10-Q 1 lll-062918x10q.htm 10-Q Document

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 29, 2018
¨
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 001-37975
L3 TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware
13-3937436
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
600 Third Avenue, New York, NY
10016
(Address of principal executive offices)
(Zip Code)
(212) 697-1111
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) 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. x Yes  ¨ No
Indicate by check mark whether the registrant has submitted electronically and posted on the corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 x
Accelerated filer
¨
Non-accelerated filer ¨ (Do not check if a smaller reporting company)
Smaller reporting company
¨
 
Emerging growth company
¨
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. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  ¨ Yes  x No
There were 78,328,669 shares of the registrant’s common stock with a par value of $0.01 outstanding as of the close of business on July 20, 2018.
 



L3 TECHNOLOGIES, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
For the quarterly period ended June 29, 2018

TABLE OF CONTENTS
 
 
Page
 No.
 
PART I — FINANCIAL INFORMATION
 
 
 
 
ITEM 1.
 
 
 
 
 
 
 
ITEM 2.
ITEM 3.
ITEM 4.
 
 
 
 
PART II — OTHER INFORMATION
 
 
 
 
ITEM 1.
ITEM 1A.
ITEM 2.
ITEM 5.
ITEM 6.



PART I — FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS
L3 TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions, except share data)
 
(Unaudited)
 
 
 
June 29,
2018
 
December 31,
2017
ASSETS
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
1,366

 
$
662

Billed receivables, net of allowances of $18 in 2018 and 2017
863

 
723

Contract assets
1,611

 

Contracts in process

 
1,933

Inventories
934

 
389

Prepaid expenses and other current assets
332

 
300

Assets held for sale

 
135

Assets of discontinued operations

 
306

Total current assets
5,106


4,448

Property, plant and equipment, net
1,137

 
1,110

Goodwill
6,651

 
6,615

Identifiable intangible assets
288

 
292

Other assets
348

 
264

Total assets
$
13,530


$
12,729

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Current portion of long-term debt
$
581

 
$

Accounts payable, trade
588

 
531

Accrued employment costs
453

 
493

Accrued expenses
264

 
217

Contract liabilities
554

 

Advance payments and billings in excess of costs incurred

 
509

Income taxes payable
25

 
19

Other current liabilities
338

 
367

Liabilities held for sale

 
17

Liabilities of discontinued operations

 
226

Total current liabilities
2,803


2,379

Pension and postretirement benefits
1,290

 
1,313

Deferred income taxes
190

 
158

Other liabilities
416

 
398

Long-term debt
3,319

 
3,330

Total liabilities
8,018


7,578

Commitments and contingencies (see Note 19)


 


Equity:
 
 
 
Shareholders’ equity:
 
 
 
Common stock: $.01 par value; 300,000,000 shares authorized, 78,242,526 shares outstanding at June 29, 2018 and 77,876,687 shares outstanding at December 31, 2017
6,723

 
6,519

Treasury stock (at cost), 84,821,829 shares at June 29, 2018 and 83,362,412 shares at December 31, 2017
(7,691
)
 
(7,404
)
Retained earnings
7,126

 
6,659

Accumulated other comprehensive loss
(714
)
 
(691
)
Total shareholders’ equity
5,444


5,083

Noncontrolling interests
68

 
68

Total equity
5,512


5,151

Total liabilities and equity
$
13,530


$
12,729


See notes to unaudited condensed consolidated financial statements.
1


L3 TECHNOLOGIES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share data)

 
Second Quarter Ended
 
June 29,
2018
 
June 30,
2017
Net sales:
 
 
 
Products
$
1,786

 
$
1,680

Services
797

 
705

Total net sales
2,583


2,385

Operating costs and expenses:
 
 
 
Cost of sales — Products
(1,349
)
 
(1,253
)
Cost of sales — Services
(578
)
 
(479
)
General and administrative expenses
(383
)
 
(359
)
Total operating costs and expenses
(2,310
)
 
(2,091
)
Gain on sale of the Crestview Aerospace and TCS businesses
48

 

Operating income
321

 
294

Interest expense
(44
)
 
(42
)
Interest and other income, net
8

 
2

Debt retirement charge
(48
)
 

Income from continuing operations before income taxes
237


254

Provision for income taxes
(48
)
 
(59
)
Income from continuing operations
189


195

Income from discontinued operations, net of income taxes
190

 
12

Net income
379


207

Net income from continuing operations attributable to noncontrolling interests
(4
)
 
(5
)
Net income attributable to L3
$
375


$
202

Basic earnings per share attributable to common shareholders:
 
 
 
Continuing operations
$
2.36

 
$
2.44

Discontinued operations
2.42

 
0.15

Basic earnings per share
$
4.78


$
2.59

Diluted earnings per share attributable to common shareholders:
 
 
 
Continuing operations
$
2.33

 
$
2.39

Discontinued operations
2.39

 
0.15

Diluted earnings per share
$
4.72


$
2.54

Cash dividends declared per common share
$
0.80

 
$
0.75

Weighted average common shares outstanding:
 
 
 
Basic
78.4

 
78.0

Diluted
79.4

 
79.5




See notes to unaudited condensed consolidated financial statements.
2


L3 TECHNOLOGIES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share data)

 
First Half Ended
 
June 29,
2018
 
June 30,
2017
Net sales:
 
 
 
Products
$
3,432

 
$
3,284

Services
1,522

 
1,422

Total net sales
4,954

 
4,706

Operating costs and expenses:
 
 
 
Cost of sales — Products
(2,540
)
 
(2,441
)
Cost of sales — Services
(1,110
)
 
(1,017
)
General and administrative expenses
(780
)
 
(717
)
Total operating costs and expenses
(4,430
)
 
(4,175
)
Gain on sale of the Crestview Aerospace and TCS businesses
48

 

Operating income
572

 
531

Interest expense
(85
)
 
(84
)
Interest and other income, net
14

 
6

Debt retirement charge
(48
)
 

Income from continuing operations before income taxes
453

 
453

Provision for income taxes
(72
)
 
(101
)
Income from continuing operations
381

 
352

Income from discontinued operations, net of income taxes
206

 
23

Net income
587

 
375

Net income from continuing operations attributable to noncontrolling interests
(9
)
 
(9
)
Net income attributable to L3
$
578

 
$
366

Basic earnings per share attributable to common shareholders:
 
 
 
Continuing operations
$
4.75

 
$
4.40

Discontinued operations
2.63

 
0.30

Basic earnings per share
$
7.38

 
$
4.70

Diluted earnings per share attributable to common shareholders:
 
 
 
Continuing operations
$
4.67

 
$
4.32

Discontinued operations
2.59

 
0.29

Diluted earnings per share
$
7.26

 
$
4.61

Cash dividends declared per common share
$
1.60

 
$
1.50

Weighted average common shares outstanding:
 
 
 
Basic
78.3

 
77.8

Diluted
79.6

 
79.4





See notes to unaudited condensed consolidated financial statements.
3


L3 TECHNOLOGIES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in millions)

 
Second Quarter Ended
 
First Half Ended
 
June 29,
2018
 
June 30,
2017
 
June 29,
2018
 
June 30,
2017
Net income
$
379

 
$
207

 
$
587

 
$
375

Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustments
(72
)
 
52

 
(39
)
 
71

Unrealized lossess on hedging instruments (1)
(10
)
 

 
(11
)
 

Pension and postretirement benefit plans:
 
 
 
 
 
 
 
Amortization of net loss and prior service cost previously recognized (2)
13

 
10

 
27

 
19

Total other comprehensive (loss) income
(69
)
 
62

 
(23
)
 
90

Comprehensive income
310


269


564


465

Comprehensive income attributable to noncontrolling interests
(4
)
 
(5
)
 
(9
)
 
(9
)
Comprehensive income attributable to L3
$
306


$
264


$
555


$
456

__________________
(1) 
Net of income tax benefit of $3 million for each of the quarterly and first half periods ended June 29, 2018.
(2) 
Net of income taxes of $4 million and $5 million for the quarterly periods ended June 29, 2018 and June 30, 2017, respectively, and net of income taxes of $8 million and $11 million for the first half periods ended June 29, 2018 and June 30, 2017, respectively.

