NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note A — Significant Accounting Policies and Recent Accounting Standards
Basis of Presentation
The accompanying Condensed Consolidated Financial Statements (Unaudited) include the accounts of Harris Corporation and its consolidated subsidiaries. As used in these Notes to Condensed Consolidated Financial Statements (Unaudited) (these “Notes”), the terms “Harris,” “Company,” “we,” “our” and “us” refer to Harris Corporation and its consolidated subsidiaries. Intracompany transactions and accounts have been eliminated in consolidation. The accompanying Condensed Consolidated Financial Statements (Unaudited) have been prepared by Harris, without an audit, in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the rules and regulations of the Securities and Exchange Commission (“SEC”). Accordingly, such interim financial statements do not include all information and footnotes necessary for a complete presentation of financial condition, results of operations and cash flows in conformity with GAAP for annual financial statements. In the opinion of management, such interim financial statements reflect all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation of our financial condition, results of operations and cash flows for the periods presented therein. The results for the
quarter ended September 28, 2018
are not necessarily indicative of the results that may be expected for the full fiscal year or any subsequent period. The balance sheet at
June 29, 2018
has been derived from our audited financial statements and reflects the adoption of Accounting Standards Update (“ASU”) 2014-09,
Revenue from Contracts with Customers (Topic 606)
, as amended (“ASC 606”), as described below under “Adoption of New Accounting Standards.” The balance sheet at June 29, 2018 does not include all of the information and footnotes required by GAAP for annual financial statements. We provide complete, audited financial statements in our Annual Report on Form 10-K, which includes information and footnotes required by the rules and regulations of the SEC. The information included in this Quarterly Report on Form 10-Q (this “Report”) should be read in conjunction with the Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and accompanying Notes to Consolidated Financial Statements included in our Annual Report on Form 10-K for the fiscal year ended
June 29, 2018
(our “Fiscal
2018
Form 10-K”).
Amounts contained in this Report may not always add to totals due to rounding.
Reclassifications
The classification of certain prior-period amounts has been adjusted in our Condensed Consolidated Financial Statements (Unaudited) to conform with current-period classifications. Reclassifications include certain direct selling and bid and proposal costs from the “Cost of product sales and services” line item to the “Engineering, selling and administrative expenses” line item in our Condensed Consolidated Statement of Income (Unaudited) and in
these Notes.
Use of Estimates
The preparation of financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the amounts reported in the accompanying Condensed Consolidated Financial Statements (Unaudited) and these Notes and related disclosures. These estimates and assumptions are based on experience and other information available prior to issuance of the accompanying Condensed Consolidated Financial Statements (Unaudited) and these Notes. Materially different results can occur as circumstances change and additional information becomes known.
Significant Accounting Policies Update
Our significant accounting policies are provided in “Note 1: Significant Accounting Policies” of our Fiscal 2018 Form 10-K.
Effective June 30, 2018, we adopted ASC 606 using the full retrospective method. Refer to the
Adoption of New Accounting Standards
section below for additional information. The significant accounting policies disclosed below reflect the impact of our adoption of ASC 606.
Revenue Recognition
We account for a contract when it has approval and commitment from all parties, the rights and payment terms of the parties can be identified, the contract has commercial substance and the collectibility of the consideration, or transaction price, is probable. Our contracts are often subsequently modified to include changes in specifications, requirements or price that may create new or change existing enforceable rights and obligations. We do not account for contract modifications (including unexercised options) or follow-on contracts until they meet the requirements noted above to account for a contract.
At the inception of each contract, we evaluate the promised goods and services to determine whether the contract should be accounted for as having one or more performance obligations. A performance obligation is a promise to transfer a distinct good or service to a customer and represents the unit of accounting for revenue recognition. A substantial majority of our revenue is derived from long-term development and production contracts involving the design, development, manufacture or modification of aerospace and defense products and related services according to the customers’ specifications. Due to the highly interdependent and interrelated nature of the underlying goods and services and the significant service of integration that we provide, which often result in the delivery of multiple units, we account for these contracts as one performance obligation. For contracts that include both development/production and follow-on support services (for example, operations and maintenance), we generally consider the follow-on services distinct in the context of the contract and account for them as separate performance obligations. Additionally, a significant amount of our revenue is derived from contracts to provide multiple distinct goods to a customer where the goods can readily be sold to other customers based on their commercial nature and, accordingly, these goods are accounted for as separate performance obligations. These arrangements are most prevalent in our Communication Systems segment and primarily involve the sale of secure tactical radios and accessories and other standard products. Shipping and handling costs incurred after control of a product has transferred to the customer (for example, in free on board shipping arrangements) are treated as fulfillment costs and, therefore, are not accounted for as separate performance obligations.
As discussed above, our contracts are often subsequently modified to include changes in specifications, requirements or price. Depending on the nature of the modification, we consider whether to account for the modification as an adjustment to the existing contract or as a separate contract. Often, the deliverables in our contract modifications are not distinct from the existing contract due to the significant integration and interrelated tasks provided in the context of the contract. Therefore, such modifications are accounted for as if they were part of the existing contract, and we may be required to recognize a cumulative catch-up adjustment to revenue at the date of the contract modification.
We determine the transaction price for each contract based on our best estimate of the consideration we expect to receive, which includes assumptions regarding variable consideration, such as award and incentive fees. These variable amounts are generally awarded upon achievement of certain negotiated performance metrics, program milestones or cost targets and can be based upon customer discretion. We include such estimated amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. We estimate variable consideration primarily using the most likely amount method.
For contracts with multiple performance obligations, we allocate the transaction price to each performance obligation based on the relative standalone selling price of the good or service underlying each performance obligation. The standalone selling price represents the amount for which we would sell the good or service to a customer on a standalone basis (i.e., not sold as a bundle with any other products or services). Our contracts with the U.S. Government, including foreign military sales contracts, are subject to the Federal Acquisition Regulations (“FAR”) and the prices of our contract deliverables are typically based on our estimated or actual costs plus a reasonable profit margin. As a result, the standalone selling prices of the goods and services in these contracts are typically equal to the selling prices stated in the contract, thereby, eliminating the need to allocate (or reallocate) the transaction price to the multiple performance obligations. In our non-U.S. Government contracts, we also generally use the expected cost plus a margin approach to determine standalone selling price. In addition, we determine standalone selling price for certain contracts that are commercial in nature based on observable selling prices.
We recognize revenue for each performance obligation when (or as) the performance obligation is satisfied by transferring control of the promised goods or services underlying the performance obligation to the customer. The transfer of control can occur over time or at a point in time.
Point in Time Revenue Recognition:
Our performance obligations are satisfied at a point in time unless they meet at least one of the following criteria, in which case they are satisfied over time:
|
|
•
|
The customer simultaneously receives and consumes the benefits provided by our performance as we perform;
|
|
|
•
|
Our performance creates or enhances an asset (for example, work in process) that the customer controls as the asset is created or enhanced; or
|
|
|
•
|
Our performance does not create an asset with an alternative use to us, and we have an enforceable right to payment for performance completed to date.
|
As noted above, a significant amount of our revenue is derived from contracts to provide multiple distinct goods to a customer that are commercial in nature and can readily be sold to other customers. These arrangements are most prevalent in our Communication Systems segment and primarily involve the sale of secure tactical radios and accessories and other standard products. These performance obligations do not meet any of the three criteria listed above to recognize revenue over time; therefore, we recognize revenue at a point in time, generally when the goods are received and accepted by the customer.
Over Time Revenue Recognition:
The majority of our revenue recognized over time is for U.S. Government development and production contracts in our Electronic Systems and Space and Intelligence Systems segments. For U.S. Government development and production contracts, there is a continuous transfer of control of the asset to the customer as it is being produced based on FAR clauses in the contract that provide the customer with lien rights to work in process and allow the customer to unilaterally terminate the contract for convenience, pay us for costs incurred plus a reasonable profit and take control of any work in process. This also typically applies to our contracts with prime contractors for U.S. Government development and production contracts, when the above-described FAR clauses are flowed down to us by the prime contractors.
Our non-U.S. Government development and production contracts, including international direct commercial contracts and U.S. contracts with state and local agencies, utilities and commercial and transportation organizations, often do not include the FAR clauses described above. However, over time revenue recognition is typically supported either through our performance creating or enhancing an asset that the customer controls as it is created or enhanced or based on other contractual provisions or relevant laws that provide us with an enforceable right to payment for our work performed to date plus a reasonable profit if our customer were permitted to and did terminate the contract for reasons other than our failure to perform as promised.
