10-Q 1 hrsq2fy1810-q.htm 10-Q Document

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 29, 2017
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                              to                            _
Commission File Number: 1-3863
HARRIS CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
 
34-0276860
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
1025 West NASA Boulevard
Melbourne, Florida
 
329l9
(Address of principal executive offices)
 
(Zip Code)
 
(321) 727-9l00
(Registrant’s telephone number, including area code)
 
No changes
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                                                                         þ   Yes    p  No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).                                                     þ  Yes    p  No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
þ
  
 
Accelerated filer
o
Non-accelerated filer
 
o
  
(Do not check if a smaller reporting company)
Smaller reporting company
o
Emerging growth company
 
o
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. p
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).      p  Yes    þ  No
The number of shares outstanding of the registrant’s common stock as of January 26, 2018 was 118,729,803 shares.
 



HARRIS CORPORATION
FORM 10-Q
For the Quarter Ended December 29, 2017
INDEX
 
 
 
 
Page
Part I. Financial Information:
 
Item 1. Financial Statements (Unaudited):
 
Condensed Consolidated Statement of Income for the Quarter and Two Quarters Ended December 29, 2017 and December 30, 2016
Condensed Consolidated Statement of Comprehensive Income for the Quarter and Two Quarters Ended December 29, 2017 and December 30, 2016
Condensed Consolidated Balance Sheet at December 29, 2017 and June 30, 2017
Condensed Consolidated Statement of Cash Flows for the Two Quarters Ended December 29, 2017 and December 30, 2016
Notes to Condensed Consolidated Financial Statements
Review Report of Independent Registered Certified Public Accounting Firm
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
 
 
Part II. Other Information:
 
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
 
 
Signature
This Quarterly Report on Form 10-Q contains trademarks, service marks and registered marks of Harris Corporation and its subsidiaries.




PART I. FINANCIAL INFORMATION
Item 1. Financial Statements.
HARRIS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF INCOME
(Unaudited)
 
Quarter Ended
 
Two Quarters Ended
 
December 29,
2017
 
December 30,
2016
 
December 29,
2017
 
December 30,
2016
 
 
 
 
 
 
 
 
 
(In millions, except per share amounts)
Revenue from product sales and services
$
1,535

 
$
1,449

 
$
2,948

 
$
2,869

Cost of product sales and services
(999
)
 
(920
)
 
(1,897
)
 
(1,817
)
Engineering, selling and administrative expenses
(264
)
 
(252
)
 
(507
)
 
(529
)
Operating income
272

 
277

 
544

 
523

Non-operating income (loss)
(2
)
 
1

 
(2
)
 
2

Interest income
1

 
1

 
1

 
1

Interest expense
(42
)
 
(44
)
 
(83
)
 
(88
)
Income from continuing operations before income taxes
229

 
235

 
460

 
438

Income taxes
(90
)
 
(72
)
 
(154
)
 
(130
)
Income from continuing operations
139

 
163

 
306

 
308

Discontinued operations, net of income taxes

 
14

 
(6
)
 
29

Net income
$
139

 
$
177

 
$
300

 
$
337

 
 
 
 
 
 
 
 
Net income per common share
 
 
 
 
 
 
 
Basic
 
 
 
 
 
 
 
Continuing operations
$
1.17

 
$
1.32

 
$
2.57

 
$
2.49

Discontinued operations

 
0.10

 
(0.05
)
 
0.22

 
$
1.17

 
$
1.42

 
$
2.52

 
$
2.71

Diluted
 
 
 
 
 
 
 
Continuing operations
$
1.15

 
$
1.30

 
$
2.52

 
$
2.45

Discontinued operations

 
0.10

 
(0.05
)
 
0.23

 
$
1.15

 
$
1.40

 
$
2.47

 
$
2.68

 
 
 
 
 
 
 
 
Cash dividends paid per common share
$
0.57

 
$
0.53

 
$
1.14

 
$
1.06

Basic weighted average common shares outstanding
118.5

 
123.7

 
118.8

 
123.8

Diluted weighted average common shares outstanding
120.9

 
125.4

 
121.1

 
125.5

See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).

1


HARRIS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(Unaudited)
 
 
Quarter Ended
 
Two Quarters Ended
 
December 29,
2017
 
December 30,
2016
 
December 29,
2017
 
December 30,
2016
 
 
 
 
 
 
 
 
 
(In millions)
Net income
$
139

 
$
177

 
$
300

 
$
337

Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation gain (loss), net of income taxes
(4
)
 
(26
)
 
21

 
(29
)
Net unrealized gain (loss) on hedging derivatives, net of income taxes

 
(1
)
 
1

 
(1
)
Net unrecognized gain on postretirement obligations, net of income taxes

 
1

 

 
2

Other comprehensive income (loss), net of income taxes
(4
)
 
(26
)
 
22

 
(28
)
Total comprehensive income
$
135

 
$
151

 
$
322

 
$
309

See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).

2


HARRIS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
(Unaudited)
 
December 29,
2017
 
June 30,
2017
 
 
 
 
 
(In millions, except shares)
Assets
 
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
422

 
$
484

Receivables
642

 
623

Inventories
942

 
841

Income taxes receivable
24

 
24

Other current assets
102

 
101

Total current assets
2,132

 
2,073

Non-current Assets
 
 
 
Property, plant and equipment
878

 
904

Goodwill
5,374

 
5,366

Other intangible assets
1,048

 
1,104

Non-current deferred income taxes
209

 
409

Other non-current assets
215

 
234

Total non-current assets
7,724

 
8,017

 
$
9,856

 
$
10,090

Liabilities and Equity
 
 
 
Current Liabilities
 
 
 
Short-term debt
$
5

 
$
80

Accounts payable
462

 
540

Compensation and benefits
120

 
140

Other accrued items
303

 
329

Advance payments and unearned income
290

 
252

Income taxes payable
38

 
31

Current portion of long-term debt
523

 
554

Total current liabilities
1,741

 
1,926

Non-current Liabilities
 
 
 
Defined benefit plans
1,202

 
1,278

Long-term debt, net
3,391

 
3,396

Non-current deferred income taxes
34

 
34

Other long-term liabilities
494

 
528

Total non-current liabilities
5,121

 
5,236

Equity
 
 
 
Shareholders’ Equity:
 
 
 
Preferred stock, without par value; 1,000,000 shares authorized; none issued

 

Common stock, $1.00 par value; 500,000,000 shares authorized; issued and outstanding 118,577,053 shares at December 29, 2017 and 119,628,884 shares at June 30, 2017
119

 
120

Other capital
1,705

 
1,741

Retained earnings
1,424

 
1,343

Accumulated other comprehensive loss
(254
)
 
(276
)
Total shareholders’ equity
2,994

 
2,928

 
$
9,856

 
$
10,090

See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).

3


HARRIS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
 
 
Two Quarters Ended
 
December 29, 2017
 
December 30, 2016
 
 
 
 
 
(In millions)
Operating Activities
 
 
 
Net income
$
300

 
$
337

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
80

 
101

Amortization of intangible assets from Exelis Inc. acquisition
50

 
66

Share-based compensation
24

 
22

Qualified pension plan contributions

 
(103
)
Pension income
(68
)
 
(49
)
(Increase) decrease in:
 
 
 
Accounts receivable
(19
)
 
125

Inventories
(102
)
 
(50
)
Increase (decrease) in:
 
 
 
Accounts payable
(78
)
 
(47
)
Advance payments and unearned income
38

 
(58
)
Income taxes
213

 
70

Other
(65
)
 
(119
)
Net cash provided by operating activities
373

 
295

Investing Activities
 
 
 
Additions of property, plant and equipment
(43
)
 
(49
)
Adjustments to proceeds from sales of businesses
(2
)
 
(25
)
Net cash used in investing activities
(45
)
 
(74
)
Financing Activities
 
 
 
Net proceeds from borrowings
248

 
185

Repayments of borrowings
(363
)
 
(300
)
Proceeds from exercises of employee stock options
18

 
27

Repurchases of common stock
(150
)
 
(100
)
Cash dividends
(137
)
 
(134
)
Other financing activities
(10
)
 
(19
)
Net cash used in financing activities
(394
)
 
(341
)
Effect of exchange rate changes on cash and cash equivalents
4

 
(6
)
Net decrease in cash and cash equivalents
(62
)
 
(126
)
Cash and cash equivalents, beginning of year
484

 
487

Cash and cash equivalents, end of quarter
$
422

 
$
361

See accompanying Notes to Condensed Consolidated Financial Statements (Unaudited).