See notes to unaudited condensed consolidated financial statements.
4


L3 TECHNOLOGIES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
(in millions, except per share data)

 
Common Stock
 
Additional Paid-in Capital
 
Treasury Stock
 
Retained Earnings
 
Accumulated Other Comprehensive Loss
 
Noncontrolling Interests
 
Total Equity
 
Shares Outstanding
 
Par Value
 
For the First Half Ended June 29, 2018:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Balance at December 31, 2017 - as reported
77.9

 
$
1

 
$
6,518

 
$
(7,404
)
 
$
6,659

 
$
(691
)
 
$
68

 
$
5,151

Cumulative effect adjustment of ASC 606 on January 1, 2018, net of taxes
 
 
 
 
 
 
 
 
13

 
 
 
 
 
13

Net income
 
 
 
 
 
 
 
 
578

 
 
 
9

 
587

Other comprehensive loss
 
 
 
 
 
 
 
 
 
 
(23
)
 
 
 
(23
)
Distributions to noncontrolling interests
 
 
 
 
 
 
 
 
 
 
 
 
(9
)
 
(9
)
Cash dividends declared ($1.60 per share)
 
 
 
 
 
 
 
 
(126
)
 
 
 
 
 
(126
)
Shares issued:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Employee savings plans
0.3

 
 
 
72

 
 
 
 
 
 
 
 
 
72

Exercise of stock options
1.2

 
 
 
103

 
 
 
 
 
 
 
 
 
103

Employee stock purchase plan
0.1

 
 
 
17

 
 
 
 
 
 
 
 
 
17

Vesting of restricted stock and performance units
0.3

 
 
 
 
 
 
 
 
 
 
 
 
 

Repurchases of common stock to satisfy tax withholding obligations
(0.1
)
 
 
 
(24
)
 
 
 
 
 
 
 
 
 
(24
)
Stock-based compensation expense
 
 
 
 
34

 
 
 
 
 
 
 
 
 
34

Treasury stock purchased
(1.5
)
 
 
 
 
 
(287
)
 
 
 
 
 
 
 
(287
)
Other
 
 
 
 
2

 
 
 
2

 
 
 
 
 
4

Balance at June 29, 2018
78.2


$
1


$
6,722


$
(7,691
)

$
7,126


$
(714
)

$
68


$
5,512

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the First Half Ended June 30, 2017:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
77.2

 
$
1

 
$
6,284

 
$
(7,224
)
 
$
6,218

 
$
(726
)
 
$
71

 
$
4,624

Net income
 
 
 
 
 
 
 
 
366

 
 
 
9

 
375

Other comprehensive income
 
 
 
 
 
 
 
 
 
 
90

 
 
 
90

Distributions to noncontrolling interests
 
 
 
 
 
 
 
 
 
 
 
 
(9
)
 
(9
)
Cash dividends declared ($1.50 per share)
 
 
 
 
 
 
 
 
(118
)
 
 
 
 
 
(118
)
Shares issued:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Employee savings plans
0.4

 
 
 
60

 
 
 
 
 
 
 
 
 
60

Exercise of stock options
0.3

 
 
 
25

 
 
 
 
 
 
 
 
 
25

Employee stock purchase plan
0.1

 
 
 
16

 
 
 
 
 
 
 
 
 
16

Vesting of restricted stock and performance units
0.3

 
 
 
 
 
 
 
 
 
 
 
 
 

Repurchases of common stock to satisfy tax withholding obligations
(0.1
)
 
 
 
(18
)
 
 
 
 
 
 
 
 
 
(18
)
Stock-based compensation expense
 
 
 
 
28

 
 
 
 
 
 
 
 
 
28

Treasury stock purchased
(0.2
)
 
 
 
 
 
(26
)
 
 
 
 
 
 
 
(26
)
Balance at June 30, 2017
78.0


$
1


$
6,395


$
(7,250
)

$
6,466


$
(636
)

$
71


$
5,047



See notes to unaudited condensed consolidated financial statements.
5


L3 TECHNOLOGIES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)

 
First Half Ended
 
June 29,
2018
 
June 30,
2017
Operating activities:
 
 
 
Net income
$
587

 
$
375

Less: income from discontinued operations, net of tax
(206
)
 
(23
)
Income from continuing operations
381

 
352

Depreciation of property, plant and equipment
90

 
82

Amortization of intangibles and other assets
26

 
24

Deferred income tax provision
21

 
25

Stock-based compensation expense
34

 
28

Contributions to employee savings plans in L3's common stock
68

 
56

Amortization of pension and postretirement benefit plans net loss and prior service cost
35

 
30

Gain on sale of property, plant and equipment

 
(42
)
Gain on sale of the Crestview Aerospace and TCS businesses
(48
)
 

Debt retirement charge
48

 

Other non-cash items
1

 
6

Changes in operating assets and liabilities, excluding amounts from acquisitions and divestitures, and discontinued operations:
 
 
 
Billed receivables
(137
)
 
(88
)
Contract assets
(266
)
 

Contracts in process

 
(123
)
Inventories
(10
)
 
(12
)
Prepaid expenses and other current assets
(82
)
 
(15
)
Accounts payable, trade
61

 
(99
)
Accrued employment costs
(38
)
 
(28
)
Accrued expenses
63

 
158

Contract liabilities
(2
)
 

Advance payments and billing in excess of costs incurred

 
(10
)
Income taxes
(22
)
 
(12
)
All other operating activities
(45
)
 
(17
)
Net cash from operating activities from continuing operations
178

 
315

 
 
 
 
Investing activities:
 
 
 
Business acquisitions, net of cash acquired
(69
)
 
(191
)
Proceeds from the sale of businesses, net of closing date cash balances
535

 
16

Capital expenditures
(108
)
 
(96
)
Dispositions of property, plant and equipment
1

 
65

Other investing activities
(29
)
 
(1
)
Net cash from (used in) investing activities from continuing operations
330

 
(207
)
 
 
 
 
Financing activities:
 
 
 
Proceeds from sale of senior notes
1,798

 

Repurchases and redemptions of senior notes
(1,263
)
 

Borrowings under revolving credit facility
501

 
1,158

Repayments of borrowings under revolving credit facility
(501
)
 
(1,158
)
Common stock repurchased
(287
)
 
(26
)
Dividends paid
(128
)
 
(119
)
Proceeds from exercises of stock options
103

 
25

Proceeds from employee stock purchase plan
17

 
16

Repurchases of common stock to satisfy tax withholding obligations
(24
)
 
(18
)
Debt issue costs
(13
)
 

Other financing activities
(6
)
 
(8
)
Net cash from (used in) financing activities from continuing operations
197

 
(130
)
Effect of foreign currency exchange rate changes on cash and cash equivalents
(8
)
 
10

Net cash from (used in) discontinued operations:
 
 
 
Operating activities
9

 
36

Investing activities
(2
)
 
