Filing context and reporting period
This is Harris Corporation’s unaudited Form 10-Q for the quarter and first three quarters ended April 1, 2016, filed May 4, 2016. The request metadata identifies “2015 Q3” and L3Harris Technologies, but the filing is for Harris Corporation’s fiscal 2016 third quarter; L3Harris Technologies did not yet exist under that name.
The company operates in Communication Systems, Space and Intelligence Systems, Electronic Systems, and Critical Networks. Results include the Exelis acquisition, completed May 29, 2015, which materially increased reported revenue, expenses, assets, debt, and shares outstanding.
Financial performance and position
| Metric | Quarter ended Apr. 1, 2016 | Quarter ended Apr. 3, 2015 | First three quarters 2016 | First three quarters 2015 |
|---|---|---|---|---|
| Revenue | $1.909 billion | $1.187 billion | $5.563 billion | $3.548 billion |
| Gross margin | $597 million; 31.3% | $433 million; 36.5% | $1.750 billion; 31.5% | $1.224 billion; 34.5% |
| Income from continuing operations | $170 million | $126 million | $183 million | $390 million |
| Net income | $168 million | $126 million | $164 million | $390 million |
| Diluted EPS from continuing operations | $1.36 | $1.20 | $1.46 | $3.69 |
| Effective tax rate | 29.5% | 29.6% | 50.3% | 28.3% |
- Third-quarter revenue increased 60.8%, while income from continuing operations increased 34.9% and diluted continuing-operations EPS increased 13.3%.
- First-three-quarter revenue increased 56.8%, but income from continuing operations declined 53.1%, primarily because of a $367 million non-cash impairment charge recorded in the second quarter.
- First-three-quarter net cash provided by operating activities was $507 million, compared with $395 million in the prior-year period. Capital expenditures were $84 million, and dividends paid were $189 million.
- Cash and cash equivalents were $302 million at April 1, 2016, down from $481 million at July 3, 2015. The company had an undrawn $1 billion revolving credit facility expiring in July 2020.
- Long-term debt, including the current portion, was $4.702 billion, compared with $5.183 billion at July 3, 2015. Short-term debt was $91 million. The company repaid $510 million of borrowings during the first three quarters, including $450 million of term-loan principal.
- Defined-benefit plan obligations were $1.716 billion. The company contributed $134 million to qualified pension plans and expected to contribute approximately $40 million more during the remainder of fiscal 2016.
Segment results
| Segment | Q3 revenue | Q3 operating income | First three quarters revenue | First three quarters operating income |
|---|---|---|---|---|
| Communication Systems | $485 million | $154 million | $1.428 billion | $413 million |
| Space and Intelligence Systems | $489 million | $76 million | $1.370 billion | $211 million |
| Electronic Systems | $393 million | $75 million | $1.149 billion | $207 million |
| Critical Networks | $551 million | $59 million | $1.658 billion | $(186) million |
Critical Networks’ first-three-quarter operating loss primarily reflects the $367 million Harris CapRock goodwill and asset impairment charge. Excluding that charge and related restructuring costs, the segment’s underlying results were materially better than the reported loss.
Material changes versus the prior comparable period
- The Exelis acquisition drove most of the year-over-year revenue growth and added approximately 19 million shares issued in the transaction, increasing weighted-average diluted shares to 124.8 million from 105.2 million for the first three quarters.
- Consolidated gross margin declined to 31.3% from 36.5% in the quarter and to 31.5% from 34.5% year to date. Management attributed the decline primarily to a greater mix of lower-margin cost-plus contracts, lower margins in certain Exelis legacy product lines, and restructuring-related write-downs.
- Net interest expense rose to $46 million from $34 million in the quarter and to $138 million from $77 million year to date, reflecting acquisition-related debt.
- Engineering, selling and administrative expense increased year to date to $877 million from $603 million, including $99 million of Exelis intangible-asset amortization and $92 million of Exelis integration and other costs. These increases were partly offset by a $101 million net liability reduction related to certain post-employment benefit plans.
- The company did not repurchase shares under its repurchase program during the first three quarters of fiscal 2016, versus $150 million of repurchases in the prior-year period. Approximately $684 million remained authorized.
- The quarterly dividend increased to $0.50 per share from $0.47. Dividends paid in the first three quarters increased to $1.50 per share from $1.41.
Guidance, outlook, risks, contingencies, and unusual items
- Management expected fiscal 2016 capital expenditures of approximately $175 million and additional fiscal-year pension contributions of approximately $40 million. No detailed consolidated revenue or EPS guidance is provided in the filing text.
- Management stated that existing cash, operating cash flow, available credit, and access to capital markets were expected to fund working capital, capital expenditures, dividends, term-loan repayments, and pension contributions for the next 12 months and the reasonably foreseeable future, while cautioning that liquidity could be affected by leverage, pension obligations, government-budget uncertainty, and capital-market conditions.
- In the second quarter, Harris recorded a $367 million non-cash impairment charge, including $290 million of goodwill, for Harris CapRock Communications because of the energy-market downturn. Management stated that the charge did not breach debt covenants and was not expected to affect ongoing performance.
- Aerostructures was classified as held for sale and was subsequently divested on April 8, 2016 for $187 million in cash plus assumption of a $23 million capitalized lease.
- The company recorded $19 million of discontinued-operation losses during the first three quarters, including a $17 million after-tax loss from a Broadcast Communications working-capital dispute and additional third-party costs.
- The SEC investigation related to historical Carefx China conduct remained ongoing. The Department of Justice had advised that it would take no action, but the company could not predict the SEC investigation’s duration, scope, or outcome.
- Environmental matters include potential responsibility associated with the Lower Passaic River cleanup, for which the EPA estimated total project costs of $1.38 billion. The company stated that its ultimate costs were not expected to be material, although allocations had not been determined.
- Key operating risks include dependence on U.S. government funding and contracts, contract-performance and cost-estimation risk, cybersecurity, international and foreign-exchange exposure, energy-market weakness, leverage and pension obligations, export controls, litigation, environmental liabilities, and potential future impairments.
Most important facts for investors to verify
- Confirm the reporting-period mismatch: this filing is Harris Corporation fiscal Q3 2016, not 2015 Q3 or a filing of L3Harris Technologies.
- Reconcile year-to-date earnings with and without the $367 million impairment, related restructuring charges, Exelis integration costs, intangible amortization, and pension-plan liability reduction.
- Assess post-Exelis leverage, scheduled and voluntary term-loan repayments, interest-rate exposure on $817 million of variable-rate term loans, and pension funding requirements.
- Evaluate whether Exelis integration savings and favorable estimate-at-completion adjustments are sustainable, given the lower consolidated gross margin.
- Monitor Critical Networks exposure to energy prices and the performance of Harris CapRock Communications.
- Review the completed Aerostructures divestiture, the remaining Broadcast Communications obligations, SEC investigation status, and environmental contingencies.
- Confirm future dividend and share-repurchase capacity against cash generation, debt maturities, pension contributions, and the company’s stated liquidity assumptions.