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HRS > SEC Filings for HRS > Form 10-K on 25-Aug-2014All Recent SEC Filings

Show all filings for HARRIS CORP /DE/

Form 10-K for HARRIS CORP /DE/


25-Aug-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

OVERVIEW

The following Management's Discussion and Analysis ("MD&A") is intended to assist in an understanding of our financial condition and results of operations. This MD&A is provided as a supplement to, should be read in conjunction with, and is qualified in its entirety by reference to, our Consolidated Financial Statements and accompanying Notes appearing elsewhere in this Report. Except for the historical information contained herein, the discussions in this MD&A contain forward-looking statements that involve risks and uncertainties. Our future results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below in this MD&A under "Forward-Looking Statements and Factors that May Affect Future Results."

The following is a list of the sections of this MD&A, together with our perspective on their contents, which we hope will assist in reading these pages:

Ÿ Business Considerations - a general description of our business; the value drivers of our business; fiscal 2014 results of operations and liquidity and capital resources key indicators; and industry-wide opportunities, challenges and risks that are relevant to us in the defense, government and commercial markets. In this section of this MD&A, "income from continuing operations" refers to income from continuing operations attributable to Harris Corporation common shareholders.

Ÿ Operations Review - an analysis of our consolidated results of operations and of the results in each of our three business segments, to the extent the segment operating results are helpful to an understanding of our business as a whole, for the three years presented in our financial statements. In this section of this MD&A, "income from continuing operations" refers to income from continuing operations attributable to Harris Corporation common shareholders.

Ÿ Liquidity, Capital Resources and Financial Strategies - an analysis of cash flows, common stock repurchases, dividends, capital structure and resources, contractual obligations, off-balance sheet arrangements, commercial commitments, financial risk management, impact of foreign exchange and impact of inflation.

Ÿ Critical Accounting Policies and Estimates - a discussion of accounting policies and estimates that require the most judgment and a discussion of accounting pronouncements that have been issued but not yet implemented by us and their potential impact on our financial position, results of operations and cash flows.

Ÿ Forward-Looking Statements and Factors that May Affect Future Results
- cautionary information about forward-looking statements and a description of certain risks and uncertainties that could cause our actual results to differ materially from our historical results or our current expectations or projections.

BUSINESS CONSIDERATIONS

General

We are an international communications and information technology company serving government and commercial markets in more than 125 countries. We are dedicated to developing best-in-class assured communications® products, systems and services for global markets. Our company generates revenue, income and cash flows by developing, manufacturing and selling communications products and software as well as providing related services. We sell directly to our customers, the largest of which are U.S. Government customers and their prime contractors, and we utilize agents and intermediaries to sell and market some products and services, especially in international markets.

We structure our operations primarily around the products and services we sell and the markets we serve, and we report the financial results of our continuing operations in the following three business segments:

Ÿ RF Communications, serving (i) U.S. Department of Defense and International Tactical Communications ("Tactical Communications") and (ii) Public Safety and Professional Communications markets;

Ÿ Integrated Network Solutions, serving (i) IT Services, (ii) Managed Satellite and Terrestrial Communications Solutions (which market is served by our Harris CapRock Communications business) and (iii) Commercial Healthcare Solutions markets; and

Ÿ Government Communications Systems, serving (i) Civil, (ii) National Intelligence and (iii) Defense markets.

In the third quarter of fiscal 2012, our Board of Directors approved a plan to exit CIS, which provided remote cloud hosting, and to dispose of the related assets, and we completed the sale of the remaining assets of CIS in the first


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quarter of fiscal 2014. In the fourth quarter of fiscal 2012, our Board of Directors approved a plan to divest Broadcast Communications, which provided digital media management solutions in support of broadcast customers, and we completed the sale of Broadcast Communications in the third quarter of fiscal 2013. Both CIS and Broadcast Communications were formerly part of our Integrated Network Solutions segment. For additional information regarding discontinued operations, see Note 3: Discontinued Operations in the Notes. Except for disclosures related to our cash flows, or unless otherwise specified, disclosures in this Report relate solely to our continuing operations.

