LHX

Business Context and Reporting Period

This filing is a Form 10-Q for Harris Corporation (now L3Harris Technologies, Inc.) for the quarterly period ended December 28, 2001. The report covers the second quarter of fiscal year 2002 and the first two quarters of fiscal year 2002. The company operates in two primary segments: Government Communications and Commercial Communications. The financial statements are unaudited but reflect all normal recurring adjustments.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Decline: Q2 revenue decreased 7.3% year-over-year, driven by a 16.5% drop in the Commercial Communications segment. This was partially offset by a 5.0% increase in the Government Communications segment.
• Operating Income Volatility: While Q2 operating income fell 23.5% year-over-year, the YTD operating income increased 90.0% to $58.9 million. This YTD improvement is largely due to a $73.5 million write-off of purchased in-process research and development in the prior year (Q2 2001) related to the WavTrace acquisition, which is not present in the current period.
• Segment Performance:
  • Government Communications: Revenue and operating income grew, aided by increased U.S. government procurement and performance award fees.
  • Commercial Communications: Revenue declined significantly due to a 55% drop in network support products (following the DSL market collapse) and weak international demand for microwave products. Operating income fell 39.4% due to revenue declines and $5.0 million in severance costs.
• Accounting Changes: The company adopted FAS 142, discontinuing goodwill amortization effective Q1 2002. Consequently, no goodwill amortization expense was recorded in the current period, whereas the prior year included $3.7 million (net of tax) for the quarter.
• Cash Flow: Net cash used in operating activities improved significantly to $(14.7) million YTD compared to $(42.3) million in the prior year, driven by reduced build-up of unbilled costs and inventories.

Guidance, Outlook, and Risks

• Outlook: Management expects sequential sales and earnings increases in the second half of fiscal 2002. Free cash flow for the full fiscal year is expected to be positive.
• Key Drivers: Growth is expected to be driven by the Government Communications segment, broadcast communications, and secure tactical radio products (e.g., Falcon II). The company recently secured a $168 million order from the U.K. Bowman Programme and a $55 million contract for the Joint Strike Fighter avionics.
• Risks and Contingencies:
  • Investment Write-downs: Harris recorded a $10 million provision to write down its investment in Terion, Inc., which filed for Chapter 11 bankruptcy. Further write-downs are possible if Terion's reorganization fails.
  • Market Conditions: Continued weakness in the global telecom market and international economic conditions pose risks to the Commercial Communications segment.
  • Foreign Exchange: A 10% adverse change in currency rates could impact the fair value of derivatives by approximately $7.1 million.
• Liquidity: The company maintains $400 million in available credit facilities with no borrowings outstanding as of period end. Management believes existing cash and credit facilities are sufficient for the next 12 months.

Investor Verification Checklist

• Verify the sustainability of the Government Communications segment growth given the reliance on U.S. government procurement cycles.
• Monitor the status of Terion, Inc.'s Chapter 11 reorganization to assess the risk of additional investment write-downs.
• Review the progress of the U.K. Bowman Programme and Joint Strike Fighter contracts to confirm revenue recognition timelines.
• Assess the impact of the discontinued goodwill amortization on future earnings comparisons and the potential for goodwill impairment charges under FAS 142.
• Track the Commercial Communications segment's ability to stabilize margins amidst the ongoing telecom market downturn.