4


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 position, 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 position, results of operations and cash flows for the periods presented therein. The results for the second quarter and first two quarters of fiscal 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 30, 2017 has been derived from our audited financial statements, but 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 30, 2017 (our “Fiscal 2017 Form 10-K”).
In connection with our divestitures in fiscal 2017 of two significant businesses that were part of our former Critical Networks segment, our remaining operations that had been part of our former Critical Networks segment were integrated with our Electronic Systems segment effective for the third quarter of fiscal 2017, and our Critical Networks segment was eliminated. 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 these changes for all periods presented in order to present all segment information on a comparable basis. There is no impact on our previously reported consolidated statements of income, balance sheets or statements of cash flows resulting from these segment changes. See Note B: Discontinued Operations in these Notes and Note 3: “Discontinued Operations and Divestitures” in the Notes to Consolidated Financial Statements in our Fiscal 2017 Form 10-K for additional information. Our historical results for all periods presented have been restated to account for businesses reported as discontinued operations in our Condensed Consolidated Financial Statements (Unaudited) and these Notes. Except for disclosures related to our cash flows, or unless otherwise specified, disclosures in our Condensed Consolidated Financial Statements (Unaudited) and these Notes relate solely to our continuing operations.
Amounts contained in this Report may not always add to totals due to rounding.
Reclassifications
Certain prior-year amounts have been reclassified in our Condensed Consolidated Financial Statements (Unaudited) to conform with current-year classifications. Reclassifications include certain human resources and information technology (“IT”) 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.
Restructuring, Exelis Acquisition-Related Integration and Other Charges
We record restructuring charges for 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

5


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 fiscal 2017, we recorded $58 million of charges for integration and other costs in connection with our acquisition of Exelis Inc. (collectively with its subsidiaries, “Exelis”), substantially all of which were included as a component of the “Engineering, selling and administrative expenses” line item in our Consolidated Statement of Income in our Fiscal 2017 Form 10-K. We had liabilities of $34 million at December 29, 2017 and $43 million at June 30, 2017 associated with this integration activity and with previous restructuring actions. The majority of the remaining liabilities as of December 29, 2017 will be paid within the next twelve months.
Adoption of New Accounting Standards
In the first quarter of fiscal 2018, we adopted an accounting standards update issued by the Financial Accounting Standards Board (“FASB”) that requires recognition of the income tax consequences of intra-entity transfers of assets other than inventory when the transfer occurs. Consequently, this update eliminates the exception to the recognition of current and deferred income taxes for intra-entity transfers of assets other than for inventory until the assets have been sold to an outside party. This update requires entities to apply a modified retrospective approach with a cumulative catch-up adjustment to beginning retained earnings in the period of adoption. In addition, entities are required to record deferred tax balances with an offset to retained earnings for unrecognized amounts that will be recognized under this update. We applied all changes required by this update using the modified retrospective approach from the beginning of fiscal 2018. Adopting this update resulted in a $27 million reduction of prepaid income tax assets from the “Other current assets” and “Other non-current assets” line items and a $27 million increase in the “Non-current deferred income taxes” line item in our Condensed Consolidated Balance Sheet (Unaudited) as of September 29, 2017.
Accounting Standards Issued But Not Yet Effective
In May 2014, the FASB issued a comprehensive new revenue recognition standard that 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 will be 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 that is recognized, this standard requires significantly more interim and annual disclosures. This standard allows for either “full retrospective” adoption (application to all periods presented) or “modified retrospective” adoption (application to only the most current period presented in the financial statements, with certain additional required footnote disclosures). In August 2015, the FASB issued an accounting standards update that deferred the effective date of the standard by one year, while continuing to permit entities to elect to adopt the standard as early as the original effective date. As a result, this standard is now effective for fiscal years, and interim reporting periods within those years, beginning after December 15, 2017, which for us is our fiscal 2019.
In preparation for the adoption of this standard, the project team we formed has made progress against the detailed implementation plan we developed, including in the following areas:
Completing an accounting guidance gap analysis, consisting of a review of significant revenue streams and     representative contracts to determine potential changes to our existing accounting policies and potential impacts to our consolidated financial statements;
Completing an inventory of our outstanding contracts and revenue streams;
Drafting a Company-wide revenue recognition policy reflecting the requirements of this standard and tailored to our businesses;
Providing Company-wide training to affected employees, including in the areas of accounting, finance, contracts, tax and segment management;
Applying the five-step model of this standard to our contracts and revenue streams to evaluate the quantitative and qualitative impacts this standard will have on our consolidated financial statements, accounting and operating policies, accounting systems, internal control structure and business practices; and
Initiating the process of reviewing the additional disclosure requirements of this standard and the potential impact on our accounting systems and internal control structure.

6


Although we are still in the process of evaluating and quantifying the impact of this standard as described above, we have identified certain changes we expect this standard to have on our consolidated financial statements. A significant portion of our revenue is derived from contracts with the U.S. Government, with revenue recognized using the percentage-of-completion (“POC”) method. We expect to recognize revenue on an “over time” basis for most of these contracts by using cost inputs to measure progress toward the completion of our performance obligations, which is similar to the POC cost-to-cost method currently used on the majority of these contracts. Consequently, we expect the adoption of this standard to impact certain of these contracts that recognize revenue using the POC units-of-delivery, milestone or other methods, resulting in recognition of revenue (and costs) earlier in the performance period as costs are incurred. We also are continuing to evaluate the potential impact of this standard in other areas, including:
The number of distinct performance obligations within our contractual arrangements;
Contract modifications;
The timing of revenue recognition based on the more prescriptive guidance for recognizing revenue on an “over time” basis, especially for certain non-U.S. Government contracts based on existing contractual language;
Incremental costs of obtaining a contract; and
Estimation and recognition of variable consideration for contracts to provide services.
Because of the broad scope of this standard, it could impact revenue and cost recognition across all of our business segments as well as related business processes and IT systems. As a result, our evaluation of the impact of this standard will continue over future periods. We also have not yet made a determination regarding the use of a full retrospective or modified retrospective adoption approach for this standard, as this determination is primarily dependent on the completion of our analysis.
In February 2016, the FASB issued a new lease standard that supersedes existing lease guidance under GAAP. This standard requires lessees to record most leases on their balance sheets but recognize expenses on their income statements in a manner similar to existing lease guidance under GAAP. Entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements, with the option to use certain relief. Full retrospective application is prohibited. 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 are currently evaluating the impact this standard will have on our financial position, results of operations and cash flows.
In March 2017, the FASB issued an accounting standards update to improve the presentation of net periodic pension cost and net periodic postretirement benefit cost. This update requires that entities present components of net periodic pension cost and net periodic postretirement benefit cost other than the service cost component separately from the service cost component and outside the subtotal of income from operations. This update must be applied retrospectively and is effective for fiscal years beginning after December 15, 2017, which for us is our fiscal 2019. Adopting this update will result in a decrease in operating income and an increase in the net non-operating components of income from continuing operations of $164 million and $183 million for fiscal 2017 and 2018, respectively. Adopting this update will not have a material impact on our financial position or cash flows.
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”), which are described in more detail below. 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, and our historical financial results have been restated to account for IT Services and CapRock as discontinued operations for all periods presented 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.

7


The major components of discontinued operations in our Condensed Consolidated Statement of Income (Unaudited) included the following:
 
 
Quarter Ended
 
Two Quarters Ended
 
 
December 30, 2016
 
December 29, 2017
 
December 30, 2016
 
 
 
 
 
 
 
 
 
(In millions)
Revenue from product sales and services
$
336

 
$

 
$
687

Cost of product sales and services
(281
)
 

 
(570
)
Engineering, selling and administrative expenses
(34
)
 

 
(72
)
Impairment of goodwill and other assets
(2
)
 

 
(2
)
Non-operating income (loss)
7

 
(3
)
 
7

Income (loss) before income taxes
26

 
(3
)
 
50

Loss on sale of discontinued operations (1)
(5
)
 

 
(7
)
Income tax expense
(7
)
 
(3
)
 
(14
)
Discontinued operations, net of income taxes
$
14

 
$
(6
)
 
$
29

 
 
 
 
 
 
 
(1)
“Loss on sale of discontinued operations” in the quarter and two quarters ended December 30, 2016 consisted of transaction costs associated with the divestiture of IT Services.
Depreciation and amortization and capital expenditures of discontinued operations in our Condensed Consolidated Statement of Income (Unaudited) included the following:
 
Quarter Ended
 
Two Quarters Ended
 
December 30, 2016
 
December 30, 2016
 
 
 
