Harris Corporation Form 10-Q Summary
Business context and reporting period
Harris Corporation reported results for the quarter and six months ended December 28, 2018, its fiscal second quarter and first two quarters of fiscal 2019. The company operated through Communication Systems, Electronic Systems, and Space and Intelligence Systems, serving defense, government, aerospace, public safety, space, intelligence, and commercial customers.
The filing was reviewed by Ernst & Young LLP and was not audited. Comparative periods reflect retrospective adoption of ASC 606 revenue recognition and ASU 2017-07 pension-cost presentation.
Financial performance and key metrics
| Metric | Quarter ended Dec. 28, 2018 | Quarter ended Dec. 29, 2017 | Change |
|---|---|---|---|
| Revenue | $1.666 billion | $1.535 billion | Up 9% |
| Gross margin | $571 million; 34% margin | $513 million; 33% margin | Up 11% |
| Income from continuing operations | $225 million | $131 million | Up 72% |
| Diluted continuing-operations EPS | $1.88 | $1.08 | Up 74% |
| Effective tax rate | 17.0% | 41.8% | Down 24.8 points |
| Metric | Six months ended Dec. 28, 2018 | Six months ended Dec. 29, 2017 | Change |
|---|---|---|---|
| Revenue | $3.208 billion | $2.945 billion | Up 9% |
| Gross margin | $1.103 billion; 34% margin | $1.004 billion; 34% margin | Up 10% |
| Income from continuing operations | $441 million | $296 million | Up 49% |
| Diluted continuing-operations EPS | $3.66 | $2.44 | Up 50% |
| Net income | $438 million | $290 million | Up 51% |
Second-quarter segment results were: Communication Systems revenue of $540 million and operating income of $162 million; Electronic Systems revenue of $617 million and operating income of $117 million; and Space and Intelligence Systems revenue of $513 million and operating income of $92 million.
Net cash provided by operating activities for the six months was $469 million, compared with $373 million in the prior-year period. Capital expenditures were $67 million, cash dividends were $163 million, and share repurchases were $200 million. Cash increased to $343 million from $288 million at June 29, 2018.
At December 28, 2018, short-term debt was $103 million and long-term debt, including the current portion, was approximately $3.716 billion. The company had $900 million available under its $1 billion revolving credit facility, after $100 million of commercial paper borrowings. Shareholders’ equity was $3.412 billion and defined-benefit plan liabilities were $635 million.
Material changes versus the prior comparable period
- Revenue increased in all three segments, led by Tactical Communications, F-35 and other avionics production, electronic warfare programs, and classified space and intelligence programs.
- Gross margin improved because of higher volume and operational efficiencies. Electronic Systems benefited from the absence of a prior-year unfavorable estimate-at-completion adjustment on a mission networks program.
- Net income benefited materially from the lower effective tax rate. The prior-year quarter included a $58 million deferred-tax-asset write-down related to the Tax Cuts and Jobs Act; the current quarter benefited from tax accounting changes and increased research and development credits.
- The company adopted ASC 606 and ASU 2017-07 effective June 30, 2018. ASC 606 created contract-asset and contract-liability classifications and reduced opening retained earnings by $15 million on July 2, 2016. Prior periods were recast for comparability.
- Six-month operating cash flow rose $96 million, principally from higher net income, increased advance payments and contractual billing activity, and lower cash use for defined-contribution plan matching.
- The quarterly dividend increased to $0.685 per share from $0.570 per share, and the company completed $200 million of share repurchases during the six months. No program repurchases occurred during the second quarter because of merger-related restrictions.
Guidance, outlook, risks and unusual items
- Ending backlog was $8.0 billion; approximately half was expected to convert to revenue within 12 months and the substantial majority within three years.
- Fiscal 2019 capital expenditures were expected to be approximately $170 million. Management expected no U.S. qualified pension contributions during the remainder of fiscal 2019, apart from minor non-U.S. contributions.
- Management expected existing cash, operating cash flow, credit availability, and access to capital markets to meet working-capital needs, capital expenditures, dividends, repurchases, and debt maturities for the next 12 months and the foreseeable future, while noting risks from leverage, government budget uncertainty, shutdowns, and capital-market disruption.
- Harris agreed to an all-stock merger of equals with L3 Technologies at a fixed exchange ratio of 1.30 Harris shares for each L3 share. The combined company was expected to be owned approximately 54% by Harris shareholders and 46% by L3 shareholders, with closing targeted for mid-2019 subject to shareholder and regulatory approvals.
- The Department of Justice issued a Second Request under the Hart-Scott-Rodino Act, extending the merger review period. Merger-related litigation alleged deficiencies in the registration statement and sought, among other remedies, to enjoin the transaction. Management considered the claims without merit but acknowledged that litigation or regulatory action could delay or prevent closing.
- Harris was exploring a possible sale of its Night Vision business in connection with regulatory review, but the business remained classified as held for use because the criteria for held-for-sale treatment had not been met.
- Net estimate-at-completion adjustments increased operating income by $2 million in the quarter but reduced operating income by $1 million for the six months. The filing emphasizes exposure to fixed-price contracts, contract-estimate changes, U.S. government funding and termination risk, cybersecurity, international operations, pension performance, leverage, environmental matters, and merger integration.
- Potentially unfavorable litigation accruals were not material. Environmental matters included potential responsibility related to the Lower Passaic River remediation, estimated by the EPA at $1.38 billion in total, although allocations among responsible parties had not been determined.
Important facts for investors to verify
- Confirm the status, timing, regulatory conditions, divestiture requirements, litigation, and expected synergies of the L3 merger.
- Assess the sustainability of earnings growth given the unusually large year-over-year tax-rate benefit and prior-year Tax Act effects.
- Monitor approximately $3.7 billion of debt, the February 2019 $300 million floating-rate note maturity, refinancing needs, and compliance with credit covenants.
- Evaluate contract-asset growth to $829 million, contract liabilities of $486 million including the non-current portion, and the quality and timing of related cash conversion.
- Review backlog conversion, fixed-price contract exposure, estimate-at-completion adjustments, and U.S. government funding and budget risks.
- Track pension funded status, future statutory contributions, and the $635 million net unfunded defined-benefit obligation.
- Verify the effect of ASC 606 and ASU 2017-07 on historical comparability and future revenue, margin, and pension-cost presentation.