L3Harris Technologies, Inc. — Form 10-K Summary
Filing and period: The supplied filing is the Form 10-K for the fiscal year ended January 1, 2021, filed March 1, 2021. It does not correspond to the requested “2019 Q4” period. Fiscal 2020 comprised 52 weeks; the prior comparable four-quarter period ended January 3, 2020 comprised 53 weeks and is generally not comparable because the L3Harris merger closed June 29, 2019.
Business Context
L3Harris is a global aerospace and defense technology company serving government and commercial customers in more than 100 countries. Its four reportable segments are Integrated Mission Systems, Space and Airborne Systems, Communication Systems, and Aviation Systems. Approximately 48,000 employees were reported at January 1, 2021, including approximately 19,000 engineers and scientists.
- U.S. Government customers, including foreign military sales funded through the U.S. Government, represented 78% of revenue.
- Revenue tied to end customers outside the United States was $3.7 billion, or 20% of revenue.
- Total backlog was $21.7 billion, including $16.3 billion of funded backlog, versus $20.6 billion and $16.2 billion, respectively, at January 3, 2020.
Financial Performance
| Metric | Fiscal 2020 | Prior comparable period |
|---|---|---|
| Revenue | $18.194 billion | $18.097 billion pro forma; $12.856 billion as reported |
| Gross margin | $5.308 billion; 29% | $5.190 billion pro forma; 29% |
| Income from continuing operations | $1.088 billion | $1.652 billion pro forma |
| Income attributable to common shareholders | $1.121 billion | $1.628 billion pro forma |
| Diluted continuing-operations EPS | $5.19 | $7.25 pro forma |
| Effective tax rate | 17.7%, approximately 18% | Approximately 10% pro forma |
| Net cash from operating activities | $2.790 billion | $1.655 billion |
| Cash and cash equivalents | $1.276 billion | $824 million |
| Capital expenditures | $368 million | $173 million |
On a pro forma basis, revenue increased 1%, driven by growth in core U.S. and international businesses, but income attributable to common shareholders declined 31%. Gross margin percentage remained 29%. Return on invested capital declined to 4% from 7%, and return on average equity declined to 5% from 10%.
Segment Results
| Segment | Revenue | Operating income/(loss) | Operating margin |
|---|---|---|---|
| Integrated Mission Systems | $5.538 billion | $847 million | 15% |
| Space and Airborne Systems | $4.946 billion | $932 million | 19% |
| Communication Systems | $4.443 billion | $1.084 billion | 24% |
| Aviation Systems | $3.448 billion | $(177) million | (5%) |
On a pro forma basis, Integrated Mission Systems revenue increased 3%, Space and Airborne Systems increased 5%, and Communication Systems increased 4%. Aviation Systems revenue declined 12%, primarily because of COVID-19 impacts on commercial aviation and the divestiture of the airport security and automation business.
Liquidity, Debt and Capital Allocation
- Net cash from operating activities was $2.790 billion, compared with $2.290 billion of share repurchases, $725 million of dividends, and $368 million of capital expenditures.
- Aggregate debt principal was $6.832 billion; debt, net of premiums, discounts and issuance costs, was $6.916 billion.
- The company had a $2 billion senior unsecured revolving credit facility, with no borrowings outstanding and full availability at year-end. The debt-to-total-capital ratio was 25%, below the 65% covenant limit.
- Unfunded defined benefit plan liabilities were $1.9 billion. Management stated that no contributions to U.S. qualified defined benefit plans were required in fiscal 2021 because of prior voluntary contributions.
- Fiscal 2021 capital expenditures were expected to be approximately $375 million.
- The quarterly dividend was increased from $0.85 to $1.02 per share, effective with the first-quarter fiscal 2021 dividend, for an annualized rate of $4.08.
- A new $6 billion share repurchase authorization was approved in January 2021, increasing total unused authorization to $6.2 billion. Management expected to repurchase up to $2.3 billion in fiscal 2021, subject to conditions.
Material Changes and Unusual Items
- The L3Harris merger materially changed the company’s scale and comparability of reported periods. L3 contributed approximately $5.5 billion of revenue to fiscal 2020 results that was not included in the corresponding prior-year period.
- Fiscal 2020 included $767 million of impairment charges, primarily related to COVID-19 impacts on the Commercial Aviation Solutions reporting unit. These included $461 million of goodwill impairment and $257 million of long-lived-asset impairment.
- The Aviation Systems segment also recorded $18 million of COVID-related restructuring and other exit costs and was affected by sharply lower commercial aviation demand.
- The company completed divestitures of Harris Night Vision, airport security and automation, Applied Kilovolts and Analytical Instrumentation, and EOTech. Divested businesses contributed $202 million of fiscal 2020 revenue.
- Merger-related charges were $171 million in fiscal 2020, including $130 million of integration costs, $31 million of inventory fair-value step-up cost, and $10 million of restructuring charges.
- Company-sponsored research and development increased to $684 million, or approximately 4% of revenue.
- Net favorable estimate-at-completion adjustments increased operating income by $400 million before tax.
Outlook, Risks and Contingencies
Management expected fiscal 2021 growth in core defense and international businesses, continued integration benefits, margin expansion, and achievement of $320 million to $350 million of net merger synergies by the end of 2021. Management expected continued weakness in commercial aviation and public safety early in fiscal 2021, followed by stability or modest recovery later in the year, although timing and magnitude remained uncertain.
- COVID-19 could continue to affect commercial aviation, public safety, supply chains, workforce availability, customer demand, and asset valuations. The company was seeking reimbursement for certain COVID-related costs, but recoverability and timing were uncertain.
- Dependence on U.S. Government funding, appropriations, contract audits, competitive bidding, contract termination rights, and changing defense priorities remains significant.
- Fixed-price contracts represented 74% of fiscal 2020 revenue and expose the company to cost overruns, inflation, supplier disruption, and execution risk.
- Goodwill was $18.9 billion at year-end. The Commercial Aviation Solutions reporting unit had $847 million of remaining goodwill and fair value approximately equal to carrying value, creating sensitivity to further deterioration in aviation markets or valuation assumptions.
- Legal claims were accrued when probable and estimable; management stated that probable litigation exposure was not material. A 2019 Department of State export-control settlement requires $13 million of civil penalties over three years, with $6.5 million suspended subject to qualifying remediation.
- Environmental liabilities were estimated at $117 million across 84 identified sites. The company also disclosed potential exposure relating to the Lower Passaic River, for which total remediation was estimated by the EPA at $1.38 billion, although allocations had not been determined.
- Subsequent to year-end, the company agreed to sell its military training business for $1.05 billion and its Combat Propulsion Systems business for approximately $400 million, subject to customary closing conditions.
Investor Verification Priorities
- Verify that comparisons use the company’s pro forma figures rather than as-reported figures because of the L3Harris merger and fiscal-year change.
- Assess the sustainability of the $400 million of favorable estimate-at-completion adjustments and the assumptions underlying percentage-of-completion accounting.
- Review remaining goodwill and intangible-asset exposure, particularly the Commercial Aviation Solutions reporting unit.
- Evaluate leverage, mandatory debt maturities, interest expense, pension obligations, and the company’s planned level of repurchases and dividends.
- Monitor recovery in commercial aviation and public safety, the effect of divestitures, and the timing and proceeds of pending divestitures.
- Reconcile backlog conversion expectations—approximately 54% by the end of 2021 and 85% by the end of 2023—with funding, delivery, cancellation, and contract-performance risks.