(2
)
Net cash from discontinued operations
7

 
34

Net increase cash and cash equivalents
704

 
22

Cash and cash equivalents, beginning of the period
662

 
363

Cash and cash equivalents, end of the period
$
1,366

 
$
385



See notes to unaudited condensed consolidated financial statements.
6


L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS

1. Description of Business
L3 Technologies, Inc. (L3 Technologies, Inc. and, together with its subsidiaries, referred to herein as L3 or the Company) is a prime contractor in Intelligence, Surveillance and Reconnaissance (ISR) systems, aircraft sustainment (including modifications and fleet management of special mission aircraft), simulation and training, night vision and image intensification equipment and security and detection systems. L3 is also a leading provider of a broad range of communication, electronic and sensor systems used on military, homeland security and commercial platforms. The Company’s customers include the United States (U.S.) Department of Defense (DoD) and its prime contractors, U.S. Government intelligence agencies, the U.S. Department of Homeland Security (DHS), foreign governments, and domestic and foreign commercial customers.
The Company has the following four reportable segments: (1) Electronic Systems, (2) Aerospace Systems, (3) Communication Systems and (4) Sensor Systems.
Electronic Systems provides a broad range of products and services, including components, products, subsystems, systems and related services to military and commercial customers. These products and services serve niche markets, such as aircraft simulation and training, power and distribution, cockpit avionics, airport security and precision weapons. Electronic Systems sells these products and services primarily to the DoD and select foreign governments. The Electronic Systems business areas are Link Training & Simulation, Power & Propulsion Systems, Commercial Aviation Solutions, Precision Engagement Systems and Security & Detection Systems.
Aerospace Systems provides products and services for the global ISR and Command, Control and Communications (C3) markets, specializing in signals intelligence (SIGINT) and multi-intelligence platforms, including engineering, modernization and sustainment solutions for military and various government aircraft, ground support equipment and other platforms. These strategic and tactical products and services provide warfighters with the ability to detect, collect, identify, analyze and disseminate information from command centers, communication nodes and air defense systems for real-time situational awareness and response. Aerospace Systems sells these products and services primarily to the DoD and select foreign governments. The Aerospace Systems business areas are Mission Integration, MAS, Aerostructures and Advanced Systems.
Communication Systems provides network and communication systems, secure communications products, radio frequency (RF) components, satellite communication terminals and space, microwave and telemetry products. These products include secure data links that are used to connect a variety of space, airborne, ground and sea-based communication systems and are used in transmission, processing, recording, monitoring and dissemination functions of these communication systems. Communication Systems sells these products and services primarily to the DoD and select foreign governments. The Communications Systems business areas are Broadband Communication Systems, Space & Power Systems and Advanced Communications.
Sensor Systems provides a broad range of multi-domain ISR mission solutions from seabed to space for DoD, intelligence community, international, federal, civil and commercial customers. Major capabilities and mission solutions include networked warfighter systems, integrated ISR and targeting systems, space avionics and imaging payloads, Counter Unmanned Aircraft Systems mission solutions, integrated maritime mission solutions, directed energy, cyber and electronic warfare, special mission command & control, lightweight unmanned undersea vehicles, modeling & simulation and life cycle support. Sensor Systems sells these products and services primarily to the DoD and select foreign governments. The Sensor Systems business areas are Space & Sensor Systems, Airborne Sensor Systems, Warrior Sensor Systems, Maritime Sensor Systems, Intelligence & Mission Systems and Advanced Programs.
Financial information with respect to the Company’s segments is included in Note 23 to the unaudited condensed consolidated financial statements and in Note 21 to the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.
On June 29, 2018, the Company completed the sale of its Vertex Aerospace businesses for a sale price of $540 million subject to customary closing net working capital adjustments. In connection with the sale, the Company recognized: (1) a pre-tax gain from continuing operations of $48 million ($25 million after income taxes) related to the Crestview Aerospace and TCS businesses (the "Crestview & TCS Businesses") and (2) a pre-tax gain from discontinued operations of $237 million ($180 million after income taxes) related to the Vertex Aerospace business. The divestiture of the Vertex Aerospace business represents a strategic


7

L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


shift by the Company to exit the logistics solution and maintenance services business for military aircraft where the Company does not provide complex ISR systems integration and modification. The Vertex Aerospace business generated sales of $1.4 billion for the year ended December 31, 2017. The assets and liabilities and results of operations of the Vertex Aerospace business are reported as discontinued operations for all periods presented.
All references made to financial data in this Quarterly Report on Form 10-Q are to the Company’s continuing operations, unless specifically noted. See Note 5 for additional information.
2. Basis of Presentation
These unaudited condensed consolidated financial statements for the quarterly and first half periods ended June 29, 2018 should be read in conjunction with the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.
Principles of Consolidation and Reporting
The accompanying financial statements comprise the consolidated financial statements of L3. The consolidated financial statements of the Company include all wholly-owned and majority-owned subsidiaries and variable interest entities (VIEs) if the Company is the primary beneficiary. The Company holds interests in certain VIEs for which it was determined the Company is not the primary beneficiary. All significant intercompany transactions are eliminated in consolidation. Investments in equity securities, joint ventures and limited liability corporations over which the Company has significant influence but does not have control are accounted for using the equity method. Investments over which the Company does not have significant influence are accounted for using the cost method. For the classification of certain current assets and liabilities, the Company uses the duration of the related contract or program as its operating cycle, which may be longer than one year.

Certain reclassifications have been made to conform prior-year amounts to the current-year presentation.
The unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission (SEC). Accordingly, they do not include all of the disclosures required by U.S. GAAP for a complete set of annual audited financial statements. The December 31, 2017 condensed consolidated balance sheet data was derived from audited financial statements but does not include all disclosures required by U.S. GAAP. In the opinion of management, all adjustments (consisting of normal and recurring adjustments) considered necessary for a fair statement of the results for the interim periods presented have been included. The results of operations for the interim periods are not necessarily indicative of results for the full year.
It is generally the Company’s established practice to close its books for the quarters ending March, June and September on the Friday preceding the end of the calendar quarter. The interim unaudited condensed consolidated financial statements included herein have been prepared and are labeled based on that convention. The Company closes its books for annual periods on December 31 regardless of what day it falls on.
Accounting Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of sales and costs of sales during the reporting period. The most significant of these estimates and assumptions for L3 relate to sales, profit and loss recognition related to performance obligations satisfied over time, fair values of assets acquired and liabilities assumed in business combinations and investments, market values for inventories reported at lower of cost or market, pension and postretirement benefit obligations, stock-based employee compensation expense, income taxes, including the valuations of deferred tax assets, litigation reserves, useful lives and valuation of recorded amounts of long-lived assets, identifiable intangible assets and goodwill. Changes in estimates are reflected in the periods during which they become known. Actual amounts may differ from these estimates and could differ materially.
Revenue Recognition
Effective January 1, 2018, the Company adopted Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers, as amended (commonly referred to as ASC 606) using the modified retrospective transition method. The cumulative


