10-K 1 d30820d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

x

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2015

¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                 to

Commission file numbers 001-14141 and 333-46983

L-3 COMMUNICATIONS HOLDINGS, INC.

L-3 COMMUNICATIONS CORPORATION

(Exact names of registrants as specified in their charters)

 

Delaware    13-3937434 and 13-3937436
(State or other jurisdiction of incorporation or organization)    (I.R.S. Employer Identification Nos.)
600 Third Avenue, New York, NY    10016
(Address of principal executive offices)    (Zip Code)

(212) 697-1111

(Telephone number)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class    Name of each exchange on which registered:
L-3 Communications Holdings, Inc.
    common stock, par value $0.01 per share
   New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

None.

 

Indicate by check mark if the registrants are well-known seasoned issuers, as defined in Rule 405 of the Securities Act.

  x  Yes ¨ No

Indicate by check mark if the registrants are not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

  ¨  Yes x No

Indicate by check mark whether the registrants (1) have 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) have been subject to such filing requirements for the past 90 days. x Yes ¨ No

Indicate by check mark whether the registrants have submitted electronically and posted on their 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 registrants were required to submit and post such files). x Yes ¨ No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrants’ knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

Indicate by check mark whether the registrant L-3 Communications Holdings, Inc. is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of ‘large accelerated filer,’ ‘accelerated filer’ and ‘smaller reporting company’ in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer x    Accelerated filer ¨    Non-accelerated filer ¨     Smaller reporting company ¨
        (Do not check if a smaller reporting company  

Indicate by check mark whether the registrant L-3 Communications Corporation is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of ‘large accelerated filer,’ ‘accelerated filer’ and ‘smaller reporting company’ in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer ¨    Accelerated filer ¨    Non-accelerated filer x     Smaller reporting company ¨
        (Do not check if a smaller reporting company  

Indicate by check mark whether the registrants are shell companies (as defined in Rule 12b-2 of the Act).  ¨  Yes  x  No

The aggregate market value of the L-3 Communications Holdings, Inc. voting stock held by non-affiliates of the Registrants as of June 26, 2015 was approximately $9.2 billion. For purposes of this calculation, the Registrants have assumed that their directors and executive officers are affiliates.

There were 77,818,517 shares of L-3 Communications Holdings, Inc. common stock with a par value of $0.01 outstanding as of the close of business on February 19, 2016.

As of June 26, 2015 and February 19, 2016, L-3 Communications Holdings, Inc. held all 100 shares of L-3 Communications Corporation common stock.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive proxy statement to be filed with the Securities and Exchange Commission (“SEC”) pursuant to Regulation 14A relating to the Registrants’ Annual Meeting of Shareholders, to be held on May 2, 2016, will be incorporated by reference in this Form 10-K in response to Items 10, 11, 12, 13 and 14 of Part III. The definitive proxy statement will be filed with the SEC no later than 120 days after the registrants’ fiscal year ended December 31, 2015.

 

 

 


Table of Contents

L-3 COMMUNICATIONS HOLDINGS, INC.

L-3 COMMUNICATIONS CORPORATION

INDEX TO ANNUAL REPORT ON FORM 10-K

For the Year Ended December 31, 2015

 

PART I

     

Item 1:

   Business      1   

Item 1A:

   Risk Factors      19   

Item 1B:

   Unresolved Staff Comments      27   

Item 2:

   Properties      28   

Item 3:

   Legal Proceedings      28   

Item 4:

   Mine Safety Disclosures      28   

PART II

     

Item 5:

  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     29   

Item 6:

   Selected Financial Data      31   

Item 7:

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      32   

Item 7A:

   Quantitative and Qualitative Disclosures About Market Risk      71   

Item 8:

   Financial Statements and Supplementary Data      71   

Item 9:

   Changes in and Disagreements With Accountants on Accounting and Financial Disclosure      71   

Item 9A:

   Controls and Procedures      72   

Item 9B:

   Other Information      73   

PART III

     

Item 10:

   Directors, Executive Officers and Corporate Governance      74   

Item 11:

   Executive Compensation      74   

Item 12:

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      74   

Item 13:

   Certain Relationships and Related Transactions, and Director Independence      74   

Item 14:

   Principal Accountant Fees and Services      74   

PART IV

     

Item 15:

   Exhibits, Financial Statement Schedules      75   

Signatures

     82   


Table of Contents

PART I

For convenience purposes in this filing on Form 10-K, “L-3 Holdings” refers to L-3 Communications Holdings, Inc., and “L-3 Communications” refers to L-3 Communications Corporation, a wholly-owned operating subsidiary of L-3 Holdings. “L-3”, “Company”, “we”, “us” and “our” refer to L-3 Holdings and its subsidiaries, including L-3 Communications.

Item 1. Business

Overview

L-3 Holdings, a Delaware corporation organized in April 1997, derives all of its operating income and cash flows from its wholly-owned subsidiary, L-3 Communications. L-3 Communications, a Delaware corporation, is a prime contractor in Intelligence, Surveillance and Reconnaissance (ISR) systems, aircraft sustainment (including modifications, logistics and maintenance), simulation and training, night vision and image intensification equipment, and security and detection systems. L-3 is also a leading provider of a broad range of communication and electronic systems and products used on military and commercial platforms. Our 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 international commercial customers.

On December 8, 2015, we entered into a definitive agreement to sell our National Security Solutions (NSS) business to CACI International Inc. The transaction was completed on February 1, 2016. NSS, which provides cybersecurity solutions, high-performance computing, enterprise IT services, analytics and intelligence analysis to the DoD, U.S. Government intelligence agencies, federal civilian agencies and foreign governments, has historically been reported as a reportable segment. In accordance with Accounting Standards Update (ASU) 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, the assets and liabilities and results of operations of NSS are reported as discontinued operations for all periods presented. Accordingly, all references made to financial data in this Annual Report on Form 10-K are to L-3’s continuing operations, unless specifically noted. NSS had sales of $1,088 million, $1,138 million and $1,202 million for the years ended December 31, 2015, 2014 and 2013, respectively.

We have the following three reportable segments: (1) Electronic Systems, (2) Aerospace Systems and (3) Communication Systems. Financial information for our segments, including sales by geographic area, is included in “Part II — Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in Note 21 to our audited consolidated financial statements.

For the year ended December 31, 2015, we generated sales of $10,466 million, consolidated operating income of $475 million, segment operating income of $890 million and net cash from operating activities from continuing operations of $1,042 million. The table below presents a summary of our 2015 sales by major category of end customer. For a more detailed presentation of our sales by end customer, see “Major Customers” within this Business section.

 

                         2015 Sales                         % of
Total Sales
     (in millions)     

DoD

   $                 6,973                      67%

Other U.S. Government

             318        3
  

 

  

 

Total U.S. Government

   $                 7,291                      70%

International (foreign governments)

                       1,799                  17

Commercial — international

              759        7

Commercial — domestic

              617        6
  

 

  

 

Total sales

   $                10,466                                100%            
  

 

  

 

 

1


Table of Contents

Business Strategy

The goal of our strategy is to build and sustain strong businesses with durable competitive discriminators and number one or number two market positions. Our business strategy is customer-focused and aims to increase shareholder value by expanding our strong positions in aerospace systems, electronic systems and communication systems by leveraging our customer relationships and pursuing adjacent market opportunities. We intend to gain market share with innovative and affordable solutions, collaboration across L-3’s business units and demonstrated past performance that address customer imperatives. We expect that we will continue to shift our business portfolio to emphasize products and systems in our core defense electronics, ISR and Communication businesses. Financially, our emphasis is on growing earnings per share and cash flow. Our strategy involves a flexible and balanced combination of organic growth, cost reductions, and select business acquisitions and divestitures, enabling us to grow the company and also return cash to our shareholders in a balanced and disciplined manner. Our strategy includes the elements discussed below.

Maintain an Agile, Accountable, Ethical and Results-Driven Culture. A key part of L-3’s strategy is our agile, accountable, and results-driven culture that focuses on meeting our customers’ needs and on achieving L-3’s strategic goals and growth objectives. L-3’s culture is made up of diverse people providing creative, innovative and affordable solutions and ideas in an environment that fosters teamwork and collaboration across our business units. Operating with integrity and a commitment to the highest standards of ethical conduct and maintaining strong internal controls are foundational elements of our strategy to build and maintain the trust of our customers, shareholders, employees, suppliers and communities where we live and work.

Strengthen and Expand Our Market Positions. We intend to use our existing prime contractor and supplier positions and internal investments to increase our market share, grow our sales organically and continue to build strong businesses with durable discriminators that have a number one or number two market position. We intend to expand our prime contractor roles in select business areas where we have domain expertise, including special operations forces and U.S. Government classified business. We expect to benefit from and expand our supplier positions to multiple bidders by leveraging our customer relationships, pursuing adjacent market opportunities and expand our content on Original Equipment Manufacturers (OEMs) platforms. As an independent supplier of a broad range of products, subsystems and systems in several key business areas, our growth will partially be driven by expanding our share of existing programs and participating in new programs. Teaming arrangements with other prime contractors and platform original equipment manufacturers is one way we intend to pursue select new business opportunities and expand our content on select platforms. We plan to maintain our diversified and broad business mix with limited reliance on any single contract, follow-on or new business opportunity. While sales to the U.S. Government, especially the DoD, will remain an integral part of L-3’s business, we also intend to continue to increase our sales to foreign governments and domestic and international commercial businesses. We expect to continue to supplement our organic sales growth by acquiring, on a select basis, businesses that provide attractive returns on investment and add new products, technologies, programs and contracts, or provide access to select DoD, other U.S. Government, international and/or commercial customers.

Collaborate to Increase Growth Opportunities. We intend to deepen the collaboration among our diversified businesses to develop new business opportunities, combine our leading technologies and deliver the right solutions to our customers quickly. We expect that our core strengths of agility, responsiveness and cost-effectiveness will allow us to continue to provide exceptional performance to our customers.

Leverage Our Excellent Customer Relationships. We intend to maintain and expand our excellent customer relationships. We also intend to continue to leverage our customer relationships and our capabilities, including proprietary technologies, to expand the scope of our products to existing and new customers. We also intend to continue to align our products, services, investments in research and development and business acquisitions to proactively address customer priorities and requirements and invest in growth areas such as aerospace systems, sensor systems and special operations.

 

2


Table of Contents

Increase Margins by Proactively Managing Our Cost Structure and Optimizing Our Business Portfolio. We intend to increase our operating margin by improving productivity and reducing direct contract costs and overhead costs, including general and administrative costs. Our effective management of labor, material, subcontractor and other direct costs is also an important element of cost control and favorable contract performance. We believe that proactively re-sizing our businesses to their anticipated sales, combined with continuous cost improvement will enable us to increase our cost competitiveness and operating margin, and to also selectively invest in new product development, business acquisitions, bids and proposals and other business development activities to win new business. We intend to continue to evaluate our portfolio of businesses to address the needs of a dynamic and demanding market place and to strengthen our core business through select business acquisitions or divestitures.

Achieve Outstanding Program Performance. We believe that outstanding performance on our existing programs and contracts in terms of on-budget, on-schedule and satisfying and exceeding technical and other contractual performance requirements, is the foundation for expanding L-3’s prime contractor and supplier positions and winning new business. We believe that a prerequisite for growing and winning new business is to retain our existing business by successfully meeting the performance criteria included in our contracts. We will continue to focus on delivering superior contract performance with affordable prices to our customers in order to maintain our reputation as an agile and responsive contractor and to differentiate ourselves from our competitors.

Attract and Retain Skilled Personnel. The success of our businesses is, to a large extent, dependent upon the knowledge and skills of our employees. We intend to continue to attract and retain employees who have management, contracting, engineering and technical skills and who have U.S. Government security clearances, particularly those with clearances of top-secret and above.

Business Acquisitions and Divestitures

During the years ended December 31, 2015, 2014 and 2013, we used net cash of $320 million, $57 million and $62 million for business acquisitions, respectively. On May 29, 2015, we completed the sale of our Marine Systems International (MSI) business to Wärtsilä Corporation for a preliminary sale price of €295 million (approximately $318 million) in cash. See “Part II — Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Business Acquisitions and Divestitures” for additional information regarding our business acquisitions and divestitures, including the sale of NSS on February 1, 2016 for a base sale price of $550 million, subject to customary adjustments for net working capital.

Products and Services

Our three reportable segments provide a wide range of products and services to various customers and are described below. See “Part II — Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Results of Operations — Reportable Segment Results of Operations” and Note 21 to our audited consolidated financial statements for financial information about each segment.

 

3


Table of Contents

Electronic Systems Reportable Segment

In 2015, Electronic Systems had net sales of $4,269 million, representing 41% of our total net sales. The businesses in this reportable segment provide a broad range of products and services, including components, products, subsystems, systems and related services to military and commercial customers in several niche markets. The table below provides a summary of the segment’s business areas and the percentage that each contributed to Electronic Systems’ net sales in 2015.

 

Business Area

   % of 2015
        Segment Sales        
 

Precision Engagement & Training

     25%      

Power & Propulsion Systems

     20          

Aviation Products & Security

     20          

Sensor Systems

     18          

Warrior Systems

     10          

Marine Systems International (divested on May 29, 2015)

     4          

Advanced Programs

     3          
  

 

 

 

Total Electronic Systems

                     100%      
  

 

 

 

The table below provides additional information for the systems, products and services; selected applications; and selected platforms or end users of our Electronic Systems reportable segment.

 

Systems/Products/Services

 

Selected Applications

 

Selected Platforms/End Users

   

Precision Engagement & Training

     
   

•       Military and commercial aircraft flight simulators, reconfigurable training devices, distributed mission training suites

 

•       Advanced simulation technologies and training for pilots, navigators, flight engineers, gunners and operators

 

•       Fixed and rotary winged aircraft and ground vehicles for U.S. Air Force (USAF), U.S. Navy (USN), U.S. Army, foreign militaries, commercial airlines and aircraft OEMs

   

•       Training services, courseware integrated logistics support and maintenance

 

•       Systems management, operations, and maintenance

 

•       Various DoD and foreign military customers

   

•       Fuzing and ordnance systems

 

•       Precision munitions, fuzes, and electronic and electro safety arming devices (ESADs)

 

•       Various DoD and foreign military customers

   

•       Unmanned systems and components

 

•       Tactical unmanned air systems (UAS), medium altitude long endurance (MALE) UAS, small expendable UAS, flight controls, sensors and remote viewing systems

 

•       U.S. DoD and foreign ministries of defense

   

•       Radar-based sensors and systems

 

•       Electronic warfare, unmanned systems, ISR and precision-guided munitions

 

•       U.S. DoD and DHS

 

4


Table of Contents

Systems/Products/Services

 

Selected Applications

 

Selected Platforms/End Users

   

•       Global Positioning System (GPS) receivers

 

•       Location tracking

 

•       Guided projectiles and precision munitions

   

•       Global airline pilot training and crew resourcing

 

•       Commercial flight training for pilots

 

•       Commercial airlines and flight training companies

   

•       Navigation systems and positioning navigation units

 

•       Satellite launch and orbiting navigation and navigation for ground vehicles and fire control systems

 

•       USAF, U.S. Army, USMC and National Aeronautics Space Administration (NASA)

   

Power & Propulsion Systems

     
   

•       Naval power delivery, conversion and switching products, and hybrid electric drives

 

•       Switching, distribution and protection, frequency and voltage conversion, propulsion motors and drive units

 

•       Naval submarines, surface ships and aircraft carriers

   

•       Heavy fuel engines, cross drive variable transmissions, turret drive systems, vehicle suspension, advanced drive systems and auxiliary power generators

 

•       Power trains and suspension systems for military vehicles, power and energy management for military hybrid electric vehicles, non-portable and under armor auxiliary power units, and heavy fueled engines for unmanned systems

 

•       U.S. Army, USMC and foreign ministries of defense, manned/unmanned military platforms

   

•       Airborne dipping sonars, submarine and surface ship towed arrays

 

•       Submarine and surface ship detection and localization

 

•       USN and foreign navies

   

•       Underwater sensor ranges

 

•       Monitor nuclear testing, track submarines and surface vessels

 

•       U.S. and foreign military and commercial customers

   

•       Service life extensions

 

•       Landing craft air cushion amphibious vehicle

 

•       USN

   

•       In-service engineering, ship repair, overhaul, upgrades and maintenance, and battle force tactical training

 

•       Embedded shipboard training systems, towed arrays, navigation systems, radar systems and electronic warfare systems

 

•       USN, U.S. Coast Guard (USCG), U.S. Army and commercial shipowners

   

•       Power plant simulation, modeling, computer systems, and training services

 

•       Submarines, nuclear and other power plants

 

•       Foreign navies, nuclear and other power plant companies

 

5


Table of Contents

Systems/Products/Services

 

Selected Applications

 

Selected Platforms/End Users

   

•       Automation, navigation, communications, and sensors and integrated Command, Control, Communications, Computers and Navigation (C4N) solutions

 

•       Vessel bridge and machinery plant platform management systems, and C4N systems

 

•       USN and foreign navies

   

•       High power microwave sources, systems & effects, pulse power systems and electromagnetics hardened construction

 

•       Forensic analysis of weapons of mass destruction, and active detection of special nuclear material.

 

•       U.K. MoD, U.S. Defense Threat Reduction Agency, U.S. Army and USAF

   

•       Ballistic missile targets

 

•       Targets for ground based ballistic missile intercept systems

 

•       U.S. Missile Defense Agency (MDA)

   

Aviation Products & Security

        
   

•       Cockpit and mission displays

 

•       High performance, ruggedized flat panel and cathode ray tube displays and processors

 

•       Various military aircraft

   

•       Airborne traffic and collision avoidance systems, terrain awareness warning systems

 

•       Reduce the potential for midair aircraft collisions and crashes into terrain by providing visual and audible warnings and maneuvering instructions to pilots

 

•       Commercial transport, business, regional and military aircraft

   

•       Advanced cockpit avionics

 

•       Pilot safety, navigation and situation awareness products

 

•       Commercial transport, business, regional and military aircraft

   

•       Solid state crash protected cockpit voice and flight data recorders

 

•       Aircraft voice and flight data recorders that continuously record voice and sounds from cockpit and aircraft intercommunications

 

•       Commercial transport, business, regional and military aircraft

   

•       Airport security systems, explosives detection systems and whole body imaging systems

 

•       Rapid scanning of passenger checked baggage and carry-on luggage, scanning of large cargo containers

 

•       DHS, including the U.S. Transportation Security Administration (TSA), domestic and international airports and state and local governments

   

•       Non-invasive security systems and portals, and sophisticated sensors with threat detection capabilities

 

•       Aviation, rail and border crossing security

 

•       TSA, U.S. Customs and Border Protection agency, various regulatory authorities and private security companies

 

6


Table of Contents

Systems/Products/Services

 

Selected Applications

 

Selected Platforms/End Users

   

Sensor Systems

     
   

•       Targeted stabilized camera systems with integrated sensors and wireless communication systems

 

•       Intelligence data collection and surveillance and reconnaissance

 

•       DoD, foreign ministries of defense, intelligence and security agencies, law enforcement, manned/unmanned platforms

   

•       Airborne and ground based high energy laser beam directors, laser designators and high tracking rate telescopes

 

•       Directed energy systems, space surveillance, satellite laser ranging and laser communications, airborne and ground target designation/illumination

 

•       USAF and NASA

   

•       Submarine photonic systems and periscopes

 

•       Virginia class submarines

 

•       USN

   

•       Force protection, electronic warfare and satellite monitoring

 

•       Counter IED systems, jamming and satellite monitoring

 

•       U.K. MoD and other foreign security agencies and ministries of defense

   

•       ISR mission management software and geospatial application technology programs

 

•       Cueing system software, hardware and video algorithms and wide-area sensor integration solutions and software

 

•       USAF, USSOCOM, Naval Surface Warfare Center and various other DoD agencies

   

Warrior Systems

     
   

•       Enhanced vision and weapon sights products

 

•       Image intensified night vision goggles/sights, holographic weapon sights, thermal sights and images, and driver viewers for special forces, pilots and aircrews, soldiers, marines, sailors and law enforcement personnel

 

•       U.S. Army, USN, USMC, DHS, foreign militaries and law enforcement agencies

   

•       Laser designation and range finder systems

 

•       Airborne and ground target designation/illumination

 

•       DoD, law enforcement and foreign customers

   

Advanced Programs

     
   

•       Optics, telescopes and precision optical subsystems

 

•       Airborne pointing and scanning stabilized mirrors and stabilized lightweight multi-spectral telescopes

 

•       NASA, DoD and National Reconnaissance Office

 

7


Table of Contents

Aerospace Systems Reportable Segment

In 2015, Aerospace Systems had net sales of $4,156 million, representing 40% of our total net sales. The businesses in this reportable segment provide products and services for the global ISR market, specializing in signals intelligence (SIGINT) and multi-intelligence platforms, to include full motion video, electro-optical, infrared, and synthetic aperture radars, along with other types of information gathering systems. These products and services provide the warfighter with the ability to collect and analyze data from command centers, communication nodes and air defense systems for real-time situational awareness and response. The businesses in this reportable segment provide select Command, Control and Communications (C3) systems products for military and other U.S. Government and select foreign government intelligence, reconnaissance and surveillance applications. We believe that these products and services are critical elements for a substantial number of major command, control and communication and intelligence gathering systems. The businesses in this reportable segment also provide modernization, upgrades and sustainment, maintenance and logistics support solutions for military and various government aircraft and other platforms. We sell these services primarily to the DoD and select foreign governments. Major products and services for this reportable segment include:

 

   

highly specialized fleet management sustainment and support services, including procurement, systems integration, sensor development, modifications and periodic depot maintenance for ISR and special mission aircraft and airborne systems;

 

   

strategic and tactical SIGINT systems that detect, collect, identify, analyze and disseminate information;

 

   

engineering, modification, maintenance, logistics and upgrades for aircraft, ground vehicles and personnel equipment;

 

   

turnkey aviation life cycle management services that integrate custom developed and commercial off-the-shelf products for various military fixed and rotary wing aircraft, including heavy maintenance and structural modifications and interior modifications; and

 

   

aerospace and other technical services related to large fleet support, such as aircraft and vehicle modernization, maintenance, repair and overhaul, logistics, support and supply chain management, primarily for military training, tactical, transport cargo and utility aircraft.

The table below provides a summary of the segment’s business areas and the percentage that each contributed to Aerospace Systems’ net sales in 2015.

 

Business Area

   % of 2015
            Segment Sales             

ISR Systems

                     52%

Logistics Solutions

                 30

Aircraft Systems

                 18
  

 

Total Aerospace Systems

                           100%        
  

 

 

8


Table of Contents

The table below provides additional information for the systems, products and services; selected applications; and selected platforms or end users of our Aerospace Systems reportable segment.

 

Systems/Products/Services

 

Selected Applications

 

Selected Platforms/End Users

   

ISR Systems

     
   

•       Prime mission systems integration, sensor development and operations and support

 

•       Signal processing, airborne SIGINT applications, antenna technology, real-time process control and software development

 

•       DoD, USAF, U.K. MoD, and other select foreign military ISR aircraft platforms and ground systems

   

•       Fleet management of special mission aircraft, including avionics and mission system upgrades and logistics support

 

•       Measurement collection and signal intelligence, special missions

 

•       DoD and classified customers within the U.S. Government

   

•       ISR operations and support

 

•       Data link support and services, special applications, classified projects, spares and repairs

 

•       USAF and U.S. Army ISR aircraft platforms and ground systems

   

Logistics Solutions

     
   

•       Logistics support and maintenance

 

•       Aircraft maintenance and repair, flight operations support for training, transport/cargo and special mission aircraft

 

•       U.S. Army, USAF, USN and select foreign militaries

   

•       Contract Field Teams (CFT)

 

•       Deployment of highly mobile, quick response field teams to customer locations to supplement the customer’s resources for various ground vehicles and aircraft

 

•       U.S. Army, USAF, USN and USMC

   

•       Contractor Operated and Managed Base Supply (COMBS)

 

•       Inventory management activities relating to flight support and maintenance, including procurement and field distribution

 

•       Military training and transport/cargo aircraft for USN, USAF and U.S. Army

   

Aircraft Systems

     
   

•       Modernization and life extension maintenance upgrades and support

 

•       Aircraft structural modifications and inspections, installation of mission equipment, navigation and avionics products and interior modifications

 

•       USN, USAF, select foreign governments, OEMs, VIP and Head-of-State (HOS) aircraft, and various military fixed and rotary wing aircraft

 

9


Table of Contents

Systems/Products/Services

 

Selected Applications

 

Selected Platforms/End Users

   

•       Fabrication and assembly of fixed and rotary wing aerostructures

 

•       Rotary wing cabin assemblies, new and modified wings and subassemblies, structure and parts fabrication for OEMs

 

•       U.S. Army, USN, USMC and OEMs

Communication Systems Reportable Segment

In 2015, Communication Systems had net sales of $2,041 million, representing 19% of our total net sales. The businesses in this reportable segment provide network and communication systems, secure communications products, radio frequency components, satellite communication terminals, and space, microwave and telemetry products. These products are used to connect a variety of space, airborne, ground and sea-based communication systems and are used in the transmission, processing, recording, monitoring, and dissemination functions of these communication systems. Major products and services for this reportable segment include:

 

   

secure data links that enable real-time information collection and dissemination to users of networked communications for airborne, satellite, ground and sea-based remote platforms, both manned and unmanned;

 

   

microwave products, including passive and active microwave components and subsystems, radar antennas and radomes, power devices and mobile and ground-based satellite communications systems;

 

   

secure terminal and communication network equipment and encryption management; and

 

   

communication systems for surface and undersea vessels and manned space flights.

The table below provides a summary of the segment’s business areas and the percentage that each contributed to Communication Systems’ net sales in 2015.

 

Business Area

   % of 2015
        Segment Sales        
 

Broadband Communication Systems

     50%      

Advanced Communications

     21         

Space & Power Systems

     19         

Tactical Satellite Communication Products

     10         
  

 

 

 

Total Communication Systems

                     100%      
  

 

 

 

 

10


Table of Contents

The table below provides additional information for the systems, products and services; selected applications; and selected platforms or end users of our Communication Systems reportable segment.

 

Systems/Products/Services

 

Selected Applications

 

Selected Platforms/End Users

   

Broadband Communication Systems

   
   

•       Airborne, space and surface data link terminals, ground stations, and transportable tactical satellite communications (SATCOM) systems

 

•       High performance, wideband secure communication links for relaying of intelligence and reconnaissance information

 

•       Manned aircraft, unmanned aerial vehicles (UAVs), naval ships, ground vehicles and satellites for the DoD

   

•       Multi-band Manpack Receivers

 

•       Portable, ruggedized terminals used for receiving reconnaissance video and sensor data from multiple airborne platforms

 

•       U.S. Special Operations Command (USSOCOM), USAF and other DoD customers

   

•       Multi-frequency time division multiple access modems and high dynamic small aperture band terminals that support SATCOM on the move using X, Ku, and Ka bands

 

•       On the move SATCOM and other tactical communications systems utilizing small aperture terminals; off road use on military vehicles, watercraft, and airborne platforms to provide two-way broadband connectivity while on the move

 

•       U.S. Army, USMC, and select foreign allies

   

•       Tactical ground based signal intercept and direction finding systems

 

•       Man portable and military vehicle mounted tactical signal intercept/exploitation and direction finding systems

 

•       U.S. Army and other DoD/U.S. intelligence agencies

   

Advanced Communications

   
   

•       Passive and active microwave components and subsystems and non-ionizing radiation monitoring equipment

 

•       Radio transmission, switching and conditioning, transponder control, channel and frequency separation, ground vehicles, aircraft and satellites

 

•       DoD and OEMs, SATCOM for DoD and various government agencies

   

•       Secure communications terminals and equipment, and secure network encryption products

 

•       Secure and non-secure voice, data and video communication for office, battlefield and secure internet protocol (IP) network applications

 

•       DoD and U.S. Government intelligence agencies

   

•       Ground-based satellite communications terminals and payloads

 

•       Interoperable, transportable ground terminals

 

•       DoD and U.S. Government intelligence agencies

 

11


Table of Contents

Systems/Products/Services

 

Selected Applications

 

Selected Platforms/End Users

   

•       Shipboard communications systems

 

•       Internal and external communications (radio rooms and workstations)

 

•       USN, USCG and foreign navies

   

•       Ultra-wide frequency and advanced radar antennas and radomes

 

•       Surveillance and radar detection

 

•       Military fixed and rotary winged aircraft, SATCOM

   

•       Low-power SATCOM products

 

•       Low-noise and low-power amplifiers, solid-state switch assemblies, uplink power control products and frequency converters

 

•       U.S. Army, other government agencies and commercial customers

   

Space & Power Systems

   
   

•       Traveling wave tube amplifiers (TWTA’s), power modules, klystrons and digital broadcast

 

•       Microwave vacuum electron devices and power modules

 

•       DoD and foreign military manned/unmanned platforms, including satellites, radar systems, communication systems, UAVs, missile defense systems, various missile programs and commercial broadcast

   

•       Telemetry and instrumentation systems

 

•       Spacecraft telemetry tracking and control, encryption and high data rate transmitters, satellite command and control software, airborne and ground test telemetry systems, and tactical intelligence receivers

 

•       Aircraft, missiles and satellites

   

Tactical Satellite Communications Products

   
   

•       Quick-deploy flyaway very small aperture terminals (VSAT) and vehicular satellite systems

 

•       Satellite communications

 

•       U.S. Army, USAF, USSOCOM and other DoD agencies, and commercial customers

   

•       Managed communications security (COMSEC) satellite networks and integrated remote VSAT satellite systems

 

•       Deployment and support of global communication networks for tactical and enterprise applications

 

•       U.S. Army, DoD/U.S. intelligence agencies, allied forces and commercial contractors

 

12


Table of Contents

Funded Backlog and Orders

We define funded backlog as the value of funded orders received from customers, less the cumulative amount of sales recognized on such orders. We define funded orders as the value of contract awards received from the U.S. Government, for which the U.S. Government has appropriated funds, plus the value of contract awards and orders received from customers other than the U.S. Government. The table below presents our funded backlog, percentage of funded backlog at December 31, 2015 expected to be recorded as sales in 2016 and funded orders for each of our reportable segments and on a consolidated basis.

