Business Context and Reporting Period
This filing is Harris Corporation’s unaudited Form 10-Q for the quarter and first two quarters ended January 2, 2015, corresponding to fiscal 2015 second quarter. The filing identifies the registrant as Harris Corporation, not L3Harris Technologies, Inc.; L3Harris was formed later through the acquisition of Harris by L3 Technologies.
Harris reported three segments: RF Communications, Government Communications Systems, and Integrated Network Solutions. The filing was reviewed, not audited, by Ernst & Young LLP.
Key Financial Metrics
| Metric | Quarter ended January 2, 2015 | Comparable quarter | First two quarters ended January 2, 2015 | Comparable period |
|---|---|---|---|---|
| Revenue | $1,206.3 million | $1,223.2 million | $2,361.7 million | $2,415.1 million |
| Gross margin | $398.5 million; 33.0% | $427.8 million; 35.0% | $791.3 million; 33.5% | $845.2 million; 35.0% |
| Income from continuing operations | $139.5 million | $137.1 million | $264.6 million | $264.5 million |
| Net income attributable to Harris | $139.5 million | $136.2 million | $264.6 million | $262.0 million |
| Diluted EPS from continuing operations | $1.32 | $1.27 | $2.50 | $2.45 |
| Operating cash flow | Not separately provided | Not separately provided | $222.2 million | $279.5 million |
- Quarterly income from continuing operations as a percentage of revenue was 11.6%, compared with 11.2% in the prior-year quarter. The first-two-quarter ratio was 11.2%, compared with 11.0%.
- Cash and cash equivalents were $469.5 million at January 2, 2015, down from $561.0 million at June 27, 2014.
- Total debt was approximately $1.65 billion, consisting primarily of $1.576 billion of long-term debt, $73.9 million of short-term debt, and $1.4 million of current long-term debt. Long-term debt had no maturity until December 2017.
- The company had a $1.0 billion senior unsecured revolving credit facility, with the full amount available at quarter-end, and was in compliance with its debt covenants.
- Capital expenditures were $79.1 million for the first two quarters. The company expected fiscal 2015 capital expenditures of approximately $200 million.
- The company paid $99.5 million in dividends and repurchased $163.8 million of common stock during the first two quarters. The quarterly dividend increased to $0.47 per share, or an annualized $1.88.
Material Changes Versus the Prior Comparable Period
- Quarterly revenue declined 1.4%; first-two-quarter revenue declined 2.2%. The declines reflected lower revenue in RF Communications and Integrated Network Solutions, partly offset by growth in Government Communications Systems.
- Gross margin percentage declined 200 basis points for the quarter and 150 basis points for the first two quarters, primarily because of lower contributions from higher-margin RF Communications and weaker margins in RF Communications and Integrated Network Solutions.
- Engineering, selling and administrative expense declined 8.4% in the quarter and 7.2% for the first two quarters, reflecting lower costs, operational-excellence actions, cost reductions, collection of the CIS note, and a prior-year legal accrual.
- RF Communications revenue declined 4.9% and operating income declined 12.2% in the quarter. Public Safety and Professional Communications remained weak, and program execution issues reduced margins.
- Government Communications Systems revenue increased 4.9% and operating income increased 16.7% in the quarter, supported by the F-35 program, classified customers, wireless products, strong program performance, and favorable mix.
- Integrated Network Solutions revenue declined 7.2% and operating income declined 12.8% in the quarter, primarily because of lower U.S. Government revenue, including NMCI and Air Force Network Centric Solutions programs.
- Net cash from operations declined 20.5% for the first two quarters, mainly because of larger reductions in accounts payable and accrued expenses and increases in receivables and inventory.
- Shares outstanding declined as a result of repurchases, supporting the 3.9% quarterly increase in diluted EPS despite lower revenue and lower pre-tax income.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management stated that existing cash, operating cash flow, the revolving credit facility, and access to capital markets were expected to fund working capital, capital expenditures, dividends, repurchases, and potential acquisitions for at least the next 12 months.
- The company did not provide clear consolidated revenue or earnings guidance in the filing.
- Favorable estimate-at-completion adjustments increased operating income by $16.3 million in the quarter and $38.4 million for the first two quarters, compared with $8.2 million and $20.5 million, respectively, in the prior-year periods. These adjustments depend on estimates for long-term development and production contracts.
- The effective tax rate was reduced by discrete benefits, including approximately $6.6 million from reinstated U.S. R&D tax credits and approximately $7.6 million from resolution of Canadian and U.S. tax matters. Aggregate discrete tax benefits were approximately $23 million for the first two quarters.
- Harris disclosed a subsequent-event agreement to acquire Exelis Inc. for approximately $4.75 billion of enterprise value through a combination of $16.625 in cash and 0.1025 Harris share per Exelis share. The transaction was expected to close in June 2015, subject to regulatory and shareholder approvals.
- The acquisition was supported by $3.4 billion of committed bridge financing. Management expected permanent term-loan and unsecured-bond financing, and warned that the resulting debt could lead to credit-rating downgrades, higher interest costs, reduced financial flexibility, and possible loss of access to commercial paper if ratings fell below investment grade.
- Harris was in arbitration with the buyer of Broadcast Communications over a post-closing working-capital adjustment. The potential outcome ranged from no additional adjustment to an $81 million downward adjustment to the purchase price; management said the buyer’s claim was without merit.
- Key risks included U.S. Government funding and contract termination, sequestration and budget uncertainty, fixed-price contract cost overruns, cybersecurity incidents, foreign-exchange exposure, international operations, litigation and arbitration, tax audits, supply-chain execution, intellectual-property claims, impairment of goodwill and other assets, and retention of key personnel.
- Management concluded that disclosure controls and procedures were effective at quarter-end. An ERP upgrade in RF Communications was not undertaken in response to a control deficiency.
Most Important Facts for Investors to Verify
- Confirm the company and period mapping: this is a Harris Corporation fiscal 2015 second-quarter filing, not a filing by the later L3Harris entity and not a calendar 2014 second quarter.
- Assess whether recurring operating performance is being obscured by favorable contract estimate adjustments and approximately $23 million of discrete tax benefits.
- Monitor RF Communications and Integrated Network Solutions for continued revenue and margin pressure, including public-safety weakness and the NMCI wind-down.
- Evaluate the Exelis transaction’s financing, expected leverage, potential credit-rating effects, integration costs, and accretion or dilution risk.
- Track operating cash conversion, inventory and receivables growth, and the sustainability of dividends and share repurchases.
- Monitor the Broadcast Communications arbitration, with potential exposure of up to $81 million, and other tax, litigation, contract-performance, and fixed-price program contingencies.