Revenue for our development and production contracts is recognized over time, typically using the percentage of completion (“POC”) cost-to-cost method, whereby we measure our progress towards completion of the performance obligation based on the ratio of costs incurred to date to estimated costs at completion under the contract. Because costs incurred represent work performed, we believe this method best depicts transfer of control of the asset to the customer.
For performance obligations to provide services that are satisfied over time, we generally recognize revenue on a straight-line basis or based on the right-to-invoice method (i.e., based on our right to bill the customer). Because these methods closely reflect the value of the services transferred to the customer, we believe these methods best depict transfer of control to the customer.
Contract Estimates:
Under the POC cost-to-cost method of revenue recognition, a single estimated profit margin is used to recognize profit for each performance obligation over its period of performance. Recognition of profit on a contract requires estimates of the total cost at completion and transaction price and the measurement of progress towards completion. Due to the long-term nature of many of our contracts, developing the estimated total cost at completion and total transaction price often requires judgment. Factors that must be considered in estimating the cost of the work to be completed include the nature and complexity of the work to be performed, subcontractor performance and the risk and impact of delayed performance. Factors that must be considered in estimating the total transaction price include contractual cost or performance incentives (such as incentive fees, award fees and penalties) and other forms of variable consideration as well as our historical experience and our expectation for performance on the contract. At the outset of each contract, we gauge its complexity and perceived risks and establish an estimated total cost at completion in line with these expectations. After establishing the estimated total cost at completion, we follow a standard Estimate at Completion (“EAC”) process in which we review the progress and performance on our ongoing contracts at least quarterly and, in many cases, more frequently. If we successfully retire risks associated with the technical, schedule and cost aspects of a contract, we may lower our estimated total cost at completion commensurate with the retirement of these risks. Conversely, if we are not successful in retiring these risks, we may increase our estimated total cost at completion. Additionally, as the contract progresses, our estimates of total transaction price may increase or decrease if, for example, we receive award fees that are higher or lower than expected. When adjustments in estimated total costs at completion or in estimated total transaction price are determined, the related impact on operating income is recognized using the cumulative catch-up method, which recognizes in the current period the cumulative effect of such adjustments for all prior periods. Any anticipated losses on these contracts are fully recognized in the period in which the losses become evident.
Net EAC adjustments resulting from changes in estimates unfavorably impacted our operating income by
$3 million
(
$2 million
after-tax or
$.02
per diluted share) and favorably by
$5 million
(
$3 million
after-tax or
$.02
per diluted share) for the quarters ended
September 28, 2018
and
September 29, 2017
, respectively. Revenue recognized from performance obligations satisfied in prior periods was
$7 million
and
$14 million
for the quarters ended
September 28, 2018
and
September 29, 2017
, respectively.
Bill-and-Hold Arrangements:
For certain of our contracts, the finished product may temporarily be stored at our location under a bill-and-hold arrangement. Revenue is recognized on bill-and-hold arrangements at the point in time when the customer obtains control of the product (for example, through a present right to payment from the customer, transfer of title and/or significant risks and rewards of ownership to the customer and customer acceptance) and all of the following criteria have been met: the arrangement is substantive (for example, the customer has requested the arrangement); the product is identified separately as belonging to the customer; the product is ready for physical transfer to the customer; and we do not have the ability to use the product or direct it to another customer.
Backlog:
Backlog, which is the equivalent of our remaining performance obligations, represents the future revenue we expect to recognize as we perform on our current contracts. Backlog comprises both funded backlog (i.e., firm orders for which funding is authorized and appropriated) and unfunded backlog. Backlog excludes unexercised contract options and potential
orders under ordering-type contracts, such as indefinite delivery, indefinite quantity (“IDIQ”) contracts.
At
September 28, 2018
, our ending backlog was
$7.9 billion
. We expect to recognize approximately half of the revenue associated with this backlog within the next
twelve
months and the substantial majority of the revenue associated with this backlog within the next
3
years.
Contract Assets and Liabilities:
The timing of revenue recognition, customer billings and cash collections results in accounts receivable, contract assets and contract liabilities at the end of each reporting period. Contract assets include unbilled amounts typically resulting from revenue recognized exceeding amounts billed to customers for contracts utilizing the POC cost-to-cost revenue recognition method. We bill customers as work progresses in accordance with agreed-upon contractual terms, either at periodic intervals, upon achievement of contractual milestones or upon deliveries and, in certain arrangements, the customer may withhold payment of a small portion of the contract price until contract completion. Contract liabilities include advance payments and billings in excess of revenue recognized, including deferred revenue associated with extended product warranties. Contract assets and liabilities are reported on a contract-by-contract basis at the end of each reporting period. The non-current portion of deferred revenue associated with extended product warranties is included within the “Other long-term liabilities” line item in our Condensed Consolidated Balance Sheet (Unaudited).
Contract assets related to amounts withheld by customers until contract completion are not considered a significant financing component of our contracts because the intent is to protect the customers from our failure to satisfactorily complete our performance obligations. Payments received from customers in advance of revenue recognition are not considered a significant financing component of our contracts because they are utilized to pay for contract costs within a
one
-year period or are requested by us to ensure the customers meet their payment obligations. See
Note G — Contract Assets and Contract Liabilities
in these Notes for additional information.
Costs to Obtain or Fulfill a Contract:
Costs to obtain a contract are incremental direct costs incurred to obtain a contract with a customer, including sales commissions and dealer fees, and are capitalized if material. Costs to fulfill a contract include costs directly related to a contract or specific anticipated contract (for example, mobilization, set-up and certain design costs) that generate or enhance our ability to satisfy our performance obligations under these contracts. These costs are capitalized to the extent they are expected to be recovered from the associated contract. Capitalized costs to obtain or fulfill a contract are amortized to expense over the expected period of benefit for contracts with terms
greater than one year
on a systematic basis that is consistent with the pattern of transfer of the associated goods and services to the customer. As a practical expedient, capitalized costs to obtain or fulfill a contract with a term of one year or less are expensed as incurred.
Adoption of New Accounting Standards
As discussed above, we adopted ASC 606 effective June 30, 2018. This standard supersedes nearly all revenue recognition guidance under GAAP and International Financial Reporting Standards and supersedes some cost guidance for construction-type and production-type contracts. The guidance in this standard is principles-based, and, consequently, entities are required to use more judgment and make more estimates than under prior guidance, including identifying contract performance obligations, estimating variable consideration to include in the contract price and allocating the transaction price to separate performance obligations. The core principle of this standard is that entities should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. To help financial statement users better understand the nature, amount, timing and potential uncertainty of the revenue and cash flows, this standard requires significantly more interim and annual disclosures. We have adopted the requirements of the new standard using the full retrospective method, which means that we have restated each prior reporting period presented and recognized the cumulative effect of applying the standard at the earliest period presented. We opted for this adoption method because we believe it provides enhanced comparability and transparency across periods. We elected to apply the practical expedient related to backlog disclosures for prior reporting periods. We also elected to apply the practical expedient related to evaluating the effects of contract modifications that occurred prior to the earliest period presented. No other transition practical expedients were applied.
Adopting this standard resulted in the recognition of a cumulative-effect adjustment of
$15 million
to reduce the opening balance of retained earnings at July 2, 2016. Our full year fiscal 2017 revenue from product sales and services decreased by
$3 million
and our income from continuing operations decreased by
$10 million
(
$.08
per share). Our full year fiscal 2018 revenue from product sales and services decreased by
$14 million
and our income from continuing operations decreased by
$19 million
(
$.15
per share). This standard also resulted in the establishment of “Contract assets” and “Contract liabilities” line items and the reclassification to these line items of amounts previously presented in the “Receivables,” “Inventories” and “Advanced payments and unearned income” line items in our Condensed Consolidated Balance Sheet (Unaudited). Total net cash provided by operating activities and total net cash provided by or used in investing activities and financing activities in our Condensed Consolidated Statements of Cash Flows (Unaudited) were not impacted by the adoption of ASC 606. These
amounts are reflected in the tables below and are updated from the preliminary assessment of the impacts of adopting ASC 606 included in our fiscal 2018 Form 10-K.