At the beginning of the first quarter of fiscal 2014, to leverage the breadth of our IT enterprise network and information assurance capabilities for the IT services market, we began managing our cyber security network testing operation as part of our Integrated Network Solutions segment rather than our Government Communications Systems segment. As a result, we reassigned $2.4 million of goodwill (determined on a relative fair value basis) to our Integrated Network Solutions segment from our Government Communications Systems segment. The historical results, discussion and presentation of our business segments as set forth in this Report have been adjusted to reflect the impact of this change to our business segment reporting structure for all periods presented in this Report.

Financial information with respect to all of our other activities, including corporate costs not allocated to the operating segments or discontinued operations, is reported as part of the "Unallocated corporate expense" or "Non-operating income (loss)" line items in our Consolidated Financial Statements and accompanying Notes.

Value Drivers of Our Business

Our two core value drivers are excellence and innovation.

Our Company-wide commitment to excellence is embodied in our Harris Business Excellence ("HBX") program, which provides the framework and tools that empower every employee to drive continuous improvement in business performance and customer satisfaction. HBX incorporates standardized, industry-proven processes and tools based on the principles of Lean and Six Sigma. Fiscal 2014 was the first full year of program implementation, and we made significant strides in three primary areas - customer satisfaction, productivity and asset velocity - through our efforts to optimize processes, eliminate waste, reduce costs and enhance quality across our Company, including in areas such as manufacturing and field operations, supply chain and overhead functions, and working capital initiatives. One method we use to drive continuous improvement is "value engineering" - continuously evaluating new materials, processes and technologies to insert into products already in production, helping to reduce costs and improve both quality and customer satisfaction.

Innovation is at the very core of our success, and investment in research and development ("R&D") represents its foundation. Our R&D investments are focused on adding new features to existing products, tailoring offerings for international markets, and creating totally new-to-the-world solutions to address our customers' toughest communications challenges. Innovation also leads to natural extensions of our core capabilities for capturing new opportunities in adjacent markets. Innovation provides differentiation and a key competitive advantage for us.

To ensure our investment in R&D is cost-effective and supports innovation across the entire Company, we have adopted a portfolio management approach, optimizing investment at the Company level rather than the business unit level. We have introduced standardized processes and common metrics to track progress and gauge success, and we have established Core Technology Centers to more fully leverage R&D investment across our Company.

Innovation at Harris also includes introducing new business models to the marketplace to provide our customers with innovative solutions at lower costs. For example, in the tactical communications market, we provide a "commercial off-the-shelf" approach that entails investing our own R&D funds to provide new mission-critical communications at a much faster pace and lower cost compared to the lengthy development cycle of the traditional program-of-record approach. We also partnered with the FAA to provide a fully-managed service for the FAA FTI network that provides mission-critical network capabilities to connect controllers and pilots across more than 4,000 nodes, resulting in significantly higher bandwidth and uptime at half the cost of the traditional approach. We also are at the forefront of a unique piggyback approach of using commercially-hosted satellite payloads to provide multiple missions on satellites, speeding time-to-mission and lowering costs compared to the traditional model of building and launching separate exquisite satellites for each mission requirement.

Key Indicators

We believe our value drivers, when implemented, will improve our financial results, including: income from continuing operations and income from continuing operations per diluted common share; revenue; income from continuing operations as a percentage of revenue; net cash provided by operating activities; return on invested capital; and return on average equity. The measure of our success is reflected in our results of operations and liquidity and capital resources key indicators as discussed below.


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Fiscal 2014 Results of Operations Key Indicators: Income from continuing operations, income from continuing operations per diluted common share, revenue, and income from continuing operations as a percentage of revenue represent key measurements of our value drivers:

Ÿ Income from continuing operations increased 15.7 percent to $539.8 million in fiscal 2014 from $466.4 million in fiscal 2013;

Ÿ Income from continuing operations per diluted common share increased 20.2 percent to $5.00 in fiscal 2014 from $4.16 in fiscal 2013;

Ÿ Revenue decreased 2.0 percent to $5.0 billion in fiscal 2014 from $5.1 billion in fiscal 2013; and

Ÿ Income from continuing operations as a percentage of revenue increased to 10.8 percent in fiscal 2014 from 9.1 percent in fiscal 2013.

Refer to MD&A heading "Operations Review" below in this Report for more information.