 

     Funded Backlog at
December 31,
     Percentage of
Funded Backlog at
December 31, 2015
Expected to be
Recorded as
Sales  in 2016
     Funded Orders  
     2015      2014         2015      2014  
     (in millions)             (in millions)  

Reportable Segment:

              

Electronic Systems

    $     3,688           $     4,494                      64%       $     4,137           $     4,811      

Aerospace Systems

     2,741            3,341            63%        3,569            4,178      

Communication Systems

     1,994            1,850            66%        2,156            1,985      
  

 

 

    

 

 

       

 

 

    

 

 

 

Consolidated

    $     8,423           $     9,685            64%       $     9,862           $     10,974      
  

 

 

    

 

 

       

 

 

    

 

 

 

Our funded backlog does not include the full potential value of our contract awards, including those pertaining to multi-year, cost-plus type contracts, which are generally funded on an annual basis. Funded backlog also excludes the potential future orders and related sales from unexercised priced contract options that may be exercised by customers under existing contracts and the potential future orders and related sales of purchase orders that we may receive in the future under indefinite quantity contracts or basic ordering agreements during the term of such agreements.

Major Customers

The table below presents a summary of our sales by end customer and the percent contributed by each to our total sales. For additional information regarding domestic and international sales, see Note 21 to our audited consolidated financial statements.

 

    2015     2014  
                Sales                  % of
    Total Sales    
                 Sales                  % of
    Total Sales    
 
    (in millions)           (in millions)        

Air Force

   $             3,166              30%        $         3,075            28%    

Army

    1,715              17            1,897            17       

Navy/Marines

    1,447              14            1,524            14       

Other Defense

    645              6            648            6       
 

 

 

   

 

 

   

 

 

   

 

 

 

Total DoD

   $ 6,973              67%        $ 7,144            65%    

Other U.S. Government

    318              3            320            3       
 

 

 

   

 

 

   

 

 

   

 

 

 

Total U.S. Government

   $ 7,291              70%        $ 7,464            68%    

International (foreign governments)

    1,799              17            1,866            17       

Commercial — international

    759              7            1,069            10       

Commercial — domestic

    617              6            587            5       
 

 

 

   

 

 

   

 

 

   

 

 

 

Total sales

   $ 10,466              100%        $ 10,986                        100%    
 

 

 

   

 

 

   

 

 

   

 

 

 

 

13


Table of Contents

Direct sales to the end customer represented approximately 66% of our consolidated 2015 sales, and sales as a subcontractor or supplier represented the remaining 34%. Additionally, approximately 68% of our DoD sales for 2015 were direct to the customer, and approximately 32% were indirect through other prime system contractors and subcontractors of the DoD.

Our sales are predominantly derived from contracts with agencies of, and prime system contractors to, the U.S. Government. Various U.S. Government agencies and contracting entities exercise independent and individual purchasing decisions, subject to annual appropriations by the U.S. Congress. For the year ended December 31, 2015, our five largest contracts (revenue arrangements) generated 14% of our consolidated sales and our largest contract (revenue arrangement) in terms of annual sales was the Fort Rucker Maintenance Support contract with the U.S. Army Aviation and Missile Life Cycle Management Command (AMCOM), which is included in our Aerospace Systems segment. Under this contract, which generated approximately 4.3% of our 2015 sales, we provide maintenance, logistics and other related sustainment support services for rotary wing aircraft assigned to Fort Rucker and satellite units in Alabama. Our period of performance under this contract, including unexercised annual options, continues through September 30, 2017.

Research and Development

We conduct research and development activities that consist of projects involving applied research, new product and systems development and select concept studies. We employ scientific, engineering and other personnel to improve our existing product lines and systems and develop new products, technologies, and systems. As of December 31, 2015, we employed approximately 7,000 engineers, substantially all of whom hold advanced degrees, who work on company-sponsored research and development efforts and customer funded research and development contracts.

Company-sponsored (Independent) research and development costs for our businesses that are U.S. Government contractors are allocated to U.S. Government contracts and are charged to cost of sales when the related sales are recognized as revenue. Research and development costs for our commercial businesses are expensed as incurred and are also charged to cost of sales. The table below presents company-sponsored (Independent) research and development expenses incurred for our U.S. Government businesses and our commercial businesses.

 

                            Year  Ended December 31,                          
                2015                              2014                              2013              
    (in millions)  

Company-Sponsored Research and Development Costs:

    

U.S. Government Contractor Businesses

   $             172           $             162           $             182      

Commercial Businesses

    56            67            76      
 

 

 

    

 

 

    

 

 

 

Total

   $ 228           $ 229           $ 258      
 

 

 

    

 

 

    

 

 

 

Customer-funded research and development costs pursuant to contracts (revenue arrangements) are not included in the table above because they are direct contract costs and are charged to cost of sales when the corresponding revenue is recognized. See Note 2 to our audited consolidated financial statements for additional information regarding research and development.

Competition

Our businesses generally encounter significant competition. We believe that we are a major provider for many of the products and services we offer to our DoD, government and commercial customers.

 

14


Table of Contents

Our ability to compete for existing and new business depends on a variety of factors, including:

 

   

the effectiveness and innovation of our technologies, systems and research and development programs;

 

   

our ability to offer superior program performance at an affordable and competitive cost;

 

   

historical, technical, cost and schedule performance;

 

   

our ability to attain supplier positions on contracts;

 

   

our ability to maintain an effective supplier and vendor base;

 

   

our ability to retain our employees and hire new ones, particularly those who have U.S. Government security clearances;

 

   

the capabilities of our facilities, equipment and personnel to undertake the business for which we compete; and

 

   

our ability to quickly and flexibly meet customer requirements and priorities.

L-3 is an aerospace and defense contractor with a broad and diverse portfolio of products and services. We have prime contractor and subcontractor positions. We supply our products and services to other prime system contractors. However, we also compete directly with other large prime system contractors for: (1) certain products, subsystems and systems, where they have vertically integrated businesses and (2) niche areas where we are a prime contractor. We also compete with numerous other aerospace and defense contractors, which generally provide similar products, subsystems, systems or services.

In addition, our ability to compete for select contracts may require us to “team” with one or more of the other prime system contractors that bid and compete for major platform programs, and our ability to “team” with them is often dependent upon the outcome of a competition for subcontracts they award.

Patents and Licenses

Generally, we do not believe that our patents, trademarks and licenses are material to our operations. Furthermore, most of our U.S. Government contracts generally permit us to use patents owned by other U.S. Government contractors. Similar provisions in U.S. Government contracts awarded to other companies make it impossible for us to prevent the use of our patents in most DoD work performed by other companies for the U.S. Government.

Raw Materials

Although we generated 63% of our 2015 sales from products and systems, our businesses are generally engaged in limited manufacturing activities and have minimal exposure to fluctuations in the supply of raw materials. For those businesses that manufacture and sell products and systems, most of the value that we provide is labor oriented, such as design, engineering, assembly and test activities. In manufacturing our products, we use our own production capabilities as well as a diverse base of third party suppliers and subcontractors. Although certain aspects of our manufacturing activities require relatively scarce raw materials, we have not experienced difficulty in our ability to procure raw materials, components, sub-assemblies and other supplies required in our manufacturing processes.

 

15


Table of Contents

Contracts

Generally, the sales price arrangements for our contracts are either fixed-price, cost-plus or time-and-material type. Generally, a fixed-price type contract offers higher profit margin potential than a cost-plus type or time-and-material type contract due to the greater levels of risk we assume on a fixed-price type contract.

On a fixed-price type contract (revenue arrangement), we agree to perform the contractual statement of work for a predetermined sales price. Although a fixed-price type contract generally permits us to retain profits if the total actual contract costs are less than the estimated contract costs, we bear the risk that increased or unexpected costs may reduce our profit or cause us to sustain losses on the contract. Accounting for the sales on a fixed-price type contract that is covered by contract accounting standards requires the preparation of estimates for: (1) the total contract revenue, (2) the total costs at completion, which is equal to the sum of the actual incurred costs to date on the contract and the estimated costs to complete the contract’s statement of work, and (3) the measurement of progress towards completion. Adjustments to original estimates for a contract’s revenue, estimated costs at completion and estimated total profit or loss are often required as work progresses under a contract, as experience is gained and as more information is obtained, even though the scope of work required under the contract may not change.

On a cost-plus type contract (revenue arrangement), we are paid our allowable incurred costs plus a profit which can be fixed or variable depending on the contract’s fee arrangement up to predetermined funding levels determined by our customers. Cost-plus type contracts with award and incentive fee provisions are our primary variable contract fee arrangement. 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 which total allowable costs bear to target cost. Award and incentive fees earned were not material to our results of operations for 2015, 2014 and 2013.

On a time-and-material type contract (revenue arrangement), we are paid on the basis of direct labor hours expended at specified fixed-price hourly rates (that include wages, overhead, allowable general and administrative expenses and profit) and materials at cost. Therefore, on cost-plus type and time-and-material type contracts we do not bear the risks of unexpected cost overruns, provided that we do not incur costs that exceed the predetermined funded amounts.

Substantially all of our cost-plus type contracts and time-and-material type contracts are with U.S. Government customers while sales to commercial customers are transacted under fixed-price sales arrangements and are included in our fixed-price contract type sales. The table below presents the percentage of our total sales generated from each contract type.

 

                     Year Ended December 31,               
Contract Type                2015                              2014                              2013              

Fixed-price(1)

     74%          76%          76%    

Cost-plus fixed fee

     14%          12%          12%    

Cost-plus award fee

     2%          2%          3%    

Cost-plus incentive fee

     5%          5%          5%    

Time-and-material

     5%          5%          4%    
  

 

 

    

 

 

    

 

 

 

Total sales

                 100%                      100%                      100%    
  

 

 

    

 

 

    

 

 

 

 

  (1) 

Includes fixed-price incentive fee type contracts contributing approximately 1% of our total sales for the years ended December 31, 2015, 2014 and 2013.

 

16


Table of Contents

Regulatory Environment

Most of our revenue arrangements with agencies of the U.S. Government, including the DoD, are subject to unique procurement and administrative rules. These rules are based on both laws and regulations, including the U.S. Federal Acquisition Regulation, that: (1) impose various profit and cost controls, (2) regulate the allocations of costs, both direct and indirect, to contracts and (3) provide for the non-reimbursement of unallowable costs. Unallowable costs include, but are not limited to, lobbying expenses, interest expenses and certain costs related to business acquisitions, including, for example, the incremental depreciation and amortization expenses arising from fair value increases to the historical carrying values of acquired assets. Our contract administration and cost accounting policies and practices are also subject to oversight by government inspectors, technical specialists and auditors. See “Part I — Item 1A — Risk Factors” for a discussion of certain additional business risks specific to our government contracts.

Our U.S. Government contracts are subject to extensive legal and regulatory requirements and, from time to time, agencies of the U.S. Government investigate whether our operations are being conducted in accordance with these requirements. Investigations could result in administrative, civil, or criminal liabilities, including repayments, disallowance of certain costs, or fines and penalties. As is common in the U.S. defense industry, we are subject to business risks, including changes in the U.S. Government’s procurement policies (such as greater emphasis on competitive procurement), governmental appropriations, national defense policies or regulations, service modernization plans, and availability of funds. A reduction in expenditures by the U.S. Government for products and services of the type we manufacture and provide, lower margins resulting from increasingly competitive procurement policies, a reduction in the volume of contracts or subcontracts awarded to us or the incurrence of substantial contract cost overruns could materially adversely affect our business.

In 2015, sales under foreign military sales (FMS) agreements, which are included in the international (foreign governments) category in the “Major Customers” table above, were $644 million, or 6% of our total consolidated sales. FMS agreements are made directly between the U.S. Government and foreign governments. In such cases, because we serve only as the supplier, we do not have unilateral control over the terms of the agreements. Certain of our sales are direct commercial sales to foreign governments. These sales are subject to U.S. Government approval and licensing under the Arms Export Control Act. Legal restrictions on sales of sensitive U.S. technology also limit the extent to which we can sell our products to foreign governments or private parties.

All of our U.S. Government contracts can be terminated by the U.S. Government either for its convenience or if we default by failing to perform under the contract. Termination for convenience provisions provide only for our recovery of costs incurred or committed settlement expenses and profit on the work completed prior to termination. Termination for default provisions provide for the contractor to be liable for excess costs incurred by the U.S. Government in procuring undelivered items from another source. Our contracts with foreign governments generally contain similar provisions relating to termination at the convenience of the customer.

Environmental Matters

Our operations are subject to various environmental laws and regulations relating to the discharge, storage, treatment, handling, disposal and remediation of certain materials, substances and wastes used in our operations. We continually assess our obligations and compliance with respect to these requirements.

We have also assessed the risk of environmental contamination for our various manufacturing facilities, including our acquired businesses and, where appropriate, have obtained indemnification, either from the sellers of those acquired businesses or through pollution liability insurance. We believe that our current operations are in substantial compliance with all existing applicable environmental laws and permits. We believe our current expenditures will allow us to continue to be in compliance with applicable environmental laws and regulations. While it is difficult to determine the timing and ultimate cost to be incurred in order to comply with these laws,

 

17


Table of Contents

based upon available internal and external assessments, with respect to those environmental loss contingencies of which we are aware, we believe there are no environmental loss contingencies that, individually or in the aggregate, would be material to our consolidated results of operations, financial position or cash flows.

Employees

As of December 31, 2015, we employed approximately 38,000 full-time and part-time employees, 86% of whom were located in the United States. Of these employees, approximately 22% are covered by approximately 148 separate collective bargaining agreements with various labor unions. The success of our business is, to a large extent, dependent upon the knowledge of our employees and on the management, contracting, engineering and technical skills of our employees. In addition, our ability to grow our businesses, obtain additional orders for our products and services and to satisfy contractual obligations under certain of our existing revenue arrangements is largely dependent upon our ability to attract and retain employees who have U.S. Government security clearances, particularly those with clearances of top-secret and above. Historically, we have renegotiated labor agreements without significant disruptions to operating activities, and we believe that relations with our employees are positive.

L-3 Holdings Obligations

The only obligations of L-3 Holdings at December 31, 2015 were: (1) its guarantee of borrowings under the revolving credit facility of L-3 Communications, and (2) its guarantee of other contractual obligations of L-3 Communications and its subsidiaries. In order to generate the funds necessary to repurchase its common stock and pay dividends declared and principal and interest on its outstanding indebtedness, if any, L-3 Holdings relies on dividends and other payments from its subsidiaries.

Available Information

We are subject to the informational requirements of the Securities Exchange Act of 1934 and, in accordance therewith, file reports, including annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission the (“SEC”). Such reports and other information can be inspected and copied at the Public Reference Room of the SEC located at 100 F Street, NE, Washington, DC 20549. Copies of such material can be obtained from the Public Reference Room of the SEC at prescribed rates. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Such material may also be accessed electronically by means of the SEC’s home page on the Internet at http://www.sec.gov.

You may also obtain a free copy of our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and proxy statement for the annual shareholders’ meeting, as well as any amendments to those reports as soon as reasonably practicable after electronic filing with the SEC through our website on the Internet at http://www.L-3com.com.

We also have a Corporate Governance webpage. You can access our Corporate Governance Guidelines and charters for the audit, compensation and nominating/corporate governance committees of our Board of Directors through our website, http://www.L-3com.com, by clicking on the “Corporate Governance” link under the heading “Investor Relations.” You can access our Code of Ethics and Business Conduct by clicking on the “Code of Ethics and Business Conduct” link under the heading “Code of Ethics.” Our Code of Ethics and Business Conduct applies to all directors, officers and employees, including our chairman and chief executive officer, our senior vice president and chief financial officer, and our vice president, controller and principal accounting officer. We will post any amendments to the Code of Ethics and Business Conduct, and any waivers that are required to be disclosed by the rules of either the SEC or the New York Stock Exchange, Inc. (NYSE), on our website within the required periods. The information on or accessible through our website is not incorporated by reference into this report.

 

 

18


Table of Contents

To learn more about L-3, please visit our website at http://www.L-3com.com. From time to time we use our website as a channel of distribution of material company information. Financial and other material information regarding L-3 is routinely posted on our website and is readily accessible.

Item 1A. Risk Factors

You should carefully consider the following risk factors and other information contained in this Form 10-K, including “Part II — Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Any of these risks could materially affect our business and our financial condition, results of operations and cash flows, which could in turn materially affect the price of our common stock.

Our contracts (revenue arrangements) with U.S. Government customers entail certain risks.

A decline in or a redirection of the U.S. defense budget could result in a material decrease in our sales, results of operations and cash flows.

Our government contracts and sales are highly correlated and dependent upon the U.S. defense budget which is subject to the congressional budget authorization and appropriations process. Congress usually appropriates funds for a given program on a September 30 fiscal year basis, even though contract periods of performance may extend over many years. Consequently, at the beginning of a major program, the contract is usually partially funded, and additional monies are normally committed to the contract by the procuring agency only as appropriations are made by Congress in future fiscal years. DoD budgets are determined by factors beyond our control, including, but not limited to, changes in U.S. procurement policies, budget considerations, current and future economic conditions, presidential administration priorities, changing national security and defense requirements, geopolitical developments and actual fiscal year congressional appropriations for defense budgets. Any of these factors could result in a significant decline in, or redirection of, current and future DoD budgets and impact our future results of operations, including our sales and operating income growth rates.

The DoD budget peaked in the fiscal year ended September 30, 2010 (FY 2010) at $690 billion and declined through FY 2015. The total budget for FY 2015 was $560 billion, a 4% decline as compared to the FY 2014 budget due to a decrease in the Overseas Contingency Operations (OCO) budget. The FY 2015 base budget (total budget less OCO) remained substantially unchanged from FY 2014 at $497 billion while the OCO budget decreased by $22 million. The total DoD budget for FY 2016 is $581 billion, an increase of 4% compared to FY 2015. The increase is due to a higher base budget of $25 billion. The FY 2016 DoD OCO budget declined slightly to $59 billion compared to $63 billion for FY 2015.

In addition, the U.S. defense budget has been affected by the U.S. Government’s overall fiscal challenges in recent years. On November 2, 2015, the President signed the Bipartisan Budget Act of 2015 (BBA), a bipartisan two-year budget and debt ceiling agreement that provides a level of stability in the U.S. Government budget process over the next two years. The BBA suspends the debt ceiling through March 15, 2017 and raises spending caps previously enacted by Congress under the Budget Control Act of 2011, as amended by The American Taxpayer Relief Act and Bipartisan Budget Act of 2013 (BCA). The spending caps on defense programs were raised by $25 billion to $548 billion for FY 2016 and by $15 billion to $551 billion for FY 2017. The BBA also sets a target for OCO funding for the DoD at $59 billion for each of FY 2016 and FY 2017, subject to the Congressional appropriation process. The BBA, however, does not change the BCA budget sequestration cuts after FY 2017. Consequently, while the BBA provides a level of stability, future DoD budgets and spending levels are difficult to predict. A significant decline in or redirection of U.S. military expenditures in the future, or the loss or significant reduction in U.S. Government funding of a large program in which we participate could have a material adverse effect on our financial position, results of operations and cash flows.

 

19


Table of Contents

We rely predominantly on sales to U.S. Government entities, and the loss or delay of a significant number of our contracts would have a material adverse effect on our results of operations and cash flows.

Our sales are predominantly derived from contracts (revenue arrangements) with agencies of, and prime system contractors to, the U.S. Government. The loss or delay of all or a substantial portion of our sales to the U.S. Government would have a material adverse effect on our results of operations and cash flows. Approximately 70%, or $7.3 billion, of our sales for the year ended December 31, 2015 were made directly or indirectly to U.S. Government agencies, including 67% to the DoD. Aggregate sales for our five largest contracts (revenue arrangements) amounted to approximately $1.4 billion, or 14% of our consolidated sales for the year ended December 31, 2015. Our largest contract (revenue arrangement) in terms of annual sales for the year ended December 31, 2015 was the Fort Rucker Maintenance Support contract with the U.S. Army Aviation and Missile Life Cycle Management Command (AMCOM), which is included in our Aerospace Systems segment and generated approximately 4.3% of our 2015 sales. Our period of performance under this contract, including unexercised annual options, continues through September 30, 2017.

A substantial majority of our total sales are for products and services under contracts with various agencies and procurement offices of the DoD or with prime contractors to the DoD. Although these various agencies, procurement offices and prime contractors are subject to common budgetary pressures and other factors, our customers exercise independent purchasing decisions. Because of this concentration of contracts, if a significant number of our DoD contracts and subcontracts are simultaneously delayed or cancelled for budgetary, performance or other reasons, it would have a material adverse effect on our results of operations and cash flows.

In addition to contract cancellations and declines in agency budgets, our backlog and future financial results may be adversely affected by:

 

   

curtailment of the U.S. Government’s use of technology or other services and product providers, including curtailment due to government budget reductions and related fiscal matters;

 

   

geopolitical developments that affect demand for our products and services;

 

   

our ability to hire and retain personnel to meet demand for our services; and

 

   

technological developments that impact purchasing decisions or our competitive position.

The DoD’s wide-ranging efficiency and better buying power initiatives, which target affordability and cost growth, could have a material effect on the procurement process and may adversely affect our existing contracts and the award of new contracts.

Since 2010, the DoD has implemented best practices to the procurement process that are intended to control cost growth throughout the acquisition cycle by developing a competitive strategy for each program. As a result, we have and continue to engage in more frequent negotiations and re-competitions on a cost or price analysis basis with every competitive bid in which we participate. In April 2015, the DoD introduced Better Buying Power 3.0 (BBP), which focuses on technology innovation, incentive-based cost-plus and fixed-price contracts and Company sponsored Independent research and development efforts. The BBP initiative significantly changed the way the U.S. Government solicits, negotiates and manages its contracts and could result in a reduction in expenditures for the type of products we manufacture for, and services we provide to, the U.S. Government, which could have a material negative impact on our future sales, earnings and cash flows. These initiatives primarily affect our businesses within the Logistics Solutions sector within the Aerospace Systems reportable segment, and could result in the loss of certain of our existing contracts (revenue arrangements) depending on how the DoD implements this initiative.

 

 

20


Table of Contents

Our government contracts contain unfavorable termination provisions and are subject to audit and modification. If a termination right is exercised by the government, it could have a material adverse effect on our business, financial condition, results of operations and cash flows.

Companies engaged primarily in supplying defense-related equipment and services to U.S. Government agencies are subject to certain business risks peculiar to the defense industry. These risks include the ability of the U.S. Government to unilaterally:

 

   

suspend us from receiving new contracts pending resolution of alleged violations of procurement laws or regulations;

 

   

terminate existing contracts;

 

   

reduce the value of existing contracts; and

 

   

audit our contract-related costs and fees, including allocated indirect costs.

All of our U.S. Government contracts can be terminated by the U.S. Government either for its convenience or if we default by failing to perform under the contract. Termination for convenience provisions provide only for our recovery of costs incurred or committed settlement expenses and profit on the work completed prior to termination. Termination for default provisions provide for the contractor to be liable for excess costs incurred by the U.S. Government in procuring undelivered items from another source. Our contracts with foreign governments generally contain similar provisions relating to termination at the convenience of the customer.

U.S. Government agencies, including the Defense Contract Audit Agency and various agency Inspectors General, routinely audit and investigate our costs and performance on contracts, as well as our accounting and general business practices. Based on the results of such audits, the U.S. Government have adjusted, and may in the future adjust, our contract related costs and fees, including allocated indirect costs. In addition, under U.S. Government purchasing regulations, some of our costs, including certain business acquisition costs, most financing costs, portions of research and development costs, and certain marketing expenses may not be reimbursable under U.S. Government contracts.

As of December 31, 2015, we had a backlog of funded orders, primarily under contracts with the U.S. Government totaling $8,423 million. As described above, the U.S. Government may unilaterally modify or terminate its contracts with us. Accordingly, most of our backlog could be modified or terminated by the U.S. Government, which would have a material adverse effect on our future sales, results of operations and cash flows.

We may not be able to win competitively awarded contracts or receive required licenses to export our products, which could have a material adverse effect on our business, financial condition, results of operations, cash flows and future prospects.

Our government contracts are subject to competitive bidding. We obtain many of our U.S. Government contracts through a competitive bidding process. We may not be able to continue to win competitively awarded contracts. In addition, awarded contracts may not generate sales sufficient to result in our profitability. We are also subject to risks associated with the following:

 

   

the frequent need to bid on programs in advance of the completion of their design, which may result in unforeseen technological difficulties and/or cost overruns;

 

   

the substantial time, effort and experience required to prepare bids and proposals for competitively awarded contracts that may not be awarded to us;

 

21


Table of Contents
   

design complexity and rapid technological obsolescence; and

 

   

the constant need for design improvement.

In addition to these risks, we are not permitted to export some of our products, and we are required to obtain licenses from U.S. Government agencies to export many of our other products and systems. Failure to receive required licenses would eliminate our ability to sell our products and systems outside the United States.

Intense competition and bid protests may adversely affect our sales, results of operations and cash flows.

The defense and commercial industries in which our businesses operate are highly competitive. We expect that the DoD’s increased use of commercial off-the-shelf products and components in military equipment will continue to encourage new competitors to enter the market. We also expect increased competition for our products and services from other providers due to the uncertainty of future U.S. defense budgets. Furthermore, the current competitive environment has resulted in an increase of bid protests from unsuccessful bidders, which typically extends the time until work on a contract can begin. For more information concerning the factors that affect our ability to compete, see “Part I — Item 1 — Business — Competition.”

We are subject to government investigations, which could have a material adverse effect on our business, financial condition, results of operations, cash flows and future prospects.

U.S. Government contracts are subject to extensive legal and regulatory requirements, and from time to time agencies of the U.S. Government investigate whether such contracts were and are being conducted in accordance with these requirements. As discussed in Note 18 to our audited consolidated financial statements, we are currently cooperating with the U.S. Government on several investigations, including the matters which were the subject of the internal review at our Aerospace Systems segment. Under U.S. Government regulations, an indictment of L-3 by a federal grand jury, or an administrative finding against us as to our present responsibility to be a U.S. Government contractor or subcontractor, could result in us being suspended for a period of time from eligibility for awards of new government contracts or task orders or in a loss of export privileges, which could have a material adverse effect on our results of operations and cash flows. A conviction, or an administrative finding against us that satisfies the requisite level of seriousness, could result in debarment from contracting with the federal government for a specific term, which could have a material adverse effect on our results of operations and cash flows.

We are subject to the risks of legal proceedings, which could have a material adverse effect on our business, financial condition, results of operations, cash flows and future prospects, as well as the risk that we may need to record an adjustment to our product returns reserve in connection with our voluntary return program for EoTech holographic weapons sight products in future periods.

