Business Context and Reporting Period
This Form 10-Q is for Harris Corporation, the predecessor of L3Harris Technologies, Inc., and covers the second quarter and first two quarters of fiscal 2016 ended January 1, 2016, compared with January 2, 2015. Results were significantly affected by the May 29, 2015 acquisition of Exelis. The company reported four segments: Communication Systems, Space and Intelligence Systems, Electronic Systems, and Critical Networks.
Key Financial Metrics
| Metric | Quarter Ended Jan. 1, 2016 | Quarter Ended Jan. 2, 2015 | First Two Quarters 2016 | First Two Quarters 2015 |
|---|---|---|---|---|
| Revenue | $1.843 billion | $1.206 billion | $3.654 billion | $2.361 billion |
| Gross margin | $562 million; 30.5% | $398 million; 33.0% | $1.153 billion; 31.6% | $791 million; 33.5% |
| Income from continuing operations | $(135) million | $139 million | $13 million | $264 million |
| Net income | $(152) million | $139 million | $(4) million | $264 million |
| Diluted EPS from continuing operations | $(1.09) | $1.32 | $0.10 | $2.50 |
| Operating cash flow | Not separately provided | Not separately provided | $387 million | $222 million |
- Cash and cash equivalents were $511 million at January 1, 2016, versus $481 million at July 3, 2015.
- Long-term debt, including the current portion, was $4.828 billion; total short-term debt was $198 million. The company also had $1 billion of available revolving credit capacity with no borrowings outstanding.
- Defined benefit plan obligations were $1.739 billion. The company contributed $97 million to qualified pension plans during the first two quarters and expected to contribute approximately $76 million more during the remainder of fiscal 2016.
- Capital expenditures were $51 million in the first two quarters; full-year fiscal 2016 capital expenditures were expected to be approximately $200 million.
- The quarterly dividend increased to $0.50 per share, or an annualized $2.00 per share. No share repurchases were made under the repurchase program during the first two quarters.
Material Changes Versus the Prior Comparable Period
- Revenue increased 52.8% in the quarter and 54.8% year to date, primarily from the inclusion of Exelis operations.
- Gross margin percentage declined to 30.5% from 33.0% for the quarter and to 31.6% from 33.5% year to date, reflecting a greater mix of lower-margin cost-plus contracts, weaker margins in legacy Exelis tactical radio and night vision businesses, and restructuring-related asset write-downs.
- Interest expense increased to $45 million from $22 million for the quarter and to $93 million from $45 million year to date, principally because of debt raised to fund the Exelis acquisition.
- Communication Systems revenue rose 12.4% to $489 million, while operating income declined 4.0% to $121 million.
- Space and Intelligence Systems revenue increased 101.8% to $446 million and operating income increased 97.1% to $67 million.
- Electronic Systems revenue increased 198.4% to $382 million and operating income increased 162.5% to $63 million.
- Critical Networks revenue increased 27.9% to $541 million, but the segment recorded a $308 million operating loss versus $50 million of operating income, primarily because of the Harris CapRock impairment.
- Operating cash flow increased 74.3% year to date, although the comparison benefited from working-capital movements and included significant pension contributions.
Guidance, Outlook, Commentary, Risks, and Unusual Items
- The company recorded a preliminary, non-cash impairment charge of $367 million related to Harris CapRock Communications, including $290 million of goodwill and $328 million after tax. The charge resulted from weakness in the energy market and reduced fiscal 2016 outlook for the business. The analysis was incomplete and subject to adjustment in the third quarter.
- Management stated that the impairment was not expected to require cash expenditures, cause covenant noncompliance, or affect ongoing financial performance, although no assurance was provided.
- Restructuring and other charges totaled $35 million in the quarter: $17 million in Communication Systems, $6 million in Electronic Systems, and $12 million in Critical Networks. Exelis integration and other costs were $46 million in the quarter and $69 million year to date; Exelis intangible-amortization expense was $33 million and $66 million, respectively.
- A $101 million reduction in liabilities for certain post-employment benefit plans benefited corporate results. The company discontinued certain significantly underfunded plans effective December 31, 2015.
- The company recorded a $21 million loss in discontinued operations, or $17 million after tax, following the final determination of a working-capital adjustment dispute related to the 2013 sale of Broadcast Communications.
- Management expected existing cash, operating cash flow, the revolving facility, and access to debt and equity markets to fund working capital, capital expenditures, dividends, term-loan repayments, and pension contributions for the next 12 months. It cautioned that liquidity could be affected by leverage, pension obligations, government-budget uncertainty, and capital-market conditions.
- Following quarter-end, the company announced plans to divest its aerostructures business, which had less than $150 million of net assets excluding goodwill, and expected a definitive agreement during fiscal 2016.
- The DOJ closed its investigation relating to Carefx China without action against the company; the SEC investigation remained ongoing, and the company could not predict its scope or outcome.
- Key risks include dependence on U.S. Government funding and contracts, fixed-price contract execution, contract-estimate changes, high leverage, pension funding requirements, foreign-exchange exposure, cybersecurity, export controls, environmental liabilities, oil and gas market weakness, and potential future goodwill impairments.
Facts an Investor Should Verify
- Confirm the final amount of the Harris CapRock goodwill and asset impairment after completion of the company’s analysis.
- Assess whether weakness in energy-related markets continues to affect Critical Networks revenue, margins, and valuation.
- Review Exelis integration costs, intangible amortization, debt repayment schedules, interest-rate exposure, and covenant headroom.
- Monitor operating cash conversion, working-capital changes, pension contributions, and the expected additional $76 million fiscal 2016 pension contribution.
- Evaluate the proposed aerostructures divestiture and any related gain, loss, proceeds, or discontinued-operations treatment.
- Track the SEC investigation involving Carefx China and the status of environmental and other contingent liabilities.
- Reconcile the filing’s fiscal 2016 period with the request metadata identifying “2015 Q2”; the source filing itself clearly states that the reporting period ended January 1, 2016.