We also adopted ASU 2017-07,
Compensation — Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost,
effective June 30, 2018. This standard requires that entities present components of net periodic pension and postretirement benefit costs other than the service cost component (“other components of net benefit cost”) separately from the service cost component. The other components of net benefit cost may be presented as a separate line item or items, or if a separate line item is not used, the line item used to present the other components of net benefit cost must be disclosed. Previously, we included each component of net benefit cost within the “Cost of product sales and services” and “Engineering, selling and administrative expenses” line items in our Condensed Consolidated Statement of Income (Unaudited). In accordance with this update, we will present the other components of net benefit cost as part of the “Non-operating income” line item in our Condensed Consolidated Statement of Income (Unaudited). We adopted this update retrospectively by recasting each prior period presented, using as our estimation basis for recasting prior periods the amounts disclosed in the Postretirement benefit plan footnote to our previously issued financial statements. Adopting this update resulted in a
$37 million
increase in cost of sales and services, a
$9 million
increase in engineering, selling and administrative expenses and a corresponding
$46 million
increase in non-operating income for the quarter ended
September 29, 2017
, with no impact to net income.
The following table summarizes the effect of adopting ASC 606 and ASU 2017-07 on our Condensed Consolidated Statement of Income (Unaudited) for the quarter ended
September 29, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended September 29, 2017
|
|
As Reported
|
|
Effect of Adopting ASC 606
|
|
Effect of Adopting ASU 2017-07
|
|
As Recast
|
|
|
|
|
|
|
|
|
|
(In millions, except per share amounts)
|
Revenue from product sales and services
|
$
|
1,413
|
|
|
$
|
(3
|
)
|
|
$
|
—
|
|
|
$
|
1,410
|
|
Cost of product sales and services
|
(885
|
)
|
|
3
|
|
|
(37
|
)
|
|
(919
|
)
|
Engineering, selling and administrative expenses
|
(256
|
)
|
|
(3
|
)
|
|
(9
|
)
|
|
(268
|
)
|
Non-operating income
|
—
|
|
|
—
|
|
|
46
|
|
|
46
|
|
Interest expense
|
(41
|
)
|
|
—
|
|
|
—
|
|
|
(41
|
)
|
Income from continuing operations before income taxes
|
231
|
|
|
(3
|
)
|
|
—
|
|
|
228
|
|
Income taxes
|
(64
|
)
|
|
1
|
|
|
—
|
|
|
(63
|
)
|
Income from continuing operations
|
167
|
|
|
(2
|
)
|
|
—
|
|
|
165
|
|
Discontinued operations, net of income taxes
|
(6
|
)
|
|
—
|
|
|
—
|
|
|
(6
|
)
|
Net income
|
$
|
161
|
|
|
$
|
(2
|
)
|
|
$
|
—
|
|
|
$
|
159
|
|
|
|
|
|
|
|
|
|
Net income per common share
|
|
|
|
|
|
|
|
Basic
|
|
|
|
|
|
|
|
Continuing operations
|
$
|
1.40
|
|
|
$
|
(0.01
|
)
|
|
$
|
—
|
|
|
$
|
1.39
|
|
Discontinued operations
|
(0.05
|
)
|
|
(0.01
|
)
|
|
—
|
|
|
(0.06
|
)
|
|
$
|
1.35
|
|
|
$
|
(0.02
|
)
|
|
$
|
—
|
|
|
$
|
1.33
|
|
Diluted
|
|
|
|
|
|
|
|
Continuing operations
|
$
|
1.38
|
|
|
$
|
(0.02
|
)
|
|
$
|
—
|
|
|
$
|
1.36
|
|
Discontinued operations
|
(0.06
|
)
|
|
0.01
|
|
|
—
|
|
|
(0.05
|
)
|
|
$
|
1.32
|
|
|
$
|
(0.01
|
)
|
|
$
|
—
|
|
|
$
|
1.31
|
|
The following table summarizes the effect of the adoption of ASC 606 on our Condensed Consolidated Balance Sheet (Unaudited) at June 29, 2018:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
June 29, 2018
|
|
As Reported
|
|
Effect of Adopting ASC 606
|
|
As Recast
|
|
|
|
|
|
|
|
(In millions, except shares)
|
Assets
|
|
|
|
|
|
Current Assets
|
|
|
|
|
|
Cash and cash equivalents
|
$
|
288
|
|
|
$
|
—
|
|
|
$
|
288
|
|
Receivables
|
735
|
|
|
(269
|
)
|
|
466
|
|
Contract assets
|
—
|
|
|
782
|
|
|
782
|
|
Inventories
|
925
|
|
|
(514
|
)
|
|
411
|
|
Income taxes receivable
|
174
|
|
|
—
|
|
|
174
|
|
Other current assets
|
101
|
|
|
2
|
|
|
103
|
|
Total current assets
|
2,223
|
|
|
1
|
|
|
2,224
|
|
Non-current Assets
|
|
|
|
|
|
Property, plant and equipment
|
900
|
|
|
—
|
|
|
900
|
|
Goodwill
|
5,372
|
|
|
—
|
|
|
5,372
|
|
Other intangible assets
|
989
|
|
|
—
|
|
|
989
|
|
Non-current deferred income taxes
|
116
|
|
|
3
|
|
|
119
|
|
Other non-current assets
|
239
|
|
|
8
|
|
|
247
|
|
Total non-current assets
|
7,616
|
|
|
11
|
|
|
7,627
|
|
|
$
|
9,839
|
|
|
$
|
12
|
|
|
$
|
9,851
|
|
|
|
|
|
|
|
Liabilities and Equity
|
|
|
|
|
|
Current Liabilities
|
|
|
|
|
|
Short-term debt
|
$
|
78
|
|
|
$
|
—
|
|
|
$
|
78
|
|
Accounts payable
|
622
|
|
|
—
|
|
|
622
|
|
Advanced payments and unearned income
|
314
|
|
|
(314
|
)
|
|
—
|
|
Contract liabilities
|
—
|
|
|
372
|
|
|
372
|
|
Compensation and benefits
|
142
|
|
|
—
|
|
|
142
|
|
Other accrued items
|
313
|
|
|
4
|
|
|
317
|
|
Income taxes payable
|
15
|
|
|
—
|
|
|
15
|
|
Current portion of long-term debt, net
|
304
|
|
|
—
|
|
|
304
|
|
Total current liabilities
|
1,788
|
|
|
62
|
|
|
1,850
|
|
Non-current Liabilities
|
|
|
|
|
|
Defined benefit plans
|
714
|
|
|
—
|
|
|
714
|
|
Long-term debt, net
|
3,408
|
|
|
—
|
|
|
3,408
|
|
Non-current deferred income taxes
|
90
|
|
|
(11
|
)
|
|
79
|
|
Other long-term liabilities
|
517
|
|
|
5
|
|
|
522
|
|
Total non-current liabilities
|
4,729
|
|
|
(6
|
)
|
|
4,723
|
|
Equity
|
|
|
|
|
|
Shareholders’ Equity:
|
|
|
|
|
|
Common stock
|
118
|
|
|
—
|
|
|
118
|
|
Other capital
|
1,714
|
|
|
—
|
|
|
1,714
|
|
Retained earnings
|
1,692
|
|
|
(44
|
)
|
|
1,648
|
|
Accumulated other comprehensive loss
|
(202
|
)
|
|
—
|
|
|
(202
|
)
|
Total equity
|
3,322
|
|
|
(44
|
)
|
|
3,278
|
|
|
$
|
9,839
|
|
|
$
|
12
|
|
|
$
|
9,851
|
|
The following table presents the effect of the adoption of ASC 606 on our Condensed Consolidated Statement of Cash Flows (Unaudited) for the quarter ended
September 29, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Quarter Ended September 29, 2017
|
|
As Reported
|
|
Effect of Adopting ASC 606
|
|
As Recast
|
|
|
|
|
|
|
|
(In millions, except shares)
|
Net income
|
$
|
161
|
|
|
(2
|
)
|
|
$
|
159
|
|
Adjustments to reconcile net income to net cash provided by operating activities:
|
|
|
|
|
|
Amortization of acquisition-related intangibles
(1)
|
28
|
|
|
—
|
|
|
28
|
|
Depreciation and other amortization
(1)
|
37
|
|
|
—
|
|
|
37
|
|
Share-based compensation
|
11
|
|
|
—
|
|
|
11
|
|
Pension income
|
(34
|
)
|
|
—
|
|
|
(34
|
)
|
(Increase) decrease in:
|
|
|
|
|
|
Accounts receivable
|
(83
|
)
|
|
29
|
|
|
(54
|
)
|
Contract assets
|
—
|
|
|
(59
|
)
|
|
(59
|
)
|
Inventories
|
(56
|
)
|
|
32
|
|
|
(24
|
)
|
Increase (decrease) in:
|
|
|
|
|
|
Accounts payable
|
(88
|
)
|
|
—
|
|
|
(88
|
)
|
Advanced payments and unearned income
|
12
|
|
|
(12
|
)
|
|
—
|
|
Contract liabilities
|
—
|
|
|
18
|
|
|
18
|
|
Income taxes
|
126
|
|
|
(1
|
)
|
|
125
|
|
Other
|
(19
|
)
|
|
(5
|
)
|
|
(24
|
)
|
Net cash provided by operating activities
|
$
|
95
|
|
|
$
|
—
|
|
|
$
|
95
|
|
_______________
|
|
(1)
|
“Amortization of acquisition-related intangibles” includes amortization of non-Exelis Inc. acquisition-related intangibles, which was previously included in the “Depreciation and amortization” line item in our Condensed Consolidated Statement of Cash Flows (Unaudited) in our Form 10-Q for the quarter ended September 29, 2017.
