L3Harris Technologies, Inc. Form 10-Q Summary
Filing and period: Quarterly report filed August 4, 2020, for the quarter and two quarters ended July 3, 2020. The request metadata identifies “2019 Q2,” but the supplied filing is clearly the 2020 second-quarter Form 10-Q. The statements are unaudited and include the combined L3Harris business following the June 29, 2019 merger with L3 Technologies; the prior-year reported period primarily reflects Harris operations only.
Business Context
L3Harris operates through four reportable segments: Integrated Mission Systems, Space and Airborne Systems, Communication Systems, and Aviation Systems. A substantial portion of revenue is derived from U.S. Government customers and contracts, including fixed-price, cost-reimbursable and time-and-materials arrangements. Ending backlog was $19.8 billion at July 3, 2020, compared with $20.6 billion at January 3, 2020; approximately two-thirds was expected to convert to revenue within twelve months.
Financial Results and Key Metrics
| Metric | Quarter ended July 3, 2020 | Two quarters ended July 3, 2020 |
|---|---|---|
| Revenue | $4.445 billion | $9.071 billion |
| Gross margin | $1.270 billion; 29% of revenue | $2.598 billion; 29% of revenue |
| Income from continuing operations | $278 million | $473 million |
| Net income attributable to L3Harris | $283 million | $500 million |
| Diluted continuing-operations EPS | $1.30 | $2.29 |
| Operating cash flow | Not separately provided for the quarter | $1.335 billion |
| Capital expenditures | Not separately provided for the quarter | $108 million |
| Cash and cash equivalents | $1.947 billion at period-end | $824 million at January 3, 2020 |
| Total debt, net | $6.939 billion | $6.951 billion at January 3, 2020 |
Net income for the two-quarter period was $472 million, including $28 million attributable to noncontrolling interests. The effective tax rate was 17.3% for the quarter and 15.1% for the two-quarter period. Non-operating income was $105 million for the quarter and $200 million year to date, primarily reflecting pension-related income. Net interest expense was $65 million for the quarter and $128 million year to date.
Segment Performance
| Segment | Quarter revenue | Quarter operating income | Year-to-date revenue | Year-to-date operating income/(loss) |
|---|---|---|---|---|
| Integrated Mission Systems | $1.331 billion | $224 million | $2.701 billion | $425 million |
| Space and Airborne Systems | $1.249 billion | $235 million | $2.441 billion | $456 million |
| Communication Systems | $1.112 billion | $265 million | $2.206 billion | $515 million |
| Aviation Systems | $800 million | $31 million | $1.811 billion | $(146) million |
Material Changes Versus Prior Comparable Period
- As reported, quarterly revenue increased 138% and year-to-date revenue increased 152%, primarily because the 2020 periods include L3 operations. Reported comparisons are therefore not meaningful without pro forma information.
- On a pro forma basis, quarterly revenue was approximately flat at $4.445 billion versus $4.448 billion, while year-to-date revenue increased 3% versus $8.834 billion.
- On a pro forma basis, quarterly income from continuing operations declined 33% to $278 million from $417 million, and year-to-date income declined 42% to $473 million from $817 million.
- Pro forma Aviation Systems revenue declined 17% for the quarter and 4% year to date, primarily from the COVID-19-related downturn in commercial aviation and the airport security and automation divestiture.
- Space and Airborne Systems and Communication Systems delivered pro forma quarterly revenue growth of 4% and 2%, respectively; Integrated Mission Systems revenue increased 7%.
- Gross margin percentage declined to 29% from 34% on an as-reported basis and to 29% from 31% on a pro forma basis, reflecting revenue mix, acquisition-related amortization, inventory fair-value step-up costs and divestiture effects.
- Diluted EPS declined primarily because of lower earnings and the approximately 104 million shares issued in the L3 merger. The company repurchased 3.3 million shares for $700 million during the first two quarters.
Cash, Debt, Liquidity and Capital Allocation
- Operating cash flow was $1.335 billion, compared with $716 million in the prior-year two-quarter period.