8

L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


effect of applying the standard was an increase of $13 million to shareholders' equity as of January 1, 2018. The Company’s statement of operations for the quarterly and first half periods ended June 29, 2018 and the Company’s balance sheet as of June 29, 2018 are presented under ASC 606, while the Company’s statement of operations for the quarterly and first half periods ended June 30, 2017 and the Company’s balance sheet as of December 31, 2017 are presented under ASC 605, Revenue Recognition. See Note 3 for disclosure of the impact of the adoption of ASC 606 on the Company’s statement of operations for the quarterly and first half periods ended June 29, 2018 and balance sheet as of June 29, 2018 and the effect of changes made to the Company’s consolidated balance sheet as of January 1, 2018.
A substantial majority of the Company’s consolidated net sales are generated from long-term contracts with customers that require it to design, develop, manufacture, modify, upgrade, test and integrate complex aerospace and electronic equipment and to provide engineering and technical services according to the customers’ specifications. These contracts are primarily with agencies of, and prime system contractors to, the U.S. Government and foreign governments and are generally priced on a fixed-price, cost-plus or time-and-material type basis. Substantially all of the Company's cost-plus and time-and-material type contracts are with the U.S. Government, primarily the DoD. Certain of the Company’s contracts with the U.S. Government are multi-year contracts incrementally funded by the customer. The transaction price on these incrementally funded contracts includes contract value amounts not yet funded by the U.S. Government when the Company has a firm order for the goods or services and it is probable that the customer will fund such amounts. In assessing probability, the Company considers, among other factors, the period of time before contract funding is expected, communication from the customer that indicates funding will be obtained and the Company's history of receiving funding under the current contract or previous similar contracts. The Company also generates sales to a lesser extent from contracts with commercial and government customers for standard product and service offerings, which are priced on a firm fixed basis. See Note 23 for additional information regarding the composition of the Company’s net sales.
The Company records sales for a contract when it has the approval and commitment of all parties, the contract identifies the rights of the parties and payment terms, the contract has commercial substance and collectibility of the consideration is probable.
To determine the proper revenue recognition method, the Company first evaluates each of its contractual arrangements to identify its performance obligations. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer. The majority of the Company’s contracts have a single performance obligation because the promise to transfer the individual good or service is not separately identifiable from other promises within the contract and is, therefore, not distinct. These contractual arrangements either require the use of a highly specialized manufacturing process to provide goods according to customer specifications or represent a bundle of contracted goods and services that are integrated and together represent a combined output, which may include the delivery of multiple units. Some of the Company's contracts have multiple performance obligations, primarily (i) related to the provision of multiple goods or services that have alternative use to the Company or that are not substantially the same or (ii) due to the contract covering multiple phases of the product lifecycle (development and engineering, production, maintenance and support). For contracts with more than one performance obligation, the Company allocates the total transaction price in an amount based on the estimated relative standalone selling prices underlying each performance obligation. In cases where a contract requires a customized good or service, the primary method used to estimate standalone selling price is the expected cost plus a margin approach. In cases where the Company sells a standard product or service offering, the standalone selling price is based on an observable standalone selling price.
The majority of the Company's sales are from performance obligations satisfied over time and are primarily with agencies of, and prime system contractors to, the U.S. Government and foreign governments. Sales are recognized over time when control is continuously transferred to the customer during the contract. For U.S. Government contracts, the continuous transfer of control to the customer is supported by contract clauses that provide for (i) progress or performance-based payments or (ii) the unilateral right of the customer to terminate the contract for its convenience, in which case the Company has the right to receive payment for costs incurred plus a reasonable profit for products and services that do not have alternative use to the Company. Foreign government and certain commercial contracts contain similar termination for convenience clauses, or the Company has a legally enforceable right to receive payment for costs incurred and a reasonable profit for products or services that do not have alternative use to the Company. Sales on fixed price and cost-plus type contracts that include performance obligations satisfied over time are generally recorded at amounts equal to the ratio of actual cumulative costs incurred divided by total estimated costs at completion, multiplied by (i) the transaction price, less (ii) the cumulative sales recognized in prior periods (cost-to-cost method).
Accounting for the sales and profits on performance obligations for which progress is measured using the cost-to-cost method involves the preparation of estimates of: (1) transaction price and (2) total costs at completion, which is equal to the sum


9

L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


of the actual incurred costs to date on the contract and the estimated costs to complete the contract's statement of work. Incurred costs include labor, material, overhead and, for the Company's U.S. Government contractor businesses, general and administrative (G&A) expenses. Incurred costs represent work performed, which corresponds with and thereby represents the transfer of control to the customer. The estimated profit or loss at completion on a contract is equal to the difference between the transaction price and the total estimated cost at completion. In the case of a contract related to complex aerospace or electronic equipment for which the total estimated costs exceed the total transaction price, a loss arises, and a provision for the entire loss is recorded in the period that the loss becomes evident. The unrecoverable costs on a loss contract that are expected to be incurred in the future periods are presented on the balance sheet as a component of other current liabilities entitled "Estimated cost in excess of estimated contract value to complete contracts in process in a loss position." See Note 10 for additional information.
The Company’s contracts give rise to variable consideration, including award and incentive fees, as well as amounts incrementally funded by the U.S. Government, or other provisions that can either increase or decrease the transaction price. Award fees provide for a fee based on actual performance relative to contractually specified performance criteria. Incentive fees provide for a fee based on the relationship between total allowable costs and target costs. Variable consideration may require the Company to exercise significant judgment to determine the total transaction price of the contract. The Company includes variable consideration in the transaction price when there is a basis to reasonably estimate the variable amount it will be entitled to receive and it is probable that a significant reversal in revenue recognized will not be required when the uncertainty is resolved. These estimates are based on historical experience, current and forecasted performance, and the Company’s judgment at the time of the evaluation.
Contract modifications routinely occur to account for changes in contract specifications or requirements. In most cases, contract modifications are for goods or services that are not distinct and, therefore, are accounted for as part of the existing contract. Transaction price estimates include additional consideration for submitted contract modifications or claims when the Company believes it has an enforceable right to the modification or claim, the amount can be reliably estimated and its realization is reasonably assured. Amounts representing modifications accounted for as part of the existing contract are included in the transaction price and recognized as an adjustment to sales on a cumulative catch-up basis.
The Company’s fixed-price type contracts with the U.S. Government typically allow for progress payments or performance-based payments. Progress payments are billed to the customer as contract costs are incurred at an amount generally equal to 80% of incurred costs. Performance based payments are billed to the customer upon the achievement of predetermined performance milestones at amounts not to exceed 90% of contract price. On contracts with progress or performance-based payments, the customer often retains a small portion of the contract price until satisfactory completion of the contractual statement of work. Since a small portion of the contract price is retained, the Company generally recognizes sales in excess of billings, which are presented as contract assets on the balance sheet. The portion of the contract price retained by the customer is a normal business practice to ensure satisfactory contract completion and, therefore, is not considered a significant financing component. Contract assets also arise from cost-plus type contracts, time-and-material type contracts and fixed-price services type contracts for revenue amounts that have not been billed by the end of the accounting period due to the timing of preparation of invoices to customers. For certain fixed-price contracts with foreign governments and commercial customers, the Company receives advance payments. Advanced payments are not considered a significant financing component because they are a negotiated contract term to ensure the customer meets its financial obligation, particularly when there are significant upfront working capital requirements. The Company records a liability for advance payments received in excess of sales recognized, which is presented as a contract liability on the balance sheet.


10

L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


Revisions or adjustments to estimates of the transaction price, estimated costs at completion and estimated profit or loss of a performance obligation are often required as work progresses under a contract, as experience is gained, as facts and circumstances change and as new information is obtained, even though the scope of work required under the contract may not change. Revisions or adjustments may also be required if contract modifications occur. The impact of revisions in profit or loss estimates are recognized on a cumulative catch-up basis in the period in which the revisions are made. The revisions in contract estimates, if significant, can materially affect the Company’s results of operations and cash flows, as well as reduce the valuations of contract assets and inventories, and in some cases result in liabilities to complete contracts in a loss position. The aggregate impact of net changes in contract estimates is presented in the table below.
 