|
Accounting Standards Issued But Not Yet Effective
In February 2016, the FASB issued a new lease standard that supersedes existing lease guidance under GAAP. This standard requires, among other things, the recognition of right-of-use assets and liabilities on the balance sheet for all leases longer than 12 months and disclosure of certain information about leasing arrangements. The standard currently allows two transition methods whereby companies may elect to use the modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements, with certain practical expedients available, or to initially apply the standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. This standard is effective for fiscal years, and interim reporting periods within those years, beginning after December 15, 2018, which for us is our fiscal 2020. We continue to evaluate the impact this standard will have on our financial condition, results of operations and cash flows, which could be material, and we have not yet made a decision on the adoption method, as this determination is primarily dependent on the completion of our analysis.
Note B — Discontinued Operations
We completed two significant divestitures during fiscal 2017, the divestiture of our government IT services business (“IT Services”) and the divestiture of our Harris CapRock Communications commercial business (“CapRock”). These divestitures individually and collectively represented a strategic shift away from non-core markets (for example, energy, maritime and government IT services). The decision to divest these businesses was part of our strategy to simplify our operating model to focus on technology-differentiated, high-margin businesses and had a major effect on our operations and financial results.
As a result, IT Services and CapRock are reported as discontinued operations in the accompanying Condensed Consolidated Financial Statements (Unaudited) and these Notes. Except for disclosures related to our cash flows, or unless otherwise specified, disclosures in the accompanying Condensed Consolidated Financial Statements (Unaudited) and these Notes relate solely to our continuing operations.
The major components of discontinued operations in our Condensed Consolidated Statement of Income (Unaudited) included a
$3 million
non-operating loss for the quarter ended
September 28, 2018
and a
$3 million
non-operating loss and
$3
million
income tax expense for the quarter ended
September 29, 2017
. For additional details regarding our discontinued operations, refer to “Note 3: Discontinued Operations and Divestitures” in our Fiscal 2018 Form 10-K.
Note C — Stock Options and Other Share-Based Compensation
During the
quarter ended September 28, 2018
, we had options or other share-based compensation outstanding under
two
shareholder-approved employee stock incentive plans (“SIPs”), the Harris Corporation 2005 Equity Incentive Plan (As Amended and Restated Effective August 27, 2010) and the Harris Corporation 2015 Equity Incentive Plan (the “2015 EIP”). Grants of share-based awards after October 23, 2015 were made under our 2015 EIP. We believe that share-based awards more closely align the interests of participants with those of shareholders. Certain share-based awards provide for accelerated vesting if there is a change in control (as defined under our SIPs). The compensation cost related to our share-based awards that was charged against income was
$14 million
and
$11 million
for the quarters ended
September 28, 2018
and
September 29, 2017
, respectively.
The aggregate number of shares of our common stock that we issued under the terms of our SIPs, net of shares withheld for tax purposes and inclusive of both continuing and discontinued operations, was
403,953
and
331,215
for the quarters ended
September 28, 2018
and
September 29, 2017
, respectively. Awards granted to participants under our 2015 EIP during the quarter ended
September 28, 2018
consisted of
270,963
stock options,
89,220
restricted shares and restricted units and
135,629
performance units. The fair value as of the grant date of each stock option award was determined using the Black-Scholes-Merton option-pricing model and the following assumptions: expected dividend yield of
1.61 percent
; expected volatility of
19.87 percent
; risk-free interest rates averaging
2.72 percent
; and expected term of
5.03
years. The fair value as of the grant date of each restricted share award and restricted unit award was based on the closing price of our common stock on the grant date. The fair value as of the grant date of each performance unit award was determined based on the fair value from a multifactor Monte Carlo valuation model that simulates our stock price and total shareholder return (“TSR”) relative to companies in our TSR peer group, less a discount to reflect the delay in payments of cash dividend-equivalents that are made only upon vesting.
Note D — Restructuring and Other Exit Costs
We record charges for restructuring and other exit activities related to sales or terminations of product lines, closures or relocations of business activities, changes in management structure, and fundamental reorganizations that affect the nature and focus of operations. Such charges include termination benefits, contract termination costs and costs to consolidate facilities or relocate employees. We record these charges at their fair value when incurred. In cases where employees are required to render service until they are terminated in order to receive the termination benefits and will be retained beyond the minimum retention period, we record the expense ratably over the future service period. These charges are included as a component of the “Cost of product sales and services” and “Engineering, selling and administrative expenses” line items in our Condensed Consolidated Statement of Income (Unaudited).
In the fourth quarter of fiscal
2018
, we recorded a
$5 million
charge for consolidation of certain Exelis Inc. (collectively with its subsidiaries, “Exelis”) facilities initiated in fiscal 2017. This charge is included as a component of the “Engineering, selling and administrative expenses” line item in our Consolidated Statement of Income in our Fiscal 2018 Form 10-K. We had liabilities of
$22 million
and
$27 million
at
September 28, 2018
and
June 29, 2018
, respectively, associated with this integration activity and with previous restructuring actions. We expect that the majority of the remaining liabilities as of
September 28, 2018
will be paid within the next twelve months.
Note E — Accumulated Other Comprehensive Loss
The components of accumulated other comprehensive loss are summarized below:
|
|
|
|
|
|
|
|
|
|
September 28, 2018
|
|
June 29, 2018
|
|
|
|
|
|
(In millions)
|
Foreign currency translation, net of income taxes of $2 million at September 28, 2018 and June 29, 2018, respectively
|
$
|
(99
|
)
|
|
$
|
(99
|
)
|
Net unrealized loss on hedging derivatives, net of income taxes of $6 million and $7 million at September 28, 2018 and June 29, 2018, respectively
|
(19
|
)
|
|
(20
|
)
|
Unrecognized postretirement obligations, net of income taxes of $30 million at September 28, 2018 and June 29, 2018, respectively
|
(84
|
)
|
|
(83
|
)
|
|
$
|
(202
|
)
|
|
$
|
(202
|
)
|
Accumulated other comprehensive loss at
June 29, 2018
reflects a reclassification to retained earnings of
$35 million
in stranded tax effects as a result of our adoption of an accounting standards update, including
$30 million
from “Unrecognized
postretirement obligation, net of income taxes,”
$4 million
from “Net unrealized loss on hedging derivatives, net of income taxes” and
$1 million
from “Foreign currency translation, net of income taxes.” See Note 2: “Accounting Changes or Recent Accounting Pronouncements” in our fiscal 2018 Form 10-K for additional information regarding this accounting standards update.
