Business Context and Reporting Period
This is Harris Corporation’s unaudited Form 10-Q for the quarter ended October 2, 2015, the first quarter of fiscal 2016; the comparable period ended September 26, 2014. The filing predates the company’s later name, L3Harris Technologies. Results include Exelis operations following the May 29, 2015 acquisition, materially affecting year-over-year comparability.
The company reported four segments: Communication Systems, Space and Intelligence Systems, Electronic Systems, and Critical Networks. It adopted a revised segment structure in fiscal 2016 without changing consolidated historical results.
Financial Performance and Liquidity
| Metric | Q1 FY2016 | Q1 FY2015 | Change |
|---|---|---|---|
| Revenue | $1,811 million | $1,155 million | Up 56.8% |
| Gross margin | $591 million; 32.6% | $393 million; 34.0% | Margin down 140 basis points |
| Engineering, selling and administrative expense | $329 million; 18.2% of revenue | $195 million; 16.9% | Expense ratio increased |
| Income before taxes | $216 million | $176 million | Up 22.7% |
| Net income | $148 million; 8.2% margin | $125 million; 10.8% margin | Up 18.4%; margin declined |
| Diluted EPS | $1.18 | $1.18 | Unchanged |
| Operating cash flow | $64 million | $80 million | Down 20.0% |
- Segment revenue and operating income were: Communication Systems $454 million and $138 million; Space and Intelligence Systems $435 million and $68 million; Electronic Systems $374 million and $69 million; and Critical Networks $566 million and $63 million.
- Cash and cash equivalents were $320 million at October 2, 2015, down from $481 million at fiscal year-end. A $1 billion revolving credit facility was fully available, with no borrowings outstanding.
- Total debt was approximately $5.08 billion, consisting of $50 million of short-term debt, $130 million of current long-term debt, and $4.901 billion of long-term debt. Debt increased primarily because of financing for the Exelis acquisition.
- Net cash used in financing was $192 million, including $173 million of debt repayments and $64 million of dividends. No share repurchases were made under the repurchase program.
- Net cash used in investing was $24 million, including $26 million of capital expenditures. Fiscal 2016 capital expenditures were expected to be approximately $200 million.
- The company contributed $61 million to qualified pension plans and expected to contribute approximately $112 million more during the remainder of fiscal 2016. Net unfunded pension obligations were approximately $1.9 billion.
- The quarterly dividend increased from $0.47 to $0.50 per share, or an annualized rate of $2.00 per share.
Material Changes Versus the Prior Comparable Period
- The Exelis acquisition drove most of the revenue increase and contributed to higher gross profit and segment operating income. Electronic Systems revenue increased 243.1%, Space and Intelligence Systems increased 71.9%, Critical Networks increased 39.1%, and Communication Systems increased 16.7%.
- Gross margin percentage declined because of a greater mix of lower-margin cost-plus contracts, partially offset by slightly higher margins on Exelis programs.
- ESA expense included $23 million of Exelis integration and other costs, while $33 million of amortization of acquired Exelis intangible assets was recorded in unallocated corporate expense. Unallocated corporate expense increased to $75 million from $17 million.
- Net interest expense increased to $47 million from $22 million because of acquisition-related debt, including $2.4 billion of new debt securities and a $1.3 billion term loan agreement.
- Diluted EPS was unchanged despite higher net income because approximately 19 million shares were issued in connection with the Exelis acquisition.
- Operating cash flow declined because of increased inventory, pension contributions, and lower accounts payable and accrued expenses.
- Net estimate-at-completion adjustments favorably affected operating income by $17 million, compared with $22 million in the prior-year quarter.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management expected existing cash, operating cash flow, the credit facility, and access to capital markets to fund working capital, capital expenditures, dividends, term-loan repayments, and pension contributions for the next 12 months and the reasonably foreseeable future. The company cautioned that high indebtedness, pension obligations, government budget uncertainty, and capital-market disruptions could impair liquidity.
- The filing does not provide clear full-year revenue or earnings guidance. It provides an expected fiscal 2016 capital-expenditure level of approximately $200 million and anticipated pension contributions of approximately $112 million for the remainder of the year.
- Revenue and profit recognition depends substantially on percentage-of-completion estimates for long-term development and production contracts. Changes in costs, schedules, funding, contract value, incentives, or claims may cause significant cumulative catch-up adjustments.
- Principal risks include dependence on U.S. government funding and contracts, contract termination or audit exposure, fixed-price contract cost overruns, defense-budget and sequestration uncertainty, international and foreign-exchange exposure, cybersecurity incidents, acquisition integration, debt service, pension funding, tax matters, environmental liabilities, intellectual-property claims, and litigation.
- A Broadcast Communications sale arbitration could result in an additional purchase-price reduction ranging from zero to $67 million; the company could not determine the likely outcome and expected resolution in fiscal 2016.
- Environmental matters include potential responsibility associated with the Passaic River remediation, for which estimated alternatives ranged from $0.4 billion to $3.2 billion. Management believed the company’s ultimate cost would not be material.
- The accounting for the Exelis acquisition remained preliminary. Purchase-price adjustments during the quarter included a $31 million reduction in current liabilities related to unrecognized tax benefits. No goodwill impairment was identified.
- The company stated that no material changes had occurred in previously disclosed risk factors and that probable litigation and environmental liabilities were either accrued, insured, or not expected to materially affect results.
Most Important Facts for Investors to Verify
- Confirm the extent to which reported growth reflects the Exelis acquisition versus organic growth, including segment-level bookings, backlog, and margins.
- Review debt maturities, variable-rate term loans, covenant headroom, refinancing needs, and the effect of acquisition financing on interest expense.
- Assess cash conversion, inventory growth, pension contributions, and the sustainability of dividends and any future share repurchases.
- Evaluate the sensitivity of earnings to contract estimate-at-completion adjustments, fixed-price program performance, and the mix of cost-plus versus fixed-price work.
- Monitor Exelis integration costs, acquired intangible amortization, preliminary purchase-price allocations, and potential goodwill impairment.
- Track the Broadcast Communications arbitration, Passaic River and other environmental matters, tax audits, and Vectrus-related indemnification exposures.