Second Quarter Ended
 
First Half Ended
 
June 29,
2018
 
June 30,
2017
 
June 29,
2018
 
June 30,
2017
 
(in millions, except per share data)
Operating income
$
64

 
$
42

 
$
128

 
$
84

Diluted earnings per share
$
0.61

 
$
0.35

 
$
1.22

 
$
0.67

Net sales recognized from the Company's performance obligations satisfied in prior periods were $71 million and $139 million for the quarterly and first half periods ended June 29, 2018, respectively, and relate to revisions in contract estimates.
Sales from performance obligations satisfied at a point in time are typically for standard goods and are recognized when the customer obtains control, which is generally upon delivery and acceptance. The Company also records sales for performance obligations relating to standard services (i.e., maintenance and extended warranties covering standard goods sold by the Company) over time by using output measures of time elapsed to measure progress toward satisfying the performance obligation.
Sales on time-and-material type contracts are generally recognized each period based on the amount billable to the customer, which is based on direct labor hours expended multiplied by the contractual fixed rate per hour, plus the actual costs of materials and other direct non-labor costs.
The following table presents a summary of the Company’s net sales by revenue recognition method as a percentage of total net sales for the first half period ended June 29, 2018.
 
% of Total Net Sales
Cost to cost method
76
%
Point in time
18
%
Output method
3
%
Billing method
3
%
Total
100
%
Remaining Performance Obligations
On June 29, 2018, the Company had $10.2 billion of remaining performance obligations, which represents the transaction price of firm orders less inception to date sales recognized. Remaining performance obligations exclude unexercised contract options and potential orders under basic ordering agreements or master-type contracts (i.e., indefinite-delivery, indefinite-quantity (IDIQ)). The Company expects to recognize sales relating to existing performance obligations of approximately $4.7 billion during the remainder of 2018, $3.5 billion in 2019, $1.2 billion in 2020 and $0.8 billion in the periods thereafter.
General and Administrative Expenses
The Company’s U.S. Government contractor businesses account for the portion of their G&A, independent research and development (IRAD) and bids and proposal (B&P) costs that are allowable and reimbursable indirect contract costs under U.S. Government procurement regulations on their U.S. Government contracts as inventory. G&A, IRAD and B&P costs are allocated to contracts for which the U.S. Government is the end customer and are charged to costs of sales when sales on the related contracts are recognized. The Company’s U.S. Government contractor businesses record the unallowable portion of their G&A, IRAD and B&P costs to expense as incurred and do not include them in inventory. G&A expenses for the Company's commercial businesses


11

L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


are expensed as incurred. The total research and development expenses incurred were $86 million and $161 million for the quarterly and first half periods ended June 29, 2018, respectively.
The Company capitalizes the incremental costs of obtaining a contract with foreign governments and foreign and domestic commercial customers (third-party sales commissions) if the Company expects to recover the costs under the contract. The Company expenses the costs to obtain a contract as incurred when the expected amortization period is one year or less. The Company classifies the portion of capitalized costs of obtaining a contract to be amortized over the next 12 months within prepaid expense and other current assets and classifies the remaining amount within other assets in its consolidated balance sheets.
Investments in and Loans to Nonconsolidated Affiliates
The Company’s investments in nonconsolidated affiliates are primarily accounted for using the equity method of accounting and are carried at cost, plus or minus the Company’s share of net earnings or losses of the investment, subject to certain other adjustments. The cost of equity method investments includes transaction costs of the acquisition. As required by U.S. GAAP, to the extent that there is a basis difference between the cost and the underlying equity in the net assets of an equity investment, the Company allocates such differences between tangible and intangible assets. The Company’s share of net earnings or losses of the investment, inclusive of amortization expense for any basis difference associated with the investment, are presented in interest and other income, net, on the Company’s consolidated statements of operations. Dividends received from the investee reduce the carrying amount of the investment. Due to the timing of receiving financial information from its nonconsolidated affiliates, the Company may record its share of net earnings or losses of such affiliates on a three-month lag basis, with the exception of the amortization expense of any basis difference related to tangible and intangible assets which are recorded currently.
3. 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 $3 million and $5 million for the quarterly and first half periods ended June 29, 2018, respectively, and increased operating income and decreased interest and other income, net, each by $2 million and $3 million for the quarterly and first half periods ended June 30, 2017, respectively. The adoption of this standard did not impact pre-tax income for the quarterly and first half periods ended June 29, 2018 and June 30, 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 first half period ended June 29, 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.


12

L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


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.


13

L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


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



14

L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


The tables below present the impact of the adoption of ASC 606 on the Company's statement of operations.
 
Second Quarter Ended June 29, 2018
STATEMENT OF OPERATIONS
Under
ASC 605
 
Effect of
ASC 606
 
As Reported
Under ASC 606
 
 
 
(in millions)
 
 
Net Sales:
 
 
 
 
 
Products
$
1,741

 
$
45

 
$
1,786

Services
797

 

 
797

Total
2,538

 
45

 
2,583

 
 
 
 
 
 
Operating costs and expenses:
 
 
 
 
 
Cost of sales — Products
$
(1,316
)
 
$
(33
)
 
$
(1,349
)
Cost of sales — Services
(561
)
 
(17
)
 
(578
)
 General and administrative expenses
(387
)
 
4

 
(383
)
 Gain on sale of the Crestview & TCS Businesses
47

 
1

 
48

Operating income
321

 

 
321

Income from continuing operations before income taxes
237

 

 
237

Provision for income taxes
(48
)
 

 
(48
)
Income from continuing operations
189

 

 
189

Income from discontinued operations, net of income taxes
191

 
(1
)
 
190

Net income
380

 
(1
)
 
379

Net income attributable to L3
$
376

 
$
(1
)
 
$
375

 
 
 
 
 
 
Basic earnings per share attributable to common shareholders:
 
 
 
 
 
Continuing operations
$
2.36

 
$

 
$
2.36

Discontinued operations
2.44

 
(0.02
)
 
2.42

Basic earnings per share
$
4.80

 
$
(0.02
)
 
$
4.78

Diluted earnings per share attributable to common shareholders:
 
 
 
 
 
Continuing operations
$
2.33

 
$

 
$
2.33

Discontinued operations
2.41

 
(0.02
)
 
2.39

Diluted earnings per share
$
4.74

 
$
(0.02
)
 
$
4.72



15

L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


 
First Half Ended June 29, 2018
STATEMENT OF OPERATIONS
Under
ASC 605
 
Effect of
ASC 606
 
As Reported
Under ASC 606
 
 
 
(in millions)
 
 
Net Sales:
 
 
 
 
 
Products
$
3,315

 
$
117

 
$
3,432

Services
1,518

 
4

 
1,522

Total
4,833

 
121

 
4,954

 
 
 
 
 
 
Operating costs and expenses:
 
 
 
 
 
Cost of sales — Products
$
(2,461
)
 
$
(79
)
 
$
(2,540
)
Cost of sales — Services
(1,089
)
 
(21
)
 
(1,110
)
 General and administrative expenses
(777
)
 
(3
)
 
(780
)
 Gain on sale of the Crestview & TCS Businesses
47

 
1

 
48

Operating income
553

 
19

 
572

Income from continuing operations before income taxes
434

 
19

 
453

Provision for income taxes
(67
)
 
(5
)
 
(72
)
Income from continuing operations
367

 
14

 
381

Income from discontinued operations, net of income taxes
206

 

 
206

Net income
573

 
14

 
587

Net income attributable to L3
$
564

 
$
14

 
$
578

 
 
 
 
 
 
Basic earnings per share attributable to common shareholders:
 
 
 
 
 
Continuing operations
$
4.57

 
$
0.18

 
$
4.75

Discontinued operations
2.63

 

 
2.63

Basic earnings per share
$
7.20

 
$
0.18

 
$
7.38

Diluted earnings per share attributable to common shareholders:
 
 
 
 
 
Continuing operations
$
4.50

 
$
0.17

 
$
4.67

Discontinued operations
2.59

 

 
2.59

Diluted earnings per share
$
7.09

 
$
0.17

 
$
7.26

The following table quantifies the impact of adopting ASC 606 on segment net sales and segment operating income for the quarterly and first half periods ended June 29, 2018.
 