Note F — Receivables
Receivables are summarized below:
|
|
|
|
|
|
|
|
|
|
September 28, 2018
|
|
June 29, 2018
|
|
|
|
|
|
(In millions)
|
Accounts receivable
|
$
|
435
|
|
|
$
|
468
|
|
Less allowances for collection losses
|
(3
|
)
|
|
(2
|
)
|
|
$
|
432
|
|
|
$
|
466
|
|
We have a receivables sale agreement (“RSA”) with a third-party financial institution that permits us to sell, on a non-recourse basis, up to
$50 million
of outstanding receivables at any given time. From time to time, we have sold certain customer receivables under the RSA, which we continue to service and collect on behalf of the third-party financial institution. Receivables sold pursuant to the RSA meet the requirements for sales accounting under ASC 860,
Transfers and Servicing
, and, accordingly, are derecognized from our Condensed Consolidated Balance Sheet (Unaudited) at the time of sale. Outstanding accounts receivable sold pursuant to the RSA were not material at
September 28, 2018
and
June 29, 2018
. Impairment losses related to receivables from contracts with customers were not material during the quarters ended
September 28, 2018
and
September 29, 2017
.
Note G — Contract Assets and Contract Liabilities
Contract assets include unbilled amounts typically resulting from revenue recognized exceeding amounts billed to customers for contracts utilizing the POC cost-to-cost revenue recognition method. We bill customers as work progresses in accordance with agreed-upon contractual terms, either at periodic intervals, upon achievement of contractual milestones or upon deliveries and, in certain arrangements, the customer may withhold payment of a small portion of the contract price until contract completion. Contract liabilities include advance payments and billings in excess of revenue recognized, including deferred revenue associated with extended product warranties. Contract assets and liabilities are reported on a contract-by-contract basis at the end of each reporting period. Changes in contract assets and contract liabilities balances during the
quarter ended September 28, 2018
were not materially impacted by any factors other than those described above.
Contract assets and contract liabilities are summarized below:
|
|
|
|
|
|
|
|
|
|
September 28, 2018
|
|
June 29, 2018
|
|
|
|
|
|
(In millions)
|
Contract assets
|
$
|
870
|
|
|
$
|
782
|
|
Contract liabilities, current
|
(410
|
)
|
|
(372
|
)
|
Contract liabilities, non-current
(1)
|
(5
|
)
|
|
(7
|
)
|
|
$
|
455
|
|
|
$
|
403
|
|
_______________
|
|
(1)
|
Non-current portion of deferred revenue associated with extended product warranties, which is included as a component of the “Other long-term liabilities” line item in our Condensed Consolidated Balance Sheet (Unaudited)
|
The components of contract assets are summarized below:
|
|
|
|
|
|
|
|
|
|
September 28, 2018
|
|
June 29, 2018
|
|
|
|
|
|
(In millions)
|
Unbilled contract receivables, gross
|
$
|
1,000
|
|
|
$
|
881
|
|
Progress payments
|
(130
|
)
|
|
(99
|
)
|
|
$
|
870
|
|
|
$
|
782
|
|
Impairment losses related to our contract assets were not material during the quarters ended
September 28, 2018
and
September 29, 2017
. For the
quarter ended September 28, 2018
, we recognized revenue of
$158 million
related to contract liabilities that were outstanding at
June 29, 2018
. For the quarter ended
September 29, 2017
, we recognized revenue of
$110 million
related to contract liabilities that were outstanding at
June 30, 2017
.
Note H — Inventories
Inventories are summarized below:
|
|
|
|
|
|
|
|
|
|
September 28, 2018
|
|
June 29, 2018
|
|
|
|
|
|
(In millions)
|
Finished products
|
$
|
81
|
|
|
$
|
91
|
|
Work in process
|
119
|
|
|
121
|
|
Raw materials and supplies
|
213
|
|
|
199
|
|
|
$
|
413
|
|
|
$
|
411
|
|
Note I — Property, Plant and Equipment
Property, plant and equipment are summarized below:
|
|
|
|
|
|
|
|
|
|
September 28, 2018
|
|
June 29, 2018
|
|
|
|
|
|
(In millions)
|
Land
|
$
|
43
|
|
|
$
|
43
|
|
Software capitalized for internal use
|
174
|
|
|
171
|
|
Buildings
|
624
|
|
|
620
|
|
Machinery and equipment
|
1,372
|
|
|
1,349
|
|
|
2,213
|
|
|
2,183
|
|
Less accumulated depreciation and amortization
|
(1,315
|
)
|
|
(1,283
|
)
|
|
$
|
898
|
|
|
$
|
900
|
|
Depreciation and amortization expense related to property, plant and equipment was
$35 million
and
$37 million
for the quarters ended
September 28, 2018
and
September 29, 2017
, respectively.
Note J — Accrued Warranties
Changes in our liability for standard warranties, which is included as a component of the “Other accrued items” and “Other long-term liabilities” line items in our Condensed Consolidated Balance Sheet (Unaudited), during the
quarter ended September 28, 2018
were as follows:
|
|
|
|
|
|
(In millions)
|
Balance at June 29, 2018
|
$
|
24
|
|
Warranty provision for sales
|
3
|
|
Settlements
|
(2
|
)
|
Balance at September 28, 2018
|
$
|
25
|
|
We also sell extended product warranties and recognize revenue from these arrangements over the warranty period. Costs of warranty services under these arrangements are recognized as incurred. Deferred revenue associated with extended product warranties was
$16 million
at
September 28, 2018
and
June 29, 2018
, and is included as a component of the “Contract liabilities” and “Other long-term liabilities” line items in our Condensed Consolidated Balance Sheet (Unaudited).
Note K — Postretirement Benefit Plans
The following tables provide the components of our net periodic benefit income for our defined benefit plans, including defined benefit pension plans and other postretirement defined benefit plans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension
|
|
Other Benefits
|
|
Quarter Ended
|
|
Quarter Ended
|
|
September 28, 2018
|
|
September 29, 2017
|
|
September 28, 2018
|
|
September 29, 2017
|
|
|
|
|
|
|
|
|
|
(In millions)
|
Net periodic benefit income
|
|
|
|
|
|
|
|
Service cost
|
$
|
9
|
|
|
$
|
10
|
|
|
$
|
—
|
|
|
$
|
—
|
|
Interest cost
|
52
|
|
|
48
|
|
|
2
|
|
|
2
|
|
Expected return on plan assets
|
(95
|
)
|
|
(92
|
)
|
|
(4
|
)
|
|
(4
|
)
|
Amortization of net actuarial loss (gain)
|
—
|
|
|
—
|
|
|
(2
|
)
|
|
—
|
|
Total net periodic benefit income
|
$
|
(34
|
)
|
|
$
|
(34
|
)
|
|
$
|
(4
|
)
|
|
$
|
(2
|
)
|
|
|
|
|
|
|
|
|
The service cost component of net periodic benefit income is included in the “Cost of product sales and services” and “Engineering, selling and administrative expenses” line items in our Condensed Consolidated Statement of Income (Unaudited). The non-service cost components of net periodic pension income are included in the "Non-operating income" line item in our Condensed Consolidated Statement of Income (Unaudited).
We made a
$300 million
voluntary contribution to our U.S. qualified pension plans in the third quarter of fiscal 2018. As a result of this voluntary contribution as well as a
$400 million
voluntary contribution made during fiscal 2017,
we made
no
contributions to our U.S. qualified benefit pension plans during the quarter ended September 28, 2018 and we currently anticipate making
no
contributions to our
U.S. qualified defined benefit pension plans
and minor contributions to a non-U.S. pension plan during the remainder of fiscal 2019. We made
no
contributions to our qualified defined benefit pension plans during
the
quarter ended September 29, 2017
.
The U.S. Salaried Retirement Plan (“U.S. SRP”), a U.S. qualified pension plan, is our largest defined benefit pension plan, with assets valued at
$4.6 billion
and a projected benefit obligation of
$5.2 billion
as of
June 29, 2018
. Effective December 31, 2016, accruals under the U.S. SRP benefit formula were frozen for all employees and replaced with a
1%
cash balance benefit formula for certain employees who were not highly compensated on December 31, 2016.
