OREANDA-NEWS. Fitch Ratings has affirmed Harris Corporation's (HRS) Long-Term Issuer Default Rating (IDR) and long term issue ratings at 'BBB-' and Short-Term IDR and commercial paper ratings at 'F3'. In addition, the Rating Outlook has been revised to Positive from Stable. Fitch's ratings covered approximately $4.8 billion of outstanding debt as of April 1, 2016. A full list of rating actions appears at the end of this release.

KEY RATING DRIVERS

The ratings are supported by the company's competitive position in the defense industry; technology capability; sizable international and commercial sales; good product diversification; adequate liquidity; and large backlog. The company has solid cash generation and strong operating margins and is expected to further improve its operations with the realized cost savings from the XLS acquisition. The ratings are also supported by adequate financial flexibility and by the stabilization of the company's main end market in fiscal 2016 (ending in June).

Fitch has revised the Rating Outlook to Positive based on expectations that HRS will continue reducing its leverage over the next two years through both voluntary and scheduled debt reductions and improving operating results. The continued impact of the Exelis (XLS) acquisition in May 2015 has left HRS' leverage metrics weak for the ratings despite significant de-leveraging during fiscal 2016. As of the last 12 months ended April 1, 2016, the company's leverage (debt/EBITDA) and adjusted leverage (adjusted debt/EBITDAR) were 2.9x and 3.1x, respectively, down from 4.1x and 4.2x at the end of fiscal year ended July 3, 2015. As of mid-April 2016, HRS had repaid approximately $683 million of the term loans incurred in the XLS acquisition. HRS is on track to retire a total of $1.8 billion of the acquisition-related debt by the end of fiscal 2018 to bring its net debt leverage to 1.5x (Fitch estimated 1.7x gross leverage).

Fitch believes the company is committed to achieving its leverage target and we anticipate the majority of excess cash will be used for debt retirement over the next two years. Fitch expects HRS' leverage and adjusted leverage will decline to 2.4x and 2.7x, respectively, by the end of fiscal 2017. FFO adjusted leverage is also expected to improve to 3.8x during the same time frame, down from 5.9x at the end of fiscal 2015.

The majority of the company's non-leverage metrics (profitability, diversity, backlog, etc.) are indicative of a strong investment-grade company. HRS is a sole source provider for many of its products and generates solid operating cash driven by strong margins and effective cost management. HRS' fiscal 2016 revenue growth has been softer than previously anticipated, largely due to the impact of the energy market downturn on CapRock, slowdown in military spending by the company's Middle East customers, completion and/or losses of several projects, and year-over-year declines in XLS' legacy communications segment.

Fitch expects HRS' revenue at the end of fiscal 2016 will be more than $500 million short of Fitch's prior fiscal 2016 revenue projections. Significant and unexpected declines in CapRock revenues resulted in a non-cash goodwill write-down of $367 million (pre-tax) during the second quarter of fiscal 2016 (2Q16). As a result of the revenue headwinds, the aforementioned write-down, and sizable one-time XLS integration costs, the company's operating margins were modestly lower in fiscal 2016 compared to Fitch's expectations.

Fitch anticipates HRS' EBITDA margins will be higher than 22% in fiscal 2017 and beyond, driven by the completion of the integration efforts and significant run-rate savings in the range of $140 million to $150 million. In addition, Fitch expects the company will generate above $500 million of free cash flows (FCF) annually after giving effect to sizable annual cash outlays associated with the dividends of more than $250 million, capital expenditures of approximately $200 million, and pension contributions of approximately $175 million.

Fitch is concerned with HRS' exposure to shocks and downturns in U. S. military spending or shifts in spending mix. The fiscal 2015 U. S. defense budget hit a trough (base budget and wartime spending), and it began rising in fiscal 2016. Fitch still considers the defense outlook to be somewhat uncertain, partly due to the Pentagon's intense focus on lowering costs, which could impact the sector's profitability, as well as the continued risk of sequestration after fiscal 2017. Fitch considers HRS' portfolio to be of good quality, with highly diversified strategically important and growing programs. Additionally, the exposure to the U. S. defense spending is mitigated by a sizable international and commercial presence. Fitch also notes that despite the larger scale that resulted from the XLS acquisition, HRS remains smaller than many of its key competitors.

