L3Harris Technologies, Inc. Form 10-K Summary
Reporting period: Fiscal year ended June 28, 2019. The provided filing is not a 2018 Q4 filing; it is Harris Corporation’s fiscal 2019 Form 10-K, filed August 22, 2019. Historical results principally represent Harris Corporation because the all-stock merger with L3 Technologies closed on June 29, 2019, one day after fiscal year-end.
Business Context
Prior to the merger, Harris operated three reportable segments: Communication Systems, Electronic Systems, and Space and Intelligence Systems. The businesses provided tactical communications, public-safety networks, electronic warfare, avionics, C4ISR, space, intelligence, geospatial, environmental, and positioning, navigation and timing solutions. Harris had approximately 18,200 employees and served customers in more than 100 countries, with approximately 77% of fiscal 2019 revenue attributable to U.S. Government customers, including foreign military sales.
Following the merger, Harris was renamed L3Harris Technologies, Inc. L3Harris shareholders owned approximately 54% and former L3 shareholders approximately 46% of the combined company on a fully diluted basis. Management expected approximately $18 billion of annualized revenue for the transition period and approximately 50,000 employees.
Financial Performance and Key Metrics
| Metric | FY2019 | FY2018 | Change |
|---|---|---|---|
| Revenue | $6.801 billion | $6.168 billion | Up 10% |
| Gross profit | $2.334 billion | $2.102 billion | Up 11% |
| Gross margin | 34% | 34% | Stable |
| Income from continuing operations | $953 million | $702 million | Up 36% |
| Continuing-operations diluted EPS | $7.89 | $5.78 | Up 37% |
| Net income | $949 million | $699 million | Up 36% |
| Effective tax rate | 14.4% | 22.7% | Improved |
| Operating cash flow | $1.185 billion | $751 million | Up $434 million |
| Capital expenditures | $161 million | $136 million | Up $25 million |
| Cash and equivalents | $530 million | $288 million | Up $242 million |
Fiscal 2019 included $65 million of L3Harris merger-related transaction and integration costs, or $49 million after tax and $0.40 per diluted share. Reported results also benefited from a lower tax rate following the Tax Cuts and Jobs Act, foreign-derived intangible income deductions, research credits, and equity compensation tax benefits.
Segment Results
| Segment | FY2019 Revenue | FY2019 Operating Income | Revenue Change |
|---|---|---|---|
| Communication Systems | $2.177 billion | $654 million | Up 14% |
| Electronic Systems | $2.583 billion | $499 million | Up 9% |
| Space and Intelligence Systems | $2.057 billion | $359 million | Up 8% |
Growth was driven by higher Department of Defense tactical-radio sales, avionics and electronic-warfare programs including F-35, F/A-18 and F-16 platforms, and classified space and intelligence programs. Company-sponsored research and development increased to $331 million from $311 million.
Liquidity, Debt, and Capital Allocation
- Long-term debt, net, was $2.763 billion at June 28, 2019; total debt including current maturities was approximately $3.419 billion net of discounts and issuance costs.
- Harris had $103 million of short-term debt, including $100 million of commercial paper.
- The company established a new $2 billion senior unsecured revolving credit facility maturing June 2024. Approximately $1.9 billion was available at year-end, and the company was compliant with its 65% total-debt-to-total-capital covenant.
- Fiscal 2019 cash uses included $325 million of dividends, $200 million of share repurchases, $281 million of net debt repayment, and $161 million of capital expenditures.
- The quarterly dividend increased from $0.685 to $0.75 per share effective for dividends declared during the transition period, implying an annualized rate of $3.00 per share.
- Net unfunded defined-benefit obligations increased to approximately $1.174 billion from $714 million, primarily due to a lower discount rate.
- Contractual cash obligations totaled approximately $7.394 billion, including $3.443 billion of debt principal, $1.736 billion of purchase obligations, $313 million of operating lease commitments, and $1.899 billion of interest.
Material Changes Versus the Prior Period
- Revenue increased 10%, while continuing-operations income increased 36%, supported by higher volume, productivity savings, operating leverage, and a lower effective tax rate.
