WASHINGTON — Harris Corporation saw its ranking on the 2016 Defense News Top 100 jump a whopping 22 spots, thanks largely to its acquisition of Exelis. For the 2017 list, its movement was understandably less dramatic, down a few slots due primarily to its divestiture of two businesses.
Defense News Executive Editor Jill Aitoro spoke to CEO Bill Brown to find out where the company sees its future opportunity, and how narrowing focus can enable growth.
Harris released its fourth-quarter and full-year earnings last week. Give me a snapshot of how the year went.
Just in a snapshot of Q4, we’re up organically after a number of quarters being down, and we’ve guided to being up organically 2 to 4 percent in fiscal ’18. Our margins came up very nicely in the quarter and the full year, to about 19.2 percent. Our orders were good, very strong year over year in the quarter, so good backlog growth going into next year. And I think one of the highlights of our fiscal ’17 was record free-cash generation. We came in at $850 million of free cash, well above last year. And, in fact, each year in the last five years have been record in terms of free-cash generation. We’ve guided to nice growth going into next year, up 2 to 4 percent, a little higher in our communications and electronics business, a little bit lower — flat or up 1 percent — in our space and intel business. We do see good, strong margins next year, and we see another year of record free-cash generation in fiscal ’18.
You’re very familiar with what we’ve done with our portfolio after we bought Exelis, [which] we closed on two years ago. We sold two businesses — CapRock and our government IT services this past year, which netted over $1 billion in proceeds. The total sales were about $1.4 billion. It gets us very focused, very lean on businesses that are technology-driven for our government and international governments. We completed Exelis integration. We said it would take us three years and generate between $100 [million] and $120 million of savings, and we finished a year early and it came in at $145 million synergy run rates. We feel very good about Exelis integration. Again, I talked about the record free cash, which is good. We used that, plus some of the proceeds from divestitures, to launch the largest share-buyback program we’ve had in this history of the corporation. We bought back just about $700 million of stock and had about $900 million in cash returned to shareholders this past year. It was very good use and deployment of capital, I believe. And we also used some of the cash to de-risk our balance sheets. We’ve been paying down debt that we took on with the Exelis acquisition; we’re about $1.3 billion towards our goal of about $2 billion by the end of ’18, so nearly there.
But we also contributed to and de-risked our pension plan. We won’t have any cash contributions required over the next several years. That’s important to know because it was one of the considerations when we bought Exelis. We have reduced our pension deficit by $1 billion, or about 40 percent, in the last year to $1.3 billion.
And one of the hallmarks of the company is, even though we’re maintaining those high margins, we continue to invest significantly in internal R&D. Company-funded R&D has been running at about 5 percent of revenue as a company — well ahead of our peers. And I think that, and some of the investments that we’ve made, is what’s allowing us to grow into fiscal ’18. I feel really good about what the team has accomplished over the course of fiscal ’17.
I recall Exelis had a bigger issue with pension liability than some. I know it’s a little bit of a false liability sometimes, given it’s dependent upon rates, but I remember when the acquisition happened, that was a factor that came up.
That’s exactly right. We did not have a pension, but they did. It was a relatively small company, and when you looked at the size of the unfunded liability — or even the gross liability — as a percentage of the market cap, it was one of the highest in the industry — in any industry in the U.S. Because of that, they were a little bit constrained [in terms of] being able to invest in new technologies to advance their business. Together, we’ve been able to absorb potential liability, we generated cash to fund it, interest rates have worked a little bit in our favor — as we had expected that they would — and we continue to invest heavily into our business. And I think you’re seeing that in the growth that’s coming through next year. It’s not just in the legacy Harris, but it’s also in the Exelis businesses as well.
So digging a little bit more, I know you saw a healthy uptake in tactical communications, driven a bit by some of the legacy radio sales internationally. Is that a long-term revenue base, or do you see that eventually petering out in terms of global buys?