- Investing activities provided $845 million, including $963 million of net proceeds from business sales, partially offset by $108 million of capital expenditures.
- Financing activities used $1.042 billion, including $700 million of share repurchases, $367 million of dividends and $254 million of debt repayments.
- The company had $1.947 billion of cash and a fully available $2 billion senior unsecured revolving credit facility expiring in June 2024. It reported no borrowings under that facility and compliance with its debt covenants.
- Fiscal 2020 capital expenditures were expected to be approximately $370 million. No further required contributions to U.S. qualified defined-benefit pension plans were expected during fiscal 2020, although net unfunded defined-benefit obligations were $1.7 billion.
- The quarterly dividend was increased to $0.85 per share, or $3.40 annualized. Future dividends and repurchases remain subject to business conditions, cash flow and board discretion.
Guidance, Outlook, Risks and Unusual Items
- Management expected Commercial Aviation Solutions revenue to decline approximately $300 million in calendar 2020 versus 2019 and expected Public Safety revenue to decline approximately $75 million, both because of COVID-19 impacts. The filing states that the ultimate effects remain uncertain and unpredictable.
- COVID-19 caused lower global air traffic, reduced demand for flight training, simulators and commercial avionics, facility closures, workforce reductions and supply-chain and operating risks. The Defense Industrial Base and U.S. Government actions supported continued operations and accelerated more than $235 million of payments to small-business suppliers.
- The company recorded $394 million of goodwill and other asset impairment and other COVID-19-related charges in the first two quarters, including a $296 million Commercial Aviation Solutions goodwill impairment in the first quarter, a $54 million additional impairment in the second quarter, and $14 million related to a potential Aviation Systems divestiture.
- Commercial Aviation Solutions and other COVID-19-related restructuring charges totaled $14 million year to date; merger-related restructuring charges were $7 million in the quarter and year to date.
- Net favorable estimate-at-completion adjustments contributed $98 million to quarterly operating income and $201 million year to date. These adjustments reflected program performance, incentive payments and synergy savings and were spread across numerous contracts.
- The airport security and automation business was sold for $951 million of net cash proceeds and a $26 million pretax loss. Applied Kilovolts and Analytical Instrumentation was sold for $12 million. EOTech was classified as held for sale at quarter-end and sold on July 31, 2020 for approximately $42 million before final adjustments. Another Aviation Systems disposal group was expected to be sold by year-end 2020.
- Two treasury locks had a combined notional amount of $650 million and a $130 million liability at quarter-end, with a $71 million after-tax unrealized loss in accumulated other comprehensive loss.
- Goodwill totaled $19.0 billion at quarter-end. Six other reporting units with approximately $10 billion of goodwill in aggregate had estimated fair values less than 10% above carrying values, creating sensitivity to further deterioration, higher discount rates or weaker commercial aviation recovery.
- Accrued probable litigation liabilities were not material. Management stated that existing litigation and environmental matters were not expected to have a material adverse effect, while acknowledging that unfavorable outcomes exceeding recorded accruals remain possible.
Important Facts for Investors to Verify
- Confirm the correct reporting period: the supplied filing is for the quarter ended July 3, 2020, not 2019 Q2.
- Reconcile reported results with pro forma results because the L3 merger makes year-over-year comparisons materially non-comparable.
- Assess the sustainability of earnings excluding $394 million of year-to-date impairment and other COVID-19-related charges, acquisition-related amortization, divestiture costs and favorable EAC adjustments.
- Monitor commercial aviation recovery, the projected $300 million revenue decline, additional goodwill impairment exposure and the performance of Aviation Systems.
- Review debt maturities, refinancing plans for the $650 million of 4.95% notes due February 2021, treasury-lock exposure and total leverage.
- Verify the timing and final proceeds from the EOTech and other Aviation Systems divestitures and the use of divestiture proceeds.
- Evaluate whether operating cash flow, dividends, share repurchases, capital expenditures and pension obligations remain compatible with the company’s debt-service requirements.