 
 
(In millions)
Depreciation and amortization
$
12

 
$
29

Capital expenditures
2

 
5

IT Services
On April 28, 2017, we completed the divestiture to an affiliate of Veritas Capital Fund Management, L.L.C. (“Veritas”) of IT Services, which primarily provided IT and engineering managed services to U.S. Government customers, for net cash proceeds of $646 million, after transaction expenses and estimated purchase price adjustments in respect of net cash and working capital, and subject to post-closing finalization of those adjustments as set forth in the definitive sales agreement entered into January 26, 2017. We recognized a pre-tax loss of $28 million on the sale of IT Services (a gain of $55 million after certain tax benefits related to the transaction or $.44 per diluted share). The decision to divest IT Services was part of our strategy to simplify our operating model to focus on technology-differentiated, high-margin businesses. IT Services was part of our former Critical Networks segment and in connection with the definitive agreement to sell IT Services, as described above, the remaining operations that had been part of the Critical Networks segment, including our air traffic management (“ATM”) business, primarily serving the Federal Aviation Administration (“FAA”), were integrated with our Electronic Systems segment effective for the third quarter of fiscal 2017, and our Critical Networks segment was eliminated. We agreed to provide various transition services to Veritas for a period of up to 18 months following the closing of the transaction pursuant to a separate agreement.

8


The following table presents the key financial results of IT Services included in “Discontinued operations, net of income taxes” in our Condensed Consolidated Statement of Income (Unaudited):
 
Quarter Ended
 
Two Quarters Ended
 
December 30, 2016
 
December 29, 2017
 
December 30, 2016
 
 
 
 
 
 
 
(In millions)
Revenue from product sales and services
$
268

 
$

 
$
543

Cost of product sales and services
(228
)
 

 
(462
)
Engineering, selling and administrative expenses
(25
)
 

 
(49
)
Impairment of goodwill and other assets
(2
)
 

 
(2
)
Non-operating loss

 
(2
)
 

Income (loss) before income taxes
13

 
(2
)
 
30

Loss on sale of discontinued operation
(5
)
 

 
(7
)
Income tax expense
(4
)
 
(3
)
 
(10
)
Discontinued operations, net of income taxes
$
4

 
$
(5
)
 
$
13

CapRock
On January 1, 2017, we completed the divestiture to SpeedCast International Ltd. (“SpeedCast”) of CapRock, which provided wireless, terrestrial and satellite communications services to energy and maritime customers, for net cash proceeds of $368 million, after transaction expenses and purchase price adjustments in respect of net cash and working capital as set forth in the definitive sales agreement entered into November 1, 2016. We recognized a pre-tax gain of $14 million on the sale of CapRock (a gain of $61 million after certain tax benefits related to the transaction, including reversal of valuation allowances on capital losses and net operating losses, or $.49 per diluted share).
The following table presents the key financial results of CapRock included in “Discontinued operations, net of income taxes” in our Condensed Consolidated Statement of Income (Unaudited):
 
Quarter Ended
 
Two Quarters Ended
 
December 30, 2016
 
December 29, 2017
 
December 30, 2016
 
 
 
 
 
 
 
(In millions)
Revenue from product sales and services
$
68

 
$

 
$
144

Cost of product sales and services
(53
)
 

 
(108
)
Engineering, selling and administrative expenses
(9
)
 

 
(23
)
Non-operating income (loss)
8

 
(1
)
 
8

Income (loss) before income taxes
14

 
(1
)
 
21

Income tax expense
(3
)
 

 
(4
)
Discontinued operations, net of income taxes
$
11

 
$
(1
)
 
$
17

Note C — Stock Options and Other Share-Based Compensation
During the two quarters ended December 29, 2017, 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 $13 million and $24 million for the quarter and two quarters ended December 29, 2017, respectively, and $11 million and $21 million for the quarter and two quarters ended December 30, 2016, 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 67,717 and 398,932 for the quarter and two quarters ended December 29, 2017, respectively, and 191,740 and 733,953 for the quarter and two quarters ended December 30, 2016, respectively. Awards granted to participants under our 2015 EIP during the quarter ended December 29, 2017 consisted of 698 stock options, 1,140 restricted shares and restricted units and 228 performance units.

9


Awards granted to participants under our 2015 EIP during the two quarters ended December 29, 2017 consisted of 412,285 stock options, 130,065 restricted shares and restricted units and 173,635 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 1.82 percent; expected volatility of 19.32 percent; risk-free interest rates averaging 1.77 percent; and expected term of 5.00 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 — Accumulated Other Comprehensive Loss
The components of accumulated other comprehensive loss are summarized below:
 
December 29, 2017
 
June 30, 2017(1)
 
 
 
 
 
(In millions)
Foreign currency translation, net of income taxes of $2 million and $1 million at December 29, 2017 and June 30, 2017, respectively
$
(92
)
 
$
(113
)
Net unrealized loss on hedging derivatives, net of income taxes of $11 million at December 29, 2017 and June 30, 2017
(16
)
 
(17
)
Unrecognized postretirement obligations, net of income taxes of $89 million at December 29, 2017 and June 30, 2017
(146
)
 
(146
)
 
$
(254
)
 
$
(276
)
 
 
 
 
 
(1)
Accumulated foreign currency translation losses of $52 million (net of income taxes of $14 million) were reclassified to earnings in fiscal 2017 as a result of the divestitures of IT Services and CapRock and are included in “Discontinued operations, net of income taxes” in our Consolidated Statement of Income in our Fiscal 2017 Form 10-K.
Note E — Receivables
Receivables are summarized below:
 
December 29, 2017
 
June 30, 2017
 
 
 
 
 
(In millions)
Accounts receivable
$
382

 
$
368

Unbilled costs and accrued earnings on cost-plus contracts
264

 
258

 
646

 
626

Less allowances for collection losses
(4
)
 
(3
)
 
$
642

 
$
623

Note F — Inventories
Inventories are summarized below:
 
December 29, 2017
 
June 30, 2017
 
 
 
 
 
(In millions)
Unbilled costs and accrued earnings on fixed-price contracts
$
532

 
$
454

Finished products
90

 
96

Work in process
111

 
96

Raw materials and supplies
209

 
195

 
$
942

 
$
841

Unbilled costs and accrued earnings on fixed-price contracts were net of progress payments of $113 million and $90 million at December 29, 2017 and June 30, 2017, respectively.

10


Note G — Property, Plant and Equipment
Property, plant and equipment are summarized below:
 
December 29, 2017
 
June 30, 2017
 
 
 
 
 
(In millions)
Land
$
43

 
$
43

Software capitalized for internal use
163

 
155

Buildings
612

 
617

Machinery and equipment
1,290

 
1,256

 
2,108

 
2,071

Less accumulated depreciation and amortization
(1,230
)
 
(1,167
)
 
$
878

 
$
904

Depreciation and amortization expense related to property, plant and equipment was $36 million and $73 million for the quarter and two quarters ended December 29, 2017, respectively, and $35 million and $74 million for the quarter and two quarters ended December 30, 2016, respectively.
Note H — Accrued Warranties
Changes in our liability for standard product 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 two quarters ended December 29, 2017 were as follows:
 
(In millions)
Balance at June 30, 2017
$
26

Warranty provision for sales
6

Settlements
(6
)
Other, including adjustments for foreign currency translation
1

Balance at December 29, 2017
$
27


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 $20 million at December 29, 2017 and $23 million at June 30, 2017 and is included as a component of the “Advance payments and unearned income” and “Other long-term liabilities” line items in our Condensed Consolidated Balance Sheet (Unaudited).