Liquidity and Capital Resources Key Indicators: Net cash provided by operating activities, return on invested capital and return on average equity also represent key measurements of our value drivers:

Ÿ Net cash provided by operating activities increased to $849.2 million in fiscal 2014 from $833.0 million in fiscal 2013;

Ÿ Return on invested capital (defined as after-tax operating income from continuing operations divided by the two-point average of invested capital at the beginning and ending of the fiscal year, where invested capital equals equity plus debt, less cash and cash equivalents) increased to 20.4 percent in fiscal 2014 from 17.1 percent in fiscal 2013; and

Ÿ Return on average equity (defined as income from continuing operations divided by the two-point average of equity at the beginning and ending of the fiscal year) increased to 31.9 percent in fiscal 2014 from 26.6 percent in fiscal 2013.

Refer to MD&A heading "Liquidity, Capital Resources and Financial Strategies" below in this Report for more information on net cash provided by operating activities.

Industry-Wide Opportunities, Challenges and Risks

Department of Defense and Other U.S. Federal Markets: U.S. Government budgets remained constrained in fiscal 2014, and we anticipate a similarly constrained spending environment in fiscal 2015. Contributing to the slow spending environment and similar to U.S. Government Fiscal Year ("GFY") 2014, Congress has yet to pass the GFY 2015 appropriations bills. This means specific budget allocations by program have not been finalized, and if not passed by October 1, 2014, we expect the U.S. Government will operate under a continuing resolution.

Deficit spending has caused U.S. Government budgets to come under significant pressure. In particular, the Budget Control Act of 2011 resulted in automatic spending reductions, known as sequestration, through budget caps for both defense and non-defense spending. In December 2013, Congress enacted the Bipartisan Budget Act of 2013, modifying the budget caps and increasing the limits on discretionary defense spending for GFY 2014 and GFY 2015 by approximately $22 billion and $9 billion, respectively, with similar spending relief for non-defense government spending. This resulted in a U.S. national defense spending cap of approximately $520 billion for GFY 2014 and approximately $521 billion for GFY 2015. Passing the 2-year, Bipartisan Budget Act of 2013 provided more certainty in the budget planning process for both GFY 2014 and 2015 and gave the DoD flexibility in deciding priorities.

For GFYs 2016 through 2021, however, the Bipartisan Budget Act of 2013 retained the previous budget caps and across-the-board spending reduction methodology as provided under the Budget Control Act of 2011, and as a result of the return to full sequestration, there remains uncertainty regarding how sequester cuts would be applied in GFY 2016 and beyond. Even under full sequestration, though, the national defense spending cap would be approximately $523 billion for GFY 2016, which is higher than the cap for GFY 2015. Alternatively, under the President's budget request dated March 2014, which ignores spending caps, national defense spending for GFY 2016 would also be higher at approximately $535 billion.

Government Oversight and Risk: As a U.S. Government contractor, we are subject to U.S. Government oversight. The U.S. Government may investigate our business practices and audit our compliance with applicable rules and regulations. Depending on the results of those investigations and audits, the U.S. Government could make claims against us. Under U.S. Government procurement regulations and practices, an indictment or conviction of a government contractor could result in that contractor being fined and/or suspended from being able to bid on, or from being awarded, new U.S. Government contracts for a period of time. Similar government oversight exists in most other countries where we conduct business.


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For a discussion of risks relating to U.S. Government contracts and subcontracts, see "Item 1. Business - Principal Customers; Government Contracts" and "Item 1A. Risk Factors" of this Report. We are also subject to other risks associated with U.S. Government business, including technological uncertainties, dependence on annual appropriations and allotment of funds, extensive regulations and other risks, which are discussed in "Item 1A. Risk Factors" and "Item 3. Legal Proceedings" of this Report.

State and Local: We also provide products to state and local government agencies that are committed to protecting our homeland and public safety. The public safety market weakened during fiscal 2014, having concluded an upgrade cycle primarily related to the Federal Communications Commission's narrow-banding mandate that drove higher-than-average market demand. Future market opportunities include upgrading aging analog infrastructure to new digital standards, as well as opportunities associated with next-generation LTE solutions for high data-rate applications, an emerging market in the early stages of development.

International: We believe there is continuing international demand for tactical radio and public safety communications for military, government, and commercial customers, as well as for turnkey managed satellite communications solutions for government, energy and maritime markets. We believe we can leverage our domain expertise and proven technology provided in the U.S. for air traffic management, weather ground system technology and commercially hosted satellite payloads in pursuing international opportunities to further expand our international business.