Note L — Income From Continuing Operations Per Share
The computations of income from continuing operations per common share are as follows:
|
|
|
|
|
|
|
|
|
|
Quarter Ended
|
|
September 28, 2018
|
|
September 29, 2017
|
|
|
|
|
|
(In millions, except per share amounts)
|
Income from continuing operations
|
$
|
216
|
|
|
$
|
165
|
|
Adjustments for participating securities outstanding
|
(1
|
)
|
|
—
|
|
Income from continuing operations used in per basic and diluted common share calculations (A)
|
$
|
215
|
|
|
$
|
165
|
|
|
|
|
|
Basic weighted average common shares outstanding (B)
|
117.9
|
|
|
119.1
|
|
Impact of dilutive share-based awards
|
2.7
|
|
|
2.1
|
|
Diluted weighted average common shares outstanding (C)
|
120.6
|
|
|
121.2
|
|
Income from continuing operations per basic common share (A)/(B)
|
$
|
1.82
|
|
|
$
|
1.39
|
|
Income from continuing operations per diluted common share (A)/(C)
|
$
|
1.78
|
|
|
$
|
1.36
|
|
Potential dilutive common shares primarily consist of employee stock options and restricted and performance unit awards. Income from continuing operations per diluted common share excludes the antidilutive impact of
160,167
and
162,770
weighted average share-based awards outstanding for the quarters ended
September 28, 2018
and
September 29, 2017
, respectively.
Note M — Income Taxes
On December 22, 2017, H.R.1, also known as the “Tax Cuts and Jobs Act,” was signed into U.S. law (“Tax Act”). Among other provisions, the Tax Act reduced the U.S. statutory corporate income tax rate from a maximum
35 percent
to a flat
21 percent
, effective January 1, 2018.
Effective Tax Rate
Our effective tax rate (income taxes as a percentage of income from continuing operations before income taxes) was
16.0 percent
in the quarter ended
September 28, 2018
compared with
27.6 percent
in the quarter ended
September 29, 2017
. In the quarter ended
September 28, 2018
,
our effective tax rate benefited from the tax rate reduction under the Tax Act
, and in the quarters ended
September 28, 2018
and
September 29, 2017
,
our effective tax rate benefited from the favorable impact of excess tax benefits related to equity-based compensation, and from several differences in GAAP and tax accounting related to investments.
Tax Law Changes
As of
September 28, 2018
, we have not fully completed our accounting for the income tax impact of enactment of the Tax Act. In accordance with SEC Staff Accounting Bulletin No.118 (“SAB 118”), we have recognized provisional amounts for income tax effects of the Tax Act that we were able to reasonably estimate. We intend to adjust the tax effects for the relevant items during the allowed measurement period. We are still evaluating certain aspects of the Tax Act and refining our calculations, which could potentially affect our current estimated valuation of our net deferred income tax balances and could give rise to new deferred tax amounts.
The Tax Act provides for a one-time transition tax on our post-1986 earnings and profits of foreign subsidiaries (“foreign E&P”) that was previously deferred from U.S. income tax expense. We have provisionally determined that we will not owe any one-time transition tax. However, we are still refining our calculations, including estimated layers of foreign E&P for fiscal 2018, which could impact the amount of one-time transition tax we will owe.
We are still in the process of evaluating the U.S. federal corporate income tax impacts of the Global Intangible Low Taxed Income (“GILTI”) and Foreign Derived Intangible Income (“FDII”) provisions of the Tax Act. In accordance with SAB 118, our first quarter tax expense includes estimated calculations for these provisions as a period cost in our effective tax rate and we will continue to modify and update our evaluation as additional regulations are issued by the U.S. Department of Treasury.
Because of the potential impact of deficit allocations on the tax basis for netted foreign E&P, we are maintaining a deferred tax liability of approximately
$24 million
in respect of potential cumulative tax basis differences of
$116 million
. New statutory or regulatory guidance requires further analysis and may result in a change in our conclusion as to the need for a deferred tax liability in respect of these cumulative tax basis differences. Other than this deferred tax liability, we have provided for no additional income taxes on any remaining undistributed foreign E&P not subject to the transition tax, or any outside tax basis differences inherent in our foreign subsidiaries, because all other amounts continue to be reinvested indefinitely.
We are continuing to monitor activity at the state and local level for conformity to the Tax Act. We do not expect a material impact to our state and local tax expense.
Note N — Fair Value Measurements
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal market (or most advantageous market, in the absence of a principal market) for the asset or liability in an orderly transaction between market participants at the measurement date. Entities are required to maximize the use of observable inputs and minimize the use of unobservable inputs in measuring fair value, and to utilize a three-level fair value hierarchy that prioritizes the inputs used to measure fair value. The three levels of inputs used to measure fair value are as follows:
|
|
•
|
Level 1 — Quoted prices in active markets for identical assets or liabilities.
|
|
|
•
|
Level 2 — Observable inputs other than quoted prices included within Level 1, including quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and inputs other than quoted prices that are observable or are derived principally from, or corroborated by, observable market data by correlation or other means.
|
|
|
•
|
Level 3 — Unobservable inputs that are supported by little or no market activity, are significant to the fair value of the assets or liabilities, and reflect our own assumptions about the assumptions market participants would use in pricing the asset or liability developed using the best information available in the circumstances.
|
In certain instances, fair value is estimated using quoted market prices obtained from external pricing services. In obtaining such data from the external pricing services, we have evaluated the methodologies used to develop the estimate of fair value in order to assess whether such valuations are representative of fair value, including net asset value (“NAV”).
Additionally, in certain circumstances, the NAV reported by an asset manager may be adjusted when sufficient evidence indicates NAV is not representative of fair value.
The following table presents assets and liabilities measured at fair value on a recurring basis (at least annually) at
September 28, 2018
and
June 29, 2018
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 28, 2018
|
|
June 29, 2018
|
|
Total
|
|
Level 1
|
|
Total
|
|
Level 1
|
|
|
|
|
|
|
|
|
|
(In millions)
|
Assets
|
|
|
|
|
|
|
|
Deferred compensation plan assets:
(1)
|
|
|
|
|
|
|
|
Equity and fixed income securities
|
$
|
50
|
|
|
$
|
50
|
|
|
$
|
46
|
|
|
$
|
46
|
|
Investments measured at NAV:
|
|
|
|
|
|
|
|
Equity and fixed income funds
|
67
|
|
|
|
|
63
|
|
|
|
Corporate-owned life insurance
|
27
|
|
|
|
|
27
|
|
|
|
Total investments measured at NAV
|
94
|
|
|
|
|
90
|
|
|
|
Total fair value of deferred compensation plan assets
|
$
|
144
|
|
|
|
|
$
|
136
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
|
|
|
|
|
|
|
|
Deferred compensation plan liabilities:
(2)
|
|
|
|
|
|
|
|
Equity securities and mutual funds
|
$
|
24
|
|
|
$
|
24
|
|
|
$
|
38
|
|
|
$
|
38
|
|
Investments measured at NAV:
|
|
|
|
|
|
|
|
Common/collective trusts and guaranteed investment contracts
|
138
|
|
|
|
|
111
|
|
|
|
Total fair value of deferred compensation plan liabilities
|
$
|
162
|
|
|
|
|
|
$
|
149
|
|
|
|
|
_______________
|
|
(1)
|
Represents diversified assets held in a “rabbi trust” associated with our non-qualified deferred compensation plans, which we include in the “Other current assets” and “Other non-current assets” line items in our Condensed Consolidated Balance Sheet (Unaudited), and which are measured at fair value.
|
|
|
(2)
|
Primarily represents obligations to pay benefits under certain non-qualified deferred compensation plans, which we include in the “Compensation and benefits” and “Other long-term liabilities” line items in our Condensed Consolidated Balance Sheet (Unaudited). Under these plans, participants designate investment options (including stock and fixed-income funds), which serve as the basis for measurement of the notional value of their accounts.
|
The following table presents the carrying amounts and estimated fair values of our significant financial instruments that were not measured at fair value (carrying amounts of other financial instruments not listed in the table below approximate fair value due to the short-term nature of those items):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
September 28, 2018
|
|
June 29, 2018
|
|
Carrying
Amount
|
|
Fair
Value
|
|
Carrying
Amount
|
|
Fair
Value
|
|
|
|
|
|
|
|
|
|
(In millions)
|
Long-term debt (including current portion)
(1)
|
$
|
3,715
|
|
|
$
|
3,842
|
|
|
$
|
3,712
|
|
|
$
|
3,848
|
|
_______________
|
|
(1)
|
Fair value was estimated using a market approach based on quoted market prices for our debt traded in the secondary market. If our long-term debt in our balance sheet were measured at fair value, it would be categorized in Level 2 of the fair value hierarchy.
|
Note O — Derivative Instruments and Hedging Activities
In the normal course of business, we are exposed to global market risks, including the effect of changes in foreign currency exchange rates. We use derivative instruments to manage our exposure to such risks and formally document all relationships between hedging instruments and hedged items, as well as the risk-management objective and strategy for undertaking hedge transactions. We recognize all derivatives in our Condensed Consolidated Balance Sheet (Unaudited) at fair value. We do not hold or issue derivatives for speculative purposes.