11


Note I — Long-Term Debt
Long-term debt is summarized below:
 
December 29, 2017
 
June 30, 2017
 
 
 
 
 
(In millions)
Variable-rate debt:
 
 
 
Term loan, 3-year tranche, due May 29, 2018
$
20

 
$
36

Term loan, 5-year tranche, due May 29, 2020

 
269

Floating rate notes, due April 30, 2020
250

 

Total variable-rate debt
270

 
305

Fixed-rate debt:
 
 
 
1.999% notes, due April 27, 2018
500

 
500

2.7% notes, due April 27, 2020
400

 
400

4.4% notes, due December 15, 2020
400

 
400

5.55% notes, due October 1, 2021
400

 
400

3.832% notes, due April 27, 2025
600

 
600

7.0% debentures, due January 15, 2026
100

 
100

6.35% debentures, due February 1, 2028
26

 
26

4.854% notes, due April 27, 2035
400

 
400

6.15% notes, due December 15, 2040
300

 
300

5.054% notes, due April 27, 2045
500

 
500

Other
14

 
14

Total fixed-rate debt
3,640

 
3,640

Total debt
3,910

 
3,945

Plus: unamortized bond premium
27

 
29

Less: unamortized discounts and issuance costs
(23
)
 
(24
)
Total debt, net
3,914

 
3,950

Less: current portion of long-term debt
(523
)
 
(554
)
Total long-term debt, net
$
3,391

 
$
3,396

On November 6, 2017, we completed the issuance and sale of $250 million in aggregate principal amount of floating rate notes due April 30, 2020 (“Floating Rate Notes”). We incurred $2 million of debt issuance costs related to the issuance of the Floating Rate Notes, which are being amortized using the effective interest rate method over the life of the Floating Rate Notes, and such amortization is reflected as a portion of interest expense in our Condensed Consolidated Statement of Income (Unaudited). The Floating Rate Notes will bear interest at a floating rate, reset quarterly, equal to three-month LIBOR plus 0.48% per year. Interest is payable quarterly in arrears on January 30, April 30, July 30 and October 30 of each year, commencing January 30, 2018. The Floating Rate Notes are not redeemable at our option prior to maturity. Upon a change of control combined with a below-investment-grade rating event, we may be required to make an offer to repurchase the Floating Rate Notes at a price equal to 101 percent of the aggregate principal amount of the Floating Rate Notes being repurchased, plus accrued interest on the Floating Rate Notes being repurchased to, but not including, the date of repurchase.
In connection with the closing of the sale of the Floating Rate Notes, we used the net proceeds, together with cash on hand, to repay in full the $253 million in remaining outstanding indebtedness under the 5-year tranche of our $1.3 billion senior unsecured term loan facility pursuant to our Term Loan Agreement, dated as of March 16, 2015, and recognized a $1 million extinguishment loss, which is included as a component of the “Non-operating income (loss)” line item in our Condensed Consolidated Statement of Income (Unaudited), as a result of associated unamortized debt issuance costs. For additional information on our long-term debt, see Note 13: “Long-Term Debt” in the Notes to Consolidated Financial Statements in our Fiscal 2017 Form 10-K.

12


Note J — 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:
 
 
Quarter Ended December 29, 2017
 
Two Quarters Ended December 29, 2017
 
 
Pension
 
Other
Benefits
 
Total
 
Pension
 
Other
Benefits
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(In millions)
Net periodic benefit income
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
9

 
$
1

 
$
10

 
$
19

 
$
1

 
$
20

Interest cost
49

 
2

 
51

 
97

 
4

 
101

Expected return on plan assets
(92
)
 
(4
)
 
(96
)
 
(184
)
 
(8
)
 
(192
)
Amortization of net actuarial loss

 
(1
)
 
(1
)
 

 
(1
)
 
(1
)
Total net periodic benefit income
$
(34
)
 
$
(2
)
 
$
(36
)
 
$
(68
)
 
$
(4
)
 
$
(72
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quarter Ended December 30, 2016
 
Two Quarters Ended December 30, 2016
 
 
Pension
 
Other
Benefits
 
Total
 
Pension
 
Other
Benefits
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(In millions)
Net periodic benefit income
 
 
 
 
 
 
 
 
 
 
 
Service cost(1)
$
14

 
$

 
$
14

 
$
29

 
$

 
$
29

Interest cost
46

 
2

 
48

 
92

 
4

 
96

Expected return on plan assets
(85
)
 
(4
)
 
(89
)
 
(170
)
 
(8
)
 
(178
)
Total net periodic benefit income
$
(25
)
 
$
(2
)
 
$
(27
)
 
$
(49
)
 
$
(4
)
 
$
(53
)
 
 
 
 
 
(1)
$1 million of the service cost component of net periodic benefit income is included as a component of the “Discontinued operations, net of income taxes” line item in our Condensed Consolidated Statement of Income (Unaudited) for the two quarters ended December 30, 2016
We made a $400 million voluntary contribution to our U.S. qualified pension plans during fiscal 2017. As a result, we made no contributions to our U.S. qualified defined benefit pension plans and minor contributions to our non-U.S. pension plan during the quarter and two quarters ended December 29, 2017. We currently anticipate making voluntary contributions of approximately $300 million to our U.S. qualified defined benefit pension plans and contributions of approximately $1 million to our non-U.S. pension plan during the remainder of fiscal 2018. We contributed $39 million and $103 million to our U.S. qualified defined benefit pension plans during the quarter and two quarters ended December 30, 2016, respectively.
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 $4.4 billion and a projected benefit obligation of $5.6 billion as of June 30, 2017. Effective December 31, 2016, future benefit accruals under the U.S. SRP benefit formula were frozen for all employees and replaced with a 1% cash balance defined benefit formula for certain non-highly compensated employees.

13


Note K — Income From Continuing Operations Per Common Share
The computations of income from continuing operations per common share are as follows:
 
 
Quarter Ended
 
Two Quarters Ended
 
December 29,
2017
 
December 30,
2016
 
December 29,
2017
 
December 30,
2016
 
 
 
 
 
 
 
 
 
(In millions, except per share amounts)
Income from continuing operations
$
139

 
$
163

 
$
306

 
$
308

Adjustments for participating securities outstanding

 

 
(1
)
 

Income from continuing operations used in per basic and diluted common share calculations (A)
$
139

 
$
163

 
$
305

 
$
308

Basic weighted average common shares outstanding (B)
118.5

 
123.7

 
118.8

 
123.8

Impact of dilutive share-based awards
2.4

 
1.7

 
2.3

 
1.7

Diluted weighted average common shares outstanding (C)
120.9

 
125.4

 
121.1

 
125.5

Income from continuing operations per basic common share (A)/(B)
$
1.17

 
$
1.32

 
$
2.57

 
$
2.49

Income from continuing operations per diluted common share (A)/(C)
$
1.15

 
$
1.30

 
$
2.52

 
$
2.45

Potential dilutive common shares primarily consist of employee stock options and performance unit awards. Employee stock options to purchase approximately 222 and 1,200,708 shares of our common stock were outstanding at December 29, 2017 and December 30, 2016, respectively, but were not included as dilutive stock options in the computations of income from continuing operations per diluted common share because the effect would have been antidilutive.
Note L — Income Taxes
Tax Reform
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 reduces the U.S. statutory corporate income tax rate from a maximum 35 percent to a flat 21 percent, effective January 1, 2018. Based on our fiscal year end, our blended U.S. statutory corporate income tax rate for fiscal 2018 will be 28 percent. Our deferred tax assets, net of deferred tax liabilities, represent anticipated corporate tax benefits to be realized in the future, and the reduction in the U.S. statutory corporate income tax rate reduced these benefits. As a result, we recognized income tax expense in our tax provision in the second quarter of fiscal 2018 to adjust our deferred tax balances to reflect the lower U.S. statutory corporate income tax rate.
Income tax expense for the quarter ended December 29, 2017 included the following adjustments to reflect impacts from the Tax Act:
A $52 million ($.43 per diluted share) estimated write-down of existing net deferred tax asset balances based on the lower tax rate and other law changes; and
A $26 million ($.21 per diluted share) benefit from the impact of our lower estimated fiscal 2018 tax rate.
Effective Tax Rate
Our effective tax rate (income taxes as a percentage of income from continuing operations before income taxes) was 39.3 percent in the quarter ended December 29, 2017 compared with 30.6 percent in the quarter ended December 30, 2016. In addition to the impacts from the Tax Act described above, our effective tax rate for the quarter ended December 29, 2017 benefited from a $22 million ($.18 per diluted share) favorable impact of releasing provisions for uncertain tax positions and the favorable impact of differences in GAAP and tax accounting related to investments. Our effective tax rate for the quarter ended December 30, 2016 was not impacted by any significant discrete item.
Our effective tax rate was 33.5 percent in the two quarters ended December 29, 2017 compared with 29.7 percent in the two quarters ended December 30, 2016. In addition to the items noted above for the quarters ended December 29, 2017 and December 30, 2016, our effective tax rate for the two quarters ended December 29, 2017 and December 30, 2016 benefited from the favorable impact of excess tax benefits related to equity-based compensation.
We have not fully completed our accounting for the income tax impact from the Tax Act enactment. For certain items, we have made a reasonable estimate of the impact on our existing net deferred income tax balances as of December 29, 2017, which is represented by the $52 million estimated adjustment from the revaluation of net deferred tax asset balances described above. For other items, we have not been able to make a reasonable estimate and continue to account for those items based on our existing accounting under Accounting Standards Codification 740, Income Taxes (“ASC 740”) and the provisions of the tax laws that were in effect immediately prior to Tax Act enactment.

