Harris Corporation Form 10-Q Summary
Reporting period: Quarter and three quarters ended March 29, 2019, compared with March 30, 2018; fiscal 2019 third quarter. The request metadata identifies “2018 Q3,” but the filing itself reports fiscal 2019 Q3. Harris reported three continuing-operations segments: Communication Systems, Electronic Systems, and Space and Intelligence Systems.
Financial Performance
| Metric | Q3 FY2019 | Q3 FY2018 | 9M FY2019 | 9M FY2018 |
|---|---|---|---|---|
| Revenue | $1.728 billion | $1.562 billion | $4.936 billion | $4.507 billion |
| Gross margin | $589 million; 34% | $534 million; 34% | $1.692 billion; 34% | $1.538 billion; 34% |
| Income from continuing operations | $243 million | $198 million | $684 million | $494 million |
| Diluted EPS from continuing operations | $2.02 | $1.63 | $5.67 | $4.07 |
| Net income | $243 million | $196 million | $681 million | $486 million |
| Effective tax rate | 14.1% | 4.8% | 15.7% | 25.3% |
- Q3 revenue increased 11%, income from continuing operations increased 23%, and diluted EPS increased 24%. Nine-month revenue increased 10%, income from continuing operations increased 38%, and diluted EPS increased 39%.
- Engineering, selling and administrative expense declined to $310 million from $331 million in Q3, primarily because the prior-year period included $45 million of charges to exit a commercial LTE radio communications business. Q3 2019 included $16 million of L3 merger-related transaction and integration costs.
- Net favorable estimate-at-completion adjustments contributed $6 million to Q3 operating income and $5 million for the nine-month period, compared with net unfavorable adjustments of $4 million and $15 million, respectively, in the comparable periods.
Segment Results
| Segment | Q3 Revenue | Q3 Operating Income | 9M Revenue | 9M Operating Income |
|---|---|---|---|---|
| Communication Systems | $568 million, up 19% | $172 million, up 19%; 30% margin | $1.577 billion, up 15% | $474 million, up 17% |
| Electronic Systems | $649 million, up 7% | $123 million, up 14%; 19% margin | $1.855 billion, up 7% | $355 million, up 13% |
| Space and Intelligence Systems | $514 million, up 7% | $87 million, up 5%; 17% margin | $1.515 billion, up 7% | $265 million, up 6% |
Growth reflected increased Tactical Communications and public-safety demand, higher avionics, release systems and electronic-warfare revenue, and stronger classified-program revenue. Space and Intelligence Systems expense growth included increased bids-and-proposals and research-and-development investment.
Cash Flow, Balance Sheet and Liquidity
- Nine-month operating cash flow was $874 million, versus $230 million in the prior-year period. The improvement was primarily attributable to higher earnings, better working-capital performance, and the absence of the prior-year $300 million voluntary pension contribution.
- Capital expenditures were $104 million for the nine months; management expects approximately $170 million of fiscal 2019 capital expenditures.
- Financing cash outflows included $303 million of debt repayments, $200 million of share repurchases, and $244 million of dividends. Cash increased $46 million to $334 million at March 29, 2019.
- Cash and cash equivalents were $334 million; short-term debt was $103 million; long-term debt, including the current portion, was approximately $3.418 billion. Debt fair value was $3.673 billion.
- The company had $900 million available under its $1 billion revolving credit facility after $100 million of commercial paper borrowings. Harris reported compliance with its debt covenants and stated that it does not currently expect material liquidity issues.
- Defined benefit plan liabilities were $601 million. Management expected no further U.S. qualified pension contributions and only minor non-U.S. contributions during the remainder of fiscal 2019, although future required contributions could be material depending on asset returns and discount rates.
- Backlog was $8.5 billion at March 29, 2019; approximately half was expected to convert to revenue within twelve months and the substantial majority within three years.
Material Changes and Unusual Items
- Harris adopted ASC 606 revenue recognition and ASU 2017-07 pension-cost presentation effective June 30, 2018 using full retrospective application. Prior periods were recast for comparability.
- The tax rate comparison was affected by favorable tax adjustments in both periods, including Tax Cuts and Jobs Act-related items in the prior-year period. The filing does not present the reported earnings as wholly representative of normalized tax performance.
- On April 4, 2019, shareholders approved the pending all-stock merger with L3 Technologies. The transaction provides L3 shareholders 1.30 Harris shares per L3 share and was expected to close around mid-calendar 2019, subject to regulatory and other conditions.
- Also on April 4, 2019, Harris agreed to sell its Night Vision business to Elbit Systems of America for $350 million in cash, subject to adjustments and closing conditions, including completion of the L3 merger. Proceeds were expected to fund L3 Harris pension plans and return cash to shareholders.
- Harris incurred $29 million of L3 merger-related transaction and integration costs during the first nine months and expected additional merger, integration and restructuring costs.
Outlook, Risks and Contingencies
- Management expected available cash, operating cash flow, credit capacity and capital-market access to fund working capital, capital expenditures, dividends, repurchases and debt maturities for the next twelve months and the reasonably foreseeable future; no formal revenue or EPS guidance was provided in the filing.
- Principal risks include dependence on U.S. Government funding and contracts, continuing resolutions or shutdowns, contract termination or audit exposure, fixed-price cost overruns, cybersecurity incidents, international and currency risks, pension funding requirements, high indebtedness, tax-rate volatility, environmental matters, and impairment of goodwill or other long-lived assets.
- The Department of Justice had issued a Second Request relating to the L3 merger. Merger-related shareholder litigation was settled and dismissed by March 18, 2019, but merger closing remained subject to regulatory approval and other conditions.
- Environmental matters include potential responsibility for remediation sites, including the Lower Passaic River, where the EPA estimated total remediation costs of $1.38 billion; Harris stated that its portion was reserved, insured or not expected to be material based on available information.
- The company entered into a $400 million treasury lock to hedge interest-rate exposure related to anticipated notes intended to refinance or repay $400 million of 2.7% notes due in April 2020. The treasury lock had an $11 million liability and an $8 million after-tax unrealized loss in accumulated other comprehensive income at quarter-end.
Investor Verification Points
- Verify the timing and final terms of the L3 merger, including regulatory approvals, integration costs, expected synergies, financing and any required divestitures.
- Assess the $350 million Night Vision divestiture, including closing conditions, purchase-price adjustments and use of proceeds.
- Reconcile reported cash flow improvement against the prior-year $300 million pension contribution and monitor working-capital conversion, particularly contract assets of $881 million.
- Evaluate leverage, debt maturities and the planned refinancing of the 2020 notes relative to post-merger capital structure.
- Monitor U.S. Government budget and contract-funding conditions, fixed-price contract estimates, backlog conversion and quarterly estimate-at-completion adjustments.
- Review pension funding sensitivity, environmental exposure, tax-rate normalization and the expected impact of the fiscal 2020 lease-accounting adoption.