At
September 28, 2018
, we had open foreign currency forward contracts with an aggregate notional amount of
$10 million
, of which
$4 million
were classified as fair value hedges and
$6 million
were classified as cash flow hedges. This compares with open foreign currency forward contracts with an aggregate notional amount of
$39 million
at
June 29, 2018
, of which
$4 million
were classified as fair value hedges and
$35 million
were classified as cash flow hedges. At
September 28, 2018
, contract expiration dates ranged from
17 days
to approximately
3 months
with a weighted average contract life of
2 months
.
Fair Value Hedges
We use foreign currency forward contracts and options to hedge certain balance sheet items, including foreign currency denominated accounts receivable and inventory. As of
September 28, 2018
, we had an outstanding foreign currency forward contract denominated in the Canadian Dollar to hedge certain balance sheet items. The net gains or losses on foreign currency forward contracts designated as fair value hedges were not material in the
quarter ended September 28, 2018
or in the
quarter ended September 29, 2017
. In addition,
no
amounts were recognized in earnings in the
quarter ended September 28, 2018
or in the
quarter ended September 29, 2017
related to hedged firm commitments that no longer qualify as fair value hedges.
Cash Flow Hedges
We use foreign currency forward contracts and options to hedge off-balance sheet future foreign currency commitments and also have hedged U.S. Dollar payments to suppliers to maintain our anticipated profit margins in our international operations. As of
September 28, 2018
, we had outstanding foreign currency forward contracts denominated in the British Pound, Euro and Australian Dollar to hedge certain forecasted transactions. The net gains or losses from cash flow hedges recognized in earnings or recorded in other comprehensive income, including gains or losses related to hedge ineffectiveness, were not material in the
quarter ended September 28, 2018
or in the
quarter ended September 29, 2017
.
Note P — Business Segment Information
We structure our operations primarily around the products, systems and services we sell and the markets we serve, and we report the financial results of our continuing operations in the following
three
reportable segments, which are also referred to as our business segments:
|
|
•
|
Communication Systems, serving markets in tactical communications and defense products, including tactical ground and airborne radio communications solutions and night vision technology, and in public safety networks;
|
|
|
•
|
Electronic Systems, providing electronic warfare, avionics, and
command, control, communications, computers, intelligence, surveillance and reconnaissance (“C4ISR”)
solutions for defense and classified customers and mission-critical communication systems for civil and military aviation and other customers; and
|
|
|
•
|
Space and Intelligence Systems, providing intelligence, space protection, geospatial, complete Earth observation, universe exploration,
positioning, navigation and timing (“PNT”),
and environmental solutions for national security, defense, civil and commercial customers, using advanced sensors, antennas and payloads, as well as ground processing and information analytics.
|
As discussed in more detail in
Note A — Significant Accounting Policies and Recent Accounting Standards
in these Notes, effective June 30, 2018, we adopted ASC 606 using the full retrospective method. The historical results, discussion and presentation of our business segments as set forth in our Condensed Consolidated Financial Statements (Unaudited) and these Notes reflect the impact of the adoption of ASC 606 for all periods presented in order to present all segment information on a comparable basis. Other than the changes that resulted from the adoption of ASC 606, the accounting policies of our business segments are the same as those described in Note 1: “Significant Accounting Policies” in our Notes to Consolidated Financial Statements in our Fiscal
2018
Form 10-K.
We evaluate each segment’s performance based on segment operating income or loss, which we define as profit or loss from operations before income taxes, including pension income and excluding interest income and expense, royalties and related intellectual property expenses, equity method investment income or loss and gains or losses from securities and other investments. Intersegment sales are generally transferred at cost to the buying segment, and the sourcing segment recognizes a profit that is eliminated. The “Corporate eliminations” line item in the table below represents the elimination of intersegment sales. The “Unallocated corporate expense and corporate eliminations” line item in the table below represents the portion of corporate expenses not allocated to our business segments and elimination of intersegment profits. The “Pension adjustment” line item in the table below represents the reconciliation of the non-service components of net periodic pension and postretirement benefit costs, which are a component of segment operating income but are included in the "Non-operating income" line item in our Condensed Consolidated Statement of Income (Unaudited) as a result of our adoption of ASU 2017-17 as discussed in
Note A — Significant Accounting Policies and Recent Accounting Standards
in these Notes. The non-service components of net periodic pension and postretirement benefit costs include interest cost, expected return on plan assets and amortization of net actuarial gain.
Segment revenue, segment operating income and a reconciliation of segment operating income to total income from continuing operations before income taxes are as follows:
|
|
|
|
|
|
|
|
|
|
Quarter Ended
|
|
September 28, 2018
|
|
September 29, 2017
|
|
|
|
|
|
(In millions)
|
Revenue
|
|
|
|
Communication Systems
|
$
|
469
|
|
|
$
|
406
|
|
Electronic Systems
|
589
|
|
|
541
|
|
Space and Intelligence Systems
|
488
|
|
|
466
|
|
Corporate eliminations
|
(4
|
)
|
|
(3
|
)
|
|
$
|
1,542
|
|
|
$
|
1,410
|
|
Income From Continuing Operations Before Income Taxes
|
Segment Operating Income:
|
|
|
|
Communication Systems
|
$
|
140
|
|
|
$
|
115
|
|
Electronic Systems
|
115
|
|
|
109
|
|
Space and Intelligence Systems
|
86
|
|
|
87
|
|
Unallocated corporate expense and corporate eliminations
(1)
|
(41
|
)
|
|
(42
|
)
|
Pension adjustment
|
(47
|
)
|
|
(46
|
)
|
Non-operating income
|
47
|
|
|
46
|
|
Net interest expense
|
(43
|
)
|
|
(41
|
)
|
|
$
|
257
|
|
|
$
|
228
|
|
|
|
|
|
|
|
_______________
|
|
(1)
|
Unallocated corporate expense and corporate eliminations included
$25 million
of expense for amortization of identifiable intangible assets acquired as a result of our acquisition of Exelis in each of the quarters ended
September 28, 2018
and
September 29, 2017
. Because the acquisition of Exelis benefited the entire Company as opposed to any individual segment, the amortization of identifiable intangible assets acquired in the Exelis acquisition was recorded as unallocated corporate expense. Corporate eliminations of intersegment profits were not material in the quarters ended September 28, 2018 and September 29, 2017.
|
Disaggregation of Revenue
Communication Systems:
Communication Systems operates principally on a “commercial” market-driven business model through which the business segment provides ready-to-ship commercial off-the-shelf products to customers in the U.S. and internationally. Communication Systems revenue is primarily derived from fixed-price contracts and is generally recognized at the point in time when the product is received and accepted by the customer. We disaggregate Communication Systems revenue by geographical region, as we believe this category best depicts how the nature, amount, timing and uncertainty of Communication Systems revenue and cash flows are affected by economic factors:
|
|
|
|
|
|
|
|
|
|
Quarter Ended
|
|
September 28, 2018
|
|
September 29, 2017
|
|
|
|
|
|
(In millions)
|
Revenue By Geographical Region
|
|
|
|
United States
|
$
|
259
|
|
|
$
|
208
|
|
International
|
210
|
|
|
198
|
|
|
$
|
469
|
|
|
$
|
406
|
|
Electronic Systems:
Electronic Systems revenue is primarily derived from U.S. Government development and production contracts and is generally recognized over time using the POC cost-to-cost method. We disaggregate Electronic Systems revenue by customer relationship, contract type and geographical region. We believe these categories best depict how the nature, amount, timing and uncertainty of Electronic Systems revenue and cash flows are affected by economic factors:
|
|
|
|
|
|
|
|
|
|
Quarter Ended
|
|
September 28, 2018
|
|
September 29, 2017
|
|
|
|
|
|
(In millions)
|
Revenue By Customer Relationship
|
|
|
|
Prime contractor
|
$
|
394
|
|
|
$
|
398
|
|
Subcontractor
|
195
|
|
|
143
|
|
|
$
|
589
|
|
|
$
|
541
|
|
Revenue By Contract Type
|
|
|
|
Fixed-price
(1)
|
$
|
478
|
|
|
$
|
422
|
|
Cost-reimbursable
|
111
|
|
|
119
|
|
|
$
|
589
|
|
|
$
|
541
|
|
Revenue By Geographical Region
|
|
|
|
United States
|
$
|
478
|
|
|
$
|
426
|
|
International
|
111
|
|
|
115
|
|
|
$
|
589
|
|
|
$
|
541
|
|
|
|
|
|
_______________
|
|
(1)
|
Includes revenue derived from time-and-materials contracts.