Fitch is also concerned by HRS' large pension deficit (including a relatively high percentage of Level III assets) and corresponding future pension funding requirements, and the impact on cash flows upon expiration of Highway and Transportation Funding Act of 2014. At the end of fiscal 2015, HRS' pension plans were underfunded by approximately $2 billion (approximately 69% funded), a slight improvement from $2.1 million deficit (also 69% funded) at the end of fiscal 2014. The pension benefit obligation (PBO) was $6.5 billion at the end of fiscal 2015, while the other post-retirement benefit obligation was $445 million (approximately 58% funded). In fiscal 2016, HRS plans to make a contribution in the range of $170 million to $180 million to its qualified pension plans and we expect future contributions will remain in the similar range for the next several years. The large pension deficit and required contributions are mitigated by expected reimbursements from the U. S. government, which treats a part of pension costs as allowable and reimbursable under some contracts.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for HRS include:

--Flat sales through 2017 and low single-digit revenue growth thereafter;

--EBITDA margins at approximately 21% in fiscal 2016. Margins are expected to increase above 22% in the following years;

--Debt repayment will be accelerated and driven by the company's cash generation;

--Dividends will increase annually;

--Share repurchases will resume in fiscal 2017. Fitch expects share repurchase amounts will depend on internal cash generation and may not resume in fiscal 2017 if the company's is not on target to achieving its net leverage goal of 1.5x by the end of fiscal 2018;

--Cash flow generation will be solid and the company will generate above $500 million FCF annually after giving effect to pension contributions and dividends;

--The company will make contributions between $170 million and $180 million towards its pension liabilities annually;

--HRS will not make material debt-funded acquisitions over the rating horizon;

--Capital expenditures will fluctuate in the range of 2.25% to 2.50% of revenues.

RATING SENSITIVITIES

Future actions that may individually or collectively cause Fitch to take a positive rating action include continued de-leveraging which would lead to sustained leverage in the range of 2x to 2.25x and adjusted leverage below 2.75x, and sustained FFO adjusted leverage below 3x. Fitch may also consider positive rating action if a stabilization of the oil and gas market or faster EBITDA margin improvements translate into better than expected operating results.

Future actions that may individually or collectively cause Fitch to take a negative rating action include if the company's leverage and adjusted leverage remain above 2.75x and 3.25x, respectively, for a prolonged and sustained period of time. Fitch may also consider a negative action if the company's FCF margin declines and remains below 4%. Additionally, it may also be considered if the company engages in sizable share repurchases or acquisitions prior to reducing leverage.

LIQUIDITY

As of April 1, 2016, HRS' $1.3 billion liquidity was composed of approximately $302 million of cash and cash equivalents and a fully available $1 billion revolving credit facility with no outstanding letters of credit. Fitch expects the company's liquidity will remain steady over the next several years as we anticipate its cash balances will not increase due to rapid debt repayment.

HRS has sizable maturities over the next two years as the XLS legacy $250 million senior unsecured notes and the $500 million senior unsecured notes become due in fiscal 2017 and fiscal 2018, respectively. In addition, Fitch estimates that as of mid-April 2016, the company had approximately $300 million outstanding on each of its three-year tranche and five-year tranche term loans, which mature in fiscals 2018 and 2020, respectively. Fitch expects the company will repay in full the three-year term loans and will pay down a significant portion of the five-year term loan by the end of fiscal 2018 to achieve its 1.5x net leverage target, and anticipates the company will manage the maturities with internally generated cash.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

Harris Corporation:

--IDR at 'BBB-';

--Senior unsecured revolving credit facility at 'BBB-';

--Senior unsecured three - and five-year term loans at 'BBB-';

--Senior unsecured notes and debentures at 'BBB-';

--Short-term IDR at 'F3';

--Commercial paper at 'F3'.

Rating Outlook was revised to Positive from Stable.