New Accounting Standards Implemented

Effective January 1, 2018, the Company adopted Financial Accounting Standards Board (FASB) ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost. Defined benefit pension and postretirement benefit cost (net benefit cost) comprise several components that reflect different aspects of the Company’s financial arrangements as well as the cost of benefits provided to employees. Under previous U.S. GAAP, those components were aggregated for reporting in the financial statements and presented within the operating section of the income statement or capitalized into assets (inventories) when appropriate. The amendments in this update require the Company to report the service cost component in the same line item as other compensation costs arising from services rendered by the employees during the period. The other components of net benefit cost are required to be presented separately from the service cost component and below income from operations. Plan administrative expenses, which were previously included in service cost, are presented together with expected return on plan assets, as a component of Interest and other income, net. The amendments in this update also allow only the service cost component to be eligible for capitalization when applicable. The amendments in this update have been applied retrospectively for the presentation of the components of net benefit cost and prospectively for the capitalization of the service cost component of net benefit cost. The adoption of this standard decreased operating income and increased interest and other income, net, each by $2 million for the quarterly period ended March 30, 2018 and increased operating income and decreased interest and other income, net, each by $1 million for the quarterly period ended March 31, 2017. The adoption of this standard did not impact pre-tax income for the quarterly periods ended March 30, 2018 and March 31, 2017.

In January 2017, the FASB issued ASU 2017-01, Clarifying the Definition of a Business, which provides additional guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendments in this update provide new guidance to determine when an integrated set of assets and activities (collectively referred to as a ‘‘set’’) is not a business. The new guidance requires that, when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. The new guidance reduces the number of transactions that need to be evaluated as a business. The Company adopted this amendment as of January 1, 2018. The adoption of ASU 2017-01 did not have a material impact on the Company's financial statements for the quarterly period ended March 30, 2018.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, as amended (commonly referred to as ASC 606), which replaces numerous requirements in U.S. GAAP, including industry-specific requirements, and provides companies with a single revenue recognition model for recognizing revenue from contracts with customers and significantly expanded the disclosure requirements for revenue arrangements. The new standard, as amended, was effective for the Company for interim and annual reporting periods beginning on January 1, 2018.

As discussed in Note 2, the Company adopted ASC 606 using the modified retrospective transition method. Results for reporting periods beginning after December 31, 2017 are presented under ASC 606, while prior period comparative information has not been restated and continues to be reported in accordance with ASC 605, Revenue Recognition, the accounting standard in effect for periods ending prior to January 1, 2018. With the adoption of ASC 606, the Company recognizes sales over time by using the cost-to-cost method on most of its (i) contracts that were covered by the contract accounting standards under ASC 605 and (ii) fixed-price type contracts that require it to perform services that are not related to the production of tangible assets. Accordingly, the adoption of ASC 606 primarily impacted certain (i) contracts previously covered by contract accounting standards that recognized revenue using the units-of-delivery method and (ii) fixed-price type contracts for services that are not related to the production of tangible assets that recognized revenue on a straight-line basis over the contractual service period.

Based on contracts in process at December 31, 2017, the Company recorded, upon adoption of ASC 606, a net increase to retained earnings of $13 million, which includes the acceleration of net sales of approximately $380 million and the related cost of sales. The adjustment to retained earnings primarily relates to contracts previously accounted for under the units-of-delivery method, which is recognized under ASC 606 earlier in the performance period as costs are incurred, as opposed to when the units are delivered under ASC 605. In accordance with the modified retrospective transition provisions of ASC 606, the Company will not recognize any of the accelerated net sales and related cost of sales at January 1, 2018 in the Company’s statements of operations for any historical or future period.

The Company made certain presentation changes to its consolidated balance sheet on January 1, 2018 to comply with ASC 606. The components of contracts in process as reported under ASC 605, which included unbilled contract receivables and inventoried contract costs, have been reclassified as contract assets and inventories, respectively, after certain adjustments described below under ASC 606. The adoption of ASC 606 resulted in an increase in unbilled contract receivables (referred to as contract assets under ASC 606) primarily from converting contracts previously applying the units-of-delivery method to the cost-to-cost method with a corresponding reduction in inventoried contract costs. The remainder of inventoried contract costs, primarily related to inventories not controlled by the Company's customers, were reclassified to inventories. Additionally, under ASC 606, the Company capitalizes costs to fulfill a contract (i.e., non-recurring costs for contract-related activities that do not transfer a good or service to the customer) and costs to obtain a contract (i.e., commissions paid to third-party agents or representatives) to prepaid expense and other current assets or other assets (non-current). The Company amortizes costs to obtain a contract and costs to fulfill a contract in a pattern similar to the recognition of sales on the contracts that the capitalized costs relate to. The Company previously accounted for costs to fulfill a contract either as inventoried contract costs or expensed them as incurred. Costs to obtain a contract were generally expensed as incurred. Advance payments and billings in excess of costs and deferred revenue, previously classified in other current liabilities, have been combined and are presented as contract liabilities.