- Operating cash flow increased substantially, partly because fiscal 2018 included a $300 million voluntary pension contribution while fiscal 2019 included essentially no U.S. qualified-plan contribution.
- Debt declined following repayment at maturity of $300 million of floating-rate notes and other debt-management actions.
- Funded backlog increased to approximately $5.8 billion from $5.2 billion; total backlog, including unfunded amounts, was $8.3 billion at year-end.
- The company adopted ASC 606 and ASU 2017-07 retrospectively. ASC 606 reduced fiscal 2018 revenue by $14 million and continuing-operations income by $19 million relative to previously reported amounts.
- Harris classified its Night Vision business as held for sale. The business generated fiscal 2019 revenue of $166 million and income before tax of $27 million.
Merger, Outlook, and Unusual Items
Management described fiscal 2019 as a transformative year and identified priorities for the transition period and following fiscal year: flawless integration, building a high-performance culture, operational excellence, accelerated innovation, and growth. Management expected approximately $190 million of capital expenditures during the fiscal transition period and anticipated using operating cash flow for dividends, repurchases, pension funding, and strategic reinvestment.
- The L3Harris merger accounting was incomplete at filing. Purchase-price allocation, acquired intangible assets, assumed liabilities, and goodwill were not yet finalized.
- On July 2, 2019, L3Harris issued approximately $3.021 billion of new notes in exchange for L3 debt, increasing the combined company’s debt profile beyond the historical Harris balance sheet presented in this filing.
- On July 1, 2019, the company authorized a new $4 billion share-repurchase program and stated that it expected, but was not obligated, to repurchase up to $2.5 billion during the following twelve months.
- The planned $350 million cash sale of Harris Night Vision was expected to close in the third quarter of calendar 2019. Proceeds were intended for pension funding and shareholder returns.
- The company changed its fiscal year-end from the Friday nearest June 30 to the Friday nearest December 31. The transition period runs from June 29, 2019 through January 3, 2020.
Principal Risks and Contingencies
- High dependence on U.S. Government spending, appropriations, contract renewals, competitive bidding, audits, and possible termination for convenience or default.
- Fixed-price contract exposure, including cost overruns, technical delays, supplier problems, inflation, penalties, and unfavorable estimate-at-completion revisions.
- Execution, integration, synergy, employee-retention, customer-retention, and systems risks associated with the L3Harris merger.
- Cybersecurity, classified-information, export-control, FCPA, procurement-integrity, and regulatory-compliance risks.
- Significant debt and pension obligations, including sensitivity to interest rates, credit ratings, pension-asset returns, and future funding requirements.
- International exposure to foreign exchange, geopolitical instability, export licensing, tariffs, sanctions, political changes, and delayed customer payments.
- Environmental liabilities, including approximately $99 million of estimated environmental liabilities across 60 potentially responsible-party sites. The EPA estimated remediation costs for the Lower Passaic River at $1.38 billion, but the company’s allocation was not determined.
- Litigation and government investigations remain possible; the accrual for probable unfavorable litigation outcomes was not material at year-end, and management did not expect known matters to have a material adverse effect.
Investor Verification Checklist
- Verify that fiscal 2019 historical results are Harris-only and are not directly comparable to post-merger L3Harris results without pro forma information.
- Review the completed merger purchase-price allocation, acquired debt, goodwill, intangible assets, pension obligations, and integration costs in subsequent filings.
- Track the Night Vision divestiture closing, final proceeds, purchase-price adjustments, and use of proceeds.
- Assess post-merger leverage, debt maturities, interest expense, credit ratings, and compliance with debt covenants.
- Evaluate whether backlog converts to revenue and cash as expected, recognizing that backlog is subject to funding changes, delays, cancellations, and estimation uncertainty.
- Monitor U.S. defense appropriations, contract awards, bid protests, government audits, cybersecurity matters, and fixed-price program performance.
- Reassess pension funding requirements after combining Harris and L3 plans and after updated discount rates and asset returns.
- Consider the effect of the new segment structure, fiscal-year change, ASC 606 accounting, and merger-related nonrecurring costs on future period comparisons.