L3Harris Technologies, Inc. — Form 10-Q Summary
Reporting period: Quarter ended April 3, 2020. The request metadata identifies “2019 Q1,” but the filing is for fiscal 2020 first quarter. Results include the L3Harris merger completed June 29, 2019; the March 29, 2019 comparable period primarily reflects Harris-only operations and is therefore not directly comparable.
Business Context and Reporting Period
L3Harris operates through four reportable segments: Integrated Mission Systems, Space and Airborne Systems, Communication Systems, and Aviation Systems. The company is primarily exposed to U.S. government and defense spending, with additional commercial aviation, public safety and international businesses.
Management stated that U.S. government operations remained largely operational during the COVID-19 pandemic, while commercial aviation, public safety, international operations, supply chains and certain customer markets were adversely affected.
Financial Performance and Key Metrics
| Metric | Q1 2020 | Q1 2019 reported | Change |
|---|---|---|---|
| Revenue | $4.626 billion | $1.728 billion | Up 168% |
| Gross margin | $1.328 billion; 29% of revenue | $589 million; 34% | Margin down 5 points |
| Income from continuing operations | $195 million | $243 million | Down 20% |
| Net income attributable to L3Harris | $217 million | $243 million | Down 11% |
| Diluted EPS from continuing operations | $0.99 | $2.02 | Down 51% |
| Operating cash flow | $533 million | $405 million | Up $128 million |
On a pro forma combined basis, revenue increased 5% to $4.626 billion from $4.386 billion, while income from continuing operations decreased 51% from $400 million to $195 million and diluted EPS decreased from $1.75 to $0.99.
- Segment revenue: Integrated Mission Systems $1.370 billion; Space and Airborne Systems $1.192 billion; Communication Systems $1.094 billion; Aviation Systems $1.011 billion.
- Segment operating income: Integrated Mission Systems $201 million; Space and Airborne Systems $221 million; Communication Systems $250 million; Aviation Systems reported an operating loss of $177 million.
- Contract estimates: Favorable estimate-at-completion adjustments increased operating income by $103 million, or $78 million after tax and $0.35 per diluted share.
- Backlog: $20.4 billion at April 3, 2020, compared with $20.6 billion at January 3, 2020. Management expected approximately 50% to convert to revenue within 12 months.
- Effective tax rate: 11.8%, compared with 14.1% in the prior reported period.
Cash Flow, Liquidity and Capital Structure
- Cash and cash equivalents were $663 million, down from $824 million at January 3, 2020.
- Operating cash flow was $533 million; capital expenditures were $48 million.
- Financing cash outflows included $700 million of share repurchases and $183 million of dividends, partially offset by $245 million of net borrowing proceeds.
- Total debt, net, was $7.190 billion, including $896 million classified as current. The company issued $250 million of floating-rate notes due 2023 during the quarter and subsequently repaid $250 million of notes due April 30, 2020.
- The company had a fully available $2 billion revolving credit facility expiring in June 2024 and reported compliance with its debt covenants.
- Management stated that existing cash, operating cash flow, available credit and capital-market access were expected to support working capital, capital expenditures, dividends, repurchases and debt maturities for the next 12 months, while cautioning that COVID-19 and market disruptions could affect future liquidity.
- Fiscal 2020 capital expenditures were expected to be approximately $400 million. No U.S. qualified pension contributions were expected during the remainder of fiscal 2020, subject to future funding requirements.
Material Changes, Unusual Items and Outlook
- COVID-19 charges: The company recognized approximately $330 million of impairment and other COVID-19-related charges, including a $296 million non-cash goodwill impairment charge in Commercial Aviation Solutions, $23 million of receivable and contract-asset write-downs, a $5 million goodwill impairment related to a pending divestiture and $3 million of aviation-related restructuring costs.
- Commercial aviation outlook: Management expected Commercial Aviation Solutions revenue to decline by approximately $300 million in calendar 2020 versus 2019 because of reduced air traffic, training demand and commercial avionics sales. Some flight-training facilities were temporarily closed.
- Public safety outlook: Public Safety revenue was expected to decline by approximately $50 million in calendar 2020 due to pressure on state and local government customers.
- Divestitures: The airport security and automation business was classified as held for sale and sold to Leidos on May 4, 2020 for approximately $1 billion of net cash proceeds before final adjustments. EOTech was agreed to be sold for $42 million, and Applied Kilovolts and Analytical Instrumentation was also classified as held for sale, with both transactions expected in mid-2020.
- Merger integration: L3Harris recorded $46 million of merger-related charges during the quarter, including $15 million of inventory fair-value step-up cost and $31 million of integration costs. Acquisition-related intangible amortization was $145 million.
- Shareholder returns: The company repurchased 3.28 million shares for $700 million and increased its quarterly dividend to $0.85 per share. Approximately $1.8 billion remained authorized for repurchases at quarter-end.
- Risk concentration: Eight reporting units with approximately $10 billion of goodwill had estimated fair values less than 10% above carrying values. Management did not anticipate further material goodwill impairments at filing, but acknowledged sensitivity to COVID-19, operating deterioration, valuation assumptions and interest rates.
Risks and Contingencies
Principal risks include the severity and duration of COVID-19, commercial aviation weakness, supply-chain disruption, remote-work and cybersecurity risks, U.S. government funding and contract termination, fixed-price contract cost overruns, merger integration execution, indebtedness, pension funding, international and foreign-exchange exposure, litigation, environmental liabilities and potential impairment of goodwill or other long-lived assets.
Accruals for probable litigation matters were not material. Management stated that existing litigation and environmental matters were either reserved, insured or not expected to have a material adverse effect, although unfavorable outcomes exceeding recorded amounts remain reasonably possible.
Facts Investors Should Verify
- Reconcile reported results with pro forma results because the prior-year reported period excludes most L3 operations.
- Assess the sustainability of the $103 million favorable contract-estimate adjustment and its contribution to quarterly earnings.
- Monitor further COVID-19 effects on Commercial Aviation Solutions, Public Safety, backlog conversion and supply chains.
- Verify the final proceeds, working-capital adjustments and accounting effects of the airport security and automation sale and other planned divestitures.
- Review goodwill sensitivity, particularly the eight reporting units with less than 10% valuation headroom.
- Evaluate debt maturities, refinancing requirements, treasury-lock losses and the company’s ability to maintain dividends and repurchases.
- Confirm future pension funding requirements and the effect of market returns and discount rates on the $1.7 billion net unfunded defined-benefit obligation.