022.
Business context
L3Harris is an aerospace and defense technology company serving U.S. and international government, defense, and commercial customers. Effective January 1, 2022, the company reorganized from four to three reportable segments: Integrated Mission Systems, Space & Airborne Systems, and Communication Systems.
Financial performance and position
| Metric | Q3 2022 | Q3 2021 | First 3 quarters 2022 | First 3 quarters 2021 |
|---|---|---|---|---|
| Revenue | $4.246 billion | $4.229 billion | $12.484 billion | $13.464 billion |
| Gross margin | $1.194 billion; 28% | $1.308 billion; 31% | $3.665 billion; 29% | $4.079 billion; 30% |
| Income from continuing operations | $(301) million | $479 million | $644 million | $1.359 billion |
| Net income attributable to L3Harris | $(300) million | $481 million | $646 million | $1.362 billion |
| Diluted EPS | $(1.56) | $2.39 | $3.33 | $6.64 |
| Operating cash flow | Not separately provided | Not separately provided | $1.376 billion | $1.865 billion |
- Q3 revenue was essentially flat year over year; first-nine-month revenue declined 7%, primarily reflecting divestitures and supply-chain disruption.
- Q3 and year-to-date results included $802 million of non-cash goodwill impairment charges: $447 million in Integrated Mission Systems and $355 million in Communication Systems.
- Cash and cash equivalents were $529 million at September 30, 2022, down from $941 million at December 31, 2021.
- Total debt was approximately $7.0 billion, including $1.063 billion of current maturities and $5.967 billion of long-term debt. Debt fair value was $6.494 billion.
- The company had no borrowings under its new $2 billion revolving credit facility, which matures in July 2027, and was in compliance with its covenants.
- Year-to-date investing cash flow was an outflow of $188 million, compared with $1.400 billion of inflow in the prior period, largely because 2021 included substantial divestiture proceeds.
- Year-to-date financing cash outflow was $1.566 billion, including $900 million of share repurchases and $650 million of dividends.
- Backlog was $21.4 billion at September 30, 2022, compared with $21.1 billion at December 31, 2021; management expected to recognize approximately 59% by the end of 2023 and 79% by the end of 2024.
Material changes versus the prior comparable period
- Integrated Mission Systems Q3 revenue increased 4% to $1.710 billion, but operating margin fell to negative 13.2% from 14.1%, primarily due to $447 million of goodwill impairment, higher input costs, material delays, and unfavorable mix.
- Space & Airborne Systems revenue increased 1% to $1.502 billion, while operating margin declined to 11.5% from 12.5%, reflecting unfavorable estimate-at-completion adjustments, higher costs, and program ramps.
- Communication Systems revenue increased 4% in Q3 to $1.068 billion, but operating margin declined to negative 9.1% from 25.0%, primarily due to a $355 million Broadband goodwill impairment and higher costs.
- Year-to-date gross margin declined 10%, reflecting higher labor, material, and overhead costs and supply-chain disruptions.
- Year-to-date favorable estimate-at-completion adjustments decreased to $342 million from $485 million; net EAC adjustments were favorable by $58 million versus $247 million in the prior period.
- Year-to-date operating cash flow decreased $489 million, primarily due to higher tax payments and increased working-capital usage, including inventories, receivables, and contract assets.
- 2022 included no material divestiture-related gains, whereas 2021 included $192 million of net divestiture-related gains and $1.598 billion of divestiture proceeds.
- Shares outstanding declined as a result of repurchases. The company repurchased 3.9 million shares for $900 million during the first three quarters of 2022, versus 13.5 million shares for $2.875 billion in the prior period.
Outlook, commentary, risks, and unusual items
- Management cited expected increases in U.S. and international defense spending and potential demand related to geopolitical tensions and Ukraine support, but noted uncertainty from continuing resolutions and changing government spending priorities.
- Inflation, higher interest rates, supply-chain disruptions, labor constraints, and fixed-price contract exposure may pressure margins and cash flow. Management stated that fixed-price contracts represented 74% of fiscal 2021 revenue.
- Goodwill at the Broadband, ADG, and Electro Optical reporting units was at increased risk of further impairment because carrying values approximated fair value after the Q3 charges. A 25-basis-point increase in the discount rate would have increased the recorded impairment by approximately $200 million.
- The company expected fiscal 2022 capital expenditures of approximately $300 million. It estimated that tax rules requiring capitalization and amortization of research and experimental expenditures could reduce fiscal 2022 operating cash flow by up to $600 million.
- On October 3, 2022, L3Harris agreed to acquire Viasat’s tactical data links product line for approximately $1.96 billion, subject to adjustments, regulatory approvals, and other closing conditions. The acquisition is expected to close in the first half of 2023 and is intended to be debt financed.
- On October 21, 2022, the board approved an additional $3.0 billion share repurchase authorization, bringing total available authorization to $4.5 billion.
- The company recorded a $31 million charge for an additional pre-merger legal contingency and a $29 million charge for severance and other termination costs during Q3.
- Management reported that probable litigation accruals were not material and that existing legal and environmental matters were not expected to have a material adverse effect, although unfavorable outcomes beyond accrued amounts remain possible.
- The interim financial statements received a review, not an audit. The independent registered public accounting firm reported that it was not aware of material modifications needed for conformity with U.S. GAAP.
Most important facts for investors to verify
- Reconcile the $802 million goodwill impairment to segment results and assess the remaining impairment risk at Broadband, ADG, and Electro Optical.
- Evaluate whether margin pressure from inflation, supply-chain disruption, program execution, and fixed-price contracts is temporary or structural.
- Monitor operating cash flow, working-capital requirements, research-cost tax effects, and the decline in cash balances.
- Assess leverage and refinancing needs in light of approximately $7.0 billion of debt and the planned $1.96 billion TDL acquisition.
- Verify the timing, financing, regulatory approvals, and integration risks associated with the TDL acquisition.
- Review government budget and continuing-resolution developments, changes in defense priorities, and their impact on precision weapons, Broadband, and other affected programs.
- Track backlog conversion, contract estimates-at-completion, and future unfavorable contract adjustments.
- Confirm the sustainability of dividends and share repurchases after funding operating needs, debt maturities, and the planned acquisition.