14


Provisional Amounts
We remeasured certain deferred income tax assets and liabilities based on the rate at which we expect them to reverse in the future, which generally is 28 percent for reversals in fiscal 2018 or 21 percent for reversals after fiscal 2018. However, we are still evaluating certain aspects of the Tax Act and refining our calculations, which potentially affects our current estimated valuation of our net deferred income tax assets and could give rise to new deferred tax amounts.
Although the Tax Act affects the tax treatment of foreign earnings and profits (“E&P”) and results in a one-time transition tax on our post-1986 foreign E&P that we have previously deferred from U.S. income tax expense, we have provisionally determined that we will not owe any transition tax. However, we are still refining our calculations, which include estimates for our fiscal 2017 and 2018 layers for foreign E&P, and they could change and therefore change the amount of transition tax we will owe.
Because of the potential impact of deficit allocations on the tax basis for netted foreign E&P of related foreign subsidiaries, we are maintaining a deferred tax liability of approximately $25 million in respect of potential cumulative tax basis differences of $116 million. New statutory or regulatory guidance and further analysis 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 anticipate future impacts at a U.S. state and local tax level related to the Tax Act; however, statutory and interpretive guidance is not available from applicable state and local tax authorities to reasonably estimate the impact. Consequently, we have not recorded provisional amounts and have continued to apply ASC 740 based on the provisions of the tax laws that were in effect immediately prior to Tax Act enactment.
Note M — 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.

15


The following table presents assets and liabilities measured at fair value on a recurring basis (at least annually) as of December 29, 2017 and June 30, 2017:
 
 
December 29, 2017
 
June 30, 2017
 
 
Total
 
Level 1
 
Total
 
Level 1
 
 
 
 
 
 
 
 
 
 
 
(In millions)
Assets
 
 
 
 
 
 
 
  Deferred compensation plan assets:(1)
 
 
 
 
 
 
 
Corporate-owned life insurance
$
26

 
 
 
$
25

 
 
Equity fund
61

 
 
 
50

 
 
Total fair value of deferred compensation plan assets
$
87

 

 
$
75

 

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
  Deferred compensation plan liabilities:(2)
 
 
 
 
 
 
 
Equity securities and mutual funds
$
44

 
$
44

 
$
46

 
$
46

Investments measured at NAV:
 
 
 
 
 
 
 
Common/collective trusts and guaranteed investment contracts
110

 
 
 
80

 
 
Total fair value of deferred compensation plan liabilities
$
154

 


 
$
126

 


 
 
 
 
 
 
 
 
 
(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 using the NAV practical expedient.
(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 money market, 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):
 
 
December 29, 2017
 
June 30, 2017
 
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
 
 
 
 
 
 
 
 
 
 
 
(In millions)
Long-term debt (including current portion)(1)
$
3,914

 
$
4,249

 
$
3,950

 
$
4,252

 
 
 
 
 
 
 
 
 
(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 N — 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 December 29, 2017, we had open foreign currency forward contracts with an aggregate notional amount of $34 million, all of which were classified as cash flow hedges. This compares with open foreign currency forward contracts with an aggregate notional amount of $33 million at June 30, 2017, of which $2 million were classified as fair value hedges and $31 million were classified as cash flow hedges. At December 29, 2017, contract expiration dates ranged from 11 days to approximately 6 months with a weighted average contract life of 4 months.

16


Fair Value Hedges
We have used foreign currency forward contracts and options to hedge certain balance sheet items, including foreign currency denominated accounts receivable and inventory. As of December 29, 2017, we had no outstanding foreign currency forward contracts to hedge balance sheet items. The net gains or losses on foreign currency forward contracts designated as fair value hedges were not material in the quarter and two quarters ended December 29, 2017 or in the quarter and two quarters ended December 30, 2016. In addition, no amounts were recognized in earnings in the quarter and two quarters ended December 29, 2017 or in the quarter and two quarters ended December 30, 2016 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 December 29, 2017, we had outstanding foreign currency forward contracts denominated in the Euro and British Pound 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 and two quarters ended December 29, 2017 or in the quarter and two quarters ended December 30, 2016.
Note O — Changes in Estimates
Estimate at Completion Adjustments
Estimates and assumptions, and changes therein, are important in connection with, among others, our segments’ revenue recognition policies related to development and production contracts. Revenue and profit related to development and production contracts are recognized using the POC method, generally based on the ratio of costs incurred to estimated total costs at completion under the contract (i.e., the “cost-to-cost” method) or the ratio of actual units delivered to estimated total units to be delivered under the contract (i.e., the “units-of-delivery” method) with consideration given for risk of performance and estimated profit. Revenue and profit on cost-reimbursable development and production contracts are recognized as allowable costs are incurred on the contract and become billable to the customer, in an amount equal to the allowable costs plus the profit on those costs.
Development and production contracts are combined when specific aggregation criteria are met. Criteria generally include closely interrelated activities performed for a single customer within the same economic environment. Development and production contracts are generally not segmented. If development and production contracts are segmented, we have determined that they meet specific segmenting criteria. Change orders, claims or other items that may change the scope of a development or production contract are included in contract value only when the value can be reliably estimated and realization is probable. Possible incentives or penalties and award fees applicable to performance on development and production contracts are considered in estimating contract value and profit rates and are recorded when there is sufficient information to assess anticipated contract performance. Incentive provisions that increase earnings based solely on a single significant event are generally not recognized until the event occurs. We are party to certain contracts with incentive provisions or award fees that are subject to uncertainty until the conclusion of the contract, and our customers may be entitled to reclaim and receive previous award fee payments.
Under the POC method of accounting, a single estimated total profit margin is used to recognize profit for each development and production contract over its period of performance. Recognition of profit on a fixed-price development or production contract requires estimates of the total cost at completion and the measurement of progress toward completion. The estimated profit or loss on a development or production contract is equal to the difference between the estimated contract value and the estimated total cost at completion. Due to the long-term nature of many of our programs, developing the estimated total cost at completion 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, the risk and impact of delayed performance, availability and timing of funding from the customer and the recoverability of any claims outside the original development or production contract included in the estimate to complete. 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 development and production 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, at the outset of a cost-reimbursable contract (for example, contracts containing award or incentive fees), we establish an estimate of total contract value, or revenue, based on our expectation of performance on the contract. As the cost-reimbursable contract progresses, our estimates of total contract value may increase or decrease if, for example, we receive

17


higher or lower than expected award fees. When adjustments in estimated total costs at completion or in estimated total contract value are determined, the related impact to 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. Anticipated losses on development and production contracts or programs in progress are charged to operating income when identified. Net EAC adjustments resulting from changes in estimates impacted our operating income unfavorably by $10 million ($7 million after-tax or $.06 per diluted share) and favorably by $1 million in the quarter and two quarters ended December 29, 2017, respectively, and favorably by $6 million ($4 million after-tax or $.03 per diluted share) and $19 million ($12 million after-tax or $.10 per diluted share) in the quarter and two quarters ended December 30, 2016, respectively.
Income Taxes
See Note L — Income Taxes in these Notes for changes in estimates disclosures associated with our accounting for income taxes.
Note P — Business Segments
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 the defense industry and ATM solutions for the civil aviation industry; 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 described in more detail in “Basis of Presentation” in Note A — Significant Accounting Policies and Recent Accounting Standards and Note B — Discontinued Operations in these Notes, in connection with our divestiture of CapRock and entering into the definitive agreement to sell IT Services in the third quarter of fiscal 2017, our other remaining operations that had been part of our former Critical Networks segment, including our ATM business primarily serving the FAA, were integrated with our Electronic Systems segment effective for the third quarter of fiscal 2017, and our Critical Networks segment was eliminated. 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 these changes for all periods presented in order to present all segment information on a comparable basis. There is no impact on our previously reported consolidated statements of income, balance sheets or statements of cash flows resulting from these segment changes. Our historical results and discussion for all periods presented have been restated to account for businesses reported as discontinued operations in our Condensed Consolidated Financial Statements (Unaudited) and these Notes.
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 2017 Form 10-K. We evaluate each segment’s performance based on its operating income or loss, which we define as profit or loss from operations before income taxes 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” and “Corporate eliminations, net” line items in the table below represent the elimination of intersegment sales and their related profits. The “Unallocated corporate expense” line item in the table below represents the portion of corporate expenses not allocated to our business segments.