We had a very good year in our tactical business. We came in about flat year over year, [whereas] we were guiding at the beginning of the year to be down pretty substantially. So better than we thought. A lot of it came out of Europe; Europe had a fantastic year, far above the prior year, upwards of 50 percent. And a lot of it is the funding that’s happening in Eastern Europe.. A lot of it is national funds. For example, Ukraine is U.S.-government funded, with a lot of investment in upgrading their network architecture. We also saw good growth in Canada, in the Central American, Latin American region. Overall, it was good. We were soft in the Middle East, [but] we knew that was going to happen. Soft in Central Asia — again, we knew that was going to happen. As we look into fiscal ’18, we see our international tactical business to be flat, or even down modestly. We’ll see very good growth in the Middle East and Africa. Africa is very strong, Northern Africa as well as sub-Saharan. We’ll see good growth in Asia, primarily coming out of Australia.
We’ll see Europe come down a little bit because it’s coming off a record year. We’ll see Central America coming down a little bit, again off a record year.
Space and intel was down a bit, but if I’m remembering correctly, that was mainly attributable to nondefense business. Am I right?
It was down about 4 percent in the quarter. It was about flat for the year, and that’s where we expected it to be. Two-thirds of that business is classified, and those budget[s] are growing well. And it’s growing in areas where we’ve got good positions. So, the outlook for the classified side of that business is pretty good.
Now in terms of that classified business, I know by its very definition you can’t talk much about it. But are there general statements in terms of the kind of investments that are really driving some of the stronger growth in that area?
For us in particular, where we’ve seen growth is around what they call space superiority -- the ability to protect the overhead architectural assets. And we have great positions in lots of different domains that support that. That’s the biggest area, it’s well-funded, and you can read very much publicly around some of the concerns that happen to be out there. Exelis has a good, strong electro-optic capability, Harris is more of a [radio frequency] player, and the combination of those two basic technologies is also opening up new mission areas for us, more end-to-end solutions that we can provide to the classified community. That’s really what’s driving the growth in the classified.
Now you mentioned, of course, that you had a couple of divestitures. Was there anything, in retrospect, that you need to build back up?
We got out of what businesses that we thought were more commodity like. So CapRock was one where they were a provider of bandwidth to both commercial and government customer. But they were an intermediary in many ways, selling capacity. We [also] sold our IT services business, which again was relatively low margin. We got out of those two pieces. What we have right now is we’ve got a great set of core businesses, core franchise. They’re all of scale, they all require technology for differentiation and I think we’re all well-positioned — given where the budgets are moving — to grow really across all of them.
You recently announced a win under the Army mobile network program. Can you give me an update on that?
Yes. It’s very, very interesting. We won a position on a $461 million IDIQ [indefinite-delivery, indefinite-quantity contract]. Typically, the Army spends between $20 [million] to $40 million a year upgrading their land mobile radio, or LMR, technology on U.S. bases. And our competitor in this space was sole-sourced up until now. That procurement has been opened. We won a position on an IDIQ and received an initial task order of $10 million. It allows us to go and compete to provide radio technology for U.S. Army bases in the U.S., and I think it will open up to other service bases in the U.S. as well. It’s a new market that we weren’t able to compete in before, and allows us to leverage off the relationships that we have today across all the services including in the Army.
That area of the business has always had its up and downs, if I remember correctly. How significant would this be in terms of potentially stabilizing the revenue there?
I think it would be a piece of it. That public safety business is low $400 millions in size.. This year it was down about 5 percent, and we’ve seen the business erode a little bit every year for the last several years. Going into fiscal ’18, we’ve seen it stabilizing. It can grow beyond that; in the low-, single-digit range is what we would expect. And winning a position on this contract vehicle — which again could provide $20 [million] to $40 million of opportunity — could drive some incremental growth for us.
Where do you see the most potential growth in the coming year for Harris?
We’ve got three segments. Our electronic systems segment has been growing very, very well. It had very strong growth this past year, up about 4 percent. We see that business growing in the mid- to high-single digits beyond fiscal ’18. It’s got a number of different pieces: one is our electronic warfare business. That business has been growing very well, orders are very strong, growing at a double-digit rate. We provide the electronic warfare systems for international F-16s, many of which will be upgraded over time. We provide the Integrated Defensive Electronic Countermeasures system for F-18s, [which involves both] new builds as well as retrofits on them. We provide the electronic warfare system on the B-52, which is being upgraded. We provide the EW systems on certain rotary aircraft. All of these are being updated, upgraded, based on threats that we’re seeing from around the world.