The table below presents the cumulative effect of the changes made to the consolidated January 1, 2018 balance sheet due to the adoption of ASC 606.



BALANCE SHEET	December 31, 2017 As Reported Under ASC 605		Adjustments Due to ASC 606			January 1, 2018 As Adjusted Under ASC 606
			(in millions)
Assets
Current assets:
Contract assets	$	—	$	1,349		$	1,349
Contracts in process	1,933		(1,933		)	—
Inventories	389		537			926
Prepaid expenses and other current assets	300		17			317
Assets held for sale	135		3			138
Assets of discontinued operations	306		(21		)	285
Total current assets	4,448		(48		)	4,400
Other assets	264		49			313
Total assets	$	12,729	$	1		$	12,730

Liabilities
Current liabilities:
Accrued expenses	$	217	$	(13	)	$	204
Contract liabilities	—		565			565
Advance payments and billing in excess of costs incurred	509		(509		)	—
Other current liabilities	367		(49		)	318
Liabilities held for sale	17		(1		)	16
Liabilities of discontinued operations	226		(23		)	203
Total current liabilities	2,379		(30		)	2,349
Deferred income taxes	158		4			162
Other liabilities	398		14			412
Total liabilities	7,578		(12		)	7,566
Shareholders' Equity
Retained earnings	6,659		13			6,672
Total equity	$	5,151	$	13		$	5,164

The table below presents the impact of the adoption of ASC 606 on the Company's statement of operations.



	First Quarter Ended March 30, 2018
STATEMENT OF OPERATIONS	Under ASC 605			Effect of ASC 606			As Reported Under ASC 606
				(in millions)
Net Sales:
Products	$	1,574		$	72		$	1,646
Services	721			4			725
Total	2,295			76			2,371

Operating costs and expenses:
Cost of sales — Products	$	(1,145	)	$	(46	)	$	(1,191	)
Cost of sales — Services	(528		)	(4		)	(532		)
General and administrative expenses	(390		)	(7		)	(397		)
Operating income	$	232		$	19		$	251
Income from continuing operations before income taxes	197			19			216
Provision for income taxes	(19		)	(5		)	(24		)
Income from continuing operations	178			14			192
Income from discontinued operations, net of income taxes	15			1			16
Net income	193			15			208
Net income attributable to L3	$	188		$	15		$	203

Basic earnings per share attributable to common shareholders:
Continuing operations	$	2.21		$	0.19		$	2.40
Discontinued operations	0.19			0.01			0.20
Basic earnings per share	$	2.40		$	0.20		$	2.60
Diluted earnings per share attributable to common shareholders:
Continuing operations	$	2.16		$	0.18		$	2.34
Discontinued operations	0.19			0.01			0.20
Diluted earnings per share	$	2.35		$	0.19		$	2.54

The following table quantifies the impact of adopting ASC 606 on segment net sales and operating income for the quarterly period ended March 30, 2018.



	Effect of ASC 606
	Sales		Operating Income
	(in millions)
Electronic Systems	$	30	$	3
Aerospace Systems	4		1
Communication Systems	20		4
Sensor Systems	22		11
Consolidated	$	76	$	19

The table below presents the impact of the adoption of ASC 606 on the Company's balance sheet.



	March 30, 2018
BALANCE SHEET	Under ASC 605		Effect of ASC 606			As Reported Under ASC 606
			(in millions)
Assets
Current assets:
Contract assets	$	—	$	1,499		$	1,499
Contracts in process	2,124		(2,124		)	—
Inventories	424		570			994
Prepaid expenses and other current assets	377		15			392
Assets of discontinued operations	312		(25		)	287
Total current assets	4,545		(65		)	4,480
Other assets	296		50			346
Total assets	$	12,888	$	(15	)	$	12,873

Liabilities
Current liabilities:
Accrued expenses	$	218	$	(21	)	$	197
Contract liabilities	—		607			607
Advance payments and billings in excess of costs incurred	576		(576		)	—
Other current liabilities	367		(48		)	319
Liabilities held for sale	20		(1		)	19
Liabilities of discontinued operations	181		(27		)	154
Total current liabilities	2,401		(66		)	2,335
Deferred income taxes	169		8			177
Other liabilities	382		15			397
Total liabilities	7,596		(43		)	7,553
Shareholders' Equity
Retained earnings	6,786		28			6,814
Total equity	$	5,292	$	28		$	5,320