It's going to be a big year for Harris Corp. (NYSE:HRS), which has a $15 billion deal pending that would catapult this under-the-radar communications and electronics vendor onto the upper echelon of defense contractors. Harris ended 2018 on a high note as well, and in the process gave investors ample reason to be excited about what's to come in the year ahead.
Harris reported adjusted earnings per share of $1.96 for its fiscal second quarter, beating the consensus estimate of $1.90 per share in earnings on revenue that came in $30 million above expectations. The company said that orders were up 27% year over year, resulting in a book-to-bill ratio of 1.06 times.
Things weren't so rosy over at merger partner L3 Technologies (NYSE:LLL), which reported adjusted fourth-quarter earnings per share of $3.10, which was $0.40 ahead of estimates thanks to a lower tax rate, decreased share count, and other items. The company actually came in about $23 million light on operating earnings if you back out tax rates and other items for issues related to its business building traveling wave tube amplifiers.
The quarterly results are important, but all eyes are understandably on what is to come as the two companies combine.
Harris shooting for the stars
Harris in recent years has focused its attention on sensors, radios, and other products aimed at the space, defense, and civilian government markets, and those businesses all reported strong numbers. Its communications systems division saw sales grow 10% from a year prior on strong demand from the Pentagon for night-vision goggles, as well as government modernization efforts. The unit delivered a 30% margin in the quarter, a range that the company is targeting for future quarters as well.
The company is benefiting from a push by state and federal agencies to upgrade systems, winning a $33 million order from Nevada for work on a statewide radio system and a $23 million order from the Air National Guard for communications tech.
Harris' space and intelligence unit also grew revenue by 11% due to increased demand coming from classified programs. CEO William Brown on a call with analysts said that Harris' shift from building components used on satellites made by other vendors to manufacturing what he calls "smallsats" entirely in-house has attracted more than $350 million worth of orders from the defense and intelligence community.
That business could grow bigger over time. Harris has the opportunity to compete for classified constellation work that could include hundreds of satellites, "so we do see over time that could be a very big opportunity for the company," Brown said.
Harris raised full fiscal year guidance on its call, boosting earnings estimates by $0.10 per share on higher sales and total company margin of 19.5% to 20%, higher than the prior 19.3% to 19.7% estimates. It also said it was on track to meet or slightly exceed its projection of $1 billion in full-year free cash flow.
L3 dinged by self-inflicted wound
Over at L3, total quarterly revenue of $2.77 billion beat expectations by $80 million based on a strong showing from its intelligence, surveillance, and reconnaissance business. Its issues came from its communications and networked systems division, which is still struggling from a 2017 decision to shed a facility where wave tubes were being manufactured.
Closing that facility and moving the business resulted in a loss of talent, which combined with the company misreading commercial space demand and other supply chain issues to derail quarterly results.
"It was pretty much a perfect storm as to all of the things that could have gone wrong," L3 CEO Christopher Kubasik said on a call with analysts.
Importantly, L-3 doesn't seem to think there will be a long-lasting effect. The company reaffirmed the 2019 guidance it filed as part of the merger paperwork, which included a 5% growth in revenue, 12% EBIT margins, and just more than $1 billion in free cash flow.
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Harris and L3 have each on their own in recent years been repositioning their businesses to capitalize on specific areas of Pentagon and government need where their expertise will allow them to compete against defense titans. The strategy, despite L3's recent stumbles, appears to be working for each individual company, and combined the two firms have the makings of a military electronics powerhouse.
There will be disruptions from the deal: Harris expects to be forced to divest its $155 million-sales night vision product line in order to win regulatory approval, though the company will still compete for new orders thanks to L3's similar business.
Brown said the deal is on track to close midyear and reiterated early expectations for $500 million in gross synergies. I believe based on Harris' success in integrating its $4.75 billion purchase of Exelis in 2015 and L3's long history as an acquirer, that number will prove to be conservative, and because it's an all-stock deal, the combined company will have plenty of cash to deploy for growth or to return to shareholders.
Mergers inherently come with risk, but I trust these management teams and believe this is the right combination at the right time. Investors would do well to buy into Harris while the company is still on the launching pad.