18


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
 
Two Quarters Ended
 
 
December 29, 2017
 
December 30, 2016
 
December 29, 2017
 
December 30, 2016
 
 
 
 
 
 
 
 
 
 
 
(In millions)
Revenue
 
 
 
 
 
 
 
Communication Systems
$
489

 
$
413

 
$
899

 
$
843

Electronic Systems
584

 
570

 
1,124

 
1,107

Space and Intelligence Systems
465

 
468

 
931

 
921

Corporate eliminations
(3
)
 
(2
)
 
(6
)
 
(2
)
 
$
1,535

 
$
1,449

 
$
2,948

 
$
2,869

Income From Continuing Operations Before Income Taxes
Segment Operating Income:(1)
 
 
 
 
 
 
 
Communication Systems
$
144

 
$
121

 
$
262

 
$
239

Electronic Systems
101

 
134

 
210

 
245

Space and Intelligence Systems
81

 
76

 
168

 
155

Unallocated corporate expense(2)
(55
)
 
(53
)
 
(96
)
 
(114
)
Corporate eliminations, net
1

 
(1
)
 

 
(2
)
Non-operating income (loss)
(2
)
 
1

 
(2
)
 
2

Net interest expense
(41
)
 
(43
)
 
(82
)
 
(87
)
 
$
229

 
$
235

 
$
460

 
$
438

 
 
 
 
 
 
 
 
 
(1)
Segment operating income for the quarter and two quarters ended December 30, 2016 included stranded costs and Financial Accounting Standards (“FAS”) pension income previously reported as part of our former Critical Networks segment but now re-allocated to our remaining three segments.
(2)
Unallocated corporate expense included (i) a $12 million adjustment for deferred compensation in the quarter and two quarters ended December 29, 2017, (ii) $13 million and $30 million of Exelis acquisition-related charges in the quarter and two quarters ended December 30, 2016, respectively, and (iii) $25 million and $50 million of expense in the quarter and two quarters ended December 29, 2017, respectively, compared with $28 million and $55 million of expense in the quarter and two quarters ended December 30, 2016, respectively, for amortization of identifiable intangible assets acquired as a result of our acquisition of Exelis. 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.
Total assets by business segment are summarized below:
 
 
December 29, 2017
 
June 30, 2017
 
 
 
 
 
 
 
(In millions)
Total Assets
 
 
 
Communication Systems
$
1,541

 
$
1,534

Electronic Systems
4,137

 
4,094

Space and Intelligence Systems
2,155

 
2,117

Corporate (1)
2,023

 
2,345

 
 
$
9,856

 
$
10,090

 
 
 
 
 
(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 benefit the entire Company as opposed to any individual segment. Exelis identifiable intangible asset balances recorded as Corporate assets were approximately $1 billion as of December 29, 2017 and June 30, 2017. Corporate assets also consisted of cash, income taxes receivable, deferred income taxes, deferred compensation plan assets and buildings and equipment.

19


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 December 29, 2017, 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 December 29, 2017 are reserved against or would not have a material adverse effect on our financial position, 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 are responsible, or are alleged to be responsible, for ongoing environmental investigation and remediation of multiple sites, including as a result of our acquisition of Exelis. These sites are in various stages of investigation and/or remediation and in some of these proceedings our liability is considered de minimis. We have received notices from the U.S. Environmental Protection Agency (“EPA”) or equivalent state or international environmental agencies 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 where we have been 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, Exelis received notice in June 2014 from the U.S. Department of Justice, Environment and Natural Resources Division, that it may be potentially responsible for contribution to the environmental investigation and remediation of multiple locations in Alaska. In addition, the EPA issued on March 4, 2016, a record of decision selecting a remedy for the lower 8.3 mile stretch of the Lower Passaic River. The EPA’s selected remedy included dredging the river bank to bank, installing an engineered cap and long-term monitoring. The EPA estimated the cost of the cleanup project will be $1.38 billion. On March 31, 2016, the EPA notified over 100 potentially responsible parties, including Exelis, of their potential liability for the cost of the cleanup project but their respective allocations have not been determined. We have found no evidence that Exelis contributed any of the primary contaminants of concern to the Passaic River. We intend to vigorously defend ourselves in this matter and we believe our ultimate costs will not be material. Although it is not feasible to predict the outcome of these environmental claims, based on available information, in the opinion of management, any payments we may be required to make as a result of environmental claims in existence at December 29, 2017 are reserved against, covered by insurance or would not have a material adverse effect on our financial position, results of operations or cash flows.

20


REVIEW REPORT OF INDEPENDENT REGISTERED CERTIFIED PUBLIC ACCOUNTING FIRM
The Board of Directors and Shareholders of Harris Corporation
We have reviewed the unaudited condensed consolidated balance sheet of Harris Corporation as of December 29, 2017, and the related unaudited condensed consolidated statements of income and comprehensive income for the quarter and two quarters ended December 29, 2017 and December 30, 2016, and the unaudited condensed consolidated statements of cash flows for the two quarters ended December 29, 2017 and December 30, 2016. These financial statements are the responsibility of the Company’s management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the unaudited condensed consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Harris Corporation as of June 30, 2017, and the related consolidated statements of income, comprehensive income, cash flows, and equity for the year then ended (not presented herein) and we expressed an unqualified audit opinion on those consolidated financial statements in our report dated August 29, 2017. In our opinion, the accompanying condensed consolidated balance sheet of Harris Corporation as of June 30, 2017, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
/s/ Ernst & Young LLP
Orlando, Florida
January 31, 2018

21


Item 2. 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 Condensed Consolidated Financial Statements (Unaudited) and accompanying Notes appearing elsewhere in this Report. In addition, reference should be made to our audited Consolidated Financial Statements and accompanying Notes to Consolidated Financial Statements and Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Fiscal 2017 Form 10-K. 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:
Results of Operations — an analysis of our consolidated results of operations and the results in each of our business segments, to the extent the segment operating results are helpful to an understanding of our business as a whole, for the periods presented in our Condensed Consolidated Financial Statements (Unaudited).
Liquidity, Capital Resources and Financial Strategies — an analysis of cash flows, funding of pension plans, common stock repurchases, dividends, capital structure and resources, off-balance sheet arrangements and commercial commitments and contractual obligations.
Critical Accounting Policies and Estimates — information about accounting policies that require critical judgments and estimates and about accounting standards that have been issued, but are not yet effective for us, and their potential impact on our financial position, results of operations and cash flows.
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.
We report the financial results of our continuing operations in the following three 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 C4ISR solutions for the defense industry and ATM solutions for the civil aviation industry; and
Space and Intelligence Systems, providing intelligence, space protection, geospatial, complete Earth observation, universe exploration, 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 described in more detail in “Basis of Presentation” in Note A — Significant Accounting Policies and Recent Accounting Standards and Note B — Discontinued Operations in the Notes, in connection with our divestiture of CapRock and entering into the definitive agreement to sell IT Services in the third quarter of fiscal 2017, our other remaining operations that had been part of our former Critical Networks segment, including our ATM business primarily serving the FAA, were integrated with our Electronic Systems segment effective for the third quarter of fiscal 2017, and our Critical Networks segment was eliminated. The historical results, discussion and presentation of our business segments as set forth in our Condensed Consolidated Financial Statements (Unaudited) and accompanying Notes and this MD&A reflect the impact of these changes for all periods presented in order to present all segment information on a comparable basis. There is no impact on our previously reported consolidated statements of income, balance sheets or statements of cash flows resulting from these segment changes.
Certain prior-year amounts have been reclassified in our Condensed Consolidated Financial Statements (Unaudited) to conform with current-year classifications. Reclassifications include certain human resources and IT 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 the Notes.
Amounts contained in this Report may not always add to totals due to rounding.


22


RESULTS OF OPERATIONS
Highlights
Operations results for the second quarter of fiscal 2018, in each case compared with the second quarter of fiscal 2017, included:
Revenue increased 6 percent to $1.54 billion from $1.45 billion;
Operating income decreased 2 percent to $272 million from $277 million;
Operating income as a percentage of total revenue (“operating margin percentage”) decreased 1 percentage point to 18 percent from 19 percent;
Income from continuing operations decreased 15 percent to $139 million from $163 million;
Income from continuing operations per diluted common share decreased 12 percent to $1.15 from $1.30;
Communication Systems revenue increased 18 percent to $489 million from $413 million and operating income increased 19 percent to $144 million from $121 million;
Electronic Systems revenue increased 2 percent to $584 million from $570 million and operating income decreased 25 percent to $101 million from $134 million; and
Space and Intelligence Systems revenue decreased 1 percent to $465 million from $468 million and operating income increased 7 percent to $81 million from $76 million.