|
Space and Intelligence Systems:
Space and Intelligence Systems revenue is primarily derived from U.S. Government development and production contracts and is generally recognized over time using the POC cost-to-cost method. We disaggregate Space and Intelligence Systems revenue by customer relationship, contract type and geographical region. We believe these categories best depict how the nature, amount, timing and uncertainty of Space and Intelligence Systems revenue and cash flows are affected by economic factors:
|
|
|
|
|
|
|
|
|
|
Quarter Ended
|
|
September 28, 2018
|
|
September 29, 2017
|
|
|
|
|
|
(In millions)
|
Revenue By Customer Relationship
|
|
|
|
Prime contractor
|
$
|
352
|
|
|
$
|
334
|
|
Subcontractor
|
136
|
|
|
132
|
|
|
$
|
488
|
|
|
$
|
466
|
|
Revenue By Contract Type
|
|
|
|
Fixed-price
(1)
|
$
|
172
|
|
|
$
|
123
|
|
Cost-reimbursable
|
316
|
|
|
343
|
|
|
$
|
488
|
|
|
$
|
466
|
|
Revenue By Geographical Region
|
|
|
|
United States
|
$
|
476
|
|
|
$
|
452
|
|
International
|
12
|
|
|
14
|
|
|
$
|
488
|
|
|
$
|
466
|
|
|
|
|
|
_______________
|
|
(1)
|
Includes revenue derived from time-and-materials contracts.
|
Total assets by business segment are summarized below:
|
|
|
|
|
|
|
|
|
|
September 28, 2018
|
|
June 29, 2018
|
|
|
|
|
|
(In millions)
|
Total Assets
|
|
|
|
Communication Systems
|
$
|
1,556
|
|
|
$
|
1,567
|
|
Electronic Systems
|
4,204
|
|
|
4,174
|
|
Space and Intelligence Systems
|
2,220
|
|
|
2,193
|
|
Corporate
(1)
|
1,909
|
|
|
1,917
|
|
|
$
|
9,889
|
|
|
$
|
9,851
|
|
|
|
|
|
_______________
|
|
(1)
|
Identifiable intangible assets acquired in connection with our acquisition of Exelis in the fourth quarter of fiscal 2015 were recorded as Corporate assets because they benefitted the entire Company as opposed to any individual segment. Exelis identifiable intangible asset balances recorded as Corporate assets were
$949 million
and
$974 million
at
September 28, 2018
and
June 29, 2018
, respectively. Corporate assets also consisted of cash, income taxes receivable, deferred income taxes, deferred compensation plan assets and buildings and equipment.
|
Note Q — Legal Proceedings and Contingencies
From time to time, as a normal incident of the nature and kind of businesses in which we are or were engaged, various claims or charges are asserted and litigation or arbitration is commenced by or against us arising from or related to matters, including but not limited to: product liability; personal injury; patents, trademarks, trade secrets or other intellectual property; labor and employee disputes; commercial or contractual disputes; strategic acquisitions or divestitures; the prior sale or use of former products allegedly containing asbestos or other restricted materials; breach of warranty; or environmental matters. Claimed amounts against us may be substantial, but may not bear any reasonable relationship to the merits of the claim or the extent of any real risk of court or arbitral awards. We record accruals for losses related to those matters against us that we consider to be probable and that can be reasonably estimated. Gain contingencies, if any, are recognized when they are realized and legal costs generally are expensed when incurred. At
September 28, 2018
, our accrual for the potential resolution of lawsuits, claims or proceedings that we consider probable of being decided unfavorably to us was not material. Although it is not feasible to predict the outcome of these matters with certainty, it is reasonably possible that some lawsuits, claims or proceedings may be disposed of or decided unfavorably to us and in excess of the amounts currently accrued. Based on available information, in the opinion of management, settlements, arbitration awards and final judgments, if any, which are considered probable of being rendered against us in litigation or arbitration in existence at
September 28, 2018
are reserved against or would not have a material adverse effect on our financial condition, results of operations or cash flows.
Environmental Matters
We are subject to numerous U.S. Federal, state, local and international environmental laws and regulatory requirements and are involved from time to time in investigations or litigation of various potential environmental issues. We or companies we have acquired are responsible, or alleged to be responsible, for environmental investigation and/or remediation of multiple sites. These sites are in various stages of investigation and/or remediation and in some cases our liability is considered de minimis. Notices from the U.S. Environmental Protection Agency (“EPA”) or equivalent state or international environmental agencies allege that a number of sites formerly or currently owned and/or operated by us or companies we have acquired, and other properties or water supplies that may be or have been impacted from those operations, contain disposed or recycled materials or wastes and require environmental investigation and/or remediation. These sites include instances of being identified as a potentially responsible party under the Comprehensive Environmental Response, Compensation and Liability Act (commonly known as the “Superfund Act”) and/or equivalent state and international laws. For example, in June 2014, the U.S. Department of Justice (“DOJ”), Environment and Natural Resources Division, notified several potentially responsible parties, including Exelis, of potential responsibility for contribution to the environmental investigation and remediation of multiple locations in Alaska. In addition, in March 2016, the EPA notified over
100
potentially responsible parties, including Exelis, of potential liability for the cost of remediation for the
8.3
-mile stretch of the Lower Passaic River, estimated by the EPA to be
$1.38 billion
, but the parties’ respective allocations have not been determined. Although it is not feasible to predict the outcome of these environmental claims made against us, based on available information, in the opinion of our management, any payments we may be required to make as a result of environmental claims made against us in existence at
September 28, 2018
are reserved against, covered by insurance or would not have a material adverse effect on our financial condition, results of operations or cash flows.
Note R — Subsequent Events
Subsequent to the end of the first quarter of fiscal 2019, on October 14, 2018, we announced that on October 12, 2018, Harris entered into an Agreement and Plan of Merger (the “Merger Agreement”), with L3 Technologies, Inc. (“L3”) and Leopard Merger Sub Inc., a wholly owned subsidiary of Harris (“Merger Sub”), pursuant to which Harris and L3 have agreed to combine in an all-stock merger of equals. Under the terms and subject to the conditions set forth in the Merger Agreement, L3 shareholders will receive a fixed exchange ratio of
1.30
shares of Harris common stock for each share of L3 common stock, consistent with the
60
-trading day average exchange ratio of the
two
companies. Upon closing of the transactions contemplated by the Merger Agreement, Harris will be re-named “L3 Harris Technologies, Inc.” and Merger Sub will merge with and into L3, with L3 being the surviving corporation and becoming a wholly-owned subsidiary of L3 Harris Technologies, Inc., which will be owned on a fully diluted basis approximately
54 percent
by Harris shareholders and
46 percent
by L3 shareholders. The Merger Agreement has been unanimously approved by the Board of Directors of each company. The transactions contemplated by the Merger Agreement are subject to satisfaction of customary closing conditions, including receipt of regulatory approvals and approval by the shareholders of each company, and we currently expect the closing to occur in mid-calendar year 2019, although we can give no assurances regarding the timing or occurrence of closing.
L3 is a leading provider of technical solutions for military, homeland security and commercial platforms headquartered in New York, New York that employs approximately
31,000
and generated calendar 2018 revenue of approximately
$10 billion
. L3 is a prime contractor in intelligence, surveillance and reconnaissance (“ISR”) systems, aircraft sustainment (including modifications and fleet management of special mission aircraft), simulation and training, night vision and image intensification equipment and security and detection systems. L3 is also a leading provider of a broad range of communication, electronic and sensor systems used on military, homeland security and commercial platforms.
The foregoing description of the Merger Agreement and the transactions contemplated thereby is not complete and is subject to, and qualified in its entirety by reference to, the Agreement and Plan of Merger, dated as of October 12, 2018, by and among L3, us, and Merger Sub, a copy of which was filed as an exhibit to our Current Report on Form 8-K filed on October 16, 2018.