At any given time, we are a defendant in various material legal proceedings and litigation matters arising in the ordinary course of business, including litigation, claims and assessments that have been asserted against acquired businesses, which we have assumed. Although we maintain insurance policies, these policies may not be adequate to protect us from all material judgments and expenses related to current or future claims and may not cover the conduct that is the subject of the litigation. Desired levels of insurance may not be available in the future at economical prices or at all. In addition, we believe that while we have valid defenses with respect to legal matters pending against us, the results of litigation can be difficult to predict, including those involving jury trials. Accordingly, our current judgment as to the likelihood of our loss (or our current estimate as to the potential range of loss, if applicable) with respect to any particular litigation matter may be wrong. A significant judgment against us, arising out of any of our current or future legal proceedings and litigation, including in connection with three putative class action lawsuits filed against us regarding the EoTech holographic weapons sights, could have a material adverse effect on our business, financial condition, results of operations, cash flows and future prospects. For a discussion of material litigation to which we are currently a party, see

 

22


Table of Contents

Note 18 to our audited consolidated financial statements. Furthermore, we continue to evaluate the amount of our product returns reserve in connection with the voluntary return program that we commenced in November 2015 for various EoTech holographic weapons sight products that may have been affected by certain performance issues. The amount of the liability will ultimately depend on our actual experience with the return program. Our continuing evaluation of the product returns reserve may lead us to record an adjustment to the product returns reserve in future periods. Any such adjustment may be material.

If we are unable to keep pace with rapidly evolving products and service offerings and technological change, there could be a material adverse effect on our business, financial condition, results of operations, cash flows and future prospects.

The rapid change of technology is a key feature of most of the markets in which our products, services and systems oriented businesses operate. To succeed in the future, we will need to continue to design, develop, manufacture, assemble, test, market and support new products and enhancements on a timely and cost-effective basis. Historically, our technology has been developed through customer-funded and internally funded research and development and through certain business acquisitions. We may not be able to continue to maintain comparable levels of research and development or successfully complete such acquisitions. In the past, we have allocated substantial funds to capital expenditures, programs and other investments. This practice will continue to be required in the future. Even so, we may not be able to successfully identify new opportunities and may not have the necessary financial resources to develop new products and systems in a timely or cost-effective manner. At the same time, products and technologies developed by others may render our products, services and systems obsolete or non-competitive.

Goodwill represents a significant asset on our balance sheet and may become impaired.

Goodwill represents the largest asset on our balance sheet, with an aggregate balance of $6,281 million at December 31, 2015. We review goodwill and intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable, and also review goodwill annually in accordance with the accounting standards for goodwill and intangible assets. The annual impairment test requires us to determine the fair value of our reporting units in comparison to their carrying values. A decline in the estimated fair value of a reporting unit could result in a goodwill impairment, and a related non-cash impairment charge against earnings, if the estimated fair value for the reporting unit is less than the carrying value of the net assets of the reporting unit, including its goodwill.

We recorded aggregate non-cash goodwill impairment charges of $955 million ($384 million in continuing operations and $571 million in discontinued operations) in 2015 primarily due to a decline in the estimated fair value of the NSS business and the Logistics Solutions business as a result of a decline in their projected future cash flows. Additionally, the fair value of two of our other reporting units exceeded the carrying value of the net assets of those reporting units by less than 20% at November 30, 2015, the date of our most recent annual impairment assessment. These two reporting units had aggregate goodwill of approximately $1,524 million. A decline in the estimated fair value of one or more of our reporting units could potentially trigger goodwill impairment charges and a material adverse effect on our results of operations. See “Part II — Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies — Goodwill and Identifiable Intangible Assets” for further discussion.

Our results of operations and cash flows are substantially affected by our mix of fixed-price, cost-plus and time-and-material type contracts.

Our sales are transacted using written revenue arrangements, or contracts, which are generally fixed-price, cost-plus or time-and-material. For a description of our revenue recognition policies, see “Part II — Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies.” For information on the percentage of our total sales generated from each contract type, see “Item 1 —Business — Contracts.”

 

23


Table of Contents

Substantially all of our cost-plus and time-and-material type contracts are with the U.S. Government, primarily the DoD. Substantially all of our sales to commercial customers are transacted under fixed-price sales arrangements and are included in our fixed-price type contract sales.

On a fixed-price type contract (revenue arrangement), we agree to perform the contractual statement of work for a predetermined sales price. Although a fixed-price type contract generally permits us to retain profits if the total actual contract costs are less than the estimated contract costs, we bear the risk that increased or unexpected costs may reduce our profit or cause us to sustain losses on the contract.

On a cost-plus type contract (revenue arrangement), we are paid our allowable incurred costs plus a profit, which can be fixed or variable depending on the contract’s fee arrangement up to predetermined funding levels established by our customers. On a time-and-material type contract (revenue arrangement), we are paid on the basis of direct labor hours expended at specified fixed-price hourly rates (that include wages, overhead, allowable general and administrative expenses and profit) and materials at cost. Therefore, on cost-plus and time-and-material type contracts, we do not bear the risks of unexpected cost overruns, provided that we do not incur costs that exceed the predetermined funded amounts.

Additionally, the impact of revisions in profit or loss estimates for all types of contracts subject to percentage of completion accounting are recognized on a cumulative catch-up basis in the period in which the revisions are made. Provisions for anticipated losses on contracts are recorded in the period in which they become evident. Amounts representing contract change orders or claims are included in sales only when they can be reliably estimated and their realization is reasonably assured. The revisions in contract estimates, if significant, can materially affect our results of operations and cash flows, as well as reduce the valuations of receivables and inventories; and in some cases, result in liabilities to complete contracts in a loss position.

Pension expense and funding may fluctuate significantly because of changes in key estimates and assumptions, including discount rates and the assumed long-term rate of return on plan assets, as well as our actual investment returns and regulatory actions, which could negatively impact our results of operations, cash flows and financial condition.

Determining our pension expense requires significant judgment, particularly with respect to our discount rates, the assumed long-term rate of return on plan assets and other actuarial assumptions. If our assumptions change significantly due to changes in economic, legislative, demographic experience and/or circumstances, our pension expense, the funded status of our plans and our cash contributions to such plans would be impacted, which could negatively affect our results of operations, cash flows and financial condition. In addition, differences between our actual investment returns and our assumed long-term rate of return on plan assets could also impact our pension expense, the funded status of our plans and our required cash contributions to the plans. Further, our pension expense and the funded status of our plans, including required cash contributions to the plans, may be impacted by regulatory actions in any given year.

Additionally, pension plan cost recoveries under Cost Accounting Standards (CAS) for our U.S. Government contracts occur in different periods from when pension expense is recognized under accounting principles generally accepted in the U.S. or when cash contributions are made. Although CAS has been revised to better align the minimum required contributions under the Employee Retirement Income Security Act of 1974 (ERISA), as amended by the Pension Protection Act of 2006, with pension plan cost recoveries under CAS, timing differences could have a material adverse effect on our cash flow.

Our business could be negatively impacted by cybersecurity threats and other disruptions.

As a U.S. defense contractor, we faced, and continue to face, various security threats, including, but not limited to, threats to the physical security of our facilities and employees, cybersecurity threats to our information technology infrastructure and attempts to gain access to our proprietary or classified information as well as the proprietary or classified information of our customers.

 

24


Table of Contents

Although we utilize various procedures and controls to monitor, deter and mitigate these threats, these procedures and controls may not be sufficient to prevent disruptions in mission critical systems, the unauthorized release of confidential, sensitive or classified information and the corruption of data, systems or networks. Any significant operational delays, or any destruction, manipulation or improper use of our or our customers’ data, information systems or networks could materially and adversely affect our financial results, damage the reputation of our products and services and require significant management attention and expense. In addition, our insurance coverage and/or indemnification arrangements that we enter into, if any, may not be adequate to cover all of the costs related to cybersecurity attacks or disruptions resulting from such events.

To date, cyber attacks directed at us have not had a material impact on our financial results. Due to the evolving nature and increased frequency of security threats, however, the impact of any future incident cannot be predicted. The threats we face vary from those common to most industries to more advanced and persistent, highly organized adversaries who target us because we operate in the defense industry and protect national security information. If we are unable to protect sensitive information, our customers or governmental authorities could question the adequacy of our threat mitigation and detection processes and procedures, which could result in us having to spend a significant amount of money to upgrade our networks and systems and could otherwise have a material adverse effect on our business, financial condition, results of operations and cash flows.

In the current environment, there are also numerous and evolving risks to cybersecurity and privacy, including the use of viruses, worms or other malicious software programs and threats involving criminal hackers, state-sponsored intrusions, terrorist attacks, industrial espionage, employee malfeasance, and human or technological error. As these risks develop and these attacks become more frequent and sophisticated, we may find it necessary to make significant further investments to protect data and infrastructure from cyber and other security attacks.

We must also rely on the safeguards put in place by customers, suppliers, vendors, subcontractors, venture partners or other third parties to minimize the impact of cyber threats, other security threats or business disruptions. These third parties may have varying levels of cybersecurity expertise and safeguards and their relationships with government contractors, such as L-3, may increase the likelihood that they are targeted by the same cyber threats we face. In the event of a breach affecting these third parties, our business and financial results could suffer materially. With respect to our commercial arrangements with these third parties, we have processes designed to require that the third parties and their employees and agents agree to maintain certain standards for the storage, protection and transfer of confidential, personal and proprietary information. However, we remain at risk of a data breach due to the intentional or unintentional non-compliance by a third party’s employee or agent, the breakdown of a third party’s data protection processes, which may not be as sophisticated as ours, or a cyber attack on a third party’s information network and systems.

Our sales to certain international customers expose us to risks associated with operating internationally.

For the year ended December 31, 2015, sales to international customers, excluding our international sales made under FMS agreements directly between the U.S. Government and foreign governments, represented approximately 18% of our consolidated sales. Consequently, our businesses are subject to a variety of risks that are specific to international operations, including the following:

 

   

export regulations that could erode profit margins or restrict exports;

 

   

compliance with the U.S. Foreign Corrupt Practices Act and similar non-U.S. regulations;

 

   

the burden and cost of compliance with foreign laws, treaties and technical standards and changes in those regulations;

 

   

contract award and funding delays;

 

 

25


Table of Contents
   

potential restrictions on transfers of funds;

 

   

currency fluctuations;

 

   

import and export duties and value added taxes;

 

   

transportation delays and interruptions;

 

   

uncertainties arising from international local business practices and cultural considerations;

 

   

sovereign government credit risk; and

 

   

potential military conflicts and political risks.

Our international contracts may include industrial cooperation agreements requiring specific local purchases, manufacturing agreements or financial support obligations, known as offset obligations, and provide for penalties if we fail to meet such requirements. See “Part II — Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Contractual Obligations” for further discussion. While we have and will continue to adopt measures to reduce the potential impact of losses resulting from the risks of our international business, these measures may not be adequate.

If we are unable to attract and retain key management and personnel, we may become unable to operate our business effectively.

Our future success depends to a significant degree upon the continued contributions of our management, and our ability to attract and retain highly qualified management and technical personnel, including employees who have U.S. Government security clearances, particularly clearances of top-secret and above. We do not maintain any key person life insurance policies for members of our management. We face competition for management and technical personnel from other companies and organizations. Failure to attract and retain such personnel would damage our future prospects.

Environmental laws and regulations may subject us to significant liability.

Our operations are subject to various U.S. federal, state and local as well as certain foreign environmental laws and regulations within the countries in which we operate relating to the discharge, storage, treatment, handling, disposal and remediation of certain materials, substances and wastes used in our operations.

New laws and regulations, stricter enforcement of existing laws and regulations, the discovery of previously unknown contamination or the imposition of new clean-up requirements may require us to incur a significant amount of additional costs in the future and could decrease the amount of cash flow available to us for other purposes, including capital expenditures, research and development and other investments and could have a material adverse effect on our business, financial condition, results of operations, cash flows and future prospects.

Our business acquisition strategy involves risks, and we may not successfully implement our strategy.

We opportunistically seek to acquire businesses that enhance our capabilities and add new technologies, products, services, programs, contracts, and customers to our existing businesses. We may not be able to continue to identify acquisition candidates on commercially reasonable terms or at all. If we make additional business acquisitions, we may not realize the benefits anticipated from these acquisitions, including sales growth, cost synergies and improving margins. Furthermore, we may not be able to obtain additional financing for business acquisitions, since such additional financing could be restricted or limited by the terms of our debt agreements or due to unfavorable capital market conditions.

The process of integrating the operations of acquired businesses into our existing operations may result in unforeseen difficulties and may require significant financial and managerial resources that would otherwise be available for the ongoing development or expansion of our existing operations. Possible future business acquisitions could result in the incurrence of additional debt and related interest expense and contingent

 

26


Table of Contents

liabilities, each of which could result in an increase to our already significant level of outstanding debt, as well as more restrictive covenants. Furthermore, in certain of our business acquisitions we have assumed all claims against and liabilities of the acquired business, including both asserted and unasserted claims and liabilities.

Our spin-off of Engility could result in substantial tax liability to us and our shareholders.

We received an Internal Revenue Service (IRS) Ruling stating that L-3 and its shareholders would not recognize any taxable income, gain or loss for U.S. federal income tax purposes as a result of the spin-off of Engility in 2012. In addition, we received an opinion of counsel that the spin-off satisfies certain requirements for tax-free treatment that are not covered in the IRS Ruling; however, an opinion of counsel is not binding on the IRS. Accordingly, the IRS or the courts may reach conclusions with respect to the spin-off that are different from the conclusions reached in the opinion of counsel. Moreover, both the IRS Ruling and the opinion of counsel are based on certain factual statements and representations made by us, which, if incomplete or untrue in any material respect, could invalidate the IRS Ruling or opinion of counsel.

If, notwithstanding receipt of the IRS Ruling and opinion of counsel, the spin-off and certain related transactions were determined to be taxable, then we would be subject to a substantial tax liability. In addition, if the spin-off were taxable, each holder of our common stock who received shares of Engility would generally be treated as having received a taxable distribution of property in an amount equal to the fair market value of the shares of Engility received.

Item 1B. Unresolved Staff Comments

None.

 

27


Table of Contents

Item 2. Properties

At December 31, 2015, we operated in 263 locations consisting of manufacturing facilities, administration, research and development and other properties throughout the United States and internationally. Of these, we owned 32 locations consisting of approximately 5.2 million square feet and leased space at 231 locations consisting of approximately 9.5 million square feet. Additionally, our Aerospace Systems segment utilized a facility consisting of approximately 3.3 million square feet through a land lease expiring in 2031 with the city of Greenville, Texas.

A summary of square footage by reportable segment as of December 31, 2015 is presented below.

 

     Leased      Owned      Government-
Owned
     Total  
     (Square feet in millions)  

Electronic Systems

     5.1                3.0                —                 8.1          

Aerospace Systems

     1.3                1.6                3.3                 6.2          

Communication Systems

     2.9                0.6                —                 3.5          
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

               9.3                          5.2                          3.3                           17.8          
  

 

 

    

 

 

    

 

 

    

 

 

 

Our reportable segments have major operations at the following locations:

 

   

Electronic Systems — Phoenix and Tempe, Arizona; Anaheim, San Diego, San Leandro and Sylmar, California; Orlando, Sarasota and St. Petersburg, Florida; Northampton and Wilmington, Massachusetts; Grand Rapids and Muskegon, Michigan; Londonderry, New Hampshire; Mount Olive, New Jersey; Albuquerque, New Mexico; Kirkwood, New York; Cincinnati and Mason, Ohio; Tulsa, Oklahoma; Philadelphia and Pittsburgh, Pennsylvania; Arlington, Garland, Grand Prairie and Plano, Texas; Ontario, Canada; Bologna, Italy; Hamilton, New Zealand; and Crawley and Tewkesbury, U.K.

 

   

Aerospace Systems — Huntsville, Alabama; Crestview, Florida; Madison, Mississippi; Greenville, Rockwall and Waco, Texas; and Quebec, Canada.

 

   

Communication Systems — San Carlos, San Diego, Simi Valley and Torrance, California; Ayer, Massachusetts; Camden, New Jersey; Hauppauge, New York; Williamsport, Pennsylvania; and Salt Lake City, Utah.

Additionally, our Corporate staff occupies a total of 0.2 million square feet of office space in New York, New York and Arlington, Virginia. Management believes all of our properties have been well maintained, are in good condition and are adequate and suitable for our business as presently conducted.

Item 3. Legal Proceedings

The information required with respect to this item can be found in Note 18 to our audited consolidated financial statements and is incorporated by reference into this Item 3.

Item 4. Mine Safety Disclosures

None.

 

28


Table of Contents

PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

The common stock of L-3 Holdings is traded on the New York Stock Exchange (NYSE) under the symbol “LLL.” On February 19, 2016, the number of holders of L-3 Holdings’ common stock was 26,848. On February 19, 2016 the closing price, as reported by the NYSE, was $117.56 per share.

The table below sets forth the amount of dividends paid per share and the high and low closing price of L-3 Holdings’ common stock as reported on the NYSE during the past two calendar years.

 

    Dividends Paid     Closing Price
(High-Low)
 
            2015                     2014             2015     2014  

Common Stock — Dividends Paid and Market Prices

       

First Quarter

   $         0.65          $         0.60           $  132.87 — $  123.06       $  117.70 — $  103.71  

Second Quarter

    0.65           0.60           126.69 —     113.38       126.76 —     113.38  

Third Quarter

    0.65           0.60           124.04 —     103.07       122.85 —     101.39  

Fourth Quarter

    0.65           0.60           128.40 —     101.90       128.34 —     108.11  
 

 

 

   

 

 

     

Year Ended December 31

   $ 2.60          $ 2.40           $  132.87 — $  101.90       $  128.34 — $  101.39  
 

 

 

   

 

 

     

On February 9, 2016, L-3 Holdings announced that its Board of Directors increased L-3 Holdings’ regular quarterly cash dividend by 8% to $0.70 per share, payable on March 15, 2016, to shareholders of record at the close of business on March 1, 2016. L-3 Holdings relies on dividends received from L-3 Communications to generate the funds necessary to pay dividends on L-3 Holdings’ common stock.

Issuer Purchases of Equity Securities

The following table provides information about repurchases of L-3 Holdings’ common stock made in the quarterly period ended December 31, 2015. Repurchases are made from time to time at management’s discretion in accordance with applicable federal securities laws. All share repurchases of L-3 Holdings’ common stock have been recorded as treasury shares.

 

Period

   Total Number
of Shares
Purchased
     Average
Price Paid
per Share
     Total Number of
Shares Purchased as
Part of Publicly
Announced Plans
or Programs
     Maximum Number
(or Approximate
Dollar Value) of
Shares that May
Yet Be Purchased
Under the Plan
or Program(1)
 
              (in millions ) 

September 26 — October 31, 2015

     702,650           $         106.70        702,650           $ 865  

November 1 — 30, 2015

     96,700             123.88        96,700           $ 853  

December 1 — 31, 2015

     397,914             119.54        397,914           $ 806  
  

 

 

       

 

 

    

Total

             1,197,264           $ 112.35                1,197,264          
  

 

 

       

 

 

    

 

  (1) 

The share repurchases described in the table above were made pursuant to the $1.5 billion share repurchase program authorized by L-3 Holdings’ Board of Directors on December 4, 2014, which authorization expires on June 30, 2017.

 

29


Table of Contents

L-3 Holdings repurchased 1,133,885 shares of its common stock at an average price of $114.60 per share for an aggregate amount of approximately $130 million from January 1, 2016 through February 19, 2016.

The graph below compares the cumulative total returns of our common stock with the cumulative total return of the Standard & Poor’s 500 Composite Stock Index and the Standard & Poor’s 1500 Aerospace & Defense Index, for the period from December 31, 2010 to December 31, 2015. These figures assume that all dividends paid over the performance period were reinvested. On July 17, 2012, we completed the Engility spin-off. Our shareholders received one share of Engility common stock for every six shares of our common stock held on the record date (July 16, 2012). The effect of the spin-off is reflected in the cumulative total return as a reinvested dividend for the year ended December 31, 2012. The figures also assume that the starting value of each index and the investment in our common stock was $100 on December 31, 2010.

We are one of the companies included in the Standard & Poor’s 1500 Aerospace & Defense Index and the Standard & Poor’s 500 Composite Stock Index. The starting point for the measurement of our common stock cumulative total return was our closing stock price of $70.49 per share on December 31, 2010. The graph is not, and is not intended to be, indicative of future performance of our common stock.

 

LOGO

 

30


Table of Contents

Item 6. Selected Financial Data

The selected financial data presented below is derived from our audited consolidated financial statements and has been adjusted to reflect the divestiture of NSS and the spin-off of Engility in 2012 and related classification of their assets, liabilities, results of operations and cash flows as discontinued operations.

 

    Year Ended December 31,  
    2015(1)     2014(2)     2013     2012     2011(3)  
    (in millions, except per share data)  

Statement of Operations Data:

         

Net sales

    $     10,466            $     10,986            $     11,420           $     11,802           $     11,636      

Operating income

    $ 475            $ 1,012           $ 1,117           $ 1,219           $ 1,288      

Loss related to business divestitures

    31            —           —           —           —      

Goodwill impairment charges

    384            —           —           —           43      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Segment operating income

    $ 890           $ 1,012           $ 1,117           $ 1,219           $ 1,331      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating margin

    4.5%         9.2%          9.8%         10.3%         11.1%     

Segment operating margin

    8.5%         9.2%          9.8%         10.3%         11.4%     

Interest and other, net

    $ (153)           $ (140)           $ (137)           $ (166)           $ (233)      

Income from continuing operations before income taxes

    $ 322            $ 872           $ 980           $ 1,053           $ 1,055      

Provision for income taxes

    (25)          (227)          (264)          (333)          (252)     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

    297           645            716           720           803      

Income from continuing operations attributable to noncontrolling interests

    (15)         (13)          (9)          (6)          (9)     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations attributable to L-3

    $ 282            $ 632           $ 707           $ 714           $ 794      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share from continuing operations allocable to L-3 Holdings’ common shareholders:

         

Basic

    $ 3.49           $ 7.40           $ 7.91           $ 7.41           $ 7.59      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

    $ 3.44           $ 7.20           $ 7.76           $ 7.32           $ 7.50      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

L-3 Holdings’ weighted average common shares outstanding:

         

Basic

    80.7           85.4           89.4           96.3           104.4      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

    81.9           87.8           91.1           97.6           105.6      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash dividends declared per common share

    $ 2.60           $ 2.40           $ 2.20           $ 2.00           $ 1.80      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

  (1) 

Income from continuing operations for the year ended December 31, 2015 includes: (1) non-cash goodwill impairment charges of $384 million ($264 million after income taxes), or $3.22 per diluted share, including $338 million related to a decline in the estimated fair value of the Logistics Solutions reporting unit, and $46 million related to a business retained by L-3 in connection with the sale of the NSS business, comprised of (i) $37 million related to the re-allocation of impairment charges recorded for the NSS reporting unit during 2015 and (ii) $9 million related to the re-allocation of goodwill, and (2) a pre-tax loss of $31 million ($20 million after income taxes), or $0.25 per diluted share, related to business divestitures.

  (2) 

The year ended December 31, 2014 includes a charge of $18 million ($15 million after income taxes, or $0.17 per diluted share) due to a product specifications matter recorded in the Electronic Systems segment.

  (3) 

The year ended December 31, 2011 includes: (1) a tax benefit of $78 million, or $0.74 per diluted share, related to a net reversal of amounts previously accrued for tax years for which the statutes of limitations have expired, (2) a non-cash goodwill impairment charge of $43 million ($42 million after income taxes, or $0.40 per diluted share), due to a decline in the estimated fair value of our Marine Services business, and (3) $14 million ($8 million after income taxes, or $0.08 per diluted share), related to an impairment charge for long-lived assets at an equity method investment. The goodwill impairment charge, related to our Marine Services business, is included in consolidated operating income, but excluded from segment operating income because the charge was excluded by management for purposes of assessing segment operating performance.

 

 

31


Table of Contents
     Year Ended December 31,  
             2015                     2014                     2013                     2012                     2011          
                 (in millions)              

Balance Sheet Data (at year end):

          

Working capital(1)

   $ 909     $ 1,689     $ 1,853     $ 1,735     $ 2,127  

Total assets

     12,085       13,715       13,868       13,687       15,387  

Long-term debt, including current portion

     3,642       3,939       3,630       3,629       4,125  

Equity

     4,429       5,360       6,056       5,527       6,733  

Cash Flow Data:

          

Net cash from operating activities from continuing operations

   $         1,042     $         1,071     $ 1,156     $         1,064     $         1,057  

Net cash used in investing activities from continuing operations

     (192 )     (221 )     (256     (198 )     (195

Net cash used in financing activities from continuing operations

     (1,178 )     (876 )     (849     (1,527 )     (1,119

 

  (1) 

Based on continuing operations and excludes net assets held for sale.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview and Outlook

L-3’s Business

L-3 is a prime contractor in Intelligence, Surveillance and Reconnaissance (ISR) systems, aircraft sustainment (including modifications, logistics and maintenance), simulation and training, night vision and image intensification equipment and security and detection systems. L-3 is also a leading provider of a broad range of communication and electronic systems and products used on military and commercial platforms. Our 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 international commercial customers.

On December 8, 2015, we entered into a definitive agreement to sell our National Security Solutions (NSS) business to CACI International Inc. The transaction was completed on February 1, 2016. NSS, which provides cybersecurity solutions, high-performance computing, enterprise IT services, analytics and intelligence analysis to the DoD, U.S. Government intelligence agencies, federal civilian agencies and foreign governments, has historically been reported as a reportable segment. In accordance with Accounting Standards Update (ASU) 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, the assets and liabilities and results of operations of NSS are reported as discontinued operations for all periods presented. Accordingly, all references made to financial data in this Annual Report on Form 10-K are to L-3’s continuing operations, unless specifically noted.

We have the following three reportable segments: (1) Electronic Systems, (2) Aerospace Systems and (3) Communication Systems. Financial information for our segments is included in Note 21 to our audited consolidated financial statements. Electronic Systems provides a broad range of components, products, subsystems, systems, and related services for military and commercial customers in several niche markets across several business areas. These business areas include precision engagement & training, sensor systems, power & propulsion systems, aviation products & security systems, warrior systems and advanced programs. Aerospace Systems delivers integrated solutions for the global ISR market and provides modernization, upgrade, sustainment, and maintenance and logistics support for a wide variety of aircraft and ground systems. Communication Systems delivers products and services for the global communications market, specializing in strategic and tactical airborne, space, ground and sea-based communication systems.

 

32


Table of Contents

We generated sales of $10,466 million and $10,986 million for the years ended December 31, 2015 and 2014, respectively, and our primary customer was the DoD. The table below presents a summary of our sales by end customer and the percent contributed by each to our total sales.

 

     2015      2014  
             Sales                      % of        
Total Sales
             Sales              % of
Total Sales
 
     (in millions)             (in millions)         

Air Force

     $ 3,166           30%        $ 3,075           28%    

Army

     1,715           17              1,897           17        

Navy/Marines

     1,447           14              1,524           14        

Other Defense

     645           6              648           6        
  

 

 

    

 

 

    

 

 

    

 

 

 

Total DoD

     $ 6,973           67%        $ 7,144           65%    

Other U.S. Government

     318           3              320           3        
  

 

 

    

 

 

    

 

 

    

 

 

 

Total U.S. Government

     $ 7,291           70%        $ 7,464           68%    

International (foreign governments)

     1,799           17              1,866           17        

Commercial — international

     759           7              1,069           10        

Commercial — domestic

     617           6              587           5        
  

 

 

    

 

 

    

 

 

    

 

 

 

Total sales

     $         10,466                           100%          $         10,986                           100%    
  

 

 

    

 

 

    

 

 

    

 

 

 

Most of our contracts (revenue arrangements) with the U.S. Government are subject to U.S. Defense Contract Audit Agency audits and various cost and pricing regulations, and include standard provisions for termination for the convenience of the U.S. Government. Multiyear U.S. Government contracts and related orders are subject to cancellation if funds for contract performance for any subsequent year become unavailable. Foreign government contracts generally include comparable provisions relating to termination for the convenience of the relevant foreign government.

Business Environment

U.S. Government Markets. Sales to U.S. Government customers represented 70% of our 2015 sales, and were primarily to DoD customers, which comprised 67% of our sales. Therefore, our annual sales are generally highly correlated to changes in U.S. Government spending levels, especially DoD budget levels.