Commercial: We are leveraging proven technologies and capabilities for government applications into attractive commercial markets. After a long history of providing satellite antennas, space electronics, and payload technology to the government market, we are applying that same technology and capability in the commercial space market. Similarly, we provide turnkey managed satellite communications solutions not only to government customers in remote and harsh locations but also for commercial energy and maritime customers. After first addressing the government healthcare IT market, we began providing a full range of interoperability and business intelligence solutions to address the growing complexity in the commercial healthcare IT market. Also, an initiative is underway to leverage our success in providing weather ground system technology for the government market into commercial markets such as agriculture, which relies heavily on advanced forecasting capabilities and other weather information.

We believe that our experience, technologies and capabilities are well aligned with the demand and requirements of the markets noted above in this Report. However, we remain subject to the spending levels, pace and priorities of the U.S. Government as well as international governments and commercial customers, and to general economic conditions that could adversely affect us, our customers and our suppliers. We also remain subject to other risks associated with these markets, including technological uncertainties, adoption of our new products and other risks that are discussed below in this Report under "Forward-Looking Statements and Factors that May Affect Future Results" and in "Item 1A. Risk Factors" of this Report.


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OPERATIONS REVIEW

Consolidated Results of Operations

                                                                 Fiscal Years Ended
                                                                    2014/2013                            2013/2012
                                                                     Percent                              Percent
                                                                    Increase/                            Increase/
                                    2014             2013           (Decrease)            2012           (Decrease)
                                                   (Dollars in millions, except per share amounts)
Revenue:
RF Communications                $  1,828.0       $  1,849.0               (1.1 )%     $  2,144.1              (13.8 )%
Integrated Network Solutions        1,462.9          1,575.8               (7.2 )%        1,609.9               (2.1 )%
Government Communications
Systems                             1,801.2          1,783.8                1.0 %         1,786.0               (0.1 )%
Corporate eliminations                (80.1 )          (96.9 )            (17.3 )%          (88.7 )              9.2 %

Total revenue                       5,012.0          5,111.7               (2.0 )%        5,451.3               (6.2 )%

Cost of product sales and
services:
Cost of product sales              (1,857.1 )       (1,919.4 )             (3.2 )%       (2,137.6 )            (10.2 )%
% of revenue from product
sales                                  58.2 %           59.9 %                               59.4 %
Cost of services                   (1,453.4 )       (1,465.6 )             (0.8 )%       (1,431.7 )              2.4 %
% of revenue from services             79.7 %           76.8 %                               77.2 %

Total cost of product sales
and services                       (3,310.5 )       (3,385.0 )             (2.2 )%       (3,569.3 )             (5.2 )%
% of total revenue                     66.1 %           66.2 %                               65.5 %

Gross margin                        1,701.5          1,726.7               (1.5 )%        1,882.0               (8.3 )%
% of total revenue                     33.9 %           33.8 %                               34.5 %

Engineering, selling and
administrative expenses              (819.6 )         (914.5 )            (10.4 )%         (940.9 )             (2.8 )%
% of total revenue                     16.4 %           17.9 %                               17.3 %

Non-operating income (loss)             4.3            (40.7 )                *              11.5                  *
Net interest expense                  (90.8 )         (106.9 )            (15.1 )%         (110.7 )             (3.4 )%

Income from continuing
operations before income
taxes                                 795.4            664.6               19.7 %           841.9              (21.1 )%
Income taxes                         (256.2 )         (202.7 )             26.4 %          (286.0 )            (29.1 )%
Effective tax rate                     32.2 %           30.5 %                               34.0 %


Income from continuing
operations                            539.2            461.9               16.7 %           555.9              (16.9 )%
Noncontrolling interests, net
of income taxes                         0.6              4.5              (86.7 )%            2.8               60.7 %

Income from continuing
operations attributable to
Harris Corporation common
shareholders                          539.8            466.4               15.7 %           558.7              (16.5 )%
% of total revenue                     10.8 %            9.1 %                               10.2 %

Discontinued operations, net
of income taxes                        (5.0 )         (353.4 )            (98.6 )%         (528.1 )            (33.1 )%

Net income attributable to
Harris Corporation common
shareholders                     $    534.8       $    113.0              373.3 %      $     30.6              269.3 %

