Business Context and Reporting Period
Harris Corporation filed this unaudited Form 10-Q for the quarter ended September 30, 2016, the first quarter of fiscal 2017. The company operated through Communication Systems, Space and Intelligence Systems, Electronic Systems, and Critical Networks. The filing text identifies the registrant as Harris Corporation, not L3Harris Technologies, Inc.
Financial Performance and Position
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Revenue | $1.754 billion | $1.811 billion | Down 3% |
| Gross profit | $579 million | $591 million | Down 2% |
| Gross margin | 33% | 33% | Comparable |
| Income before taxes | $225 million | $216 million | Up 4% |
| Net income | $160 million | $148 million | Up 8% |
| Diluted EPS | $1.27 | $1.18 | Up 8% |
| Effective tax rate | 28.9% | 31.5% | Improved |
| Operating cash flow | $43 million | $64 million | Down 33% |
Net income represented approximately 9% of revenue, compared with approximately 8% in the prior comparable quarter. The effective tax rate benefited from adoption of new share-based compensation accounting guidance, which provided a $10 million, or $0.08 per diluted share, tax benefit.
At September 30, 2016, cash and cash equivalents were $284 million, down from $487 million at July 1, 2016. Long-term debt, including the current portion, totaled $4.467 billion at carrying value, with estimated fair value of $4.829 billion. The company had $19 million of short-term debt and no borrowings under its $1 billion revolving credit facility, which was fully available. The company reported compliance with its debt covenants.
Cash used in investing activities was $46 million, including $21 million of capital expenditures and a $25 million adjustment to proceeds from the sale of a business. Cash used in financing activities was $201 million, including $100 million of share repurchases, $68 million of dividends, and $30 million of net debt repayments. The company paid a quarterly dividend of $0.53 per share, increased from $0.50.
Material Changes Versus the Prior Comparable Period
- Communication Systems revenue declined 5% to $431 million and operating income declined 14% to $119 million, primarily due to lower international SINCGARS radio sales and unfavorable product and program mix.
- Space and Intelligence Systems revenue increased 4% to $453 million and operating income increased 18% to $80 million, driven by intelligence community work and NASA’s Radiation Budget Instrument program.
- Electronic Systems revenue declined 3% to $361 million, partly because the divested Aerostructures business contributed $19 million in the prior-year quarter; operating income nevertheless increased 7% to $74 million.
- Critical Networks revenue declined 7% to $527 million because of lower CapRock energy-related revenue and IT services revenue; operating income increased 5% to $66 million due to restructuring, cost containment, and integration savings.
- Engineering, selling and administrative expense declined 5% to $311 million, primarily from Exelis integration synergies and restructuring-related savings.
- Net interest expense declined 9% to $43 million, reflecting lower average debt after $533 million of term-loan repayments from the second quarter of fiscal 2016 through the current quarter.
- Operating cash flow declined because of lower receivable collections and lower advance payments and unearned income.
Guidance, Outlook, Commentary, Risks and Unusual Items
- Management expected fiscal 2017 capital expenditures of approximately $175 million and additional qualified pension contributions of approximately $125 million during the remainder of the fiscal year.
- Management stated that existing cash, operating cash flow, the available revolving facility, and access to capital markets were expected to support working capital, capital expenditures, dividends, repurchases, debt repayments, and pension contributions for the next 12 months and the reasonably foreseeable future.
- The company had net unfunded defined benefit plan obligations of approximately $2.2 billion and contributed $64 million to qualified pension plans during the quarter.
- Favorable estimate-at-completion adjustments contributed $13 million to operating income, compared with $17 million in the prior-year quarter. These adjustments reflect judgment in estimating costs, contract value, incentives, and completion of long-term contracts.
- The company adopted new share-based compensation accounting guidance prospectively, increasing income tax benefit by $10 million and operating cash flow by $10 million for the quarter.
- Following quarter-end, the company repaid $250 million of 4.25% notes due October 1, 2016 using cash and commercial paper borrowings.
- On November 1, 2016, the company agreed to sell its non-strategic CapRock commercial business to SpeedCast for $425 million in cash, subject to customary adjustments and closing conditions. Proceeds were expected to be used for debt reduction and shareholder returns; closing was expected in the third quarter of fiscal 2017.
- Key risks included dependence on U.S. Government funding and contracts, contract termination or audit exposure, fixed-price contract cost overruns, cybersecurity incidents, international and foreign-exchange exposure, pension and interest-rate volatility, high indebtedness, environmental liabilities, goodwill impairment, and weakness in energy-related markets.
- The company stated that probable litigation and environmental obligations were either reserved, insured, or not expected to materially affect financial condition, results of operations, or cash flows. The SEC and DOJ had determined not to bring charges related to the historical Carefx China matter.
- Two reporting units had fiscal 2016 goodwill-test fair values only 10% to 15% above carrying values. Management reported no impairment indicators during the quarter but identified potential sensitivity to business deterioration, higher interest rates, and continued weakness in IT services.
Important Facts for Investors to Verify
- Confirm the issuer and period: the filing is for Harris Corporation’s first quarter of fiscal 2017, not a filing under the later L3Harris Technologies name.
- Reconcile the decline in revenue with the increase in net income and EPS, including the $10 million tax benefit, lower interest expense, pension income, restructuring savings, and contract estimate adjustments.
- Assess liquidity after the $250 million post-quarter-end note repayment, considering $284 million of cash, $4.467 billion of debt, commercial paper usage, and the $1 billion undrawn revolver.
- Monitor the company’s approximately $2.2 billion unfunded defined benefit obligation and expected additional $125 million fiscal 2017 pension contributions.
- Evaluate the sustainability of $100 million quarterly share repurchases and the $0.53 dividend alongside debt reduction and relatively low operating cash flow.
- Track the proposed $425 million CapRock sale, its regulatory and closing conditions, use of proceeds, and effects on revenue, goodwill, and debt.
- Review sensitivity of long-term contract estimates, goodwill valuations, U.S. Government funding, energy-market demand, and IT services performance.