Filing Overview
Company: Harris Corporation, the predecessor company to L3Harris Technologies. The supplied filing is a Form 10-K for the fiscal year ended June 30, 2017, filed August 29, 2017; it is not a 2016 Q4 filing. Results are generally presented for continuing operations, with historical periods restated for discontinued operations.
Business Context and Reporting Period
Harris provided mission-critical communications, electronic systems, space, intelligence, avionics, electronic warfare, public safety, air traffic management and related technology solutions to government and commercial customers in more than 100 countries. The company had approximately 17,000 employees, including approximately 7,700 engineers and scientists.
- Communication Systems: tactical communications, night vision and public safety networks.
- Electronic Systems: electronic warfare, avionics, C4ISR and air traffic management.
- Space and Intelligence Systems: intelligence, space, geospatial, environmental and positioning, navigation and timing solutions.
The former Critical Networks segment was eliminated in fiscal 2017. Remaining operations were integrated into Electronic Systems, while IT Services and Harris CapRock Communications were reported as discontinued operations.
Financial Performance
| Metric | Fiscal 2017 | Fiscal 2016 | Change |
|---|---|---|---|
| Revenue | $5.900 billion | $5.992 billion | Down 2% |
| Gross profit | $2.089 billion | $2.092 billion | Flat |
| Gross margin | 35% | 35% | Flat |
| Income from continuing operations | $638 million | $611 million | Up 4% |
| Diluted continuing-operations EPS | $5.12 | $4.87 | Up 5% |
| Net income | $553 million | $324 million | Up $229 million |
| Net cash from operating activities | $569 million | $924 million | Down $355 million |
- Income from continuing operations represented approximately 11% of revenue, compared with 10% in fiscal 2016.
- The effective tax rate was 29.5%, compared with 30.9% in fiscal 2016. Fiscal 2017 included a $23 million tax benefit from adoption of share-based compensation accounting guidance.
- Company-sponsored research and development increased to $310 million from $305 million.
- Cash and cash equivalents were $484 million at June 30, 2017, compared with $487 million at July 1, 2016.
- Total debt was approximately $3.945 billion in principal amount, including $3.396 billion of long-term debt, net of issuance costs and other adjustments.
- The consolidated total indebtedness-to-total-capital ratio was 58%, below the 65% covenant limit.
- Net unfunded defined benefit plan obligations declined to approximately $1.3 billion from $2.3 billion after a $400 million voluntary pension contribution.
Segment Results
| Segment | Fiscal 2017 Revenue | Fiscal 2017 Operating Income | Fiscal 2017 Margin | Revenue Change |
|---|---|---|---|---|
| Communication Systems | $1.753 billion | $524 million | 30% | Down 6% |
| Electronic Systems | $2.251 billion | $464 million | 21% | Up 1% |
| Space and Intelligence Systems | $1.902 billion | $311 million | 16% | Flat |
Company-wide funded backlog increased to approximately $4.2 billion from $4.0 billion. Management expected approximately 64% of fiscal 2017 year-end funded backlog to convert to revenue in fiscal 2018, although timing and fulfillment were not assured.
Material Changes Versus the Prior Comparable Period
- Revenue declined primarily because of lower tactical communications revenue, the loss of Aerostructures revenue following its divestiture, and certain environmental and commercial space programs moving from build-out to sustainment phases.
- Profitability improved despite lower revenue. Cost containment, Exelis integration synergies, higher pension income and lower restructuring costs supported operating income and margins.
- Communication Systems revenue fell, but operating income increased slightly to $524 million as expense reductions offset lower sales.
- Electronic Systems operating income rose 8% to $464 million, supported by electronic warfare and the ramp-up of the UAE BMS-ELTS program, partly offset by the ADS-B program transition to sustainment.
- Space and Intelligence Systems operating income increased 8% to $311 million, driven by improved program performance and higher classified-customer revenue.
- Operating cash flow fell because pension contributions increased materially, including the $400 million voluntary contribution.
- Harris used $710 million for share repurchases, paid $262 million in dividends and repaid $499 million of borrowings on a net basis.