The DoD budget peaked in the fiscal year ended September 30, 2010 (FY 2010) at $690 billion and declined through FY 2015. The total budget for FY 2015 was $560 billion, a decline of 4% as compared to the FY 2014 budget due to a decrease in the Overseas Contingency Operations (OCO) budget. The FY 2015 base budget remained substantially unchanged from FY 2014 at $497 billion while the OCO budget decreased by $22 million. The total DoD budget for FY 2016 is $581 billion, an increase of 4% compared to FY 2015. The increase is due to a higher base budget of $25 billion. The FY 2016 DoD OCO budget declined slightly to $59 billion compared to $63 billion for FY 2015.

On November 2, 2015, the President signed the Bipartisan Budget Act of 2015 (BBA), a bipartisan two-year budget and debt ceiling agreement that provides a level of stability in the U.S. Government budget process over the next two years. The BBA suspends the debt ceiling through March 15, 2017 and raises spending caps previously enacted by Congress under the Budget Control Act of 2011, as amended by The American Taxpayer Relief Act and Bipartisan Budget Act of 2013 (BCA). The spending caps on defense programs were raised by $25 billion to $548 billion for FY 2016 and by $15 billion to $551 billion for FY 2017. The BBA also sets a target for OCO funding for the DoD at $59 billion for each of FY 2016 and FY 2017, subject to the Congressional appropriation process. The BBA, however, does not change the BCA budget sequestration cuts after FY 2017.

 

 

33


Table of Contents

On February 9, 2016, the Administration submitted its FY 2017 DoD Proposed Budget Request (PBR). The total FY 2017 DoD budget request is $583 billion ($524 million base budget, $59 million OCO), which is substantially unchanged compared to the appropriated FY 2016 DoD budget. The FY 2017 PBR complies with the BBA. The table below presents the FY 2011 through FY 2016 enacted budgets and the President’s DoD budget projections for FY 2017 to FY 2021, as provided in the FY 2017 PBR.

 

     DoD Budget      Annual
Total
Budget
Change(1)
 

Fiscal Year (Ending September 30)

   Base      OCO      Total     
     (in billions)  

2011

   $           528       $           159       $           687         0%   

2012

   $ 530       $ 115       $ 645         -6%   

2013

   $ 496       $ 82       $ 578                     -10%   

2014

   $ 496       $ 85       $ 581         +1%   

2015

   $ 497       $ 63       $ 560         -4%   

2016

   $ 522       $ 59       $ 581         +4%   

2017

   $ 524       $ 59       $ 583         0%   

2018

   $ 557         (2)            +6%   

2019

   $ 565         (2)            +1%   

2020

   $ 570         (2)            +1%   

2021

   $ 585         (2)            +3%   

 

Source: United States Department of Defense fiscal year 2017 budget request.

(1) 

The annual budget change for FY 2018 to FY 2021 are calculated on only the base budgets. The base budget cumulative average growth rate over the five year period from FY 2016 to FY 2021 is approximately 2%.

(2) 

The FY 2017 PBR did not include a budget amount for OCO appropriations after FY 2017, which will be addressed by the next President’s administration.

While the BBA provides a level of stability, future DoD budgets and spending levels are determined by a number of factors beyond our control, including changes to U.S. procurement policies, current and future domestic and international budget conditions, presidential administration priorities and changing national security and defense requirements. Furthermore, while members of Congress and the Administration continue to discuss various options to address the U.S. Government’s overall fiscal challenges, we cannot predict the outcome of these efforts. We believe that L-3 will benefit from several of the DoD’s focus areas such as ISR, unmanned systems, undersea warfare, precision strike, secure communications, missile defense and space programs, electronic warfare, aircraft readiness and the ability to project power in denied environments. Uncertainties continue to exist regarding how sequestration cuts, which are scheduled to resume in FY 2018, will be implemented in DoD budgets and how they will affect L-3’s DoD business. For more information on the risks and uncertainties related to our U.S. Government contracts, see “Part I — Item 1A — Risk Factors” in this Annual Report on Form 10-K.

International and Commercial Markets

Sales to end customers other than the U.S. Government represented 30% of our 2015 sales, including 2% of our consolidated sales related to Marine Systems International (MSI), which we divested on May 29, 2015. We expect sales to international and commercial customers to represent 29% of our consolidated 2016 sales. These sales are generally affected by international government security and military priorities, as well as the fiscal situations of our international government end customers, global economic conditions for our commercial end markets and our competitive success in winning new business and increasing market share.

Key Performance Measures

The primary financial performance measures that we use to manage our businesses and monitor results of operations are (i) sales, (ii) operating income, and (iii) net cash from operating activities (“Operating Cash Flow”). Management believes that these financial performance measures are the primary growth drivers for our earnings per share and cash flow per common share. Generally, in evaluating our businesses and contract performance, we focus on net sales, operating income, operating margin, which we define as operating income as a percentage of sales, and Operating Cash Flow, and not the type or amount of operating costs.

 

34


Table of Contents

One of our primary business objectives is to increase sales organically and through select business acquisitions. We define organic sales growth as the increase or decrease in sales for the current period compared to the prior period, excluding sales in the: (1) current period from business acquisitions that are included in our actual results of operations for less than twelve months, and (2) prior period from business divestitures that are included in our actual results of operations for the twelve-month period prior to the divestiture date. We expect to supplement, strengthen and enhance our existing businesses by selectively acquiring businesses that: (1) add important new technologies and products, (2) provide access to select customers, programs and contracts and (3) provide attractive returns on investment. Another important financial performance measure that we use is operating margin, because sales growth combined with operating margin levels determine our operating income levels. Operating Cash Flow is also an important financial performance measure because Operating Cash Flow measures our ability to convert operating income into cash after paying income taxes and interest expenses and investing in working capital.

Sales Trends. For the year ended December 31, 2015, consolidated net sales of $10,466 million declined by 5%, compared to the year ended December 31, 2014, due to a decrease in organic sales of $269 million, or 2.4%, and a decrease of $354 million, or 3.2%, related to business divestitures. These decreases were partially offset by net sales from business acquisitions of $103 million, or 0.9%. Our average annual sales declined for the five years ended December 31, 2015 by 2% as average annual organic sales declined by approximately 3% and average annual sales growth from business acquisitions, net of divestitures, was approximately 1%. See “Results of Operations,” including segment results below for a further discussion of sales.

For the years ended December 31, 2015, 2014 and 2013, our largest contract (revenue arrangement) in terms of annual sales was the Fort Rucker Maintenance Support contract with the U.S. Army Aviation and Missile Life Cycle Management Command (AMCOM), which is included in our Aerospace Systems segment. Under this contract, which generated approximately 4% of our 2015, 2014 and 2013 sales, we provide maintenance, logistics and other related sustainment support services for rotary wing aircraft assigned to Fort Rucker and satellite units in Alabama. Our period of performance, including unexercised annual options, continues through September 30, 2017.

We derived approximately 67% of our 2015 sales from DoD customers and, as a result, our sales are highly correlated to DoD budget levels. DoD budgets are a function of several factors and uncertainties beyond our control, including, but not limited to, changes in U.S. procurement policies, budget considerations, current and future economic conditions, presidential administration priorities, U.S. military engagements, changing national security and defense requirements, geo-political developments, actual fiscal year congressional appropriations for defense budgets, and sequestration and other DoD budget reductions. Any of these factors could result in a significant increase, decrease or redirection of DoD budgets and impact L-3’s future results of operations, including our sales and operating income growth rates. Additionally, L-3’s future results of operations will be affected by our ability to retain our existing business, including our revenue arrangements with DoD customers, and to successfully re-compete for existing business and compete for new business, which largely depends on: (1) our successful performance on existing contracts, (2) the effectiveness and innovation of our technologies and research and development activities, (3) our ability to offer better program performance than our competitors at an affordable cost, and (4) our ability to retain our employees and hire new ones, particularly those employees who have U.S. Government security clearances. We expect our 2016 consolidated sales to decline by approximately 4% compared to 2015, including an organic sales decline of 2.5%. We expect organic international sales to decline by approximately 14% due to the completion of certain contracts with foreign governments, and organic sales to the DoD and U.S. Government to decline by approximately 2% due to the final phase of the U.S. military drawdown from Afghanistan. We expect organic commercial sales to increase by approximately 8% primarily for commercial aviation products. See “Other Events” for information related to the MSI divestiture, which contributed approximately 2% of our consolidated sales in 2015.

Operating Income Trends. For the year ended December 31, 2015, our consolidated operating income was $475 million and our consolidated operating margin was 4.5%. Our consolidated operating income and consolidated operating margin for the year ended December 31, 2015 were reduced by goodwill impairment

 

35


Table of Contents

charges of $384 million and a loss of $31 million related to business divestitures, each of which are further discussed below. The goodwill impairment charges and losses related to business divestitures are excluded from segment operating income, because they are excluded by management for purposes of assessing segment operating performance. Our segment operating income was $890 million for the year ended December 31, 2015, a decrease of 12% from $1,012 million for the year ended December 31, 2014, and our segment operating income as a percentage of sales (segment operating margin) was 8.5% for the year ended December 31, 2015, a decrease of 70 basis points from 9.2% for the year ended December 31, 2014. See “Results of Operations”, including segment results below for a further discussion of operating margin.

Results for the year ended December 31, 2015 were impacted by contract cost growth charges of $101 million at the Platform Integration division in the Aerospace Systems segment on the international head-of-state aircraft modification contracts. The losses on international head-of-state contracts resulted from higher estimated engineering, production and support labor, and material costs. The increased costs are primarily driven by additional delays in aircraft delivery caused by rework identified during the year as a result of internal program reviews, customer inspections, functional check flights and internal design reviews. During the year actions were taken to: (i) provide increased program management resources, (ii) improve engineering practices, (iii) in-source certain work previously expected to be performed by subcontractors to reduce future rework and help us manage to the updated schedule, (iv) improve assembly processes and (v) improve quality assurance processes.

Our effective management of labor, material, subcontractor and other direct costs is an important element of cost control and favorable contract performance. We believe that proactively re-sizing our businesses to their anticipated sales, combined with continuous cost improvement will enable us to increase our cost competitiveness. While we continue to undertake cost management actions, such as reducing our indirect costs, resizing select business units, and improving our productivity and contract performance in an effort to maintain or even increase operating margin, these efforts may not be successful and may be partially or fully offset by other cost increases. Although we expect our 2016 annual consolidated and segment operating margin to increase as compared to 2015, changes in the competitive environment and DoD procurement practices, lower consolidated sales and changes in annual pension expense, including related assumptions such as the benefit obligation discount rates, among other factors, could result in lower operating margin. Furthermore, select business acquisitions and new business, including contract renewals and new contracts, could have lower future operating margins compared to L-3’s operating margins on existing contracts, and could reduce future consolidated and segment operating margins.

Operating Cash Flow Trends. For the year ended December 31, 2015, Operating Cash Flow was $1,042 million, a decline of 3%, compared to the year ended December 31, 2014. The decrease is primarily due to lower operating income, partially offset by less cash used for working capital, primarily trade accounts payable and accrued expenses.

Other Events

Discontinued Operations. On December 8, 2015, we entered into a definitive agreement to sell our NSS business to CACI International Inc. The transaction was completed on February 1, 2016 for a preliminary sale price of $561 million, subject to finalization based on customary adjustments for closing date net working capital.

 

36


Table of Contents

The table below presents statement of operations data for NSS, which has been classified as discontinued operations and includes allocated interest expense for debt not directly attributable or related to L-3’s other operations. Interest expense was allocated in accordance with the accounting standards for discontinued operations and was based on the ratio of NSS’s net assets to the sum of: (1) total L-3 consolidated net assets and (2) L-3 consolidated total debt. See Note 3 to the audited consolidated financial statements for additional information.

 

                 Year Ended December 31,              
     2015     2014     2013  
     (in millions)  

Product and service revenues

   $     1,088     $     1,138     $     1,202     
  

 

 

   

 

 

   

 

 

 

Operating (loss) income from discontinued operations(1)

     (523     73       95     

Interest expense allocated to discontinued operations

     (20     (20     (20)     
  

 

 

   

 

 

   

 

 

 

(Loss) income from discontinued operations before income taxes(1)

   $ (543   $ 53     $ 75     

Income tax benefit (expense)

     21        (21 )     (31)    
  

 

 

   

 

 

   

 

 

 

(Loss) income from discontinued operations, net of income taxes(1)

   $ (522   $ 32     $ 44     
  

 

 

   

 

 

   

 

 

 

 

  (1) 

The year ended December 31, 2015, includes a goodwill impairment charge of $571 million ($537 million after income taxes).

Goodwill Impairment Charges and Loss Related to Business Divestitures. Our 2015 results from continuing operations were impacted by the items discussed below, which decreased consolidated operating income by $415 million, net income from continuing operations attributable to L-3 by $284 million and diluted earnings per share from continuing operations by $3.47:

 

   

Non-cash goodwill impairment charges of $384 million ($264 million after income taxes), or $3.22 per diluted share, including: (i) $338 million related to a decline in the estimated fair value of the Logistics Solutions reporting unit as a result of a decline in its projected future cash flows, and (ii) $46 million related to a business retained by L-3 in connection with the sale of the NSS business, comprised of $37 million related to the re-allocation of impairment charges recorded for the NSS reporting unit during 2015, and $9 million relating to the re-allocation of goodwill; and

 

   

A pre-tax loss of $31 million ($20 million after income taxes) or $0.25 per diluted share, related to business divestitures.

Our 2015 results from discontinued operations were impacted by goodwill impairment charges of $571 million ($537 million after income taxes), or $6.56 per diluted share, relating to the NSS business. During the third quarter of 2015, a decline in the projected future cash flows of NSS indicated that the carrying amount of the goodwill for the NSS business may not be recoverable. Accordingly, we performed an impairment test for the NSS business, determined that the implied goodwill was lower than the carrying amount, and recorded a non-cash impairment charge of $491 million, of which $456 million is included in discontinued operations, for the resulting impairment of goodwill. In connection with L-3’s annual goodwill impairment test, we determined that the implied goodwill of NSS was lower than the carrying amount and recorded an additional non-cash impairment charge of $117 million, of which $115 million is included in discontinued operations, for the impairment of goodwill of the NSS reporting unit.

In summary, we recorded total impairment charges relating to the NSS business aggregating $608 million during the year ended December 31, 2015, including $117 million during the fourth quarter of 2015 and $491 million during the third quarter of 2015. The NSS goodwill impairment charges were allocated between income from continuing operations and income from discontinued operations based on the relative fair values of the NSS business retained by L-3, and the NSS business sold at each goodwill impairment test date. This resulted in $37 million classified in income from continuing operations and the remaining $571 million classified in income from discontinued operations.

 

37


Table of Contents

Debt Repurchases, Issuances and Redemptions. On December 7, 2015, L-3 Communications commenced a cash tender offer for up to $300 million aggregate principal amount of its 3.95% Notes due 2024, 1.50% Notes due 2017 and 3.95% Notes due 2016 with an early tender date of December 18, 2015. On December 18, 2015, L-3 determined and announced the pricing terms of this cash tender offer, including total consideration of $986.57 per $1,000 principal amount of 3.95% Notes due 2024. On December 22, 2015, $300 million of 3.95% Notes due 2024, accepted by L-3 in connection with the early tender date, were settled for $296 million in cash, plus accrued and unpaid interest, up to but not including the repurchase date. In connection with the repurchase of the $300 million of 3.95% Notes due 2024, we recorded a debt retirement charge of approximately $1 million.

On May 28, 2014, L-3 Communications issued $350 million in principal amount of 1.50% Senior Notes that mature on May 28, 2017 (2017 Senior Notes) and $650 million in principal amount of 3.95% Senior Notes that mature on May 28, 2024 (2024 Senior Notes). The 2017 Senior Notes and 2024 Senior Notes (together referred to as the “Senior Notes”) were issued at a bond discount of $1 million and $3 million, respectively. The net cash proceeds of $988 million from this Senior Notes offering were used primarily to fund the retirement of our 3% Convertible Contingent Debt Securities (CODES) as discussed below. The remaining net proceeds were used for general corporate purposes.

On May 13, 2014, L-3 Holdings called for the redemption of all of its outstanding CODES effective on June 2, 2014. The conversion value of CODES of $935 million was calculated in accordance with the indenture governing the CODES. L-3 Holdings settled the entire conversion value with respect to converted CODES in cash. As of June 20, 2014, the CODES have been retired. As a result of the conversion, we recorded a reduction to shareholders’ equity of $161 million, related to the excess conversion value over the fair value of the debt component of the CODES, net of deferred tax liability.

Business Acquisitions and Divestitures

As discussed above, one aspect of our strategy is to selectively acquire businesses that add new products and technologies, or provide access to select customers, programs and contracts. We intend to continue acquiring select businesses for reasonable valuations that will provide attractive returns to L-3. Our business acquisitions, depending on their contract-type, sales mix or other factors, could reduce L-3’s consolidated operating margin while still increasing L-3’s operating income, earnings per share, and net cash from operating activities. In addition, we may also dispose of certain businesses if we determine that they no longer fit into L-3’s overall business strategy and we are able to receive an attractive price.

 

38


Table of Contents

Acquisitions. The table below summarizes the acquisitions that we have completed during the years ended December 31, 2013, 2014, and 2015 referred to herein as business acquisitions. See Note 3 to our audited consolidated financial statements for further information regarding our business acquisitions. During the year ended December 31, 2015, we used net cash of $320 million for business acquisitions.

 

Business Acquisitions

  Date Acquired     Segment      Purchase
Price(1)
 
                 (in millions)  

2013

      

Mustang Technology Group, L.P. (Mustang)

    December 19, 2013       Electronic Systems         $ 54        
      

 

 

 

Total 2013

         $ 54        
      

 

 

 

2014

      

Data Tactics Corporation (L-3 Data Tactics)

    March 4, 2014       Discontinued Operations         $ 57        
      

 

 

 

Total 2014

         $ 57        
      

 

 

 

2015

      

MITEQ, Inc.

    January 21, 2015        Communication Systems         $ 41        

CTC Aviation Group (L-3 CTC)

    May 27, 2015        Electronic Systems         236        

ForceX, Inc. (L-3 ForceX)

    October 13, 2015        Electronic Systems         61        
      

 

 

 

Total 2015

         $     338        
      

 

 

 

 

  (1) 

The purchase price represents the contractual consideration for the acquired business, excluding adjustments for net cash acquired and acquisition transaction costs.

All of our business acquisitions are included in our consolidated results of operations from their dates of acquisition. We regularly evaluate potential business acquisitions. On January 22, 2016, we acquired the assets of Advanced Technical Materials, Inc. (ATM) for a purchase price of $27 million (subject to customary adjustments), which was financed with cash on hand. ATM develops and manufactures a broad product line of passive microwave waveguides and specialized coaxial components.

Business Divestitures. We regularly evaluate potential business divestitures. During the year ended December 31, 2015, we completed the sales of MSI, Broadcast Sports Inc. (BSI), the Tinsley Product Line and Klein Associates, Inc. (Klein). The adjustments we recorded related to the business divestitures are included in the loss related to business divestitures caption on the audited consolidated statements of operations and discussed below. Additionally, these adjustments, the proceeds received and net sales included in continuing operations related to our business divestitures, are summarized in the table below.

 

     Year Ended December 31, 2015  
     Loss Related to
Business Divestiture
     Proceeds
Received
     Net Sales  
     (in millions)  

MSI divestiture

   $ (17)         $          318         $          185     

BSI divestiture

     (4)           26           7     

Tinsley Product Line divestiture

     (8)           4           9     

Klein divestiture

     (2)           10           8     
  

 

 

    

 

 

    

 

 

 

Total

   $                 (31)         $ 358         $ 209     
  

 

 

    

 

 

    

 

 

 

MSI Divestiture. On May 29, 2015, we completed the sale of our MSI business to Wärtsilä Corporation for a preliminary sale price of €295 million (approximately $318 million), in addition to the assumption by Wärtsilä Corporation of approximately €60 million of MSI employee pension-related liabilities. The sale price is subject to finalization based on customary adjustments for closing date net working capital. MSI was a sector within our Electronic Systems segment, primarily selling to the commercial shipbuilding industry. In accordance

 

39


Table of Contents

with ASU 2014-08, MSI’s assets and liabilities are classified as held for sale in our audited consolidated balance sheet at December 31, 2014 and MSI’s results of operations are included in income from continuing operations for all periods presented. See Note 3 to our audited consolidated financial statements for the major assets and liabilities included in held for sale relating to MSI at December 31, 2014. During the year ended December 31, 2015, we recorded a pre-tax loss of $17 million ($6 million after income taxes, or $0.07 per diluted share) related to the divestiture of MSI. The loss is comprised of: (1) $17 million for a non-cash impairment charge, (2) a loss of $4 million on a forward contract to sell Euro proceeds from the MSI divestiture and (3) a realized gain of $4 million upon completion of the sale of MSI, each of which is discussed below.

The accounting standards for long-lived assets to be disposed of by sale require us to measure assets and liabilities of a disposal group, classified as held for sale, at the lower of its carrying amount or fair value less costs to sell, at the end of each reporting period. As a result of the decline in the estimated U.S. dollar equivalent divestiture proceeds due to the weakening of the Euro against the U.S. dollar, the carrying value of the MSI disposal group exceeded its fair value at March 27, 2015. Accordingly, a pre-tax non-cash impairment charge of $17 million ($12 million after income taxes, or $0.15 per diluted share) was recorded during the quarterly period ended March 27, 2015.

In March 2015, we entered into a forward contract to sell €285 million of the proceeds obtained from the divestiture of MSI at a rate of $1.0782. We accounted for this contract as an economic hedge and recorded a mark to market adjustment to earnings based on the fair value of the forward contract at March 27, 2015. Accordingly, we recorded an unrealized pre-tax loss of $5 million ($3 million after income taxes, or $0.03 per diluted share) during the quarterly period ended March 27, 2015. On May 29, 2015, upon settlement of the contract, we realized $4 million of the $5 million previously recorded pre-tax loss and recorded a $1 million pre-tax gain ($1 million after income taxes, or $0.01 per diluted share) in the quarterly period ended June 26, 2015.

During the quarterly period ended June 26, 2015, we realized a pre-tax gain of $4 million ($8 million after income tax benefits, or $0.10 per diluted share), based on the proceeds received on the date of sale.

BSI Divestiture. On April 24, 2015, we divested our BSI business for a sale price of $26 million. BSI is a provider of wireless technology and communications systems services for use in the field of sports television broadcasting, and was included in the Sensor Systems sector of the Electronic Systems segment. The divestiture resulted in a pre-tax loss of $4 million ($6 million after income taxes, or $0.08 per diluted share) during the year ended December 31, 2015. In accordance with ASU 2014-08, BSI’s assets and liabilities as of December 31, 2014, and results of operations for all periods presented are classified as held and used in the audited consolidated financial statements.

Tinsley Product Line Divestiture. On July 27, 2015, we divested our Tinsley Product Line for a sale price of $4 million. Tinsley is a provider of optical components, sub-assemblies and passive sub-systems and was included in the Sensor Systems sector of the Electronic Systems segment. The divestiture resulted in a pre-tax loss of $8 million ($6 million after income taxes, or $0.08 per diluted share) during the 2015 Third Quarter. In accordance with ASU 2014-08, Tinsley’s assets and liabilities as of December 31, 2014, and results of operations for all periods presented are classified as held and used in the audited consolidated financial statements.

Klein Divestiture. On December 31, 2015, we divested our Klein business for a sale price of $10 million. Klein is a provider of side scan sonar equipment and waterside security and surveillance systems, and was included in the Power & Propulsion Systems sector of the Electronic Systems segment. The divestiture resulted in a pre-tax loss of $2 million ($2 million after income taxes, or $0.02 per diluted share) during the quarterly period ended December 31, 2015. In accordance with ASU 2014-08, Klein’s assets and liabilities as of December 31, 2014, and results of operations for all periods presented are classified as held and used in the audited consolidated financial statements.

NSS Divestiture. On December 8, 2015, we entered into a definitive agreement to sell our NSS business to CACI International Inc. See “Other Events – Discontinued Operations” above for further discussion of the divestiture and impact on our audited consolidated financial statements.

 

40


Table of Contents

Critical Accounting Policies

Our significant accounting policies are described in Note 2 to our audited consolidated financial statements. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP) requires us 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 cost of sales during the reporting period. The most significant of these estimates and assumptions relate to contract revenue, profit and loss recognition, fair values of assets acquired and liabilities assumed in business combinations, market values for inventories reported at lower of cost or market, pension and post-retirement benefit obligations, stock-based employee compensation expense, income taxes, including the valuations of deferred tax assets, litigation reserves and environmental obligations, accrued product warranty costs, liabilities for the voluntary return program of various EoTech holographic weapon sights products, and the recoverability, useful lives and valuation of recorded amounts of long-lived assets, identifiable intangible assets and goodwill. Changes in estimates are reflected in the period during which they become known. Actual amounts will differ from these estimates and could differ materially. We believe that our critical accounting estimates have the following attributes: (1) we are required to make assumptions about matters that are uncertain and require judgment at the time of the estimate, (2) use of reasonably different assumptions could have changed our estimates, particularly with respect to estimates of contract revenues and costs, and recoverability of assets, and (3) changes in the estimate could have a material effect on our financial condition or results of operations. We believe the following critical accounting policies contain the more significant judgments and estimates used in the preparation of our financial statements.

Contract Revenue Recognition and Contract Estimates. Approximately 49% of our consolidated net sales are generated from contracts (revenue arrangements) that require us to design, develop, manufacture, modify, upgrade, test and integrate complex aerospace and electronic equipment, and to provide related engineering and technical services according to the buyer’s specifications. These revenue arrangements or contracts are generally fixed-price, cost-plus, or time-and-material type and are covered by accounting standards for construction-type and production-type contracts and federal government contractors. Substantially all of our cost-plus type and time-and-material type contracts are with the U.S. Government, primarily the DoD. Certain of our contracts with the U.S. Government are multi-year contracts that are funded annually by the customer, and sales on these multi-year contracts are based on amounts appropriated (funded) by the U.S. Government. Our remaining sales are accounted for in accordance with accounting standards for revenue arrangements with commercial customers.

Sales and profits on fixed-price type contracts that are covered by accounting standards for construction-type and production-type contracts and federal government contractors are substantially recognized using percentage-of-completion (POC) methods of accounting. Sales on such contracts represent approximately 41% of our consolidated net sales. Sales and profits on fixed-price production contracts under which units are produced and delivered in a continuous or sequential process are recorded as units are delivered based on their contractual selling prices (the “units-of-delivery” method). Sales and profits on each fixed-price production contract under which units are not produced and delivered in a continuous or sequential process, or under which a relatively few number of units are produced, are recorded based on the ratio of actual cumulative costs incurred to total estimated costs at completion of the contract multiplied by the total estimated contract revenue, less cumulative sales recognized in prior periods (the “cost-to-cost” method). Under both POC methods of accounting, a single estimated total profit margin is used to recognize profit for each contract over its entire period of performance, which can exceed one year.

Accounting for the sales on these fixed-price contracts requires the preparation of estimates of: (1) total contract revenue, (2) total costs at completion, which is equal to the sum of the actual incurred costs to date on the contract and the estimated costs to complete the contract’s statement of work, and (3) measurement of progress towards completion. The estimated profit or loss at completion on a contract is equal to the difference between the total estimated contract revenue and the total estimated cost at completion. Under the units-of-delivery method, sales on a fixed-price type contract are recorded as the units are delivered during the period based on their contractual selling prices. Under the cost-to-cost method, sales on a fixed-price type contract are

 

41


Table of Contents

recorded at amounts equal to the ratio of actual cumulative costs incurred divided by total estimated costs at completion, multiplied by (i) the total estimated contract revenue, less (ii) the cumulative sales recognized in prior periods. The profit recorded on a contract in any period using either the units-of-delivery method or cost-to-cost method is equal to (i) the current estimated total profit margin multiplied by the cumulative sales recognized, less (ii) the amount of cumulative profit previously recorded for the contract. In the case of a contract for which the total estimated costs exceed the total estimated revenues, 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 future periods are recorded 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.”

