Harris Corporation Form 10-K Summary
Business context and reporting period
The supplied filing is for Harris Corporation, not L3Harris Technologies, and covers the 52-week fiscal year ended July 1, 2016. The request metadata references “2015 Q4,” but the filing is an annual Form 10-K for fiscal 2016. Harris provided mission-critical communications, space, intelligence, electronic systems, managed networks and IT services to government and commercial customers in more than 100 countries, with approximately 21,000 employees.
Fiscal 2016 reflected the first full year of operations following the May 29, 2015 acquisition of Exelis for approximately $4.7 billion. Harris reported four segments: Communication Systems, Space and Intelligence Systems, Electronic Systems and Critical Networks.
Key financial metrics
| Metric | Fiscal 2016 | Fiscal 2015 | Change |
|---|---|---|---|
| Revenue | $7.467 billion | $5.083 billion | Up 47% |
| Gross profit | $2.335 billion | $1.735 billion | Up 35% |
| Gross margin | 31% | 34% | Down 3 percentage points |
| Income from continuing operations | $345 million | $334 million | Up 3% |
| Continuing-operations diluted EPS | $2.75 | $3.11 | Down 12% |
| Net income attributable to Harris | $324 million | $334 million | Down 3% |
| Net cash from operating activities | $924 million | $854 million | Up $70 million |
| Cash and cash equivalents | $487 million | $481 million | Up $6 million |
| Total debt | $4.494 billion | $5.168 billion | Down $674 million |
| Long-term debt, net | $4.120 billion | $5.053 billion | Down $933 million |
| Unfunded defined-benefit obligations | Approximately $2.2 billion | Approximately $1.9 billion | Higher |
The effective tax rate increased to 43.5% from 29.9%, primarily because much of the Harris CapRock impairment was nondeductible. Interest expense increased to $183 million from $130 million due to acquisition-related borrowings.
Segment performance
| Segment | Fiscal 2016 revenue | Fiscal 2016 operating income/(loss) | Year-over-year revenue change |
|---|---|---|---|
| Communication Systems | $1.864 billion | $530 million | Up 2% |
| Space and Intelligence Systems | $1.899 billion | $294 million | Up 89% |
| Electronic Systems | $1.530 billion | $277 million | Up 162% |
| Critical Networks | $2.233 billion | $(106) million | Up 33% |
Critical Networks’ loss primarily reflected a $367 million non-cash impairment charge related to Harris CapRock Communications, including $290 million of goodwill, following weakness in the energy market. Excluding the impairment, the segment also faced lower IT-services revenue and reduced energy-market activity.
Material changes versus the prior comparable period
- Revenue growth was primarily acquisition-driven because fiscal 2016 included a full year of Exelis operations, compared with only about one month in fiscal 2015.
- Gross margin declined to 31% from 34%, reflecting a higher mix of lower-margin cost-plus contracts, weaker margins in certain Exelis legacy product lines and restructuring-related write-downs.
- Continuing-operations EPS declined despite higher earnings because the Exelis transaction increased the diluted share count and the Company recorded the Harris CapRock impairment.
- Harris repaid approximately $730 million of borrowings and reduced total debt by approximately $674 million during the year. Management stated that the debt repayments represented roughly one-third of its three-year debt-reduction goal.
- Harris completed the divestiture of its Aerostructures business for $187 million in cash at closing, plus assumption of a $23 million capitalized lease, and recorded a $10 million net gain.
- A final determination in a dispute related to the prior Broadcast Communications divestiture resulted in a $24 million pretax, or $21 million after-tax, loss in discontinued operations.
- Fiscal 2016 included $104 million of Exelis integration and other costs, $48 million of restructuring and other charges, $11 million of inventory-step-up amortization and a $101 million net liability reduction for certain post-employment plans.
- Research and development expense increased to $309 million from $277 million.