Effect of ASC 606
 
Second Quarter Ended June 29, 2018
 
First Half Ended June 29, 2018
 
Sales
 
Operating Income
 
Sales
 
Operating Income
 
(in millions)
Electronic Systems
$
14

 
$
4

 
$
44

 
$
7

Aerospace Systems
(2
)
 
(7
)
 
2

 
(6
)
Communication Systems
21

 
(1
)
 
41

 
3

Sensor Systems
12

 
3

 
34

 
14

Segment totals
$
45

 
$
(1
)
 
$
121

 
$
18



16

L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


The table below presents the impact of the adoption of ASC 606 on the Company's balance sheet.
 
June 29, 2018
BALANCE SHEET
Under
ASC 605
 
Effect of
ASC 606
 
As Reported
Under ASC 606
 
 
 
(in millions)
 
 
Assets
 
 
 
 
 
Current assets:
 
 
 
 
 
Contract assets
$

 
$
1,611

 
$
1,611

Contracts in process
2,185

 
(2,185
)
 

Inventories
405

 
529

 
934

Prepaid expenses and other current assets
316

 
16

 
332

Assets held for sale

 

 

Assets of discontinued operations

 

 

Total current assets
5,135

 
(29
)
 
5,106

Other assets
300

 
48

 
348

Total assets
$
13,511

 
$
19

 
$
13,530

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Current liabilities:
 
 
 
 
 
Accrued expenses
$
279

 
$
(15
)
 
$
264

Contract liabilities

 
554

 
554

Advance payments and billings in excess of costs incurred
522

 
(522
)
 

Other current liabilities
384

 
(46
)
 
338

Total current liabilities
2,832

 
(29
)
 
2,803

Deferred income taxes
181

 
9

 
190

Other liabilities
402

 
14

 
416

Total liabilities
8,024

 
(6
)
 
8,018

Shareholders' Equity
 
 
 
 
 
Retained earnings
7,101

 
25

 
7,126

Total equity
$
5,487

 
$
25

 
$
5,512

4. Accounting Standards Issued and Not Yet Implemented
In February 2018, the FASB issued ASU 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The amendments in this update allow a reclassification from accumulated other comprehensive income (AOCI) to retained earnings for stranded tax effects resulting from the U.S. Tax Cuts and Jobs Act (U.S. Tax Reform). The new standard is effective for the Company beginning on January 1, 2019, with early adoption permitted. The Company will adopt ASU 2018-02 effective January 1, 2019. The Company does not expect the adoption of this standard will have a material effect on its financial position, results of operations or cash flows.
In August 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities. The amendments in this update intend to better align the Company risk management activities and financial reporting for hedging relationships through changes to both the designation and measurement guidance for qualifying hedge relationships and the presentation of hedge results. The amendments in this update require the Company to present the earnings effect of the hedging instrument in the same income statement line in which the earnings effect of the hedged item is reported. Current U.S. GAAP provides for hedge accounting only for the portion of the hedge deemed to be highly effective and requires the Company to separately reflect the amount by which the hedging instrument does not offset the hedged item, which is referred to as the ineffective amount. The amendments in this update no longer require the Company to separately measure and report hedge ineffectiveness. The new standard is effective for the Company for interim and annual reporting periods beginning on January 1, 2019, with early adoption permitted. For cash flow hedges existing at the date of adoption, the Company is required to apply a cumulative effect adjustment relating to the separate measurement of ineffectiveness to the opening balance of retained earnings. The amended


17

L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


presentation and disclosure guidance is required only prospectively. The Company will adopt ASU 2017-12 effective January 1, 2019. The Company does not expect the adoption of this standard to have a material effect on its financial position, results of operations or cash flows.
In February 2016, the FASB issued ASU 2016-02, Leases, which updates the existing guidance on accounting for leases and requires new qualitative and quantitative disclosures about the Company’s leasing activities. The new standard requires the Company to recognize lease assets and lease liabilities on the balance sheet for all leases under which the Company is the lessee, including those classified as operating leases under previous accounting guidance. The Company will measure leases commencing after the adoption date based on the present value of the lease payments due over the lease term (as defined in ASU 2016-02), after applying the separation and allocation guidance of the new standard. The new standard, as amended, will be effective for the Company for interim and annual reporting periods beginning on January 1, 2019, with early adoption permitted. In the adoption year, the Company will be required to (i) measure and recognize its existing leases based on the present value of the remaining minimum lease payments, as defined in existing guidance on accounting for leases, and (ii) restate each prior reporting period presented. The Company is currently evaluating the expected impact of the adoption of this standard on its consolidated financial statements and disclosures related to leasing activities. The Company plans to adopt ASU 2016-02 effective January 1, 2019. The Company has made progress in implementing the new standard by selecting a lease accounting system and assessing available practical expedients. The Company is in the process of accumulating and processing the data required to measure its existing leases and evaluating accounting policy and internal control changes to support management in the financial reporting and disclosure of leasing activities. See Note 18 to the audited consolidated financial statements for the year ended December 31, 2017, included in the Company’s Annual Report on Form 10-K for additional information about the Company’s leases, including the future minimum lease payments of the Company's operating leases at December 31, 2017.
Other accounting standard updates effective for interim and annual periods beginning after December 31, 2018 are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
5. Acquisitions, Divestitures and Discontinued Operations
Business Acquisitions
The Company continually evaluates potential acquisitions that either strategically fit within the Company’s existing portfolio or expand the Company’s portfolio into new product lines or adjacent markets. The Company has completed a number of acquisitions that have been accounted for as business combinations and have resulted in the recognition of goodwill in the Company’s financial statements. This goodwill includes the know-how of the assembled workforce, the ability of the workforce to further improve technology and product offerings and the expected cash flows resulting from these efforts. Goodwill may also include expected synergies resulting from the complementary strategic fit these businesses bring to existing operations. The business acquisitions discussed below are included in the Company’s results of operations from their respective dates of acquisition.
2018 Business Acquisitions
Applied Defense Solutions, Inc. (Applied Defense Solutions). On June 29, 2018, the Company acquired Applied Defense Solutions, Inc., renamed L3 ADS, Inc., for a purchase price of $53 million, which was financed with cash on hand. Applied Defense Solutions is a leading aerospace engineering, software development and space situational awareness company. The goodwill recognized for this business was $40 million, which was assigned to the Sensor Systems segment, and is not expected to be deductible for income tax purposes. The final purchase price is subject to customary adjustments for final working capital. The final purchase price allocation, which is expected to be completed in the fourth quarter of 2018, will be based on final appraisals and other analysis of fair values of acquired assets and liabilities. The Company does not expect that differences between the preliminary and final purchase price allocation will have a material impact on its results of operations or financial position.
Latitude Engineering, LLC (Latitude Engineering). On June 28, 2018, the Company acquired Latitude Engineering, LLC, renamed L3 Latitude Engineering, Inc., for a purchase price of $15 million, which was financed with cash on hand. The purchase price is subject to additional contingent consideration not to exceed $20 million, $15 million of which is based on Latitude Engineering’s post-acquisition financial performance for the four year period ended December 31, 2021, and the remaining $5 million is based on certain post-acquisition milestone achievements through December 31, 2020. Latitude Engineering is engaged in the design, manufacturing, integration, servicing, operation and support of hybrid quadrotor unmanned aerial systems. The Company recorded a $4 million liability on the acquisition date for the fair value of the contingent consideration. The goodwill recognized for this business was $14 million, which was assigned to the Electronic Systems segment and is expected to be deductible for income tax purposes. The final purchase price is subject to customary adjustments for final working capital. The final purchase