Net cash provided by operating activities increased 26 percent to $373 million in the first two quarters of fiscal 2018 from $295 million in the first two quarters of fiscal 2017.
Consolidated Results of Operations
 
 
Quarter Ended
 
Two Quarters Ended
 
 
December 29, 2017
 
December 30, 2016
 
% Inc/(Dec)
 
December 29, 2017
 
December 30, 2016
 
% Inc/(Dec)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in millions, except per share amounts)
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Communication Systems
$
489

 
$
413

 
18
 %
 
$
899

 
$
843

 
7
 %
Electronic Systems
584

 
570

 
2
 %
 
1,124

 
1,107

 
2
 %
Space and Intelligence Systems
465

 
468

 
(1
)%
 
931

 
921

 
1
 %
Corporate eliminations
(3
)
 
(2
)
 
*

 
(6
)
 
(2
)
 
*

Total revenue
1,535

 
1,449

 
6
 %
 
2,948

 
2,869

 
3
 %
Cost of product sales and services
(999
)
 
(920
)
 
9
 %
 
(1,897
)
 
(1,817
)
 
4
 %
Gross margin
536

 
529

 
1
 %
 
1,051

 
1,052

 

% of total revenue
35
%
 
37
%
 
 
 
36
%
 
37
%
 
 
Engineering, selling and administrative expenses
(264
)
 
(252
)
 
5
 %
 
(507
)
 
(529
)
 
(4
)%
% of total revenue
17
%
 
17
%
 
 
 
17
%
 
18
%
 
 
Operating income
272

 
277

 
(2
)%
 
544

 
523

 
4
 %
% of total revenue
18
%
 
19
%
 
 
 
18
%
 
18
%
 
 
Non-operating income (loss)
(2
)
 
1

 
*

 
(2
)
 
2

 
*

Net interest expense
(41
)
 
(43
)
 
(5
)%
 
(82
)
 
(87
)
 
(6
)%
Income from continuing operations before income taxes
229

 
235

 
(3
)%
 
460

 
438

 
5
 %
Income taxes
(90
)
 
(72
)
 
25
 %
 
(154
)
 
(130
)
 
18
 %
Effective tax rate
39
%
 
31
%
 
 
 
33
%
 
30
%
 
 
Income from continuing operations
$
139

 
$
163

 
(15
)%
 
$
306

 
$
308

 
(1
)%
% of total revenue
9
%
 
11
%
 
 
 
10
%
 
11
%
 
 
Income from continuing operations per diluted common share
$
1.15

 
$
1.30

 
(12
)%
 
$
2.52

 
$
2.45

 
3
 %
* Not meaningful
 
 
 
 
 
 
 
 
 
 
 

23


Revenue
Second Quarter 2018 Compared With Second Quarter 2017: The increase in revenue in the second quarter of fiscal 2018 compared with the second quarter of fiscal 2017 was primarily due to higher revenue in our Communication Systems and Electronic Systems segments, partially offset by a slight revenue decline in our Space and Intelligence Systems segment.
First Two Quarters 2018 Compared With First Two Quarters 2017: The revenue increase in the first two quarters of fiscal 2018 compared with the first two quarters of fiscal 2017 was due to higher revenue in all three segments.
See “Discussion of Business Segment Results of Operations” below in this MD&A for further information.
Gross Margin
Second Quarter 2018 Compared With Second Quarter 2017: The slight increase in gross margin in the second quarter of fiscal 2018 compared with the second quarter of fiscal 2017 was primarily due to higher revenue in our Communication Systems segment, mostly offset by a $22 million favorable contract settlement on the Automatic Dependent Surveillance-Broadcast (“ADS-B”) program in the second quarter of fiscal 2017 in our Electronic Systems segment and a reduction in benefits from net EAC adjustments in our Electronic Systems segment.
First Two Quarters 2018 Compared With First Two Quarters 2017: The slight decrease in gross margin in the first two quarters of fiscal 2018 compared with the first two quarters of fiscal 2017 was primarily due to an unfavorable impact from the ADS-B program, including the favorable contract settlement in the second quarter of fiscal 2017 and the program transition from build-out to sustainment, mostly offset by higher revenue in our Communication Systems segment.
See “Discussion of Business Segment Results of Operations” below in this MD&A for further information.
Gross Margin Percentage
Second Quarter 2018 Compared With Second Quarter 2017: The slight decrease in gross margin as a percentage of total revenue (“gross margin percentage”) in the second quarter of fiscal 2018 compared with the second quarter of fiscal 2017 was primarily due to the impact of the $22 million favorable contract settlement on the ADS-B program in the second quarter of fiscal 2017 and a reduction in benefits from net EAC adjustments in our Electronic Systems segment, mostly offset by the impact of higher revenue in our Communication Systems segment.
First Two Quarters 2018 Compared With First Two Quarters 2017: The slight decrease in gross margin percentage in the first two quarters of fiscal 2018 compared with the first two quarters of fiscal 2017 was primarily due to the same reasons as noted above regarding the second quarters of fiscal 2018 and 2017.
See “Discussion of Business Segment Results of Operations” below in this MD&A for further information.
Engineering, Selling and Administrative Expenses
Second Quarter 2018 Compared With Second Quarter 2017: The increase in engineering, selling and administrative (“ESA”) expenses in the second quarter of fiscal 2018 compared with the second quarter of fiscal 2017 was primarily due to a $12 million adjustment for deferred compensation in the second quarter of fiscal 2018 and higher research and development expenses, partially offset by cost containment and not incurring in the second quarter of fiscal 2018 any Exelis acquisition-related charges, which totaled $13 million in the second quarter of fiscal 2017. ESA as a percentage of total revenue (“ESA percentage”) in the second quarter of fiscal 2018 was comparable with the second quarter of fiscal 2017 as the increase in ESA expenses was offset by the increase in revenue.
First Two Quarters 2018 Compared With First Two Quarters 2017: The decreases in ESA expenses and ESA percentage in the first two quarters of fiscal 2018 compared with the first two quarters of fiscal 2017 were primarily due to cost containment and not incurring in the first two quarters of fiscal 2018 any Exelis acquisition-related charges, which totaled $30 million in the first two quarters of fiscal 2017, partially offset by the effect of the other items discussed above regarding the second quarters of fiscal 2018 and 2017.
See “Discussion of Business Segment Results of Operations” below in this MD&A for further information.
Operating Income
Second Quarter 2018 Compared With Second Quarter 2017: The decreases in operating income and operating income as a percentage of total revenue (“operating margin percentage”) in the second quarter of fiscal 2018 compared with the second quarter of fiscal 2017 were primarily due to the combined effects of the reasons noted above in this “Consolidated Results of Operations” discussion regarding the second quarters of fiscal 2018 and 2017.

24


First Two Quarters 2018 Compared With First Two Quarters 2017: The increase in operating income and comparability of operating margin percentage in the first two quarters of fiscal 2018 compared with the first two quarters of fiscal 2017 were primarily due to the combined effects of the reasons noted above in this “Consolidated Results of Operations” discussion regarding the first two quarters of fiscal 2018 and 2017.
Income Taxes
Second Quarter 2018 Compared With Second Quarter 2017: Our effective tax rate (income taxes as a percentage of income from continuing operations before income taxes) was 39.3 percent in the second quarter of fiscal 2018 compared with 30.6 percent in the second quarter of fiscal 2017. In the second quarter of fiscal 2018, our effective tax rate was impacted by a $52 million estimated write-down of existing net deferred tax asset balances due to the enactment of lower U.S. statutory corporate income tax rates and other tax law changes, partially offset by a $26 million benefit from the corresponding impact of our lower estimated fiscal 2018 tax rate, a $22 million favorable impact of releasing provisions for uncertain tax positions and the favorable impact of differences in GAAP and tax accounting related to investments. In the second quarter of fiscal 2017, our effective tax rate was not impacted by any significant discrete item.
First Two Quarters 2018 Compared With First Two Quarters 2017: Our effective tax rate was 33.5 percent in the first two quarters of fiscal 2018 compared with 29.7 percent in the first two quarters of fiscal 2017. In addition to the items noted above for the second quarters of fiscal 2018 and 2017, our effective tax rate for the first two quarters of fiscal 2018 and 2017 benefited from the favorable impact of excess tax benefits related to equity-based compensation.
Income From Continuing Operations
Second Quarter 2018 Compared With Second Quarter 2017: The decrease in income from continuing operations in the second quarter of fiscal 2018 compared with the second quarter of fiscal 2017 was primarily due to the combined effects of the reasons noted above in this “Consolidated Results of Operations” discussion regarding the second quarters of fiscal 2018 and 2017.
First Two Quarters 2018 Compared With First Two Quarters 2017: The slight decrease in income from continuing operations in the first two quarters of fiscal 2018 compared with the first two quarters of fiscal 2017 was primarily due to the combined effects of the reasons noted above in this “Consolidated Results of Operations” discussion regarding the first two quarters of fiscal 2018 and 2017.
Income From Continuing Operations Per Diluted Common Share
Second Quarter 2018 Compared With Second Quarter 2017: The decrease in income from continuing operations per diluted common share in the second quarter of fiscal 2018 compared with the second quarter of fiscal 2017 was primarily due to lower income from continuing operations, partially offset by fewer diluted weighted average common shares outstanding due to repurchases of shares of common stock under our repurchase program during the last two quarters of fiscal 2017 and first two quarters of fiscal 2018.
First Two Quarters 2018 Compared With First Two Quarters 2017: The increase in income from continuing operations per diluted common share in the first two quarters of fiscal 2018 compared with the first two quarters of fiscal 2017 was primarily due to fewer diluted weighted average common shares outstanding due to repurchases of shares of common stock under our repurchase program during the last two quarters of fiscal 2017 and first two quarters of fiscal 2018.
See “Common Stock Repurchases” below in this MD&A for further information.

