Business Context and Reporting Period
This is Harris Corporation’s Form 10-Q for the quarter and first three quarters ended March 31, 2017, covering fiscal 2017. The filing is for Harris Corporation, not the later L3Harris Technologies entity. Results were restated for CapRock and IT Services as discontinued operations. Continuing operations comprise Communication Systems, Space and Intelligence Systems, and Electronic Systems; the former Critical Networks segment was eliminated.
Financial Performance and Position
| Metric | Q3 FY2017 | Q3 FY2016 | 9M FY2017 | 9M FY2016 |
|---|---|---|---|---|
| Revenue | $1.489 billion | $1.550 billion | $4.358 billion | $4.459 billion |
| Income from continuing operations | $164 million | $159 million | $472 million | $469 million |
| Diluted EPS from continuing operations | $1.31 | $1.26 | $3.77 | $3.74 |
| Net income | $85 million | $168 million | $422 million | $164 million |
| Operating cash flow | Not separately provided for the quarter | $489 million | $507 million |
- Q3 gross margin was 35% of revenue, compared with 35% in the prior-year quarter. For the first nine months, gross margin was 36%, compared with 35%.
- Q3 income from continuing operations represented approximately 11% of revenue, compared with 10% in the prior-year quarter.
- The Q3 effective tax rate was 29.6%, compared with 28.1%; the nine-month rate was 29.7% in both periods.
- Cash and cash equivalents were $302 million at March 31, 2017, down from $487 million at July 1, 2016.
- Long-term debt, including the current portion, was approximately $3.98 billion; short-term debt was $233 million. The $1 billion revolving credit facility had $775 million available, after $225 million of commercial paper borrowings.
- Net unfunded defined-benefit obligations were $2.1 billion. Pension contributions were $143 million through nine months, with approximately $446 million of additional contributions anticipated during the remainder of fiscal 2017.
- Capital expenditures were $79 million through nine months; full-year fiscal 2017 capital expenditures were expected to be approximately $130 million.
- Cash dividends were $0.53 per share in Q3 and $1.59 per share for the first nine months. The annualized dividend rate was $2.12 per share.
Material Changes Versus the Prior Comparable Period
- Q3 revenue declined 4%, primarily because of lower legacy Exelis tactical-radio and night-vision revenue, lower environmental-program revenue, the prior-year contribution from divested Aerostructures, and lower ADS-B and wireless-product revenue.
- Q3 income from continuing operations increased 3% and diluted EPS increased 4%, helped by cost containment, integration synergies, higher pension income, lower acquisition-related charges, and fewer shares outstanding after repurchases.
- Communication Systems revenue declined 5% and operating income declined 7% in Q3. Nine-month revenue declined 9% and operating income declined 6%, largely due to lower tactical communications sales.
- Space and Intelligence Systems revenue declined 3% in Q3, while operating income increased 1%. For nine months, revenue increased 2% and operating income increased 11%, supported by intelligence-community demand and improved program performance.
- Electronic Systems revenue declined 4% in Q3, but operating income increased 4%. Nine-month revenue was essentially flat and operating income increased 16%, supported by a mission-networks contract settlement, electronic-warfare growth, program performance, and integration savings.
- Operating cash flow decreased 4% to $489 million for the first nine months. Financing cash use increased to $942 million, including $460 million of share repurchases, $199 million of dividends, and net debt repayments.
- Harris completed the CapRock sale on January 1, 2017 for $375 million of net cash proceeds and recognized a $23 million pretax gain, or $70 million after specified tax benefits.
- Shares repurchased during the first nine months totaled 4.13 million for $460 million. A new $1 billion repurchase authorization was approved in January 2017, in addition to approximately $223 million remaining under the prior authorization.
Outlook, Commentary, Risks and Unusual Items
- Management stated that existing cash, operating cash flow, the credit facility, and access to capital markets were expected to fund working capital, capital expenditures, dividends, repurchases, debt repayment, and pension contributions for the next 12 months and the reasonably foreseeable future. No formal revenue or earnings guidance was provided in the filing.
- IT Services was classified as held for sale and sold on April 28, 2017 for approximately $650 million of net cash proceeds, subject to post-closing adjustments. The business generated a $238 million noncash impairment charge in discontinued operations, including $228 million of goodwill impairment.
- Discontinued operations reduced Q3 net income by $79 million and reduced nine-month net income by $50 million. The discontinued-operations results include IT Services, CapRock, and residual Broadcast Communications activity.
- Management identified a remaining Electronic Systems reporting unit whose estimated fair value exceeded carrying value by only 10% to 15%. Future deterioration, higher interest rates, or weaker projections could result in additional goodwill impairment.
- Key risks include dependence on U.S. Government funding and contracts, contract termination or audit risk, fixed-price cost overruns, cybersecurity threats, pension funding requirements, substantial debt, tax and environmental contingencies, international and foreign-exchange exposure, export controls, litigation, and future impairment of goodwill or other assets.
- Legal and environmental matters were described as not expected to have a material adverse effect based on currently available information, although unfavorable outcomes exceeding recorded accruals remain possible.
- The company adopted new share-based compensation accounting in fiscal 2017, producing a $9 million Q3 and $21 million nine-month income-tax benefit. A new revenue-recognition standard was expected to become effective in fiscal 2019 and could affect contract revenue and cost timing.
Important Facts for Investors to Verify
- Confirm that comparisons use the restated continuing-operations results following the CapRock and IT Services divestitures.
- Assess the sustainability of earnings improvement given lower revenue, reliance on favorable contract estimates, pension income, tax benefits, and share repurchases.
- Verify completion economics and final purchase-price adjustments for the April 28, 2017 IT Services sale.
- Monitor debt reduction, commercial-paper borrowings, credit-facility availability, and the substantial remaining pension contribution requirement.
- Evaluate the sensitivity of the Electronic Systems goodwill balance to operating performance, interest rates, and valuation assumptions.
- Review the timing and final settlement of the second tranche of the $350 million accelerated share-repurchase transaction.
- Consider exposure to U.S. Government budget decisions, contract funding and termination, cybersecurity, environmental claims, tax audits, and other contingencies.