18

L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


price allocation, which is expected to be completed in the fourth quarter of 2018, will be based on final appraisals and other analysis of fair values of acquired assets and liabilities. The Company does not expect that differences between the preliminary and final purchase price allocation will have a material impact on its results of operations or financial position.
2017 Business Acquisitions
The final purchase price and final purchase price allocations for the 2017 acquisitions of Kigre, Inc. (Kigre), Escola De Aviacao Aerocondor, S.A. (G-Air) and Adaptive Methods, Inc. (Adaptive Methods) have been finalized as of the second quarter of 2018. The final purchase price allocations resulted in a $3 million increase to goodwill. The final purchase price for Doss Aviation, Inc. (Doss Aviation) is subject to customary adjustments for final working capital. The final purchase price allocation for Doss Aviation, which is expected to be completed in the third quarter of 2018, will be based on final analysis of fair values of acquired contracts and customer relationship intangible assets. The Company does not expect that differences between the preliminary and final purchase price allocation will have a material impact on its results of operations or financial position.
Business Acquisitions Announced After June 29, 2018
Azimuth Security and Linchpin Labs. On July 11, 2018, the Company entered into a definitive agreement to acquire Azimuth Security and Linchpin Labs, two information security businesses that significantly strengthen the Company's existing C6ISR (Command, Control, Communications, Computers, Cyber-Defense and Combat Systems, and Intelligence, Surveillance and Reconnaissance) capabilities and create synergies to drive future growth in cyber and international markets. The combined purchase price for the two businesses was approximately AUD $270 million (approximately $200 million). The purchase price is subject to an upward adjustment of up to AUD $43 million (approximately $32 million), payable in L3 common stock, based on the combined company’s post-acquisition sales for each of the 12-month periods ending June 30, 2019 to 2021, which would be payable in 2019 to 2021. This transaction is anticipated to be completed during the second half of 2018, subject to customary closing conditions and regulatory approvals.
See Note 3 to the audited consolidated financial statements for the year ended December 31, 2017, included in the Company’s Annual Report on Form 10-K for additional information about the Company’s 2017 business acquisitions.
Unaudited Pro Forma Statements of Operations Data
The following unaudited pro forma Statements of Operations data present the combined results of the Company and its business acquisitions completed during the first half period ended June 29, 2018 and the year ended December 31, 2017, assuming that the business acquisitions completed during 2018 and 2017 had occurred on January 1, 2017 and January 1, 2016, respectively. The unaudited pro forma Statements of Operations data below include adjustments for additional amortization expense related to acquired intangible assets and depreciation assuming the 2018 and 2017 acquisitions had occurred on January 1, 2017 and January 1, 2016, respectively.
 
Second Quarter Ended
 
First Half Ended
 
June 29,
2018
 
June 30,
2017
 
June 29,
2018
 
June 30,
2017
 
(in millions, except per share data)
Pro forma net sales
$
2,592

 
$
2,413

 
$
4,973

 
$
4,765

Pro forma income from continuing operations attributable to L3
$
187

 
$
189

 
$
375

 
$
343

Pro forma net income attributable to L3
$
377

 
$
201

 
$
581

 
$
366

Pro forma diluted earnings per share from continuing operations
$
2.36

 
$
2.38

 
$
4.71

 
$
4.32

Pro forma diluted earnings per share
$
4.75

 
$
2.53

 
$
7.30

 
$
4.61

The unaudited pro forma results disclosed in the table above are based on various assumptions and are not necessarily indicative of the results of operations that would have occurred had the Company completed these acquisitions on the dates indicated above.


19

L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


Investments in Nonconsolidated Affiliates
Peak Nano Optics, LLC (Peak Nano). On February 6, 2018, the Company acquired a 25% interest in Peak Nano Optics, LLC, for a purchase price of $20 million. Peak Nano is a nanotechnology company, which allows for the design and manufacturing of polymer lenses for military, sporting and commercial optics applications using its nanolayer gradient refractive index (GRIN) technology. The purchase price is subject to a contingent payment of $30 million based upon Peak Nano meeting certain development milestones on or before August 5, 2018. The $6 million fair value of the contingent consideration liability was recorded on the investment date (See Note 16). The Company determined Peak Nano is a VIE as it did not have sufficient equity at risk to finance its activities. The Company, however, is not the primary beneficiary because it does not have the power to direct the activities that are most significant to the economic performance of Peak Nano. Accordingly, Peak Nano is accounted for under the equity method of accounting.
As of the acquisition date, the carrying amount of the investment was greater than the Company's equity in the underlying assets of Peak Nano due primarily to the difference in the carrying amount of the indefinite-lived amortizable intangible assets including goodwill and in-process research and development (IPR&D). The basis difference attributable to goodwill and IPR&D is $11 million and $13 million, respectively.
Additionally, the Company has a $5 million loan receivable from Peak Nano.
Business Divestitures
2018 Divestitures
As discussed in Note 1, on June 29, 2018, the Company completed the sale of its Crestview & TCS Businesses. The assets and liabilities of the Crestview & TCS Businesses are classified as held for sale in the Company’s audited consolidated balance sheet as of December 31, 2017. The Crestview & TCS Businesses, which were within the Company’s Aerospace Segment, primarily provided aircraft fabrication and assembly of fixed and rotary wing aero structures as well as avionics hardware and software systems to address mission critical needs. The table below presents Crestview & TCS Businesses’ results of operations and is included in continuing operations.
 
First Half Ended
 
June 29, 2018
 
(in millions)
Net Sales
$
64

Gain on sale of businesses
$
48

Income from continuing operations before income taxes
$
3



20

L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


Crestview & TCS Businesses. The major classes of assets and liabilities included as held for sale related to the Crestview & TCS Businesses are presented in the table below.
 
December 31,
2017
 
(in millions)
Assets
 
Billed receivables
$
14

Contracts in process
33

Total current assets
47

Property, plant and equipment, net
34

Goodwill
52

Identifiable intangible assets
2

Total assets classified as held for sale
$
135

 
 
Liabilities
 
Accounts payable, trade
$
3

Accrued employment costs
2

Accrued expenses
3

Other current liabilities
5

Total current liabilities
13

Deferred income taxes
4

Total liabilities classified as held for sale
$
17

Discontinued Operations
Vertex Aerospace. As discussed in Note 1, on June 29, 2018, the Company completed the sale of its Vertex Aerospace business. The table below presents the statements of operations data for Vertex Aerospace. The amounts presented in discontinued operations include allocated interest expenses for debt not directly attributable or related to L3’s other operations. Interest expense was allocated in accordance with the accounting standards for discontinued operations and were based on the ratio of Vertex Aerospace’s net assets to the sum of: (1) L3 consolidated total net assets and (2) L3 consolidated total debt.
 
Second Quarter Ended
 
First Half Ended
 
June 29,
2018
 
June 30,
2017
 
June 29,
2018
 
June 30,
2017
 
(in millions)
Net sales
$
226

 
$
351

 
$
597

 
$
703

Operating costs and expenses (1)
(212
)
 
(332
)
 
(561
)
 
(667
)
Operating income from discontinued operations
14

 
19

 
36

 
36

Interest expense allocated to discontinued operations

 

 
(1
)
 
(1
)
Gain on sale of businesses
237

 

 
237

 

Income from discontinued operations before income taxes
251

 
19

 
272

 
35

Income tax expense
(61
)
 
(7
)
 
(66
)
 
(12
)
Income from discontinued operations, net of income taxes
$
190

 
$
12

 
$
206

 
$
23

__________________
(1) 
For the quarterly and first half periods ended June 29, 2018, the Company recognized $3 million of trailing expenses related to the sale of NSS.


21

L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


The major classes of assets and liabilities that were included in discontinued operations related to Vertex Aerospace are presented in the table below. These balances were classified as current at December 31, 2017 as the sale was expected to be completed within one year and the proceeds are not expected to be used to pay down long-term debt.
 
