L3Harris Technologies, Inc. — Form 10-Q Summary
Business context and reporting period
Unaudited quarterly filing for the period ended September 27, 2019, filed October 31, 2019. This was the first quarter after the June 29, 2019 all-stock merger of Harris Corporation and L3 Technologies. The quarter includes L3 operations from the merger date, while the prior-year period reflects Harris only; reported year-over-year comparisons are therefore not generally comparable. Management also provides unaudited pro forma comparisons.
The company operates through Integrated Mission Systems, Space and Airborne Systems, Communication Systems, and Aviation Systems. The fiscal year-end changed to the Friday nearest December 31, creating a transition period ending January 3, 2020.
Key financial metrics
| Metric | Quarter ended September 27, 2019 | Prior comparable information |
|---|---|---|
| Revenue | $4.431 billion | $1.542 billion reported; $4.018 billion pro forma |
| Gross margin | $1.189 billion; 27% of revenue | $532 million reported; $1.187 billion pro forma |
| Income from continuing operations | $435 million | $216 million reported; $373 million pro forma |
| Net income attributable to L3Harris | $429 million | $213 million |
| Diluted EPS from continuing operations | $1.90 | $1.78 reported; $1.63 pro forma |
| Operating cash flow | $81 million | $117 million |
| Capital expenditures | $84 million | $31 million |
| Cash and equivalents | $1.001 billion | $530 million at June 28, 2019 |
| Total debt, net | $6.963 billion, including $656 million current | $3.419 billion at June 28, 2019 |
| Backlog | $20.3 billion | Not clearly provided |
Income from continuing operations before taxes was $440 million. The effective tax rate was 1.1%, compared with 16.0% reported and 10.6% pro forma in the prior-year period. The unusually low rate benefited from excess equity-compensation tax benefits, utilization of capital-loss carryforwards against the Night Vision divestiture gain, and releases of uncertain tax positions.
Material changes versus prior periods
- Pro forma revenue increased 10% and pro forma income from continuing operations increased 17%; pro forma diluted EPS increased from $1.63 to $1.90.
- L3 contributed approximately $2.67 billion of revenue and approximately $190 million of income before taxes during the quarter.
- Revenue growth on a pro forma basis was led by Space and Airborne Systems, Integrated Mission Systems, and Communication Systems; Aviation Systems revenue declined 1% pro forma.
- Gross margin percentage declined to 27% from 30% pro forma, primarily due to a $92 million inventory fair-value step-up charge and revenue mix.
- Engineering, selling and administrative expense included $281 million of merger, integration, restructuring, and related costs. Total merger-related charges were $373 million, including $111 million of restructuring charges and $92 million of inventory step-up cost.
- The company recorded a $229 million pretax gain on the sale of Harris Night Vision and a $12 million gain on the sale of the Stormscope product line.
- Goodwill increased to $20.749 billion from $5.340 billion and intangible assets increased to $7.516 billion from $870 million, primarily due to preliminary purchase accounting for the merger.
- Debt increased principally from $3.5 billion of debt assumed in the merger. Net interest expense increased to $58 million from $43 million on a reported basis.
Cash flow, liquidity, debt, and capital allocation
- Cash increased $471 million to $1.001 billion. Investing cash flow was $1.414 billion, including $1.132 billion of cash acquired in the merger and $346 million of Night Vision sale proceeds.
- Financing cash flow was negative $1.014 billion, including $750 million of share repurchases, $177 million of dividends, and $100 million of debt repayments.
- The company had a fully available $2 billion senior unsecured revolving credit facility expiring in June 2024 and reported compliance with its debt covenants.
- Management expects approximately $190 million of capital expenditures during the fiscal transition period and believes available cash, operating cash flow, credit capacity, and market access will support expected needs for the next 12 months and foreseeable future.
- The quarterly dividend increased to $0.75 per share, or an annualized $3.00. The $4 billion repurchase authorization had approximately $3.25 billion remaining at September 27, 2019.
- The company contributed $327 million to defined-benefit pension plans, including a $302 million voluntary U.S. contribution. Net unfunded defined-benefit obligations were $2.1 billion.
Guidance, outlook, commentary, risks, and unusual items
- No formal revenue or earnings guidance is clearly provided in the filing. Management expects backlog of $20.3 billion to convert to revenue, with approximately half expected within 12 months and the substantial majority within three years.
- Management expects no further U.S. qualified pension contributions during the remainder of the transition period, subject to future funding requirements and plan performance.
- Merger accounting remains preliminary and may change during the measurement period. Management could not yet reasonably estimate total future merger-related restructuring costs because facility-consolidation plans were still being developed.
- Material risks include dependence on U.S. Government funding and contracts, partially funded or terminable contracts, fixed-price contract cost overruns, integration execution, substantial indebtedness, pension obligations, tax-rate volatility, cybersecurity, supply-chain and subcontractor performance, foreign-exchange exposure, litigation, environmental matters, and potential goodwill or intangible-asset impairment.
- Unrecognized tax benefits were $384 million, of which $324 million could favorably affect future tax rates if recognized. Accrued interest and penalties were $29 million.
- The company reported no material probable litigation accruals and stated that existing litigation and environmental matters were not expected to have a material adverse effect, although unfavorable outcomes exceeding recorded amounts remain possible.
- The company adopted lease accounting guidance and recognized $934 million of operating lease right-of-use assets and $960 million of operating lease liabilities; management stated the adoption did not materially affect results or cash flows.
Most important facts for investors to verify
- Verify pro forma rather than reported comparisons, given that the prior-year period excludes L3 operations.
- Track merger integration costs, restructuring cash payments, facility-consolidation plans, and realization of anticipated synergies.
- Assess leverage, upcoming maturities of $656 million within 12 months, debt refinancing plans, and the $107 million treasury-lock liability.
- Evaluate recurring profitability excluding the $229 million divestiture gain, unusually low tax rate, merger-related charges, and purchase-accounting effects.
- Monitor operating cash conversion, working-capital requirements, pension funding, capital expenditures, dividends, and the pace of share repurchases.
- Review the final purchase-accounting allocations, including goodwill, intangible values, tax positions, and potential impairment exposure.
- Confirm U.S. Government budget and contract-funding conditions, backlog conversion, fixed-price contract performance, and the status of major legal and environmental contingencies.