Adjustments to estimates for a contract’s revenue, estimated costs at completion and estimated profit or loss are often required as work progresses under a contract, as experience is gained and more information is obtained, even though the scope of work required under the contract may not change, or if contract modifications occur. The impact of revisions in profit (loss) estimates for all types of contracts subject to percentage-of-completion accounting are recognized on a cumulative catch-up basis in the period in which the revisions are made. Amounts representing contract change orders or claims are included in sales only when they can be reliably estimated and their realization is reasonably assured. The revisions in contract estimates, if significant, can materially affect our results of operations and cash flows, as well as reduce the valuations of receivables and inventories, and, in some cases, result in liabilities to complete contracts in a loss position. Aggregate net changes in contract estimates amounted to increases of $49 million, or 10% of consolidated operating income (6% of segment operating income) for the year ended December 31, 2015, increases of $72 million, or 7% of consolidated operating income for the year ended December 31, 2014, and $106 million, or 9% of consolidated operating income for the year ended December 31, 2013.

Sales and profits on cost-plus type contracts that are covered by accounting standards for government contractors are recognized as allowable costs are incurred on the contract, at an amount equal to the allowable costs plus the estimated profit on those costs. Sales on such contracts represent approximately 8% of our consolidated net sales. The estimated profit on a cost-plus contract is fixed or variable based on the contractual fee arrangement. Incentive and award fees are our primary variable fee contractual arrangement. Incentive and award fees on cost-plus type contracts are included as an element of total estimated contract revenues and recorded to sales when a basis exists for the reasonable prediction of performance in relation to established contractual targets and we are able to make reasonably dependable estimates for them. Sales and profits on time-and-material type contracts are recognized on the basis of direct labor hours expended multiplied by the contractual fixed rate per hour, plus the actual costs of material and other direct non-labor costs. On a time-and-material type contract, the fixed hourly rates include amounts for the cost of direct labor, indirect contract costs and profit. Cost-plus type or time-and-material type contracts generally contain less estimation risks than fixed-price type contracts.

Sales on arrangements for (1) fixed-price type contracts that require us to perform services that are not related to production of tangible assets (Fixed-Price Service Contracts), and (2) certain commercial customers are recognized in accordance with accounting standards for revenue arrangements with commercial customers. Sales for our businesses whose customers are primarily commercial business enterprises are substantially generated from single element revenue arrangements. Sales are recognized when there is persuasive evidence of an arrangement, delivery has occurred or services have been performed, the selling price to the buyer is fixed or determinable and collectability is reasonably assured. Sales for Fixed-Price Service Contracts that do not contain measurable units of work performed are generally recognized on a straight-line basis over the contractual service period, unless evidence suggests that the revenue is earned, or obligations fulfilled, in a different manner. Sales for Fixed-Price Service Contracts that contain measurable units of work performed are generally recognized when the units of work are completed. Sales and profit on cost-plus and time-and-material type contracts within the scope of revenue recognition accounting standards for revenue arrangements with commercial customers are recognized in the same manner as those within the scope of contract accounting standards, except for incentive and award fees. Cost-based incentive fees are recognized when they are realizable in the amount that would be due under the contractual termination provisions as if the contract was terminated. Performance based incentive fees and award fees are recorded as sales when objective evidence exists that the fees have been earned.

 

42


Table of Contents

For contracts with multiple deliverables, we apply the separation and allocation guidance under the accounting standard for revenue arrangements with multiple deliverables, unless all the deliverables are covered by contract accounting standards, in which case we apply the separation and allocation guidance under contract accounting standards. Revenue arrangements with multiple deliverables are evaluated to determine if the deliverables should be separated into more than one unit of accounting. We recognize revenue for each unit of accounting based on the revenue recognition policies discussed above.

Sales and cost of sales in connection with contracts to provide services to the U.S. Government that contain collection risk because the contracts are incrementally funded and subject to the availability of funds appropriated, are deferred until the contract modification is obtained, indicating that adequate funds are available to the contract or task order.

Goodwill and Identifiable Intangible Assets. In accordance with the accounting standards for business combinations, we record 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). Identifiable intangible assets are recognized as assets apart from goodwill if they arise from contractual or other legal rights, or if they are capable of being separated or divided from the acquired business and sold, transferred, licensed, rented or exchanged. However, we do not recognize separate intangible assets for the assembled workforces of our business acquisitions.

Generally, the largest separately identifiable intangible asset from the businesses that we acquire is the value of their assembled workforces, which includes the human capital of the management, administrative, marketing and business development, scientific, engineering and technical employees of the acquired businesses. The success of our businesses, including their ability to retain existing business (revenue arrangements) and to successfully compete for and win new business (revenue arrangements), is primarily dependent on the management, marketing and business development, contracting, engineering and technical skills and knowledge of our employees, rather than on productive capital (plant and equipment, and technology and intellectual property). Additionally, for a significant portion of our businesses, our ability to attract and retain employees who have U.S. Government security clearances, particularly those with top-secret and above clearances, is critical to our success, and is often a prerequisite for retaining existing revenue arrangements and pursuing new ones. Generally, patents, trademarks and licenses are not material for our acquired businesses. Furthermore, our U.S. Government contracts (revenue arrangements) generally permit other companies to use our patents in most domestic work performed by such other companies for the U.S. Government. Therefore, because intangible assets for assembled workforces are part of goodwill, the substantial majority of the intangible assets for our acquired business acquisitions are recognized as goodwill. Additionally, the value assigned to goodwill for our business acquisitions also includes the value that we expect to realize from cost reduction measures that we implement for our acquired businesses. Goodwill equals the amount of the purchase price of the business acquired in excess of the sum of the fair value of identifiable acquired assets, both tangible and intangible, less the fair value of liabilities assumed. At December 31, 2015, we had goodwill of $6,281 million and identifiable intangible assets of $199 million.

The most significant identifiable intangible asset that is separately recognized in accordance with U.S. GAAP for our business acquisitions is customer contractual relationships. All of our customer relationships are established through written customer contracts (revenue arrangements). The fair value for customer contractual relationships is determined, as of the date of acquisition, based on estimates and judgments regarding expectations for the estimated future after-tax earnings and cash flows (including cash flows from working capital) arising from the follow-on sales on contract (revenue arrangement) renewals expected from customer contractual relationships over their estimated lives, including the probability of expected future contract renewals and sales, less a contributory asset charge, all of which is discounted to present value. All identifiable intangible assets are amortized over their estimated useful lives as the economic benefits are consumed. We review customer contractual relationships for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable in accordance with the accounting standards for long-lived assets. If any

 

43


Table of Contents

such event or change in circumstances occurs, and, if our revised estimates of future after-tax cash flows are significantly lower than our estimates at the date we acquired the customer contractual relationships, we may be required to record an impairment charge to write-down these intangible assets to their realizable values. We also review and update our estimates of the duration of our customer contractual relationships, at least annually. If such estimates indicate that the duration of our customer contractual relationships has decreased compared to the estimates made as of the date we acquired these intangible assets, then we accelerate the amortization period for our customer contractual relationships over their remaining useful lives.

We review goodwill for impairment annually as of November 30 and whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. The accounting standards for goodwill allow for the assessment of qualitative factors, such as macroeconomic conditions, industry and market conditions and entity relevant events or circumstances to determine whether it is more likely or not that the fair value of a reporting unit is less than its carrying amount. L-3 did not utilize a qualitative assessment approach for the November 30, 2015 goodwill impairment test, as we chose instead to complete the quantitative two-step testing process for each reporting unit.

A reporting unit is an operating segment, as defined by the segment reporting accounting standards, or a component of an operating segment. A component of an operating segment is a reporting unit if the component constitutes a business for which discrete financial information is available and is reviewed by operating segment management. Two or more components of an operating segment may be aggregated and deemed a single reporting unit for goodwill impairment testing purposes if the components have similar economic characteristics.

L-3 had 10 reporting units at December 31, 2015 (and 11 reporting units at November 30, 2015 when our annual goodwill impairment assessment was completed) compared to 12 reporting units at December 31, 2014. The reduction in the number of our reporting units was due to the divesture of the MSI reporting unit, and the reclassification of the NSS reporting unit into discontinued operations due to the sale of NSS. The Aviation Products and Security & Detection Systems reporting units were consolidated, and the Advanced Programs reporting unit was separated from the Sensor Systems reporting unit. The reporting units that were consolidated had fair values in excess of their carrying values at the time of the realignments and the related goodwill for each was reassigned to the current reporting unit.

L-3’s aggregate balance of goodwill from continuing operations decreased by $231 million to $6,281 million at December 31, 2015 from $6,512 million at December 31, 2014 due to goodwill impairment charges of $384 million, $99 million for foreign currency translation adjustments and $20 million related to business dispositions, partially offset by an increase of $244 million for business acquisitions and $28 million for reclassifications from discontinued operations related to the business retained from the NSS divestiture. L-3’s aggregate balance of goodwill from discontinued operations decreased by $599 million to $390 million at December 31, 2015 from $989 million at December 31, 2014 due to $571 million of goodwill impairment charges and $28 million for reclassifications to continuing operations related to the business retained from the NSS divestiture. The table below presents the number of reporting units and the associated goodwill at December 31, 2015 for each of our reportable segments.

 

Reportable Segment

   Number of
    Reporting Units    
     Aggregate 
Goodwill
 
            (in millions)  

Electronic Systems

                             6          $             3,925               

Aerospace Systems

     2            1,353               

Communication Systems

     2            1,003               
  

 

 

    

 

 

 

Total from continuing operations

     10          $ 6,281               
  

 

 

    

 

 

 

Total from discontinued operations

     1          $ 390               
  

 

 

    

 

 

 

The first step in the process of testing goodwill for potential impairment is to compare the carrying value of the reporting unit to its fair value. If a potential impairment is identified, the second step is to measure the

 

44


Table of Contents

impairment loss by comparing the implied fair value of goodwill with the carrying value of goodwill of the reporting unit. Our methodology for determining the fair value of a reporting unit is estimated using a discounted cash flow (DCF) valuation approach, and is dependent on estimates for future sales, operating income, depreciation and amortization, income tax payments, working capital changes, and capital expenditures, as well as expected long-term growth rates for cash flows. All of these factors are affected by economic conditions related to the industries in which we operate (predominantly the U.S. defense industry), as well as, conditions in the U.S. capital markets.

We recorded aggregate goodwill impairment charges of $955 million in 2015 primarily due to a decline in the estimated fair value of the NSS business and the Logistics Solutions business as a result of the decline in their projected future cash flows. The adjustments we recorded related to goodwill impairment charges are presented in a separate caption on the audited consolidated statements of operations, and are summarized and further discussed below.

 

     Year Ended December 31, 2015  
     Goodwill Impairment Charges  
     Continuing
Operations
     Discontinued
Operations
     L-3
Consolidated
 
            (in millions)         

Logistics Solutions reporting unit impairment

   $ 338       $       $ 338   

NSS reporting unit impairment

     37         571         608   

Re-allocation of goodwill for business retained from NSS

     9                 9   
  

 

 

    

 

 

    

 

 

 

Total

   $ 384       $ 571       $ 955   
  

 

 

    

 

 

    

 

 

 

Based on our annual impairment test as of November 30, 2015, we recorded non-cash impairment charges of $455 million for the impairment of goodwill during the fourth quarter of 2015. The goodwill impairment charges were comprised of: (1) $338 million related to a decline in the estimated fair value of the Logistics Solutions reporting unit, which is part of the Aerospace Systems segment, as a result of a decline in its projected future cash flows and (2) $117 million, of which $115 million is included in discontinued operations, related to a decline in the estimated fair value of the NSS reporting unit based on the purchase price indicated in the definitive agreement entered into on December 8, 2015 to sell the NSS business. The decline in projected future cash flows for Logistics Solutions was caused by projected future year lower sales volumes and operating margins. Logistics Solutions did not achieve its 2015 annual plan for orders due to an inability to win new business, in part due to delays of certain contract competitions, as well as certain contract recompetition losses. Additionally, Logistics Solutions did not achieve its 2015 annual plan for sales and operating income primarily due to reduced flight hours and competitive pricing pressures on logistics and maintenance contracts. We determined, during the preparation of our 2016 financial plan and three year forecast (2016-2018), that these factors will continue to affect the future sales and operating income performance of the Logistics Solutions reporting unit.

In connection with the sale of the NSS business, we recorded a non-cash impairment charge of $9 million during the fourth quarter of 2015 related to the re-allocation of goodwill to a business retained by L-3.

During the third quarter of 2015, a decline in the projected future cash flows of NSS indicated that the carrying amount of the goodwill for the NSS business may not be recoverable. Accordingly, we performed an impairment test for the NSS business, determined that the implied goodwill was lower than the carrying amount, and recorded a non-cash impairment charge of $491 million, of which $456 million is included in discontinued operations, for the impairment of goodwill. The goodwill impairment charge was due to a decline in the estimated fair value of the NSS business as a result of a decline in the projected future cash flows of NSS caused by NSS’s inability to achieve its planned 2015 orders, sales and operating income, primarily due to lower than expected new commercial and international business awards, and a reduced outlook for operating margin and international sales.

 

45


Table of Contents

The more significant assumptions used in our DCF valuations to determine the fair values of our reporting units in connection with the goodwill valuation assessment at November 30, 2015 were: (1) detailed three-year cash flow projections for each of our reporting units, (2) the expected long-term cash flow growth rates for each of our reporting units (commonly known as Terminal Growth Rates), which approximate the expected long-term nominal growth rate for the U.S. DoD budget, the U.S. economy and the respective industries in which the reporting units operate, expected inflation rates, and specific circumstances for each reporting unit, including contracts or programs ending and expected new business, and (3) risk adjusted discount rates, which represent the weighted average cost of capital (WACC) for each reporting unit and include the estimated risk-free rate of return that is used to discount future cash flow projections to their present values. There were no changes to the underlying methods used in 2015 as compared to the prior year DCF valuations of our reporting units.

Each reporting unit WACC was comprised of: (1) an estimated required rate of return on equity, based on publicly traded companies with business and economic risk characteristics comparable to each of L-3’s reporting units (Market Participants), including a risk free rate of return of 2.63% on the 20 year U.S. Treasury Bond as of November 30, 2015 (2.62% as of November 30, 2014) and an equity risk premium of 6% (unchanged compared to November 30, 2014), and (2) an after-tax rate of return on Market Participants’ debt, which was derived from a selected Corporate bond index having a Baa debt rating, consistent with the credit rating of the Market Participants. Each of the estimated required rate of return on equity and the after-tax rate of return on Market Participants’ debt is weighted by the relative market value percentages of the Market Participants’ equity and debt. The WACC assumptions for each reporting unit are based on a number of market inputs that are outside of our control and are updated annually to reflect changes to such market inputs as of the date of our annual goodwill impairment assessments, including changes to: (1) the estimated required rate of return on equity based on historical returns on common stock securities of Market Participants and the Standard & Poor’s 500 Index over the prior five-year period, (2) the risk free rate of return based on the prevailing market yield on the 20 year U.S. Treasury Bond, (3) the rate of return on Corporate bonds having a debt rating consistent with the credit rating of the Market Participants, and (4) the relative market value percentages of Market Participants’ equity and debt.

The table below presents the weighted average risk adjusted discount rate assumptions in WACC, used in our DCF valuation for each of our reportable segments for our goodwill impairment assessments at November 30, 2015 and 2014.

 

     WACC

Reportable Segments

   2015   2014

Electronic Systems(1)

           7.28%               7.01%    

Aerospace Systems(2)

   7.11%       6.83%

Communication Systems(3)

   7.36%       6.90%

 

  (1) 

The weighted average risk adjusted discount rate in WACC for the Electronic Systems reportable segment is comprised of separate discount rates for each reporting unit within the segment that range from 7.00% to 8.12% for 2015 and 6.71% to 8.37% for 2014.

  (2) 

The weighted average risk adjusted discount rate in WACC for the Aerospace Systems reportable segment is comprised of separate discount rates for each reporting unit within the segment that range from 7.00% to 8.41% for 2015 and 6.71% to 7.35% for 2014.

  (3) 

The weighted average risk adjusted discount rate in WACC for the Communication Systems reportable segment is comprised of separate discount rates for each reporting unit within the segment that range from 7.00% to 8.12% for 2015 and 6.71% to 6.93% for 2014.

As presented in the table below, L-3’s historical three-year average annual cash flow growth rates for 2015, 2014 and 2013 for our reportable segments ranged from a negative 18% to a positive 21%. The annual cash flows generated by each of our reporting units vary from year to year, and, therefore, the annual cash flow growth rates do not result in linear trends, due to a number of factors, including, but not limited to: (1) variability of annual sales volume and sales growth rates, (2) increases and decreases in working capital, including customer advance payments and billings on multi-year contracts (revenue arrangements) with long-term performance periods (exceeding one year), (3) the timing of invoicing and cash collections between fiscal years from receivables due from customers on multi-year contracts (revenue arrangements), (4) the timing of increases and decreases of

 

46


Table of Contents

select inventories procured and produced in anticipation of future product sales, which frequently overlap the ending and beginning of fiscal years, (5) the timing of the receipt of award fee and incentive fee payments from customers on contracts (revenue arrangements), (6) variability in annual cash outlays for research and development costs, (7) changes in cash outlays for capital expenditures for property, plant and equipment, and (8) increases in annual sales and costs and expense volumes of a reporting unit resulting from business acquisitions. As a result of the factors discussed above and the varying sizes of our reporting units, the annual cash flow levels and growth rates at the reporting unit level tend to fluctuate significantly from year to year.

The 2015 cash flow amount and the cash flow growth rate for each of the last three years for each of our segments are presented in the following table.

 

Reportable Segment

   Estimated 2015 
    Cash Flow(1)    
   Estimated Average Annual Cash Flow Growth Rate(1)
     (in millions)    2015    2014    2013    3 Yr. Average

Electronic Systems(2)

   $            415                (7)%              10 %            (6)%              (1) %  

Aerospace Systems(3)

   $            196              (24)%            (38)%              8 %            (18) %  

Communication Systems(4)

   $            287                (2)%              75 %            (9)%              21 %  

 

  (1) 

Reportable segment estimated cash flow excludes interest payments on debt and other corporate cash flows.

  (2) 

The decrease in 2015 cash flows for Electronic Systems was primarily related to Warrior Systems which was negatively impacted by costs related to alleged performance issues with EoTech’s holographic weapons sight (HWS) products and working capital reductions for night vision products in 2014 that did not recur in 2015, partially offset by increased cash flow at Aviation Products & Security due to increases in working capital during 2014 that did not recur in 2015. The increase in 2014 cash flows was primarily a result of a lower effective tax rate, as well as lower working capital requirements at Warrior Systems, partially offset by an increase in working capital for MSI. The decrease in 2013 cash flows was due to lower operating income compared to 2012 and liquidation of advance payments for Sensor Systems.

  (3) 

The decrease in 2015 cash flows for Aerospace Systems was due to lower operating income compared to 2014 at Aircraft Systems due to cost growth on international head-of-state aircraft modification contracts and higher working capital requirements at ISR Systems. The decrease in 2014 cash flows for Aerospace Systems was due to lower operating income compared to 2013 at Logistics Solutions and Aircraft Systems, partially offset by a decrease in tax payments as a result of a lower effective tax rate. The increase in 2013 cash flows was due to small ISR aircraft sales to the DoD.

  (4) 

The decrease in 2015 cash flows for Communication Systems was due to an increase in capital expenditures. The increase in 2014 cash flows for Communication Systems was due to lower working capital requirements and capital expenditures, as well as higher operating income and a decrease in tax payments as a result of a lower effective income tax rate. The decrease in 2013 cash flows was due to lower operating income, partially offset by lower capital expenditures.

We consistently consider several factors to determine expected future annual cash flows for our reporting units, including, historical multi-year average cash flow trends by reporting unit and the expected future cash flow growth rates for each of our reporting units primarily based on our estimates of future sales, operating income, and working capital changes. Furthermore, the substantial majority of our reporting units are primarily dependent upon the DoD budget and spending. Sales from DoD customers generate a significant portion of our annual sales and have historically represented approximately 65% or more of our total sales. Accordingly, to determine expected future annual cash flows for our reporting units we also consider: (1) the DoD budget and spending priorities, (2) expansion into new markets, (3) changing conditions in existing markets for our products, systems and services, (4) possible termination of certain government contracts, (5) expected success in new business competitions and re-competitions on existing business, and (6) anticipated operating margins and working capital requirements, which vary significantly depending on the stage of completion (early, mature, ending) of contracts (revenue arrangements). We closely monitor changes in these factors and their impact on the expected cash flow of our reporting units. In addition to these factors that were relevant and specific to each of our reporting units, our goodwill impairment assessments as of November 30, 2015 assumed 2% nominal growth in the base budget beginning with FY 2017, consistent with the base budget cumulative average growth rate during the five year period from FY 2016 to FY 2021, as shown in the DoD budget table presented with our discussion of the business environment on page 34.

Additionally, our actual cash flows may be higher than our projections and the DCF valuation does not reflect actions that we may take to increase the profitability and cash flows of our reporting units, including our two reporting units with fair value cushions of less than 20% in the second table below. Actions we may take

 

47


Table of Contents

include consolidating and streamlining select business operations, creating future synergies with other L-3 businesses, or pursuing incremental targeted growth opportunities. Additionally, the DCF valuations do not assume future business acquisitions or divestitures.

The table below presents the estimated: (1) 2016 cash flow amount, (2) average annual cash flow growth rates for 2016 – 2018, and (3) weighted average annual cash flow growth rates after 2018 for each of our reportable segments.

 

Reportable Segment

   Estimated 2016
Cash Flow(1)
     Estimated Average Annual Cash Flow Growth Rates(1)  
     (in millions)      3 Yr. Average
2016 – 2018
     2019-2020      After 2020 Terminal
Growth Rate
 

Electronic Systems(2)

   $                 313(2)                     (0)%                      2%                            2%  

Aerospace Systems(3)

   $ 163(3)         14 %          2%        2%  

Communications Systems(4)

   $ 139(4)         (16)%          2%        2%  

 

  (1) 

Reportable segment estimated cash flow excludes interest payments on debt and other corporate cash flows.

  (2) 

Electronic Systems projected cash flow is expected to decrease by $102 million from $415 million in 2015 to $313 million in 2016. The decrease is primarily due to an increase in forecasted tax payments as a result of a higher effective tax rate in 2016, higher working capital requirements at Power & Propulsion Systems and Aviation Products & Security, and higher capital expenditures at Precision Engagement & Training. Electronic Systems projected cash flow levels are expected to increase to $411 million by 2018, compared to $313 million in 2016 primarily due to forecasted annual sales growth of approximately 3% in 2017 and 2018, and an improvement in forecasted operating margins of approximately 100 basis points from 2016 to 2018. The improvement in forecasted operating margins from 2016 to 2018 is primarily due to higher expected sales volumes for the segment and a reduced level of new business investments for the Advanced Programs business forecasted in 2018. Additionally, cash flows are expected to improve by 2018 due to increased cash receipts on a large engines production contract for a foreign government.

  (3) 

Aerospace Systems projected cash flow is expected to decrease by $33 million from $196 million in 2015 to $163 million in 2016. The decrease is primarily due to costs in excess of contract value related to performance on the international head-of-state contracts at Aircraft Systems and an increase in forecasted tax payments as a result of a higher effective tax rate, partially offset by higher expected operating income in 2016 at Aircraft Systems and Logistics Solutions. Aerospace Systems projected cash flow levels are expected to increase to $215 million by 2018, compared to $163 million in 2016 primarily due to costs in excess of contract value related to performance on the international head-of-state contracts at Aircraft Systems, which are negatively impacting 2016 cash flows, and not expected to recur in 2018.

  (4) 

Communications Systems projected cash flow is expected to decrease by $148 million from $287 million in 2015 to $139 million in 2016. The decrease is primarily due to a reduction in working capital requirements at Broadband Communication Systems during 2015 that is not expected to recur in 2016, and higher forecasted tax payments as a result of a higher effective tax rate. Communication Systems projected cash flow levels are expected to increase to $142 million by 2018, compared to $139 million in 2016 primarily due to forecasted average annual sales growth of approximately 2.5% during 2017 and 2018, and an improvement in forecasted operating margins of approximately 40 basis points from 2016 to 2018 primarily related to the Space & Power Systems business for higher expected demand of power devices for commercial satellites, partially offset by expected growth in working capital during 2017 and 2018 to support the forecasted increase in sales.

A decline in the estimated fair value of a reporting unit could result in a goodwill impairment, and a related non-cash impairment charge against earnings, if the estimated fair value for the reporting unit is less than the carrying value of the net assets of the reporting unit, including its goodwill. A large decline in estimated fair value of a reporting unit could result in an adverse effect on our financial condition and results of operations.

As discussed above, the more significant assumptions used in our DCF valuations for each of our reporting units were detailed three-year undiscounted cash flow projections, risk adjusted discount rates, or WACC, used to discount the cash flow projections to their present value and expected Terminal Growth Rates. The current year (2016-2018) consolidated three-year undiscounted cash flow projections declined 6% compared to the prior year (2015-2017), with the changes by each reporting unit ranging from a decline of 100% to an increase of 12%. The risk adjusted discount rate, or WACC, increased by an average of 36 basis points compared to the prior year valuations primarily due to a 50 basis point increase in the weighted average after-tax cost of debt. The expected Terminal Growth Rates utilized in the current year valuations were consistent with those utilized in the prior year valuations, including 3% for the Aviation Products & Security reporting unit due to higher expected growth in the commercial aviation market, and 2% for all other reporting units due to a continued improved outlook for DoD budgets and a 2% cumulative average annual growth rate for the DoD base budget during the five year period from FY 2016 to FY 2021.

 

48


Table of Contents

As part of our annual impairment test, we evaluated the sensitivity of the DCF fair value estimates for each reporting unit, which were used for our goodwill impairment assessment, by separately assessing the impact on the estimated fair value of each reporting unit by: (1) increasing the risk adjusted discount rate (WACC) by 50 basis points, or (2) reducing the Terminal Growth Rate by 50 basis points, compared to those used in our estimated fair value calculations, while holding all other assumptions unchanged. All of our reporting units would have had a fair value in excess of their carrying value under both scenarios. In addition, we applied hypothetical decreases to the estimated fair values of each of our reporting units. We determined that a decrease in fair value of at least 20% would be required before any reporting unit, with the exception of two reporting units presented in the table below, would have a carrying value in excess of its fair value. The table below presents the: (1) risk adjusted discount rates, (2) annual cash flow and three-year average growth rate, (3) 2015 cash flow, (4) goodwill balance, and (5) excess fair value percentage and dollar amount, for each of these two reporting units.

 

Reporting Unit

  Risk Adjusted
  Discount Rates  
    Estimated Annual Cash Flow
Growth Rate(1)
    Estimated
2015
Cash Flows(1)
    Goodwill
Balance(2)
    Excess
Fair Value(3)
 
    2015     2014     2013     3-Year
Average    
       

($ in millions)

                 

Warrior Systems(4)

                7.08 %         (88)%           90%           (29)%       (9 )%   $         7        $     604           9%      $ 79  

Power & Propulsion Systems(5)

    7.00 %     7%         20%       54 %       27 %   $ 83        $ 920           18%      $   202  

 

  (1) 

Reporting unit cash flow excludes interest payments on debt and other corporate cash flows.

  (2) 

The goodwill balance is as of November 30, 2015, our goodwill impairment testing date.

  (3) 

The excess fair value represents the percentage and dollar amount by which the fair value of a reporting unit must decline before a potential impairment is identified and would require the second step of the goodwill impairment assessment to be performed.

  (4) 

Our DCF valuation for the Warrior Systems reporting unit assumed higher projected cash flow of approximately 73% in 2016 compared to 2015 due to higher operating income in 2016 as a result of costs incurred in 2015 related to alleged performance issues with HWS products that are not expected to recur in 2016. In addition, our DCF valuation assumed that projected cash flow in 2017 will grow 7% primarily due to increased sales and remain flat in 2018. Projected cash flows are expected to grow 2% annually beginning in 2019.

  (5) 

Our DCF valuation for the Power & Propulsion Systems reporting unit assumed projected cash flow of approximately $30 million in 2016 compared to cash flows of $83 million in 2015 due to expected lower operating income, increased working capital needs and liquidation of advance balances in 2016, as well as an increase in forecasted tax payments as a result of a higher effective income tax rate. In 2017, cash flows are assumed to increase to $63 million primarily due to cash receipts on a large engines production contract for a foreign government. In 2018, cash flows are assumed to increase to $72 million due to increasing sales and operating income, as well as increased cash receipts on a large engines production contract for a foreign government. Projected cash flows are expected to grow 2% annually beginning in 2019.