Cash flow, liquidity and capital allocation
- Operating cash flow was $924 million; capital expenditures were $152 million; and net cash used in investing activities was only $1 million, compared with $3.284 billion in fiscal 2015 due to the Exelis acquisition.
- At July 1, 2016, the full $1 billion senior unsecured revolving credit facility was available, and no commercial paper borrowings were outstanding.
- The consolidated indebtedness-to-total-capital ratio was 60%, below the 65% covenant limit.
- Fiscal 2017 capital expenditures were expected to be approximately $175 million.
- Fiscal 2017 contributions to U.S. qualified pension plans were expected to be approximately $185 million to $195 million.
- The Board subsequently increased the quarterly dividend from $0.50 to $0.53 per share, the fifteenth consecutive annual increase. Harris also stated that it intended to restart share repurchases in fiscal 2017; approximately $684 million remained available under the repurchase authorization at year-end.
- Management stated that cash, operating cash flow, available credit and access to capital markets were expected to cover working capital, capital expenditures, dividends, debt repayments and pension contributions for the foreseeable future, while noting that future liquidity was not assured.
Guidance, outlook, management commentary and risks
- Management expected a similarly constrained U.S. Government spending environment in fiscal 2017, despite greater near-term budget certainty from the Bipartisan Budget Act of 2015.
- Approximately 76% of fiscal 2016 revenue came from U.S. Government customers, including foreign military sales funded through the U.S. Government. Government appropriations, contract funding, audits, bid protests and termination rights therefore remain major risks.
- Total funded and unfunded backlog was approximately $10.8 billion, including $5.1 billion funded. Harris expected to convert approximately 68% of funded backlog at July 1, 2016 into fiscal 2017 revenue, but cautioned that backlog could be delayed, cancelled or not converted as expected.
- Management emphasized Exelis integration, synergy capture, operational excellence, portfolio optimization, innovation and disciplined capital deployment. It stated that synergy savings were a full year ahead of the original plan.
- Key risks include fixed-price contract cost overruns, program-estimate changes, cybersecurity incidents, dependence on government budgets, international and export-control exposure, currency movements, supplier and subcontractor disruption, pension funding requirements, debt servicing, goodwill impairment and technological obsolescence.
- The SEC investigation related to historical Carefx China conduct remained ongoing, although the Department of Justice had determined not to take action. Management did not believe the matter would have a material adverse effect based on information available at filing.
- Environmental liabilities were estimated at approximately $106 million. Harris was identified as one of more than 100 potentially responsible parties concerning the Lower Passaic River cleanup, for which the EPA estimated total project costs of $1.38 billion; Harris stated that its ultimate cost was not expected to be material.
- For fiscal 2017, Harris expected a pension accounting-method change to reduce U.S. defined-benefit service and interest costs by approximately $46 million. Future benefit accruals under the U.S. Salaried Retirement Plan were scheduled to freeze effective December 31, 2016.
Most important facts for an investor to verify
- Confirm the applicable issuer and period: the source is Harris Corporation’s fiscal 2016 Form 10-K, not a 2015 fourth-quarter filing for L3Harris Technologies.
- Separate acquisition-driven revenue growth from organic growth and assess the sustainability of Exelis synergies.
- Evaluate Critical Networks’ recovery after the Harris CapRock impairment and continued weakness in energy and IT-services markets.
- Review debt maturities, variable-rate exposure, covenant headroom, pension contributions and the approximately $2.2 billion unfunded benefit obligation.
- Assess whether the $10.8 billion backlog, particularly the unfunded portion, is realistically convertible into revenue and cash flow.
- Adjust earnings analysis for the $367 million impairment, integration and restructuring charges, benefit-plan liability reduction, Aerostructures gain and discontinued-operation loss.
- Monitor U.S. Government appropriations, sequestration and contract-renewal or termination risk given the 76% government-linked revenue exposure.
- Review the ongoing SEC investigation, tax audits, environmental matters and indemnification risks inherited through Exelis and prior spin-offs.