Strategic Transactions and Unusual Items
- Harris completed the sale of IT Services on April 28, 2017 for net cash proceeds of $646 million. The business generated a $240 million noncash impairment charge in discontinued operations, including $228 million related to goodwill, but the transaction produced an after-tax gain of $55 million due to tax effects.
- Harris completed the sale of CapRock on January 1, 2017 for net cash proceeds of $370 million and recognized an after-tax gain of $61 million.
- Discontinued operations produced an $85 million net loss in fiscal 2017, compared with a $287 million net loss in fiscal 2016.
- Fiscal 2017 included $51 million of after-tax Exelis acquisition-related and other charges, or $0.41 per diluted share.
- Harris repurchased 6.34 million shares for $710 million and had approximately $973 million remaining under its fiscal 2017 repurchase authorization at year-end.
- The quarterly dividend was increased after year-end from $0.53 to $0.57 per share, or an annualized rate of $2.28.
Guidance, Outlook and Management Commentary
Management expected fiscal 2018 revenue growth across all three continuing-operations segments, continued margin discipline and improved operating cash flow. Management cited improving U.S. Government funding visibility, including support for major Department of Defense and civil-agency programs.
- Communication Systems was expected to benefit from tactical-radio modernization, particularly in the second half of fiscal 2018, and from stabilization in international tactical markets.
- Electronic Systems was expected to grow through electronic warfare opportunities on F-35, F-16, F-18, B-52 and C-130J platforms.
- Space and Intelligence Systems was expected to benefit from classified-program growth and increasing commercial-space activity.
- Fiscal 2018 capital expenditures were expected to be approximately $130 million.
- Management did not anticipate contributions to U.S. qualified pension plans in fiscal 2018 following the fiscal 2017 voluntary contribution, although future statutory requirements could change.
- Management stated that existing cash, operating cash flow, the revolving credit facility and capital-market access were expected to support working capital, capital expenditures, dividends, share repurchases and debt maturities for the foreseeable future.
Key Risks and Contingencies
- Approximately 74% of fiscal 2017 revenue was tied to U.S. Government customers, exposing the company to appropriations, sequestration, continuing resolutions, program cancellations, audits and policy changes.
- Fixed-price contracts create exposure to cost overruns, schedule delays, inflation, supplier problems and technical-performance risk.
- Cyberattacks or security breaches could disrupt Harris or customer systems and expose classified, proprietary or personal information.
- Debt service and refinancing requirements remained significant, including approximately $556 million of long-term debt maturities in fiscal 2018 and $1.883 billion of projected interest payments over the contractual schedule.
- Pension results and future funding requirements remained sensitive to asset returns, discount rates, interest rates and mortality assumptions.
- Goodwill was $5.366 billion, and one Electronic Systems reporting unit with approximately $1.45 billion of goodwill had estimated fair value less than 10% above carrying value.
- Environmental liabilities were estimated at approximately $106 million across 60 potentially responsible sites, primarily related to Exelis operations. Management considered probable litigation accruals immaterial and did not expect existing matters to have a material adverse effect.
- Tax audits and unrecognized tax benefits could change future tax expense. Unrecognized tax benefits were $90 million at June 30, 2017.
- International operations faced currency, export-control, geopolitical, foreign-government funding, corruption and payment risks.
Most Important Facts for Investors to Verify
- Confirm the requested period: the supplied document is Harris Corporation’s fiscal 2017 10-K, not a 2016 Q4 filing and not a filing under the L3Harris name.
- Reconcile continuing-operations results with the restated discontinued-operations presentation for IT Services and CapRock.
- Review debt maturities, refinancing plans and covenant headroom, particularly the fiscal 2018 maturities and the 65% indebtedness-to-capital covenant.
- Assess whether expected fiscal 2018 growth and backlog conversion are supported by actual U.S. Government appropriations and contract awards.
- Evaluate the sustainability of cash returns after $710 million of share repurchases, $262 million of dividends and substantial pension funding.
- Monitor the financially sensitive Electronic Systems goodwill reporting unit and the company’s substantial aggregate goodwill balance.
- Review pension assumptions and future required contributions, as the reported reduction in the unfunded liability was heavily influenced by a voluntary contribution and market performance.