As discussed previously, in addition to the annual goodwill impairment assessment, we review goodwill for impairment whenever events or changes in circumstances indicate that the carrying amount of a reporting unit’s goodwill may not be recoverable. As such, listed below are certain circumstances, depending on their outcomes, that may require us to review goodwill for impairment for one or more of the two reporting units in the table above prior to the next annual assessment (November 30, 2016):

 

   

lower than expected annual sales from our contracts with the DoD, arising from unanticipated changes or reductions to future DoD budgets;

 

   

the ability of the reporting units, in particular Warrior Systems to achieve 2016 projected sales, operating income and cash flow; and

 

   

the effect of our voluntary return program for various EoTech holographic weapons sight products that commenced in November 2015 on Warrior Systems expected sales, operating income and cash flow.

Pension Plan and Postretirement Benefit Plan Obligations. The obligations for our pension plans and postretirement benefit plans and the related annual costs of employee benefits are calculated based on several long-term assumptions, including discount rates and expected mortality for employee benefit liabilities, and rates of return on plan assets, and expected annual rates for salary increases for employee participants in the case of

 

49


Table of Contents

pension plans, and expected annual increases in the costs of medical and other health care benefits in the case of postretirement benefit obligations. These long-term assumptions are subject to revision based on changes in interest rates, financial market conditions, expected versus actual returns on plan assets, expected participant mortality and other actuarial assumptions, including future rates of salary increases, benefit formulas and levels, and rates of increase in the costs of benefits. Changes in the assumptions, if significant, could materially affect the amount of annual net periodic benefit costs recognized in our results of operations from one year to the next, the liabilities for the pension plans and postretirement benefit plans, and our annual cash requirements to fund these plans. Our pension expense for 2016 is expected to decrease by $43 million to $96 million from $139 million in 2015. Our discount rate assumption increased from a weighted average rate of 4.14% at December 31, 2014 to 4.63% at December 31, 2015. The expected decrease in our 2016 pension expense is primarily due to the increase in the weighted average discount rate and a change in the approach to measure service and interest costs, partially offset by the impact of lower plan assets resulting from lower than expected actual pension asset returns during 2015.

In 2016, we will change the approach utilized to estimate the service and interest cost components of expense for all of our pension and postretirement benefit plans. Historically, we estimated the service and interest cost components using a single weighted average discount rate derived from the yield curve used to measure the benefit obligation at the beginning of the period. We will elect to use a spot rate approach for our plans in the estimation of the components of benefit cost by applying specific spot rates along the yield curve to the relevant projected cash flows, as we believe this provides a more precise estimate of service and interest costs. This is a change in estimate and we will account for it prospectively beginning in 2016. This change does not affect the measurement of our total benefit obligation. The estimated weighted average discount rates used to measure 2016 pension service and interest costs are 4.93% and 3.98%, respectively. The previous method would have used a weighted average discount rate for both pension service and interest costs of 4.63%, which represents the weighted average discount rate used to determine our benefit obligation at December 31, 2015. We expect this change to result in a reduction to pension expense of approximately $25 million compared to the prior approach. We do not expect this change will result in a material impact to postretirement medical expense. See “Part II — Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Pension Plans” for a further discussion of our estimated 2016 pension expense.

Discount rates are used to determine the present value of our pension obligations and also affect the amount of pension expense in any given period. The discount rate assumptions used to determine our pension and postretirement benefit obligations at December 31, 2015 and 2014 were based on a hypothetical AA yield curve represented by a series of annualized individual discount rates. Each bond issue underlying the yield curve is required to have a rating of AA or better by Moody’s Investors Service, Inc. and/or Standard & Poor’s. The resulting discount rate reflects the matching of plan liability cash flows to the yield curve. For a sensitivity analysis projecting the impact of a change in the discount rate on our projected benefit obligation and pension expense, see “Part II — Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Pension Plans.”

Valuation of Deferred Income Tax Assets and Liabilities. At December 31, 2015, we had deferred tax assets of $654 million, deferred tax liabilities of $861 million and a valuation allowance of $9 million. The deferred tax assets included $12 million for loss carryforwards and $6 million for tax credit carryforwards which are subject to various limitations and will expire if unused within their respective carryforward periods. Deferred income taxes are determined separately for each of our tax-paying entities in each tax jurisdiction. The future realization of our deferred income tax assets ultimately depends on our ability to generate sufficient taxable income of the appropriate character (for example, ordinary income or capital gains) within the carryback and carryforward periods available under the tax law and, to a lesser extent, our ability to execute successful tax planning strategies. Based on our estimates of the amounts and timing of future taxable income and tax planning strategies, we believe that we will be able to realize our deferred tax assets, except for capital losses and certain U.S. Federal, foreign and state net operating losses. A change in the ability of our operations to continue to generate future taxable income, or our ability to implement desired tax planning strategies, could affect our

 

50


Table of Contents

ability to realize the future tax deductions underlying our deferred tax assets, and require us to provide a valuation allowance against our deferred tax assets. The recognition of a valuation allowance would result in a reduction to net income and, if significant, could have a material impact on our effective tax rate, results of operations and financial position in any given period.

Liabilities for Pending and Threatened Litigation. We are subject to litigation, government investigations, proceedings, claims or assessments and various contingent liabilities incidental to our business or assumed in connection with certain business acquisitions. In accordance with the accounting standards for contingencies, we accrue a charge for a loss contingency when we believe it is both probable that a liability has been incurred, and the amount of the loss can be reasonably estimated. If the loss is within a range of specified amounts, the most likely amount is accrued, and we accrue the minimum amount in the range if no amount within the range represents a better estimate. Generally, we record the loss contingency at the amount we expect to pay to resolve the contingency and the amount is generally not discounted to the present value. Amounts recoverable under insurance contracts are recorded as assets when recovery is deemed probable. Contingencies that might result in a gain are not recognized until realizable. Changes to the amount of the estimated loss, or resolution of one or more contingencies could have a material impact on our results of operations, financial position and cash flows. See Note 18 to our audited consolidated financial statements for further discussion of our litigation matters.

Valuation of Long-Lived Assets. In addition to goodwill and identifiable intangible assets recognized in connection with our business acquisitions, our long-lived assets also include property, plant and equipment, capitalized software development costs for software to be sold, leased or otherwise marketed, and certain long-term investments. As of December 31, 2015, the consolidated carrying values of our property, plant and equipment were $1,097 million, capitalized software development costs were $61 million and certain long-term investments were $11 million. As of December 31, 2015, the carrying value of our property, plant and equipment represented 9% of total assets and the carrying value of our capitalized software development costs and certain long-term investments each represented less than 1% of total assets. We review the valuation of our long-lived assets whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. An impairment loss is recognized when the carrying amount of a long-lived asset exceeds its fair value or net realizable value expected to result from the asset’s use and eventual disposition. We use a variety of factors to assess valuation, depending upon the asset. Long-lived assets are evaluated based upon the expected period the asset will be utilized, and other factors depending on the asset, including estimated future sales, profits and related cash flows, estimated product acceptance and product life cycles, changes in technology and customer demand, and the performance of invested companies and joint ventures. Changes in estimates and judgments on any of these factors could have a material impact on our results of operations and financial position.

 

51


Table of Contents

Results of Operations

The following information should be read in conjunction with our audited consolidated financial statements. The following information has been adjusted to reflect the divestiture of NSS and related classification of its results of operations and cash flows as discontinued operations. Also, our results of operations for the periods presented are affected by our business acquisitions. See Note 3 to our audited consolidated financial statements for a discussion of our business acquisitions and dispositions.

Consolidated Results of Operations

The table below provides selected financial data, excluding discontinued operations, for the years ended December 31, 2015, 2014 and 2013.

 

      Year Ended
December 31,
     Increase/
    (decrease)    
     Year Ended
December 31,
           Decrease        
(in millions, except per share data)    2015      2014         2014      2013     

Net sales

   $     10,466               $     10,986             (5)%       $     10,986           $     11,420            (4)%   

Operating income

   $ 475               $ 1,012             (53)%       $ 1,012           $ 1,117             (9)%   

Loss related to business divestitures

     31                —            nm            —            —            nm       

Goodwill impairment charges

     384                —            nm            —            —            nm       
    

 

 

    

 

 

       

 

 

    

 

 

      

Segment operating income

   $ 890               $ 1,012             (12)%       $ 1,012           $ 1,117             (9)%   
    

 

 

    

 

 

       

 

 

    

 

 

      

Operating margin

     4.5%              9.2%         (470) bpts        9.2%         9.8%         (60) bpts  

Segment operating margin

     8.5%             9.2%         (70) bpts         9.2%          9.8%          (60) bpts   

Interest expense

   $ 169              $ 158            7%       $ 158          $ 157            —       

Interest and other income, net

   $ 17              $ 18            (6)%      $ 18          $ 20            (10)%   

Debt retirement charge

   $ 1              $ —             nm           $ —          $ —            —       

Effective income tax rate

   $ nm              $ 26.0%         nm          $ 26.0%         26.9%         (90) bpts   

Net income from continuing operations attributable to L-3

   $ 282              $ 632            (55)%      $ 632          $ 707            (11)%   

Adjusted net income from continuing operations attributable to L-3(1)

   $ 566              $ 632            (10)%      $ 632          $ 707            (11)%   

Diluted earnings per share from continuing operations

   $ 3.44              $ 7.20            (52)%      $ 7.20          $ 7.76            (7)%   

Adjusted diluted earnings per share from continuing operations(1)

   $ 6.91              $ 7.20            (4)%      $ 7.20          $ 7.76            (7)%   

Diluted weighted average common shares outstanding

     81.9                87.8            (7)%        87.8            91.1            (4)%   

 

nm – not meaningful

 

  (1)   Non-GAAP metric that excludes the goodwill impairment charge and the aggregate loss related to business divestitures. See the table on page 56 for a reconciliation of this measure.

  

         

2015 Compared with 2014

Net Sales: For the year ended December 31, 2015, consolidated net sales of $10.5 billion decreased $520 million, or 5%, compared to the year ended December 31, 2014. Organic sales for the year ended December 31, 2015 declined $269 million, or 3%. Organic sales exclude $354 million related to business divestitures and $103 million from business acquisitions. Sales to the U.S. Government declined 2%, or $173 million, to $7,291 million in the year ended December 31, 2015 compared to $7,464 million in the year ended December 31, 2014, driven primarily by U.S. defense budget constraints and reductions from sequestration, and by the U.S. military drawdown in Afghanistan. Sales to international and commercial customers declined 10%, or $347 million, to $3,175 million in the year ended December 31, 2015, compared to $3,522 million in the year ended December 31, 2014. Organic sales to international and commercial customers decreased $92 million, or 3%, driven by foreign currency exchange rate changes.

 

52


Table of Contents

Sales from products decreased by $250 million to $6,589 million for the year ended December 31, 2015, compared to $6,839 million for the year ended December 31, 2014. Product sales represented 63% and 62% of consolidated net sales for each of the years ended December 31, 2015 and 2014, respectively. Sales from products declined by: (1) $260 million related to the divestiture of MSI, (2) $113 million for Aircraft Systems due to unfavorable contract performance adjustments on international head-of-state aircraft modification contracts and lower volume to the United States Air Force (USAF) from the DoD’s planned reduction of the Compass Call aircraft and the DoD’s retirement of the Joint Cargo Aircraft (JCA), (3) $79 million related to foreign currency exchange rate changes, (4) $49 million for reduced sales at Warrior Systems driven by lower volume for night vision goggles and the holographic weapons sight voluntary return program at EoTech and (5) $37 million for Space & Power Systems primarily due to lower volume for satellite command and control software for U.S. Government agencies and high frequency radios for a foreign government. These decreases were partially offset by an increase of: (1) $130 million primarily for large ISR aircraft systems for U.S. Government customers and small ISR aircraft systems to the DoD and a foreign government, (2) $100 million primarily due to a higher mix of product sales for Broadband Communication Systems and (3) $58 million primarily for Aviation Products & Security Systems due to deliveries of cockpit avionics products to commercial and DoD customers and airport security systems products to international customers.

Sales from services decreased by $270 million to $3,877 million for the year ended December 31, 2015, compared to $4,147 million for the year ended December 31, 2014. Service sales represented 37% and 38% of consolidated net sales for each of the years ended December 31, 2015 and 2014, respectively. Sales from services declined by: (1) $81 million due to a lower mix of services sales for Broadband Communication Systems, (2) $72 million primarily related to lower sales for small ISR aircraft fleet management services to the DoD due to the U.S. military drawdown in Afghanistan, (3) $72 million related to the MSI and BSI business divestitures, (4) $63 million related to lower volume for field maintenance and sustainment services, primarily for U.S. Army and U.S. Navy aircraft due to the completion of contracts and lower demand and lower prices due to competitive pressures and (5) $29 million related to foreign currency exchange rate changes. These decreases were partially offset by an increase of $47 million primarily due to a higher mix of services sales for Aircraft Systems. See the reportable segment results below for additional discussion of our segment sales trends.

Operating income and operating margin: Consolidated operating income for the year ended December 31, 2015 decreased by $537 million to $475 million, compared to the year ended December 31, 2014. Segment operating income for the year ended December 31, 2015 decreased by $122 million, or 12%, compared to the year ended December 31, 2014. Segment operating margin decreased by 70 basis points to 8.5% for the year ended December 31, 2015 compared to 9.2% for the year ended December 31, 2014. This decrease was driven by higher pension expense of $61 million and unfavorable contract performance adjustments at the Aerospace Systems segment, partially offset by outside accounting and legal advisory expenses incurred in 2014 for the Internal Review completed in October 2014. See the reportable segment results below for additional discussion of sales and operating margin trends.

Interest expense: Interest expense for the year ended December 31, 2015 increased by $11 million compared to the year ended December 31, 2014 due to the issuance of $1 billion in new debt on May 28, 2014, partially offset by the redemption of our 3% Convertible Contingent Debt securities in June 2014.

Interest and other income: Interest and other income, net, for the year ended December 31, 2015 decreased primarily due to lower interest income for a benefit plan trust and lower interest income accretion related to the net investment in sales-type leases of flight simulator systems during the year ended December 31, 2015, partially offset by a loss recorded on the sale of a business within the Warrior Systems sector of the Electronic Systems segment during the year ended December 31, 2014.

Effective income tax rate: The effective income tax rate for the year ended December 31, 2015 is not meaningful due to the goodwill impairment charges taken during 2015. Excluding the goodwill impairment charges and related income tax benefit, the effective income tax rate for 2015 would have decreased to 20.5% from 26.0% in

 

53


Table of Contents

2014. The decrease was primarily due to: (1) $17 million of foreign tax benefits related to a legal restructuring of our foreign entities and (2) an increased benefit from the Federal Research and Experimentation Tax Credit.

Net income from continuing operations attributable to L-3 and diluted earnings per share (EPS) from continuing operations: Net income from continuing operations attributable to L-3 in the year ended December 31, 2015 decreased to $282 million, compared to $632 million in the year ended December 31, 2014. Diluted EPS from continuing operations decreased 52% to $3.44 from $7.20 in the year ended December 31, 2014.

Adjusted net income from continuing operations attributable to L-3 and adjusted diluted EPS from continuing operations: Adjusted net income from continuing operations attributable to L-3 decreased 10% to $566 million compared to the year ended December 31, 2014, and adjusted diluted EPS from continuing operations decreased 4% to $6.91.

Diluted weighted average common shares outstanding: Diluted weighted average common shares outstanding for the year ended December 31, 2015 declined by 7% compared to the year ended December 31, 2014 due to repurchases of L-3 common stock in connection with our share repurchase programs authorized by our Board of Directors, partially offset by additional shares issued in connection with various employee stock-based compensation programs and contributions to employee savings plans made in common stock.

2014 Compared with 2013

Net Sales: For the year ended December 31, 2014, consolidated net sales of $11 billion decreased $434 million, or 4%, compared to the year ended December 31, 2013, as lower sales to the DoD caused by sequestration cuts and the continuing U.S. military drawdown from Afghanistan impacted each segment. Net sales to the U.S. Government, including sales from acquired businesses of $41 million, declined 7%, or $544 million, to $7,464 million in the year ended December 31, 2014, compared to $8,008 million in the year ended December 31, 2013. This decrease was partially offset by an increase in net sales to international and commercial customers of 3%, or $110 million, to $3,522 million in the year ended December 31, 2014, compared to $3,412 million in the year ended December 31, 2013. Net sales to international and commercial customers, as a percentage of consolidated net sales, increased to 32% for the year ended December 31, 2014, as compared to 30% for the year ended December 31, 2013.

Sales from products decreased by $290 million to $6,839 million for the year ended December 31, 2014, compared to $7,129 million for the year ended December 31, 2013. Product sales represented 62% of consolidated net sales for each of the years ended December 31, 2014 and 2013. Sales of products declined: (1) $222 million for Broadband Communication Systems, primarily due to lower U.S. Army demand for remote video terminals driven by the U.S. military drawdown from Afghanistan, and lower volume for airborne and ground-based networked communication systems as contracts near completion and due to declining demand related to DoD budget reductions, (2) $124 million for Aircraft Systems due to reduced deliveries of aircraft cabin assemblies and subassemblies based on contractual delivery schedules, lower volume for the Canadian DND and commercial contracts nearing completion, and lower volume to the USAF from the DoD’s planned reduction in the Compass Call aircraft fleet, partially offset by increased volume for the Australia C-27J aircraft, (3) $55 million for Sensor Systems due to declining demand primarily for airborne EO/IR turrets to the U.S. military related to the drawdown from Afghanistan and the completion of a contract for force protection products for a foreign ministry of defense, (4) $32 million primarily for Tactical Satellite Communications due to lower demand and timing of deliveries of mobile and ground-based satellite communication systems for the U.S. military and (5) $14 million for Precision Engagement & Training primarily due to reduced deliveries of U.S. Army, rotary wing training systems for the Flight School XXI program based on contractual delivery schedules, lower volume for upgrades for F/A-18 flight simulator trainers and completed contracts for guidance products for the U.S. Army. These decreases were partially offset by organic sales growth of: (1) $42 million for Space & Power Systems due to increased deliveries of power devices for commercial satellites, (2) $42 million for Aviation Products & Security Systems due to increased demand for airport security system products from

 

54


Table of Contents

international customers and the Transportation Security Administration (TSA) and (3) $32 million for MSI due to timing of deliveries of shipbuilding products to a foreign navy and commercial customers. The Mustang Technology Group acquisition increased sales by $41 million.

Sales from services decreased by $144 million to $4,147 million for the year ended December 31, 2014, compared to $4,291 million for the year ended December 31, 2013. Service sales represented 38% of consolidated net sales for each of the years ended December 31, 2014 and 2013. Sales from services decreased: (1) $72 million due to lower volume for Aircraft Systems to the USAF from the DoD’s retirement of the JCA, (2) $46 million due to lower sales for small ISR aircraft fleet management services to the DoD due to the U.S. military drawdown in Afghanistan, (3) $19 million due to a lower mix of services sales primarily for Tactical Satellite Communications and (4) $7 million due to lower demand for field maintenance and sustainment services for USAF training aircraft. See the reportable segment results for additional discussion of our segment sales trends.

Operating income and operating margin: Operating income for the year ended December 31, 2014 of $1,012 million decreased $105 million, or 9%, compared to the year ended December 31, 2013. Operating margin decreased by 60 basis points to 9.2% for the year ended December 31, 2014, compared to 9.8% for the year ended December 31, 2013. Operating margin decreased by: (1) 130 basis points due to lower sales and mix changes and unfavorable contract performance adjustments in the Aerospace Systems segment and $25 million of outside accounting and legal advisory costs incurred in connection with the internal review of the Aerospace Systems segment and (2) 20 basis points due to a charge of $18 million in the Electronic Systems segment related to a product specifications matter. These decreases were partially offset by lower pension expense of $94 million ($59 million after income taxes, or $0.67 per diluted share), which increased operating margin by 90 basis points. See the reportable segment results below for additional discussion of segment operating margin trends.

Interest expense: Interest expense for the year ended December 31, 2014 increased by $1 million compared to the year ended December 31, 2013, primarily due to higher amortization of bond discounts and debt issuance costs relating to new debt that was issued during the year ended December 31, 2014.

Interest and other income: Interest and other income, net, for the year ended December 31, 2014 decreased due to a loss recorded on the sale of a business within the Warrior Systems sector of the Electronic Systems segment of $3 million.

Effective income tax rate: The effective tax rate for the year ended December 31, 2014 decreased to 26.0% from 26.9% primarily due to a lower effective tax rate on foreign earnings.

Net income from continuing operations attributable to L-3 and diluted EPS from continuing operations: Net income from continuing operations attributable to L-3 in the year ended December 31, 2014 decreased 11% to $632 million compared to the year ended December 31, 2013, and diluted EPS from continuing operations decreased 7% to $7.20 from $7.76.

Diluted weighted average common shares outstanding: Diluted weighted average common shares outstanding for the year ended December 31, 2014 declined by 4% compared to the year ended December 31, 2013 due to repurchases of L-3 common stock in connection with our share repurchase programs authorized by our Board of Directors, partially offset by additional shares issued in connection with various employee stock-based compensation programs and contributions to employee savings plans made in common stock.

 

55


Table of Contents

The table below presents a reconciliation of net income from continuing operations attributable to L-3 to adjusted net income from continuing operations attributable to L-3 and diluted EPS from continuing operations to adjusted diluted EPS from continuing operations.

 

    Year Ended December 31,  
    2015     2014     2013  
    (in millions, except per share data)  

Net income from continuing operations attributable to L-3

  $             282      $             632      $             707   

Loss on business divestitures

    20                 

Goodwill impairment charges

    264                 
 

 

 

   

 

 

   

 

 

 

Adjusted net income from continuing operations attributable to L-3(1)

  $ 566      $ 632      $ 707   
 

 

 

   

 

 

   

 

 

 

Diluted EPS from continuing operations attributable to L-3 Holdings’ common stockholders

  $ 3.44      $ 7.20      $ 7.76   

EPS impact of loss on business divestitures(A)

    0.25                 

EPS impact of the goodwill impairment charges(B)

    3.22                 
 

 

 

   

 

 

   

 

 

 

Adjusted diluted EPS from continuing operations(1)

  $ 6.91      $ 7.20      $ 7.76   
 

 

 

   

 

 

   

 

 

 

(A)         Loss on business divestitures

  $ (31   $      $   

      Tax benefit

    11                 
 

 

 

   

 

 

   

 

 

 

      After-tax impact

    (20              

      Diluted weighted average common shares outstanding

    81.9                 

      Per share impact(2)

  $ (0.25   $      $   
 

 

 

   

 

 

   

 

 

 

(B)         Goodwill impairment charges

  $ (384   $      $   

      Tax benefit

    120                 
 

 

 

   

 

 

   

 

 

 

      After-tax impact

    (264              

      Diluted weighted average common shares outstanding

    81.9                 

      Per share impact

  $ (3.22   $      $   
 

 

 

   

 

 

   

 

 

 

 

  (1) 

Adjusted diluted EPS is diluted EPS attributable to L-3 Holdings’ common stockholders, excluding the charges or credits relating to business divestitures and non-cash goodwill impairment charges. Adjusted net income attributable to L-3 is net income attributable to L-3, excluding the charges or credits relating to business divestitures and non-cash goodwill impairment charges. These amounts are not calculated in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP). We believe that the charges or credits relating to business divestitures and non-cash goodwill impairment charges affect the comparability of the results of operations for 2015 to the results of operations for 2014. We also believe that disclosing net income and diluted EPS excluding the charges or credits relating to business divestitures and non-cash goodwill impairment charges will allow investors to more easily compare the 2015 results to the 2014 results. However, these measures may not be defined or calculated by other companies in the same manner.

  (2) 

Amounts may not recalculate directly due to rounding.

 

56


Table of Contents

Reportable Segment Results of Operations. The table below presents selected data by reportable segment reconciled to consolidated totals. The results of operations of the NSS business sold to CACI International Inc. are classified as discontinued operations for all periods presented. Accordingly, the NSS business is no longer a reportable segment. See Note 21 to our audited consolidated financial statements for additional reportable segment data.

 

    Year Ended December 31,
    2015   2014      2013  
    (dollars in millions)

Net sales:(1)

      

Electronic Systems

  $         4,269      $         4,645               $         4,639          

Aerospace Systems

    4,156        4,321                 4,551          

Communication Systems

    2,041        2,020                 2,230          
 

 

 

 

 

 

 

    

 

 

 

Consolidated net sales

  $ 10,466      $ 10,986               $ 11,420          
 

 

 

 

 

 

 

    

 

 

 

Operating income:

      

Electronic Systems

  $ 489      $ 533               $ 529          

Aerospace Systems

    205        283                 421          

Communication Systems

    196        196                 167          
 

 

 

 

 

 

 

    

 

 

 

Total segment operating income

    890        1,012                 1,117          

Loss related to business divestitures

    (31     —                 —           

Goodwill impairment charges

    (384     —                 —           
 

 

 

 

 

 

 

    

 

 

 

Consolidated operating income

  $ 475      $ 1,012               $ 1,117          
 

 

 

 

 

 

 

    

 

 

 

Operating margin:

      

Electronic Systems

    11.5  %           11.5%              11.4%       

Aerospace Systems

    4.9  %      6.5%              9.3%       

Communication Systems

    9.6  %      9.7%              7.5%       
 

 

 

 

 

 

 

    

 

 

 

Total segment operating margin

    8.5  %      9.2%              9.8%        

Loss related to business divestitures

    (0.3 )%      —                  —            

Goodwill impairment charges

    (3.7 )%      —                  —            
 

 

 

 

 

 

 

    

 

 

 

Consolidated operating margin

    4.5  %      9.2%               9.8%        
 

 

 

 

 

 

 

    

 

 

 

 

  (1) 

Net sales are after intercompany eliminations.

Electronic Systems

 

         
     Year Ended December 31,     Decrease     Year Ended December 31,     Increase  
     2015     2014       2014     2013    
    

(dollars in millions)

 

Net sales

  $       4,269            $       4,645              (8.1)%         $       4,645          $       4,639                0.1%         

Operating income

    489              533              (8.3)%           533            529            0.8%         

Operating margin

    11.5%           11.5%           —  bpts       11.5%         11.4%         10   bpts  

2015 Compared with 2014

Electronic Systems net sales for the year ended December 31, 2015 decreased by $376 million, or 8%, compared to the year ended December 31, 2014. Excluding $354 million related to the divestitures of MSI, BSI, and the Tinsley Product Line, and $49 million for the CTC and ForceX acquisitions, organic sales declined $71 million, or 2%. The decrease was due to: (1) $85 million related to foreign currency exchange rate changes and (2) $24 million related to reduced sales at Warrior Systems driven by lower volume for night vision goggles and $20 million related to the holographic weapons sight voluntary return program at EoTech, further discussed

 

57


Table of Contents

below. These decreases were partially offset by $58 million, primarily for Aviation Products & Security Systems, due to deliveries of cockpit avionics products to commercial and DoD customers and airport security systems products to international customers.

Electronic Systems operating income for the year ended December 31, 2015 decreased by $44 million, or 8%, compared to the year ended December 31, 2014. Operating margin remained at 11.5% compared to the year ended December 31, 2014. Operating margin increased by: (1) 50 basis points due to acquisitions and divestitures, (2) 40 basis points for favorable contract performance adjustments and (3) 20 basis points due to lower severance expense of $8 million. These increases were offset by decreases of: (1) 80 basis points primarily due to lower volume for Sensor Systems and sales mix changes for Aviation Products & Security and (2) 30 basis points due to higher pension expense of $13 million.

In November 2015, we commenced a voluntary return program and began accepting customer returns for various EoTech holographic weapons sight (HWS) products that may have been affected by certain performance issues. The return program gives eligible owners of such HWS products the option to return their products in exchange for the purchase price, including shipping costs. We recorded a reduction to net sales of $20 million in the Warrior Systems sector of the Electronic Systems segment in the 2015 fourth quarter associated with establishing a product returns reserve to reflect the estimated cost of the return program. Our estimated product returns reserve is based on several factors, including the number of HWS units that we anticipate purchasers will return. Our product returns reserve estimate is based on: (1) our analysis of various factors, including an assumed product return rate consistent with claim rates in other circumstances, (2) our experience to date with the voluntary return program, and among other things, an assumption that only a very small percentage of the total number of HWS products sold by us and eligible for the voluntary return program will be returned, and (3) an assumed average unit purchase price of approximately $500. The voluntary return program is in the early stages of implementation, and we will continue to evaluate the amount of the product returns reserve in connection with the return program. Our evaluation, including as a result of our actual experience with the voluntary return program, may lead us to record an adjustment to the product returns reserve in future periods. Any such adjustment could be material.