Income from continuing
operations per diluted common
share attributable to Harris
Corporation common
shareholders                     $     5.00       $     4.16              20.2  %      $     4.80              (13.3 )%

* Not meaningful

Revenue

Fiscal 2014 Compared With Fiscal 2013: The decrease in revenue in fiscal 2014 compared with fiscal 2013 was primarily due to lower revenue in our Integrated Network Solutions segment, while modestly lower revenue in our RF Communications segment offset modestly higher revenue in our Government Communications Systems segment. The $113 million decrease in revenue in our Integrated Network Solutions segment was primarily due to lower revenue from U.S. Government customers across the segment.


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Fiscal 2013 Compared With Fiscal 2012: The decrease in revenue in fiscal 2013 compared with fiscal 2012 was primarily due to lower revenue in our RF Communications and Integrated Network Solutions segments. The $295 million decrease in revenue in our RF Communications segment was primarily due to lower Tactical Communications revenue. The $34 million decrease in revenue in our Integrated Network Solutions segment was due to lower IT Services revenue, partially offset by moderate revenue growth in Harris CapRock Communications and our healthcare operations.

See the "Discussion of Business Segment Results of Operations" discussion below in this MD&A for further information.

Gross Margin Percentage

Fiscal 2014 Compared With Fiscal 2013: Gross margin as a percentage of revenue ("gross margin percentage") in fiscal 2014 was essentially unchanged from fiscal 2013 and primarily reflects a 1.0 percentage point increase in gross margin percentage in our Government Communications Systems segment resulting from good program execution, partially offset by a 0.7 percentage point decrease in gross margin percentage in our RF Communications segment resulting from weakness at Public Safety and Professional Communications.

Fiscal 2013 Compared With Fiscal 2012: The decrease in gross margin percentage in fiscal 2013 compared with fiscal 2012 was primarily due to a lower percentage of our overall sales generated by our higher-margin RF Communications segment and a 1.9 percentage point decrease in gross margin percentage in our Integrated Network Solutions segment, partially offset by a 1.4 percentage point increase in gross margin percentage in our RF Communications segment.

See the "Discussion of Business Segment Results of Operations" discussion below in this MD&A for further information.

Engineering, Selling and Administrative Expenses

Fiscal 2014 Compared With Fiscal 2013: The decrease in engineering, selling and administrative ("ESA") expenses and ESA expenses as a percentage of revenue ("ESA percentage") in fiscal 2014 compared with fiscal 2013 was primarily due to $74.7 million of charges recorded in the fourth quarter of fiscal 2013 for company-wide restructuring and other actions and the benefit in fiscal 2014 from prior-year restructuring actions, and an out-of-period adjustment in the third quarter of fiscal 2014 related to our post-employment benefit plan that reduced general and administrative expenses, partially offset by higher research and development expenses.

Overall Company-sponsored research and development costs were $264.1 million in fiscal 2014 compared with $254.1 million in fiscal 2013 (including a $17.8 million write-off of capitalized software in our Integrated Network Solutions segment, as described below).

Fiscal 2013 Compared With Fiscal 2012: The increase in ESA percentage in fiscal 2013 compared with fiscal 2012 was primarily due to a 3.0 percentage point increase in ESA percentage in our RF Communications segment, partially offset by a 2.5 percentage point decrease in ESA percentage in our Integrated Network Solutions segment. The increase in ESA percentage in our RF Communications segment was primarily driven by ESA expenses in fiscal 2013 that were essentially flat with fiscal 2012 relative to a 14 percent decrease in segment revenue. Although benefiting from operational excellence initiatives and restructuring actions, RF Communications segment ESA expenses in fiscal 2013 were higher primarily due to an 8 percent increase in spending on research and development compared with fiscal 2012 and also included a $9 million charge for restructuring actions in the fourth quarter of fiscal 2013. The decrease in ESA percentage in our Integrated Network Solutions segment was primarily due to lower general and administrative expenses, including the impact of ongoing cost-reduction efforts and $58 million of charges recorded in fiscal 2012 for integration and other costs associated with our acquisitions of CapRock, Schlumberger GCS and Carefx, partially offset by $44 million of charges recorded in fiscal 2013 for asset impairments and a $17.8 million write-off of . . .

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