December 31,
2017
 
(in millions)
Assets
 
Current assets
$
284

Property, plant and equipment, net
13

Other intangible assets
7

Other assets
2

Total assets of discontinued operations
$
306

 
 
Liabilities
 
Accounts payable, trade
$
63

Other current liabilities
131

Current liabilities
194

Long-term liabilities
32

Total liabilities of discontinued operations
$
226


2017 Divestitures
During the first half period ended June 30, 2017, the Company completed the sales of the CTC Aviation Jet Services Limited (Aviation Jet Services) business, the L3 Coleman Aerospace (Coleman) business and the Display Product Line. The table below presents pre-tax (loss) gain recognized, the proceeds received and net sales included in continuing operations from these divestitures.
 
First Half Ended June 30, 2017
 
Pre-Tax (Loss) gain
 
Proceeds Received
 
Net Sales
 
(in millions)
Aviation Jet Services divestiture
$
(5
)
 
$
1

 
$
1

Coleman divestiture
(3
)
 
17

 
9

Display Product Line divestiture
4

 
7

 

Total
$
(4
)
 
$
25

 
$
10

Aviation Jet Services Divestiture. On March 1, 2017, the Company divested its Aviation Jet Services business for a sales price of £1 million (approximately $1 million). Aviation Jet Services provided non-core aircraft management and operational services as part of commercial training solutions based in the United Kingdom and was included in the Electronic Systems segment.
Coleman Divestiture. On February 24, 2017, the Company divested its Coleman business for a sales price of $15 million. Coleman provided air-launch ballistic missile targets and was included in the Electronic Systems segment.
Display Product Line Divestiture. On February 23, 2017, the Company divested its Display Product Line for a sales price of $7 million. The Display Product Line provided cockpits to various military aircraft and was included in the Electronic Systems segment.


22

L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


Net sales and income before income taxes for Aviation Jet Services, Coleman and the Display Product Line, included in L3’s consolidated statements of operations, are presented in the table below on an aggregate basis and are included in income from continuing operations for all periods presented.
 
First Half Ended
 
June 30, 2017
 
(in millions)
Net sales
$
10

Income before income taxes
$
2

6. Contract Assets and Contract Liabilities
Contract assets represent accumulated incurred costs and earned profits on contracts with customers that have been recorded as sales but have not been billed to customers and are classified as current. Contract liabilities consist of advance payments and billings in excess of costs incurred and deferred revenue and represent amounts received in excess of sales recognized on contracts. The Company classifies advance payments and billings in excess of costs incurred as current and deferred revenue as current or non-current based on the expected timing of sales recognition. Contract assets and contract liabilities are determined on a contract by contract basis at the end of each reporting period. The non-current portion of contract liabilities is included in other liabilities in the Company's consolidated balance sheets (see Note 10).
The table below presents the components of net contract assets (liabilities).
 
June 29,
2018
 
January 1,
2018
 
(in millions)
Contract assets
$
1,611

 
$
1,349

Contract liabilities — current
(554
)
 
(565
)
Contract liabilities — non-current
(33
)
 
(28
)
Net contract assets (liabilities)
$
1,024

 
$
756

Net contract assets (liabilities) increased from January 1, 2018 to June 29, 2018, primarily due to sales exceeding billings due to contractual billing terms on U.S. Government contracts related to Link Training & Simulation, Space & Power Systems, Advanced Communications and Mission Integration. Contract assets increased by $262 million primarily due to the same factors as discussed above. Contract liabilities decreased by $6 million primarily due to advances received by Mission Integration for aircraft procurements related to U.S. and foreign government contracts during the first half period ended June 29, 2018.
The Company did not recognize any impairment losses on contract assets during the quarterly and first half periods ended June 29, 2018.
For the first half period ended June 29, 2018, the Company recognized sales of $351 million related to its contract liabilities at January 1, 2018.
The components of contract assets are presented in the table below.
 
June 29,
2018
 
January 1,
2018
 
(in millions)
Unbilled contract receivables, gross
$
2,643

 
$
2,232

Unliquidated progress payments and advances
(1,032
)
 
(883
)
Total contract assets
$
1,611

 
$
1,349



23

L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


7. Contracts in Process
The components of contracts in process are presented in the table below.
 
December 31,
2017
 
(in millions)
Unbilled contract receivables, gross
$
1,874

Unliquidated progress payments
(761
)
Unbilled contract receivables, net
1,113

Inventoried contract costs, gross
891

Unliquidated progress payments
(71
)
Inventoried contract costs, net
820

Total contracts in process
$
1,933

The table below presents a summary of G&A, IRAD and B&P costs included in inventoried contract costs and the changes to them, including amounts charged to operating costs and expenses by the Company’s U.S. Government contractor businesses for the quarterly and first half periods ended June 30, 2017.
 
Second Quarter Ended
 
First Half Ended
 
June 30, 2017
 
June 30, 2017
 
(in millions)
Amounts included in inventoried contract costs at beginning of the period
$
177

 
$
173

Contract costs incurred:
 
 
 
IRAD and B&P
78

 
154

Other G&A
199

 
399

Total
277

 
553

Amounts charged to operating costs and expenses
(280
)
 
(552
)
Amounts included in inventoried contract costs at end of the period
$
174

 
$
174

8. Inventories
Inventories at Lower of Cost or Realizable Value. The table below presents the components of inventories at the lower of cost (first-in, first-out or average cost) or realizable value. The Company's inventories at December 31, 2017 were comprised primarily of amounts related to standard products. In addition, the Company classified inventories related to contracts for complex aerospace and electronic equipment and engineering and technical services according to the customers' specifications as inventoried contract costs, which was a component of contracts in process on the consolidated balance sheet at December 31, 2017. See Note 7 for additional information. In accordance with ASC 606, all inventories that customers do not currently control are classified within inventories on the Company's consolidated balance sheet at June 29, 2018, without regard to whether the goods promised to the customer are standard or customized.
 
June 29,
2018
 
December 31,
2017
 
(in millions)
Raw materials, components and sub-assemblies
$
318

 
$
184

Work in process
430

 
98

Finished goods
186

 
107

Total
$
934


$
389

Inventories at June 29, 2018 included G&A costs of $62 million. G&A costs incurred and recorded in inventories totaled $597 million during the first half period ended June 29, 2018, and G&A costs charged to expense from inventories totaled $585 million during the first half period ended June 29, 2018. See Note 7 for information on G&A costs included in contracts in process for the quarterly and first half periods ended June 30, 2017.


24

L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


9. Goodwill and Identifiable Intangible Assets
Goodwill. In accordance with the accounting standards for business combinations, the Company records the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition (commonly referred to as the purchase price allocation). The table below presents the changes in goodwill allocated to the Company’s reporting units in each reportable segment.
 
Electronic Systems
 
Aerospace Systems
 
Communication Systems
 
Sensor Systems
 
Consolidated Total
 
(in millions)
Goodwill
$
2,856

 
$
1,146

 
$
1,058

 
$
1,659

 
$
6,719

Accumulated impairment losses
(43
)
 

 
(35
)
 
(26
)
 
(104
)
December 31, 2017
2,813


1,146


1,023


1,633


6,615

Business acquisitions (1)
16

 

 

 
43

 
59

Foreign currency translation adjustments
(15
)
 
(3
)
 

 
(5
)
 
(23
)
June 29, 2018
2,814


1,143


1,023


1,671


6,651

Goodwill
2,857

 
1,143

 
1,058

 
1,697

 
6,755

Accumulated impairment losses
(43
)
 

 
(35
)
 
(26
)
 
(104
)
 
$
2,814


$
1,143