2014 Compared with 2013

Electronic Systems net sales for the year ended December 31, 2014 increased by $6 million, or less than 1%, compared to the year ended December 31, 2013. Sales increased: (1) $37 million for Aviation Products & Security Systems due to increased volume for airport security system products from international customers and the TSA, (2) $28 million for MSI due to timing of deliveries of shipbuilding products to a foreign navy and commercial customers, (3) $25 million for Power & Propulsion Systems primarily due to increased volume on certain contracts including an engine production contract to a foreign military and missile targets to the Missile Defense Agency (MDA), partially offset by lower volume on undersea warfare products, and (4) $16 million primarily for Warrior Systems due to increased deliveries of night vision goggles to foreign militaries and the U.S. Army, partially offset by lower demand for holographic weapons sights for the commercial sporting and recreational markets. The Mustang Technology Group business acquisition increased sales by $41 million. These increases were partially offset by sales decreases of: (1) $71 million for Precision Engagement and Training due to reduced deliveries of U.S. Army rotary wing training systems for the Flight School XXI program, lower volume for upgrades for F/A-18 flight simulator trainers and completed contracts for guidance products for the U.S. Army, and (2) $70 million primarily for Sensor Systems primarily due to lower volume for airborne EO/IR turrets to the U.S. military due to the drawdown from Afghanistan, and the completion of a contract for force protection products for a foreign ministry of defense.

Electronic Systems operating income for the year ended December 31, 2014 increased by $4 million, or 1%, compared to the year ended December 31, 2013. Operating margin increased by 10 basis points to 11.5%. Operating margin increased by 70 basis points due to lower pension expense of $31 million and 30 basis points primarily due to improved contract performance, primarily for Power & Propulsion Systems, Precision Engagement and Training and Warrior Systems. These increases were offset by decreases of: (1) 50 basis points primarily due to lower sales for Sensor Systems, and (2) 40 basis points due to a charge of $18 million related to a product specifications matter.

 

58


Table of Contents

Aerospace Systems

 

         
     Year Ended December 31,    
Decrease
    Year Ended December 31,     Decrease  
     2015     2014       2014     2013    
     (dollars in millions)  

Net sales

  $       4,156            $       4,321              (3.8)%         $       4,321            $       4,551              (5.1)%      

Operating income

    205              283              (27.6)%           283              421              (32.8)%      

Operating margin

    4.9%           6.5%           (160) bpts       6.5%           9.3%           (280) bpts  

2015 Compared with 2014

Aerospace Systems net sales for the year ended December 31, 2015 decreased by $165 million, or 4%, compared to the year ended December 31, 2014. Sales decreased $159 million for Aircraft Systems and $63 million for Logistics Solutions. Sales for ISR Systems increased by $57 million. Sales decreased for Aircraft Systems due to lower volume of: (1) $74 million primarily on the USAF Compass Call aircraft and the DoD’s retirement of the JCA, (2) $39 million on international head-of-state aircraft modification contracts primarily due to unfavorable contract performance adjustments, (3) $28 million for modification contracts primarily for the U.S. Navy maritime patrol aircraft and (4) $18 million primarily for aircraft cabin assemblies and subassemblies. The decrease in sales for Logistics Solutions was due to lower volume for field maintenance and sustainment services, primarily for U.S. Army and U.S. Navy aircraft due to the completion of contracts and lower demand and lower prices due to competitive pressures. The increase in ISR Systems was due to an increase in sales of $182 million primarily for large ISR aircraft systems for U.S. Government customers and small ISR aircraft systems to the DoD and a foreign government, partially offset by $125 million of lower sales for small ISR aircraft fleet management services to the DoD due to the U.S. military drawdown in Afghanistan.

Aerospace Systems operating income for the year ended December 31, 2015 decreased by $78 million, or 28%, compared to the year ended December 31, 2014. Operating margin decreased by 160 basis points to 4.9%. Operating margin decreased by: (1) 250 basis points due to contract performance adjustments at Aircraft Systems, which included $101 million of cost growth on international head-of-state aircraft modification contracts, compared to $15 million of cost growth on the same contracts in the year ended December 31, 2014, (2) 100 basis points primarily due to reduced flight hours and lower pricing due to competitive pressures on logistics and maintenance contracts, including the U.S. Navy T-45 contract and (3) 70 basis points due to higher pension expense of $28 million. These decreases were partially offset by: (1) 110 basis points due to favorable contract performance adjustments at ISR Systems, (2) 70 basis points for improved performance on the Army C-12 contract due to better terms on the new contract and $18 million due to a partial recovery of cost overruns recognized in prior periods on the previous contract, (3) 40 basis points due to a $17 million increase in reserves for excess and obsolete inventory at Logistics Solutions recorded during the year ended December 31, 2014 and (4) 40 basis points due to $25 million of outside accounting and legal advisory expenses incurred for the Internal Review completed in October 2014.

2014 Compared with 2013

Aerospace Systems net sales for the year ended December 31, 2014 decreased by $230 million, or 5%, compared to the year ended December 31, 2013. Sales decreased $198 million for Aircraft Systems, $25 million for ISR Systems and $7 million for Logistics Solutions. Aircraft Systems sales decreased: (1) $89 million due to lower volume to the USAF from the DoD’s retirement of the JCA and the DoD’s planned reduction in the Compass Call aircraft fleet, (2) $89 million due to lower volume for aircraft modifications for the U.S. Navy maritime patrol aircraft due to the transition to a new aircraft platform and international head-of-state aircraft, (3) $59 million primarily due to lower volume for the Canadian DND and commercial contracts nearing completion and (4) $48 million due to reduced deliveries of aircraft cabin assemblies and subassemblies. These decreases were partially offset by a sales increase of $55 million for the Australia C-27J aircraft and $32 million

 

59


Table of Contents

primarily due to higher volume for foreign military aircraft modification contracts. ISR Systems sales declined primarily due to lower sales and volume for small ISR aircraft and aircraft systems due to the U.S. military drawdown in Afghanistan. Logistics Solutions sales declined due to decreased volume for field maintenance and sustainment services for USAF training aircraft.

Aerospace Systems operating income for the year ended December 31, 2014 decreased by $138 million, or 33%, compared to the year ended December 31, 2013. Operating margin declined by 280 basis points to 6.5%. Operating margin declined by: (1) 180 basis points primarily due to lower sales and mix changes, (2) 80 basis points due to unfavorable contract performance adjustments on modification contracts for international head-of-state and search and rescue aircraft, (3) 60 basis points due to $25 million of charges for outside accounting and legal advisory costs incurred in connection with the internal review of the Aerospace Systems segment, and (4) 40 basis points primarily due to unfavorable contract performance adjustments on a number of contracts for aircraft cabin assemblies. These decreases were partially offset by 80 basis points due to lower pension expense of $35 million.

Communication Systems

 

         
     Year Ended December 31,     Increase/
(decrease)
    Year Ended December 31,     Increase/
(decrease)
 
     2015     2014       2014     2013    
                 (dollars in millions)                      

Net sales

  $     2,041            $     2,020              1.0%           $     2,020            $     2,230              (9.4)%      

Operating income

    196              196              —                 196              167              17.4%       

Operating margin

    9.6%           9.7%           (10) bpts       9.7%           7.5%           220 bpts   

2015 Compared with 2014

Communication Systems net sales for the year ended December 31, 2015 increased by $21 million, or 1%, compared to the year ended December 31, 2014. Excluding $55 million related to the Miteq acquisition, organic sales declined by $34 million, or 2%. The decrease was due to: (1) $37 million for Space & Power Systems, primarily satellite command and control software for U.S. Government agencies and high frequency radios for a foreign government and (2) $20 million for Advanced Communications products, primarily secure data recorders and communications equipment for the U.S. military as contracts near completion. These decreases were offset by $23 million for Broadband Communication Systems, primarily due to increased volume for development and production of secure networked communication systems for the U.S. military. For Tactical Satellite Communications products, lower sales of mobile and ground based satellite communication systems for the U.S. military were offset by sales on a new contract for the Australian Defence Force.

Communication Systems operating income for the year ended December 31, 2015 remained the same at $196 million compared to the year ended December 31, 2014. Operating margin decreased by 10 basis points to 9.6%. Operating margin decreased by 100 basis points due to higher pension expense of $20 million. Improved contract performance and sales and mix changes, partially offset by lower margins from the Miteq acquisition, increased operating margin by 90 basis points.

2014 Compared with 2013

Communication Systems net sales for the year ended December 31, 2014 decreased by $210 million, or 9%, compared to the year ended December 31, 2013. Sales decreased $194 million for Broadband Communication Systems primarily due to: (1) lower volume for airborne and ground-based networked communication systems as contracts near completion and demand declines due to DoD budget reductions, (2) lower U.S. Army demand for remote video terminals and ISR support services driven by the U.S. military drawdown from Afghanistan, and (3) the completion of a specialty radio frequency (RF) contract for the U.S. Army. Sales also decreased $62 million for Tactical Satellite Communications products primarily due to lower demand and timing of deliveries

 

60


Table of Contents

of mobile and ground-based satellite communication systems for the U.S. military. These decreases were partially offset by an increase of $46 million primarily for Space & Power Systems due to increased deliveries of power devices for commercial satellites.

Communication Systems operating income for the year ended December 31, 2014 increased by $29 million, or 17%, compared to the year ended December 31, 2013. Operating margin increased by 220 basis points to 9.7%. Operating margin increased by: (1) 140 basis points due to lower pension expense of $28 million, (2) 50 basis points due to improved productivity, and (3) 30 basis points primarily due to lower development and production costs for Broadband Communication Systems.

Liquidity and Capital Resources

Anticipated Sources and Uses of Cash Flow

At December 31, 2015, we had total cash and cash equivalents of $207 million. While no amounts of the cash and cash equivalents are considered restricted, $153 million was held by the Company’s foreign subsidiaries. The repatriation of cash held in non-U.S. jurisdictions is subject to local capital requirements, as well as income tax considerations. Our primary source of liquidity is cash flow generated from operations and our cash on hand. We generated $1,042 million of net cash from operating activities from continuing operations during the year ended December 31, 2015. Significant cash uses during the year ended December 31, 2015 included $740 million to repurchase shares of our common stock, $320 million related to business acquisitions, $296 million to repurchase $300 million aggregate principal amount of our 3.95% Notes due 2024, $214 million related to dividends and $197 million related to capital expenditures. Additionally, L-3 received net cash proceeds of $318 million for the MSI, BSI, Tinsley Product Line and Klein divestitures.

As of December 31, 2015, we had the full availability of our $1 billion Amended and Restated Revolving Credit Facility (Credit Facility), which expires on February 3, 2017. We currently believe that our cash from operating activities together with our cash on hand and available borrowings under our Credit Facility will be adequate for the foreseeable future to meet our anticipated requirements for working capital, capital expenditures, defined benefit plan contributions, commitments, contingencies, research and development expenditures, select business acquisitions (depending on the size), program and other discretionary investments, interest payments, income tax payments, L-3 Holdings’ dividends and share repurchases. Additionally, we expect to retire approximately $300 million of aggregate principal amount of debt in 2016, using a portion of the proceeds received from the divestiture of NSS, which was completed on February 1, 2016.

Balance Sheet

Billed receivables decreased by $57 million to $746 million at December 31, 2015 from $803 million at December 31, 2014 primarily due to: (1) the timing of billings and collections for Precision Engagement & Training, (2) $16 million for foreign currency translation adjustments, and (3) $12 million from the MSI, BSI, Tinsley Product Line, and Klein business divestitures. These decreases were partially offset by an increase of $21 million from the L-3 CTC, Miteq, and L-3 ForceX business acquisitions.

Contracts in process decreased by $67 million to $2,081 million at December 31, 2015 from $2,148 million at December 31, 2014. During the year ended December 31, 2015, contracts in process decreased: (1) $25 million for foreign currency translation adjustments, (2) $10 million primarily for the MSI, BSI, Tinsley Product Line and Klein business divestitures, and (3) $32 million comprised of:

 

   

decreases of $8 million in unbilled contract receivables primarily due to shipments for Broadband Communication Systems, partially offset by sales exceeding billings for Precision Engagement & Training and

 

   

decreases of $24 million in inventoried contract costs, comprised of decreases for Sensor Systems and Aircraft Systems, partially offset by increases for Broadband Communication Systems due to the timing of deliveries.

 

61


Table of Contents

L-3’s receivables days sales outstanding (DSO) was 70 at December 31, 2015, compared with 72 at December 31, 2014. We calculate our DSO by dividing: (1) our aggregate end of period billed receivables and net unbilled contract receivables, by (2) our trailing 12 month sales adjusted, on a pro forma basis, to include sales from business acquisitions and exclude sales from business divestitures that we completed as of the end of the period and discontinued operations, multiplied by the number of calendar days in the trailing 12 month period (365 days at December 31, 2015 and 2014). Our trailing 12 month pro forma sales were $10,314 million at December 31, 2015 and $10,460 million at December 31, 2014. The decrease in DSO during 2015 was primarily due to a decrease in net billed and unbilled contract receivables, which is discussed above.

Inventories increased by $45 million to $333 million at December 31, 2015 from $288 million at December 31, 2014, primarily due to $16 million of acquired inventories from the Miteq business acquisition and for Aviation Products & Security Systems and Space & Power Systems to support customer demand.

The decrease in assets and liabilities held for sale was due to the divestiture of MSI on May 29, 2015.

The decrease in assets of discontinued operations was primarily due to $571 million of goodwill impairment charges relating to the NSS business.

The increase in PP&E was primarily due to capital expenditures exceeding depreciation expense during 2015.

Goodwill decreased by $231 million to $6,281 million at December 31, 2015 from $6,512 million at December 31, 2014. The table below presents the changes in goodwill by segment.

 

        Electronic    
Systems
        Aerospace    
Systems
    Communication
Systems
     Consolidated 
Total
 
    (in millions)  

Balance at December 31, 2014

  $     3,773          $     1,730          $     1,009         $     6,512       

Business acquisitions(1)

    233            —            11           244       

Business divestitures(2)

    (20)           —            —           (20)      

Impairment charges(3)

    (26)           (338)           (20)           (384)      

Business retained from NSS divestiture

    26            —            2           28       

Foreign currency translation adjustments(4)

    (61)           (39)           1           (99)      
 

 

 

   

 

 

   

 

 

   

 

 

 

Balance at December 31, 2015

  $     3,925          $     1,353          $     1,003         $     6,281       
 

 

 

   

 

 

   

 

 

   

 

 

 

 

  (1) 

The increase in goodwill for the Electronic Systems segment was due to the L-3 CTC and L-3 ForceX business acquisitions. The increase in goodwill for the Communication Systems segment was due to the Miteq business acquisition.

  (2) 

The decrease in goodwill for the Electronic Systems segment was due to the divestitures of BSI, the Tinsley Product Line and Klein.

  (3) 

See “Other Events” for a discussion of goodwill impairment charges recorded during 2015.

  (4) 

The decrease in goodwill presented in the Electronic Systems segment was primarily due to the strengthening of the U.S. dollar against the Canadian dollar, the British pound and the Euro during 2015. The decrease in goodwill presented in the Aerospace Systems segment was due to the strengthening of the U.S. dollar against the Canadian dollar during 2015.

The increase in identifiable intangible assets was primarily due to $39 million of intangible assets recognized for the L-3 CTC, L-3 ForceX and Miteq business acquisitions, partially offset by amortization expense.

The fluctuations in accounts payable and accrued expenses were primarily due to the timing of when invoices for purchases from third party vendors and subcontractors were received and payments were made, and $11 million of acquired balances from the L-3 CTC, Miteq, and L-3 ForceX business acquisitions.

Accrued employment costs increased primarily due to an increase in accrued salaries and wages due to the timing of payroll dates at the end of 2015 compared to the end of 2014.

 

62


Table of Contents

Pension Plans

L-3 maintains defined benefit pension plans covering approximately 29% of its employees. At December 31, 2015, L-3’s projected benefit obligation (PBO), which includes accumulated benefits plus the incremental benefits attributable to projected future salary increases for covered employees, was $3,448 million and exceeded the fair value of L-3’s pension plan assets of $2,552 million by $896 million. At December 31, 2014, L-3’s PBO was $3,663 million and exceeded the fair value of L-3’s pension plan assets of $2,570 million by $1,093 million. The $197 million decrease in our unfunded status was primarily due to the increase in our weighted average discount rate from 4.14% at December 31, 2014 to 4.63% at December 31, 2015 and the divestiture of MSI on May 29, 2015, which included the assumption by Wärtsilä Corporation of MSI’s pension liabilities.

The expected long-term return on plan assets assumption represents the average rate that we expect to earn over the long-term on the assets of our benefit plans, including those from dividends, interest income and capital appreciation. We utilize a third-party consultant to assist in the development of the expected long-term return on plan assets, which is based on expectations regarding future long-term rates of return for the plans’ investment portfolio, with consideration given to the allocation of investments by asset class and historical and forward looking rates of return for each individual asset class. With respect to the determination of our expected long-term return on plan assets assumption for the year ended December 31, 2015, we considered: (1) a 20 year forward looking return on plan assets as developed by our third-party consultant, which is currently 7.99% for our U.S. plans and 7.25% for our Canadian plans and (2) our historical returns. While we review historical rates of return on our plan assets, the substantial volatility in any one year can result in historical data that is less indicative of future returns. Accordingly, we give greater consideration toward forward looking returns in developing our expected long-term return on plan assets assumption. In reviewing our historical returns, we noted that the average annual return on our U.S. pension plan assets over the period since L-3’s formation in 1997 through 2014, net of investment management fees and administrative costs, determined on an arithmetic basis, was 7.73%. Arithmetic annual averages represent the simple average returns over independent annual periods. In addition, the actual annual returns have exceeded our long-term return on plan assets assumption in 11 of the past 18 years since L-3’s formation. Since we have not had a significant change in investment strategy, and based on the forward looking and historical returns on our plan assets discussed above and an allotment for active management, we believe our existing weighted average long-term return on plan assets assumption of 8.13% is within a reasonable range, and determined that our weighted average long-term return on plan assets assumption in 2015 was 8.14%, which has increased slightly due to the effects of weighting the component assumptions for our U.S. and Canadian plan assets.

We recorded net actuarial gains of $132 million in the year ended December 31, 2015 primarily due to the increase in our weighted average discount rate, partially offset by lower than expected actual pension asset returns during 2015 as noted above, which is reflected in accumulated other comprehensive loss. Actuarial gains and losses in a period represent the difference between actual and actuarially assumed experience, primarily due to discount rates and pension plan asset returns. Actuarial gains and losses that our pension plans experience are not recognized in pension expense in the year incurred, but rather are recorded as a component of accumulated other comprehensive income (loss). The accumulated gains and losses in excess of a corridor, defined as the greater of 10% of the fair value of a plan’s assets and 10% of its projected benefit obligation, are generally amortized to pension expense in future periods over the estimated average remaining service periods of the covered employees. See Note 19 to our audited consolidated financial statements for additional information regarding our pension plans.

Our pension expense for 2015 was $139 million. We currently expect pension expense for 2016 to decrease $43 million to approximately $96 million primarily due to the increase in our weighted average discount rates and a change in the approach to measure service and interest costs, partially offset by the impact of lower plan assets resulting from lower than expected actual pension asset returns during 2015.

 

 

63


Table of Contents

Our pension expense for 2016 may be different from our current expectations when finalized due to a number of factors, including the effect of any future business acquisitions and divestitures for which we assume liabilities for pension benefits, changes in headcount at our businesses that sponsor pension plans, actual pension plan contributions and changes (if any) to our pension assumptions for 2016, including the discount rate, mortality rates, expected long-term return on plan assets and salary increases.

Our cash pension contributions for 2015 were $97 million and we currently expect to contribute approximately $100 million to our pension plans in 2016. Actual 2016 pension contributions could be affected by changes in the funded status of our pension plans during 2016. A substantial portion of our pension plan contributions for L-3’s businesses that are U.S. Government contractors are recoverable as allowable indirect contract costs at amounts generally equal to the annual pension contributions.

Our projected benefit obligation and annual pension expense are significantly affected by, holding all other assumptions constant, certain actuarial assumptions. The following table illustrates the sensitivity of a change in certain assumptions for our pension plans and resulting increase (decrease) to the 2016 expected pension expense and PBO at December 31, 2015.

 

         Effect on 2016 Pension    
Expense
  Effect on
    December 31, 2015    
PBO
     (in millions)

25 basis point decrease in discount rate

     $                 13       $             120  

25 basis point increase in discount rate

       (13 )       (113 )

25 basis point decrease in expected return on assets

       6         N/A  

25 basis point increase in expected return on assets

       (6 )       N/A  

Statement of Cash Flows

The table below provides a summary of our cash flows from (used in) operating, investing, and financing activities for the periods indicated.

 

         Year Ended December 31,      
         2015             2014             2013      
     (in millions)  

Net cash from operating activities from continuing operations

     $      1,042       $      1,071       $      1,156  

Net cash used in investing activities from continuing operations

     (192 )     (221 )     (256 )

Net cash used in financing activities from continuing operations

     (1,178 )     (876 )     (849 )

Operating Activities — Continuing Operations

2015 Compared with 2014. We generated $1,042 million of cash from operating activities during the year ended December 31, 2015, a decrease of $29 million compared with $1,071 million generated during the year ended December 31, 2014. The decrease was due to $348 million of lower income from continuing operations. This decrease was partially offset by increases of: (1) $260 million for higher non-cash expenses related to goodwill impairment charges, net of related tax benefits and (2) $59 million of less cash used for changes in operating assets and liabilities primarily related to trade accounts payable and accrued expenses. The net cash from changes in operating assets and liabilities is further discussed above under “Liquidity and Capital Resources — Balance Sheet.”

2014 Compared with 2013. We generated $1,071 million of cash from operating activities during the year ended December 31, 2014, a decrease of $85 million compared with $1,156 million generated during the year ended December 31, 2013. The decrease was due to $71 million of lower income from continuing operations and

 

64


Table of Contents

$28 million of more cash used for changes in operating assets and liabilities primarily related to trade accounts payable. This decrease was partially offset by an increase of $14 million, primarily for higher non-cash expenses related to deferred income taxes, consistent with lower payments for income taxes in 2014 compared to 2013.

Interest Payments. Our cash from operating activities included interest payments on debt of $182 million for the year ended December 31, 2015, $176 million for the year ended December 31, 2014, and $171 million for the year ended December 31, 2013. Our interest expense also included amortization of deferred debt issuance costs and bond discounts, which are non-cash items.

Investing Activities — Continuing Operations

During 2015, we used $192 million of cash primarily to: (1) acquire three businesses discussed under “Business Acquisitions and Divestitures” for $320 million and (2) pay $197 million for capital expenditures. These cash outflows were partially offset by net proceeds received of $318 million from the MSI, BSI, Tinsley Product Line and Klein divestitures.

During 2014, we used $221 million of cash primarily to: (1) acquire L-3 Data Tactics and (2) pay $174 million for capital expenditures.

During 2013, we used $256 million of cash primarily to: (1) acquire the Mustang business and (2) pay $204 million for capital expenditures. These cash outflows were partially offset by proceeds of $12 million from dispositions of property, plant and equipment.

Financing Activities — Continuing Operations

Debt

At December 31, 2015, total outstanding debt was $3,642 million, all of which was senior debt compared to $3,939 million at December 31, 2014. The decrease is primarily due to the repurchase of $300 million of our 3.95% Notes due 2024 on December 22, 2015. We anticipate retiring an additional $300 million of aggregate principal amount of debt in 2016. At December 31, 2015, there were no borrowings or letters of credit outstanding under our $1 billion Credit Facility. Accordingly, we had the full availability of our $1 billion facility for future borrowings. We also had $425 million of outstanding standby letters of credit with financial institutions covering performance and financial guarantees per contractual requirements with certain customers at December 31, 2015. These standby letters of credit may be drawn upon in the event that we do not perform on certain of our contractual requirements. At December 31, 2015, our outstanding debt matures between November 15, 2016 and May 28, 2024. See Note 9 to our audited consolidated financial statements for the components of our debt at December 31, 2015.

On February 24, 2015, Moody’s changed our rating outlook to negative from stable and affirmed our Baa3 senior unsecured rating. On April 29, 2015, Standard and Poor’s also changed our rating outlook to negative from stable and affirmed our BBB- senior unsecured rating. On December 11, 2015, Fitch affirmed our stable outlook and BBB- senior unsecured rating. We consider our credit rating as an important element of our capital allocation strategy and, while no assurances can be given, we intend to maintain our investment grade credit rating.

 

65


Table of Contents

Debt Issuances

The terms of each of the outstanding Senior Notes issued by L-3 Communications during the year ended December 31, 2014 are presented in the table below. There were no debt issuances during the years ended December 31, 2015 and 2013. See Note 9 to our audited consolidated financial statements for additional information on the redemption provisions of our outstanding Senior Notes.

 

Note

  

  Date of Issuance  

     Amount  
Issued
       Bond  
Discount
     Net
Cash
  Proceeds  
     Effective
Interest
Rate
  Redemption
at Treasury
Rate+
 
          (in millions)             

1.50% Senior Notes due May 28, 2017

   May 28, 2014    $     350      $     1      $     347      1.55%     10 bps   

3.95% Senior Notes due May 28, 2024

   May 28, 2014    $     650      $     3      $     641      4.02%     20 bps   

Debt Repayments

On December 7, 2015, L-3 Communications commenced a cash tender offer for up to $300 million aggregate principal amount of its 3.95% Notes due 2024, 1.50% Notes due 2017 and 3.95% Notes due 2016 with an early tender date of December 18, 2015. On December 18, 2015, L-3 determined and announced the pricing terms of this cash tender offer, including total consideration of $986.57 per $1,000 principal amount of 3.95% Notes due 2024. On December 22, 2015, $300 million of 3.95% Notes due 2024, accepted by L-3 in connection with the early tender date, were settled for $296 million in cash, plus accrued and unpaid interest, up to but not including the repurchase date. In connection with the repurchase of $300 million of the 3.95% Notes due 2024, we recorded a debt retirement charge of approximately $1 million.

On May 13, 2014, L-3 Holdings called for the redemption of all of its outstanding CODES effective on June 2, 2014 (the Redemption Date). The redemption price for the CODES was $1,000 per $1,000 principal amount of the CODES, plus accrued and unpaid interest to, but excluding, the Redemption Date. Holders of the CODES were entitled to convert all or a portion thereof (in integral multiples of $1,000) at any time prior to the close of business on the business day immediately preceding the Redemption Date. The conversion value of CODES of $935 million was calculated in accordance with the indenture governing the CODES. L-3 Holdings settled the entire conversion value with respect to converted CODES in cash. As a result of the conversion, we recorded a reduction to shareholders’ equity of $161 million, related to the excess conversion value over the fair value of the debt component of the CODES, net of deferred tax liability.

Debt Covenants and Other Provisions. The Credit Facility and Senior Notes contain financial and/or other restrictive covenants. See Note 9 to our audited consolidated financial statements for a description of our debt and related financial covenants and cross default provisions. We were in compliance with our financial and other restrictive covenants at December 31, 2015.

Guarantees. The borrowings under the Credit Facility are fully and unconditionally guaranteed by L-3 Holdings and by substantially all of the material 100% owned domestic subsidiaries of L-3 Communications on an unsecured senior basis. The payment of principal and premium, if any, and interest on the Senior Notes is fully and unconditionally guaranteed, on an unsecured senior basis, jointly and severally, by L-3 Communications’ material 100% owned domestic subsidiaries that guarantee any of its other indebtedness. The guarantees of the Credit Facility and the Senior Notes rank pari passu with each other.

 

66


Table of Contents

Equity

During 2015 and 2014, L-3 Holdings’ Board of Directors authorized the following quarterly cash dividends:

 

Date Declared

   Record Date    Cash
Dividend
Per Share
     Total Cash
Dividends
Declared
  Date Paid
                 (in millions)    

2015

          

February 10

   March 2    $     0.65      $    55(1)   March 16

May 5

   May 18    $     0.65      $    54(1)   June 15

June 10

   August 17    $     0.65      $    53(1)   September 15

October 20

   November 16    $     0.65      $    51(1)   December 15

2014

          

February 11

   March 3    $     0.60      $    53(2)   March 17

May 6

   May 19    $     0.60      $    53(2)   June 16

June 24

   August 18    $     0.60      $    52(2)   September 15

October 20

   November 17    $     0.60      $    51(2)   December 15

 

  (1) 

During the year ended December 31, 2015, we paid $214 million of cash dividends, including a $1 million net reduction of accrued dividends for employee held stock rewards.

  (2) 

During the year ended December 31, 2014, we paid $208 million of cash dividends, including a $1 million net increase of accrued dividends for employee held stock awards.

