Business Context and Reporting Period
Harris Corporation’s unaudited Form 10-Q covers the quarter and first two quarters of fiscal 2017 ended December 30, 2016, with comparisons to January 1, 2016. The filing predates the company’s later L3Harris name. Continuing operations comprised Communication Systems, Space and Intelligence Systems, Electronic Systems, and Critical Networks. CapRock was classified as discontinued operations and was sold on January 1, 2017.
Key Financial Metrics
| Metric | Quarter ended Dec. 30, 2016 | Prior comparable quarter | Change |
|---|---|---|---|
| Revenue | $1.700 billion | $1.748 billion | Down 3% |
| Gross margin | $562 million; 33% of revenue | $545 million; 31% | Margin up 2 points |
| Income from continuing operations | $168 million | $197 million | Down 15% |
| Diluted continuing-operations EPS | $1.33 | $1.58 | Down 16% |
| Net income | $177 million | Net loss of $152 million | Prior period included a large discontinued-operations loss |
| Effective tax rate | 31% | 30% | Up 1 point |
For the first two quarters, revenue was $3.378 billion, down 2%; income from continuing operations was $324 million, down 6%; diluted continuing-operations EPS was $2.57, down 7%; and gross margin was $1.120 billion, or 33% of revenue, versus 32% in the prior period.
Segment results for the quarter were: Communication Systems revenue of $413 million and operating income of $121 million; Space and Intelligence Systems revenue of $468 million and operating income of $77 million; Electronic Systems revenue of $384 million and operating income of $79 million; and Critical Networks revenue of $454 million and operating income of $75 million.
Cash Flow, Liquidity, Debt and Capital Allocation
- Operating cash flow for the first two quarters was $295 million, down from $387 million, primarily because of lower receivables collections.
- Investing cash use was $74 million, including $49 million of capital expenditures. Fiscal 2017 capital expenditures were expected to be approximately $150 million.
- Financing cash use was $341 million, including $134 million of dividends, $100 million of share repurchases, and $115 million of net debt repayments.
- Cash and cash equivalents declined to $361 million from $487 million at July 1, 2016.
- Long-term debt, including the current portion, was approximately $4.217 billion; short-term debt was $183 million. The company had $175 million outstanding under its commercial paper program and $825 million available under its $1 billion revolving credit facility.
- The company paid quarterly dividends of $0.53 per share, increased from $0.50, and repurchased 1.1 million shares for $100 million during the first two quarters.
- Defined benefit plan obligations were a significant funding requirement. The company contributed $103 million during the first two quarters and expected to contribute approximately $485 million during the remainder of fiscal 2017, including approximately $400 million of voluntary contributions.
Material Changes Versus the Prior Comparable Period
- Communication Systems revenue declined 16% in the quarter, primarily because of lower international tactical sales, while operating income remained $121 million due to favorable mix, cost containment and restructuring savings.
- Space and Intelligence Systems revenue increased 5% and operating income increased 13%, driven principally by higher intelligence-community revenue.
- Electronic Systems revenue increased 1% and operating income increased 25%, reflecting strong electronic-warfare and avionics program performance and lower expenses. Prior-period revenue included $18 million from the divested Aerostructures business.
- Critical Networks revenue increased 2% and operating income increased 19%, partly because of a $22 million contract settlement. First-half revenue was lower because of reduced IT-services revenue.
- Corporate results were adversely affected by the absence of a $101 million post-employment-benefit liability reduction recognized in the prior-year quarter. This more than offset lower Exelis integration costs.
- Prior-year discontinued operations included a $367 million noncash CapRock impairment charge and a $21 million loss on the sale of Broadcast Communications. Current-quarter discontinued operations generated $9 million after tax.
- Net estimate-at-completion adjustments favorably affected operating income by $8 million in the quarter and $21 million in the first half, versus $24 million and $41 million, respectively, in the prior comparable periods.
Guidance, Outlook, Commentary and Risks
- Management stated that existing cash, operating cash flow, the credit facility and access to debt and equity markets were expected to support working capital, capital expenditures, dividends, repurchases, debt repayment and pension contributions for the next 12 months and the reasonably foreseeable future.
- CapRock was sold for $425 million in cash, subject to customary adjustments. The company subsequently used $248 million of proceeds to repay term-loan principal.
- On January 26, 2017, Harris agreed to sell its government IT Services business for $690 million in cash, subject to conditions. The company expected closing before the end of fiscal 2017, but disclosed no assurance that the transaction would close. It expected an approximately $130 million after-tax loss on the sale and planned to classify the business as discontinued operations beginning in the third quarter.
- Following the IT Services transaction, Critical Networks was to be eliminated as a reporting segment, with remaining operations moved to Electronic Systems.
- The board approved an additional $1 billion share-repurchase authorization. Management also expected to use divestiture proceeds for repurchases and approximately $400 million of voluntary pension contributions.
- Key risks include dependence on U.S. Government funding and contracts, defense-budget uncertainty, fixed-price contract cost overruns, program-estimate changes, cybersecurity incidents, international and foreign-exchange exposure, pension funding and interest-rate risk, substantial indebtedness, goodwill impairment, environmental matters, litigation, export controls and execution of planned divestitures.
- Management reported no material changes to previously disclosed risk factors. Accrued probable litigation losses were not material, and management believed existing environmental matters would not materially affect results, although outcomes remain uncertain.
Investor Verification Points
- Verify the filing period: this is Harris Corporation’s fiscal second quarter of 2017, ended December 30, 2016, rather than a filing labeled “2016 Q2.”
- Reconcile continuing-operations results with total net income, particularly the prior-period CapRock impairment and other discontinued-operations items.
- Track completion, proceeds, purchase-price adjustments and the approximately $130 million expected loss related to the IT Services divestiture.
- Monitor debt reduction, commercial-paper usage, interest expense and the planned pension contributions, including the company’s $2.1 billion net unfunded defined benefit obligation.
- Assess whether Communication Systems’ international tactical-sales weakness persists and whether contract settlements and favorable estimate adjustments are recurring.
- Review the effect of the new $1 billion repurchase authorization on liquidity, leverage and pension funding.