25


Discussion of Business Segment Results of Operations
Communication Systems Segment
 
Quarter Ended
 
Two Quarters Ended
 
December 29, 2017
 
December 30, 2016
 
% Inc/(Dec)
 
December 29, 2017
 
December 30, 2016
 
% Inc/(Dec)
 
 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in millions)
Revenue
$
489

 
$
413

 
18
 
$
899

 
$
843

 
7
 %
Cost of product sales and services
(256
)
 
(208
)
 
23
 
(466
)
 
(426
)
 
9
 %
Gross margin
233

 
205

 
14
 
433

 
417

 
4
 %
% of revenue
48
%
 
50
%
 
 
 
48
%
 
49
%
 
 
ESA expenses
(89
)
 
(84
)
 
6
 
(171
)
 
(178
)
 
(4
)%
% of revenue
18
%
 
20
%
 
 
 
19
%
 
21
%
 
 
Segment operating income
$
144

 
$
121

 
19
 
$
262

 
$
239

 
10
 %
% of revenue
29
%
 
29
%
 
 
 
29
%
 
28
%
 
 
Second Quarter 2018 Compared With Second Quarter 2017: The increase in segment revenue in the second quarter of fiscal 2018 compared with the second quarter of fiscal 2017 was primarily due to $57 million of higher U.S. Department of Defense tactical communications sales from readiness demand across all of the Services and $15 million of higher international tactical communications sales, driven by strong growth in the Middle East.
The increase in segment gross margin in the second quarter of fiscal 2018 compared with the second quarter of fiscal 2017 was primarily due to the increase in revenue. The 2 percentage point decrease in segment gross margin percentage in the second quarter of fiscal 2018 compared with the second quarter of fiscal 2017 was primarily due to a less favorable mix of program and product revenue. The increase in segment ESA expenses in the second quarter of fiscal 2018 compared with the second quarter of fiscal 2017 was primarily due to higher selling costs, reflecting the higher international tactical communications sales, and higher employment costs. The 2 percentage point decrease in segment ESA percentage in the second quarter of fiscal 2018 compared with the second quarter of fiscal 2017 was primarily due to the increase in segment revenue and cost containment.
The increase in segment operating income and comparability of segment operating margin percentage in the second quarter of fiscal 2018 compared with the second quarter of fiscal 2017 reflected the combined effects of the items discussed above regarding this segment.
First Two Quarters 2018 Compared With First Two Quarters 2017: The increases in segment revenue and segment gross margin in the first two quarters of fiscal 2018 compared with the first two quarters of fiscal 2017 were primarily due to the same reasons as noted above regarding this segment for the second quarters of fiscal 2018 and 2017.
Segment gross margin percentage for the first two quarters of fiscal 2018 decreased slightly compared with the first two quarters of fiscal 2017 primarily due to the same reasons as noted above regarding this segment for the second quarters of fiscal 2018 and 2017, partially offset by the benefit of operational excellence improvements. The decreases in segment ESA expenses and ESA percentage in the first two quarters of fiscal 2018 compared with the first two quarters of fiscal 2017 were primarily due to cost containment.
The increases in segment operating income and operating margin percentage in the first two quarters of fiscal 2018 compared with the first two quarters of fiscal 2017 reflected the combined effects of the items discussed above regarding this segment for the first two quarters of fiscal 2018 and 2017.

26


Electronic Systems Segment
 
Quarter Ended
 
Two Quarters Ended
 
December 29, 2017
 
December 30, 2016
 
% Inc/(Dec)
 
December 29, 2017
 
December 30, 2016
 
% Inc/(Dec)
 
 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in millions)
Revenue
$
584

 
$
570

 
2
 %
 
$
1,124

 
$
1,107

 
2
 %
Cost of product sales and services
(421
)
 
(378
)
 
11
 %
 
(792
)
 
(742
)
 
7
 %
Gross margin
163

 
192

 
(15
)%
 
332

 
365

 
(9
)%
% of revenue
28
%
 
34
%
 
 
 
30
%
 
33
%
 
 
ESA expenses
(62
)
 
(58
)
 
7
 %
 
(122
)
 
(120
)
 
2
 %
% of revenue
11
%
 
10
%
 
 
 
11
%
 
11
%
 
 
Segment operating income
$
101

 
$
134

 
(25
)%
 
$
210

 
$
245

 
(14
)%
% of revenue
17
%
 
24
%
 
 
 
19
%
 
22
%
 
 
Second Quarter 2018 Compared With Second Quarter 2017: The increase in segment revenue in the second quarter of fiscal 2018 compared with the second quarter of fiscal 2017 was primarily due to $25 million of higher revenue from avionics and C4ISR programs and higher revenue in wireless solutions, partially offset by a $22 million favorable contract settlement on the ADS-B program in our mission networks business in the second quarter of fiscal 2017.
Segment gross margin decreased $29 million and segment gross margin percentage decreased 6 percentage points in the second quarter of fiscal 2018 compared with the second quarter of fiscal 2017 primarily due to the $22 million favorable contract settlement on the ADS-B program in the second quarter of fiscal 2017 and a reduction in benefits from net EAC adjustments, partially offset by the gross margin impact of higher volume in avionics and C4ISR. The increases in segment ESA expenses and ESA percentage in the second quarter of fiscal 2018 compared with the second quarter of fiscal 2017 were primarily due to higher R&D expenses.
The decreases in segment operating income and operating margin percentage in the second quarter of fiscal 2018 compared with the second quarter of fiscal 2017 reflected the combined effects of the items discussed above regarding this segment.
First Two Quarters 2018 Compared With First Two Quarters 2017: The increase in segment revenue in the first two quarters of fiscal 2018 compared with the first two quarters of fiscal 2017 was primarily due to $42 million of higher revenue in avionics and C4ISR programs and $13 million of incremental inception-to-date services revenue in our ATM business, partially offset by an unfavorable impact from the ADS-B program, including the favorable contract settlement in the second quarter of fiscal 2017 and the program transition from build-out to sustainment.
Segment gross margin decreased $33 million and segment gross margin percentage decreased 3 percentage points in the first two quarters of fiscal 2018 compared with the first two quarters of fiscal 2017 primarily due to a $36 million unfavorable impact from the ADS-B program, including the favorable contract settlement in the second quarter of fiscal 2017 and the program transition from build-out to sustainment. The increase in segment ESA expenses and comparability of ESA percentage in the first two quarters of fiscal 2018 compared with the first two quarters of fiscal 2017 was primarily due to higher R&D expenses and the impact of higher segment revenue.
The decreases in segment operating income and operating margin percentage in the first two quarters of fiscal 2018 compared with the first two quarters of fiscal 2017 reflected the combined effects of the items discussed above regarding this segment for the first two quarters of fiscal 2018 and 2017.

27


Space and Intelligence Systems Segment
 
Quarter Ended
 
Two Quarters Ended
 
December 29, 2017
 
December 30, 2016
 
% Inc/(Dec)
 
December 29, 2017
 
December 30, 2016
 
% Inc/(Dec)
 
 
 
 
 
 
 
 
 
 
 
 
 
(Dollars in millions)
Revenue
$
465

 
$
468

 
(1
)%
 
$
931

 
$
921