Can "Small" Defense Contractor Harris Survive?

Following the implementation of sequestration, I wrote an article about how "big" defense contractors, such as Boeing (NYSE: BA  ) and Northrop Grumman (NYSE: NOC  ) , would feel the pinch but probably be OK, whereas "small" defense contractors had more to worry about.

Well, Harris (NYSE: HRS  ) , a communication and IT company, falls into the category of "small defense contractor." So to get an idea of how it's doing, I interviewed Harris' CEO, Bill Brown. Here's what he had to say about Harris and sequestration.

The broken government bank
Unquestionably, sequestration is bad for defense companies. In fact, when I asked Brown about Harris' biggest challenge, here's what he said:

"The biggest challenge was that the external environment was rapidly changing. Our core U.S. government customers, who represent more than two-thirds of our revenue, were experiencing a highly uncertain and challenging fiscal environment."  

To put that into numbers, on its latest 10-K, filed on Aug. 28, Harris reported that its total backlog as of June 28 was $6,789 million, compared with approximately $6,993 million at the end of fiscal 2012.

However, the decrease in backlog isn't unique to Harris. For example, in Northrop Grumman's latest quarterly report, its total backlog ending June 30 declined to $37.7 billion, compared with $40.8 billion last Dec. 31, 2012. In contrast, Boeing's total backlog increased thanks to strong commercial airline sales, but its total defense backlog decreased to $51.5 billion on June 30, compared with $51.6 billion on March 31. Clearly, sequestration is hurting defense profits.

But it's not catching Harris unaware. As Brown said:

We have factored the expected impact of sequestration into our fiscal 2014 guidance, and we expect top-line revenue to be 1-3% lower than in FY13. Our view of the impact is based on a combination of customer feedback on larger programs and a broad cut on the remaining business. Beyond that, outside of a clear budget resolution, it is difficult for anyone to tell what the actual impact will be.  

Can Harris survive?
Reduced government spending isn't likely to change anytime soon. So, to combat it, here's what Brown said Harris needs to do: "Diversify our sales and earnings base, shift the business portfolio to higher growth verticals and international markets, and adapt our skills honed performing U.S. government contracts to faster-paced, more complex international and commercial markets."  

And that's not just talk. In June, Harris won a $92 million contract from a Middle Eastern company to supply it with Fusion 4G LTE base stations and tactical radios. And in July, Harris won a $61 million order from Poland to supply the Ministry of National Defense with Falcon III AN/PRC-117G manpack radios, and Falcon III AN/PRC-152A handheld radios.  

Moreover, Harris is continuing to win contracts in the United States. Recently, Harris won a $38 million contract to supply the Air Force with Falcon III AN/PRC-117G multiband manpack and AN/PRC-152A multiband handheld tactical radio systems. Also in September, Harris won a $140.7 million contract to produce mid-tier networking vehicular radios for the U.S. Army. Further, at the end of September Harris won a place on the Army's $4.1 billion contract for communications and transmissions systems.

What this means going forward
Sequestration is moving full steam ahead, but Harris is facing it head-on. Yes, it's experienced a decrease in its backlog and revenue projections, but that's expected, given the current government budget environment. Further, Harris has a plan on how to survive reduced spending and is actively expanding into international markets. In addition, Harris has a few competitive advantages up its sleeve, which we'll dive into in Part 4 of my exclusive interview with Bill Brown. Check back soon.

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