L-3 Holdings repurchased $740 million, or 6.4 million shares, of its common stock during the year ended December 31, 2015 compared to $823 million, or 6.9 million shares, of its common stock during the year ended December 31, 2014.

L-3 Holdings announced, on February 9, 2016, that its Board of Directors had increased L-3 Holdings’ regular quarterly cash dividend by 8% to $0.70 per share, payable on March 15, 2016, to shareholders of record at the close of business on March 1, 2016.

The number of holders of L-3 Holdings’ common stock, on February 19, 2016, was 26,848. On February 19, 2016, the closing price of L-3 Holdings’ common stock, as reported by the NYSE, was $117.56 per share.

Contractual Obligations

The table below presents our estimated total contractual obligations from our continuing operations at December 31, 2015, including the amounts expected to be paid or settled for each of the periods indicated below.

 

            Payments due by Period  
     Total      Less than
1 year
    1 – 3 years      3 – 5 years     More than
5 years
 
            (in millions)        

Contractual Obligations

            

Debt, including current portion(1)

   $     3,650        $       500         $ 350          $     1,800      $     1,000  

Interest payments(2)

     720        161       275            220        64  

Non-cancelable operating leases(3)

     527        80       149            137 (4)      161  

Notes payable and capital lease obligations

     10                2             1        7   

Purchase obligations(5)

     1,874        1,640       202            9        23  

Other long-term liabilities(6)

     246        114 (7)      85            12        35  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total(8)

   $     7,027      $     2,495          $    1,063           $     2,179      $     1,290  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

 

  (1) 

Represents principal amount of debt and only includes scheduled principal payments.

 

67


Table of Contents
  (2) 

Represents expected interest payments on L-3’s debt balance as of December 31, 2015 using the stated interest rate on our fixed rate debt, assuming that current borrowings remain outstanding to the contractual maturity date.

  (3) 

Non-cancelable operating leases are presented net of estimated sublease rental income.

  (4) 

Includes the residual value guarantee for three real estate lease agreements, expiring on August 31, 2020, that are accounted for as operating leases. We have the right to exercise options under the lease agreements to renew the leases, to purchase the properties for $45 million or sell the properties on behalf of the lessor. If we elect to sell the properties, we must pay the lessor a residual value guarantee of $39 million. See Note 18 to our audited consolidated financial statements for a further description of these leases.

  (5) 

Represents open purchase orders at December 31, 2015 for amounts expected to be paid for goods or services that are legally binding.

  (6) 

Other long-term liabilities primarily consist of workers compensation and deferred compensation for the years ending December 31, 2017 and thereafter and also include pension and postretirement benefit plan contributions that we expect to pay in 2016.

  (7) 

Our pension and postretirement benefit plan funding policy is generally to contribute in accordance with cost accounting standards that affect government contractors, subject to the Internal Revenue Code and regulations thereon. For 2016, we expect to contribute approximately $100 million to our pension plans and approximately $10 million to our postretirement benefit plans. Due to the current uncertainty of the amounts used to compute our expected pension and postretirement benefit plan funding, we believe it is not practicable to reasonably estimate such future funding for periods in excess of one year and we may decide or be required to contribute more than we expect to our pension and postretirement benefit plans.

  (8) 

Excludes all income tax obligations, a portion of which represents unrecognized tax benefits in connection with uncertain tax positions taken, or expected to be taken on our income tax returns as of December 31, 2015 since we cannot determine the time period of future tax consequences. For additional information regarding income taxes, see Note 16 to our audited consolidated financial statements.

We also may enter into industrial cooperation agreements, sometimes referred to as offset agreements, as a condition to obtaining orders for our products and services from certain customers in foreign countries. These agreements are designed to enhance the social and economic environment of the foreign country by requiring the contractor to promote investment in the country. Offset agreements may be satisfied through activities that do not require us to use cash, including transferring technology, providing manufacturing and other consulting support to in-country projects and the purchase by third parties of supplies from in-country vendors. These agreements also may be satisfied through our use of cash for such activities as purchasing supplies from in-country vendors, providing financial support for in-country projects, establishment of ventures with local companies and building or leasing facilities for in-country operations. We typically do not commit to offset agreements until orders for our products or services are definitive. The amounts ultimately applied against our offset agreements are based on negotiations with the customer and typically require cash outlays that represent only a fraction of the original amount in the offset agreement. The costs to satisfy our offset obligations are included in the estimates of our total costs to complete the contract and may impact our profitability and cash flows. The ability to recover investments that we make are generally dependent upon the successful operation of ventures that we do not control and may involve products and services that are dissimilar to our business activities. At December 31, 2015, the remaining obligations under our outstanding offset agreements totaled $1.5 billion, which primarily relate to our Aerospace Systems and Electronic Systems segments, some of which extend through 2028. To the extent we have entered into purchase obligations at December 31, 2015 that also satisfy offset agreements, those amounts are included in the preceding table. Offset programs usually extend over several years and may provide for penalties, estimated at approximately $104 million at December 31, 2015, in the event we fail to perform in accordance with offset requirements. While historically we have not been required to pay material penalties, resolution of offset requirements are often the result of negotiations and subjective judgments.

 

68


Table of Contents

Off Balance Sheet Arrangements

The table below presents our estimated total contingent commitments and other guarantees at December 31, 2015, including the amounts expected to be paid or settled for each of the periods indicated below.

 

        Total         Commitment Expiration by Period  
          2016             2017-2018             2019-2020         2021 and
    thereafter    
 
    (in millions)  

Contingent Commitments

         

Other standby letters of credit(1)

      $     425             $     289             $     93             $     42               $    1      

Other guarantees(2)

    7           —           7           —            —      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total(3)

      $     432             $     289             $     100             $     42                $    1      
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

  (1) 

Represents outstanding letters of credit with financial institutions covering performance and financial guarantees per contractual requirements with certain customers. These letters of credit may be drawn upon in the event of L-3’s nonperformance.

  (2) 

Represents the minimum guarantees made by L-3 or the lessee under the purchase option for certain operating leases in which the lease renewal is not exercised (see Note 18 to our audited consolidated financial statements for a description of these guarantees).

  (3) 

The total amount does not include residual value guarantees for two real estate lease agreements, expiring on August 31, 2020, that are accounted for as operating leases. We have the right to exercise options under the lease agreements to purchase both properties for $45 million on or before August 31, 2020. See Note 18 to our audited consolidated financial statements for a further description of these leases.

Legal Proceedings and Contingencies

We are engaged in providing products and services under contracts with the U.S. Government and, to a lesser degree, under foreign government contracts, some of which are funded by the U.S. Government. All such contracts are subject to extensive legal and regulatory requirements, and, periodically, agencies of the U.S. Government investigate whether such contracts were and are being conducted in accordance with these requirements. Under U.S. Government procurement regulations, an indictment by a federal grand jury, or an administrative finding against us as to our present responsibility to be a U.S. Government contractor or subcontractor, could result in the suspension for a period of time from eligibility for awards of new government contracts or task orders or in a loss of export privileges, and could have a material adverse effect on our results of operations and cash flows. A conviction, or an administrative finding that satisfies the requisite level of seriousness, could result in debarment from contracting with the federal government for a specified term and could have a material adverse effect on our results of operations and cash flows. We are currently cooperating with the U.S. Government on several investigations, none of which we anticipate will have a material adverse effect on our results of operations or cash flows. Also, we have been periodically subject to litigation, government investigations, proceedings, claims or assessments and various contingent liabilities incidental to our business. We accrue for these contingencies when it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. For a description of our legal proceedings and contingencies, see Note 18 to our audited consolidated financial statements.

We continually assess our obligations with respect to applicable environmental protection laws. While it is difficult to determine the timing and ultimate cost that we will incur to comply with these laws, based upon available internal and external assessments, with respect to those environmental loss contingencies of which we are aware, we believe that even without considering potential insurance recoveries, if any, there are no environmental loss contingencies that, in the aggregate, would be material to our consolidated financial position, results of operations or cash flows.

Derivative Financial Instruments and Other Market Risk

Included in our derivative financial instruments are foreign currency forward contracts. All of our derivative financial instruments that are sensitive to market risk are entered into for purposes other than trading.

 

69


Table of Contents

Interest Rate Risk. Our Credit Facility is subject to variable interest and is therefore sensitive to changes in interest rates. The interest rates on the Senior Notes are fixed-rate and are not affected by changes in interest rates. Additional data on our debt obligations and our applicable borrowing spreads included in the interest rates we would pay on borrowings under the Credit Facility, if any, are provided in Note 9 to our audited consolidated financial statements.

Foreign Currency Exchange Risk. Our U.S. and foreign businesses enter into contracts with customers, subcontractors or vendors that are denominated in currencies other than their functional currencies. To protect the functional currency equivalent cash flows associated with certain of these contracts, we enter into foreign currency forward contracts, which are generally designated and accounted for as cash flow hedges. At December 31, 2015, our foreign currency forward contracts had maturities ranging through 2020, a notional value of $265 million and a corresponding net fair value that was a liability of $14 million.

Accounting Standards Issued and Not Yet Implemented

For a discussion of accounting standards issued and not yet implemented, see Note 2 to our audited consolidated financial statements.

Inflation

The effect of inflation on our sales and earnings has not been significant. Although a majority of our sales are made under long-term contracts (revenue arrangements), the selling prices of such contracts, established for deliveries in the future, generally reflect estimated costs to be incurred in these future periods. In addition, some of our contracts provide for price adjustments through cost escalation clauses.

Forward-Looking Statements

Certain of the matters discussed concerning our operations, cash flows, financial position, economic performance and financial condition, including in particular, the likelihood of our success in developing and expanding our business and the realization of sales from backlog, include forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act.

All statements other than historical facts may be forward-looking statements, such as “may,” “will,” “should,” “likely,” “projects,” “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” and similar expressions are used to identify forward-looking statements. We caution investors that these statements are subject to risks and uncertainties many of which are difficult to predict and generally beyond our control that could cause actual results to differ materially from those expressed in, or implied or projected by, the forward-looking information and statements. Some of the factors that could cause actual results to differ include, but are not limited to, the following: our dependence on the defense industry; backlog processing and program slips resulting from delayed awards and/or funding from the DoD and other major customers; the U.S. Government fiscal situation; changes in DoD budget levels and spending priorities; U.S. Government failure to raise the debt ceiling; our reliance on contracts with a limited number of customers and the possibility of termination of government contracts by unilateral government action or for failure to perform; the extensive legal and regulatory requirements surrounding many of our contracts; our ability to retain our existing business and related contracts; our ability to successfully compete for and win new business; or, identify, acquire and integrate additional businesses; our ability to maintain and improve our operating margin; the availability of government funding and changes in customer requirements for our products and services; our significant amount of debt and the restrictions contained in our debt agreements and actions taken by rating agencies that could result in a downgrade of our debt; our ability to continue to recruit, retain and train our employees; actual future interest rates, volatility and other assumptions used in the determination of pension benefits and equity based compensation, as well as the market performance of benefit plan assets; our collective bargaining agreements, our ability to successfully negotiate contracts with labor unions and our ability to favorably resolve labor disputes

 

70


Table of Contents

should they arise; the business, economic and political conditions in the markets in which we operate; global economic uncertainty; the DoD’s Better Buying Power and other efficiency initiatives; events beyond our control such as acts of terrorism; our ability to perform contracts on schedule; our international operations including currency risks and compliance with foreign laws; our extensive use of fixed-price type revenue arrangements; the rapid change of technology and high level of competition in which our businesses participate; risks relating to technology and data security; our introduction of new products into commercial markets or our investments in civil and commercial products or companies; the outcome of litigation matters; results of audits by U.S. Government agencies and of ongoing governmental investigations, including the Aerospace Systems segment; our ability to predict the level of participation in, and the related costs of, our voluntary return program for certain EoTech holographic weapons sight products, and our ability to change and terminate the voluntary return program at our discretion; the impact on our business of improper conduct by our employees, agents or business partners; goodwill impairments and the fair values of our assets; and the ultimate resolution of contingent matters, claims and investigations relating to acquired businesses, and the impact on the final purchase price allocations.

In addition, for a discussion of other risks and uncertainties that could impair our results of operations or financial condition, see “Part I — Item 1A — Risk Factors” and Note 18 to our audited consolidated financial statements, in each case included in this Annual Report on Form 10-K for the year ended December 31, 2015 and any material updates to these factors contained in any of our future filings.

Readers of this document are cautioned that our forward-looking statements are not guarantees of future performance and the actual results or developments may differ materially from the expectations expressed in the forward-looking statements.

As for the forward-looking statements that relate to future financial results and other projections, actual results will be different due to the inherent uncertainties of estimates, forecasts and projections and may be better or worse than projected and such differences could be material. Given these uncertainties, you should not place any reliance on these forward-looking statements. These forward-looking statements also represent our estimates and assumptions only as of the date that they were made. We expressly disclaim a duty to provide updates to these forward-looking statements, and the estimates and assumptions associated with them, after the date of this filing, to reflect events or changes in circumstances or changes in expectations or the occurrence of anticipated events.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

For data regarding quantitative and qualitative disclosures related to our market risk sensitive financial instruments, see “Part II — Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources — Derivative Financial Instruments and Other Market Risk” and Note 13 to our audited consolidated financial statements. See Notes 12 and 14 to our audited consolidated financial statements for the aggregate fair values and notional amounts of our foreign currency forward contracts at December 31, 2015.

Item 8. Financial Statements and Supplementary Data

See our audited consolidated financial statements beginning on page F-1.

Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

None.

 

71


Table of Contents

Item 9A. Controls and Procedures

Conclusions Regarding Effectiveness of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to provide reasonable assurance that information required to be disclosed in our reports that we file or submit under the Securities Exchange Act of 1934 related to L-3 Holdings and L-3 Communications is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms, and that such information is accumulated and communicated to our management, including our Chairman and Chief Executive Officer and our Senior Vice President and Chief Financial Officer, to allow timely decisions regarding required disclosures. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. Our management, with the participation of our Chairman and Chief Executive Officer and our Senior Vice President and Chief Financial Officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2015. Based upon that evaluation, our Chairman and Chief Executive Officer and our Senior Vice President and Chief Financial Officer concluded that, as of December 31, 2015, the design and operation of our disclosure controls and procedures were effective to accomplish their objectives at the reasonable assurance level.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our consolidated financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of L-3 Holdings and L-3 Communications, (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and directors, and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the consolidated financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements in our consolidated financial statements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management assessed the effectiveness of L-3 Holdings’ and L-3 Communications’ internal control over financial reporting as of December 31, 2015. In making these assessments, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control —Integrated Framework, issued in 2013. Based on our assessments and those criteria, management determined that L-3 Holdings and L-3 Communications maintained effective internal control over financial reporting as of December 31, 2015.

The effectiveness of the Company’s internal control over financial reporting as of December 31, 2015 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report. See page F-2 to our audited consolidated financial statements for their report.

Remediation of Material Weaknesses in Internal Control Over Financial Reporting

As previously disclosed in Management’s Report on Internal Control Over Financial Reporting included in the company’s Annual Report on Form 10-K for the year ended December 31, 2014, our management previously

 

72


Table of Contents

identified two material weaknesses: (1) ineffective control environment at its Aerospace Systems segment and (2) insufficient and ineffective review of certain employee concerns regarding violations of the company’s accounting policies and internal controls over financial reporting by company personnel. To remediate these material weaknesses, the company: (1) terminated and replaced certain senior level employees at the Aerospace Systems segment, Logistics Solutions sector, Platform Integration division and Army Sustainment division, (2) expanded the financial reporting leadership team at the Aerospace Systems segment by establishing and filling a controller position, (3) provided additional training for financial management personnel at the Aerospace Systems segment and its divisions with regard to the company’s accounting policies and internal controls over financial reporting, (4) strengthened procedures for the review of employee concerns by designating senior level employees to oversee and manage the investigations of alleged violations of the Company’s accounting policies and internal controls over financial reporting and (5) appointed a new vice president and corporate ethics officer.

The Company tested the controls and found them to be effective. As a result, the Company has concluded that, as of December 31, 2015, these two material weaknesses have been remediated.

Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Item 9B. Other Information

None.

 

73


Table of Contents

PART III

Item 10. Directors, Executive Officers and Corporate Governance

The Company posts its Code of Ethics and Business Conduct on the Corporate Governance webpage of its website at http://www.L-3com.com under the link “Code of Ethics and Business Conduct.” The Company’s Code of Ethics and Business Conduct applies to all directors, officers and employees, including our chairman and chief executive officer, our senior vice president and chief financial officer, and our corporate controller and principal accounting officer. We will post any amendments to the Code of Ethics and Business Conduct, and any waivers that are required to be disclosed by the rules of either the SEC or the NYSE, on our website within the required periods.

The remaining information called for by Item 10 will be included in the sections captioned “Proposal 1. Election of Directors,” “Continuing Members of the Board of Directors,” “Executives and Certain Other Officers of the Company,” “Section 16(A) Beneficial Ownership Reporting Compliance” and “The Board of Directors and Certain Governance Matters” in the definitive proxy statement (the “Company’s Proxy Statement”) relating to the Company’s 2016 Annual Meeting of Shareholders, to be held on May 2, 2016, and is incorporated herein by reference. L-3 Holdings will file its proxy statement with the SEC pursuant to Regulation 14A within 120 days after the end of its 2015 fiscal year covered by this Form 10-K.

Item 11. Executive Compensation

The “Compensation Discussion and Analysis,” “Compensation Committee Report,” “Tabular Executive Compensation Disclosure,” “Compensation of Directors” and “Compensation Committee Interlocks and Insider Participation” sections of the Company’s Proxy Statement are incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The “Security Ownership of Certain Beneficial Owners,” “Security Ownership of Management” and “Equity Compensation Plan Information” sections of the Company’s Proxy Statement are incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions, and Director Independence

The “Certain Relationships and Related Transactions” and “The Board of Directors and Certain Governance Matters” sections of the Company’s Proxy Statement are incorporated herein by reference.

Item 14. Principal Accountant Fees and Services

The “Independent Registered Public Accounting Firm Fees” section of the Company’s Proxy Statement is incorporated herein by reference.

 

74


Table of Contents

PART IV

Item 15. Exhibits, Financial Statement Schedules

The agreements and other documents filed as exhibits to this report are not intended to provide factual information or other disclosure other than with respect to the terms of the agreements or other documents themselves, and you should not rely on them for that purpose. In particular, any representations and warranties made by us in these agreements or other documents were made solely within the specific context of the relevant agreement or document and may not describe the actual state of affairs as of the date they were made or at any other time.

(a)(1) Financial statements filed as part of this report:

 

         Page    
    Number    
 

Report of Independent Registered Public Accounting Firm

     F-2   

Consolidated Balance Sheets as of December 31, 2015 and December 31, 2014

     F-3   

Consolidated Statements of Operations for the years ended December 31, 2015, 2014 and 2013

     F-4   

Consolidated Statements of Comprehensive Income for the years ended December 31, 2015, 2014 and 2013

     F-5   

Consolidated Statements of Equity for the years ended December 31, 2015, 2014 and 2013

     F-6   

Consolidated Statements of Cash Flows for the years ended December 31, 2015, 2014 and 2013

     F-7   

Notes to Consolidated Financial Statements

     F-8   

(a)(2) Financial Statement Schedules

Financial statement schedules are omitted since the required information is either not applicable or is included in our audited consolidated financial statements.

 

75


Table of Contents

Exhibits

 

          Exhibit        
             No.        

  

Description of Exhibits

  2.1

   Distribution Agreement between L-3 Communications Holdings, Inc. and Engility Holdings, Inc. dated as of July 16, 2012 (incorporated by reference to Exhibit 2.1 to the Registrants’ Quarterly Report on Form 10-Q for the period ended September 28, 2012
(File Nos. 001-14141 and 333-46983)).

  2.2

   Stock Purchase Agreement, dated as of December 7, 2015, by and among L-3 Communications Corporation, CACI International Inc and CACI, Inc.-Federal (incorporated by reference to Exhibit 2.1 to the Registrants’ Current Report on Form 8-K filed on December 11, 2015 (File Nos. 001-14141 and 333-46983)).

  3.1

   Amended and Restated Certificate of Incorporation of L-3 Communications Holdings, Inc. (incorporated by reference to Exhibit 3.1 to the Registrants’ Current Report on Form 8-K filed on May 2, 2013 (File Nos. 001-14141 and 333-46983)).

*3.2

   Amended and Restated By-Laws of L-3 Communications Holdings, Inc.

  3.3

   Certificate of Incorporation of L-3 Communications Corporation (incorporated by reference to Exhibit 3.1 to L-3 Communications Corporation’s Registration Statement on Form S-4/A filed on September 12, 1997 (File No. 333-31649)).

  3.4

   Amended and Restated By-laws of L-3 Communications Corporation (incorporated by reference to Exhibit 3.2 to the Registrants’ Current Report on Form 8-K filed on December 17, 2007 (File Nos. 001-14141 and 333-46983)).

  4.1

   Form of Common Stock Certificate of L-3 Communications Holdings, Inc. (incorporated by reference to Exhibit 4.1 to the Registrants’ Quarterly Report on Form 10-Q for the quarter ended June 25, 2010 (File Nos. 001-14141 and 333-46983)).

  4.2

   Indenture dated as of October 2, 2009 among L-3 Communications Corporation, the guarantors named therein and The Bank of New York Mellon, as Trustee (incorporated by reference to Exhibit 4.15 to the Registrants’ Quarterly Report on Form 10-Q for the quarter ended September 25, 2009 (File Nos. 001-14141 and 333-46983)).

  4.3

   Supplemental Indenture dated as of February 3, 2012 among L-3 Communications Corporation, The Bank of New York Mellon, as Trustee, and the guarantors named therein to the Indenture dated as of October 2, 2009 among L-3 Communications Corporation, the guarantors named therein and The Bank of New York Mellon, as Trustee (incorporated by reference to Exhibit 4.7 to the Registrants’ Annual Report on Form 10-K for the year ended December 31, 2011 (File Nos. 001-14141 and 333-46983)).

  4.4

   Indenture, dated as of May 21, 2010, among L-3 Communications Corporation, the guarantors named therein and The Bank of New York Mellon Trust Company, N.A., as Trustee (incorporated by reference to Exhibit 4.1 to the Registrants’ Current Report on Form 8-K dated May 24, 2010 (File Nos. 001-14141 and 333-46983)).

  4.5

   First Supplemental Indenture, dated as of May 21, 2010, among L-3 Communications Corporation, the guarantors named therein and The Bank of New York Mellon Trust Company, N.A., as Trustee (incorporated by reference to Exhibit 4.2 to the Registrants’ Current Report on Form 8-K dated May 24, 2010 (File Nos. 001-14141 and 333-46983)).

  4.6

   Second Supplemental Indenture, dated as of February 7, 2011, among L-3 Communications Corporation, the guarantors named therein and The Bank of New York Mellon Trust Company, N.A., as Trustee (incorporated by reference to Exhibit 4.2 to the Registrants’ Current Report on Form 8-K dated February 8, 2011 (File Nos. 001-14141 and 333-46983)).

  4.7

   Third Supplemental Indenture, dated as of November 22, 2011, among L-3 Communications Corporation, the guarantors named therein and The Bank of New York Mellon Trust Company, N.A, as Trustee (incorporated by reference to Exhibit 4.2 to the Registrants’ Current Report on Form 8-K dated November 22, 2011 (File Nos. 001-14141 and
333-46983)).

 

76


Table of Contents

          Exhibit        
             No.        

  

Description of Exhibits

  4.8

   Fourth Supplemental Indenture, dated as of February 3, 2012, among L-3 Communications Corporation, the guarantors named therein and The Bank of New York Mellon Trust Company, N.A, as Trustee (incorporated by reference to Exhibit 4.12 to the Registrants’ Annual Report on Form 10-K for the fiscal year ended December 31, 2011
(File Nos. 001-14141 and 333-46983)).

  4.9

   Fifth Supplemental Indenture, dated as of May 28, 2014, among L-3 Communications Corporation, the guarantors named therein and The Bank of New York Mellon Trust Company, N.A, as Trustee (incorporated by reference to Exhibit 4.2 to the Registrants’ Current Report on Form 8-K dated May 28, 2014 (File Nos. 001-14141 and 333-46983)).

  10.1

   Amended and Restated Credit Agreement, dated as of February 3, 2012, among L-3 Communications Corporation, L-3 Communications Holdings, Inc. and certain subsidiaries of the Registrants from time to time party thereto as guarantors, certain lenders from time to time party thereto, and Bank of America, N.A., as administrative agent (incorporated by reference to Exhibit 10.1 to the Registrants’ Current Report on Form 8-K dated February 3, 2012 (File Nos. 001-14141 and 333-46983)).

†10.2

   L-3 Communications Holdings, Inc. Amended and Restated 1998 Directors Stock Option Plan for Non-Employee Directors (incorporated by reference to Exhibit 10.16 to the Registrants’ Annual Report on Form 10-K for the year ended December 31, 2006 (File Nos. 001-14141 and 333-46983)).

†10.3

   Form of L-3 Communications Holdings, Inc. 1998 Directors Stock Option Plan Nonqualified Stock Option Agreement (incorporated by reference to Exhibit 10.96 of the Registrants’ Annual Report on Form 10-K for the year ended December 31, 2004 (File Nos. 001-14141 and 333-46983)).

†10.4

   Form of L-3 Communications Holdings, Inc. 1998 Directors Stock Option Plan Nonqualified Stock Option Agreement (2007 Version) (incorporated by reference to Exhibit 10.3 of the Registrants’ Annual Report on Form 10-K for the year ended December 31, 2007 (File Nos. 001-14141 and 333-46983)).

†10.5

   L-3 Communications Holdings, Inc. Amended and Restated 1999 Long Term Performance Plan (Conformed copy reflecting all amendments through February 11, 2008) (incorporated by reference to Exhibit 10.4 of the Registrants’ Annual Report on Form 10-K for the year ended December 31, 2007 (File Nos. 001-14141 and 333-46983)).

†10.6

   Form of L-3 Communications Holdings, Inc. 1999 Long Term Performance Plan Nonqualified Stock Option Agreement (2006 Version) (incorporated by reference to Exhibit 10.64 to the Registrants’ Annual Report on Form 10-K for the year ended December 31, 2006 (File Nos. 001-14141 and 333-46983)).

†10.7

   L-3 Communications Holdings, Inc. 2008 Amended and Restated Long Term Performance Plan (incorporated by reference to Exhibit 10.10 to the Registrants’ Annual Report on Form 10-K for the year ended December 31, 2013 (File Nos. 001-14141 and 333-46983)).

†10.8

   Form of L-3 Communications Holdings, Inc. 2008 Long Term Performance Plan Nonqualified Stock Option Agreement (2008 Version) (incorporated by reference to Exhibit 10.2 of the Registrants’ Quarterly Report on Form 10-Q for the period ended June 27, 2008 (File Nos. 001-14141 and 333-46983)).

†10.9

   Form of L-3 Communications Holdings, Inc. 2008 Long Term Performance Plan Nonqualified Stock Option Agreement (2009 Version) (incorporated by reference to Exhibit 10.1 of the Registrants’ Quarterly Report on Form 10-Q for the period ended June 26, 2009 (File Nos. 001-14141 and 333-46983)).

†10.10

   Form of L-3 Communications Holdings, Inc. 2008 Long Term Performance Plan Nonqualified Stock Option Agreement (2011 Version) (incorporated by reference to Exhibit 10.12 of the Registrants’ Annual Report on Form 10-K for the year ended December 31, 2010 (file Nos. 001-14141 and 333-46983)).

 

77


Table of Contents

          Exhibit        
             No.        

  

Description of Exhibits

†10.11

   Form of L-3 Communications Holdings, Inc. 2008 Long Term Performance Plan Nonqualified Stock Option Agreement (2014 Version) (incorporated by reference to Exhibit 10.3 of the Registrants’ Quarterly Report on Form 10-Q for the period ended March 28, 2014 (File Nos. 001-14141 and 333-46983)).

†10.12

   Form of Amended and Restated L-3 Communications Holdings, Inc. 2008 Long Term Performance Plan Nonqualified Stock Option Agreement (2011 and 2012 CEO Version) (incorporated by reference to Exhibit 10.14 of the Registrants’ Annual Report on Form 10-K for the year ended December 31, 2012 (File Nos. 001-14141 and 333-46983)).

†10.13

   Form of Amended and Restated L-3 Communications Holdings, Inc. 2008 Long Term Performance Plan Nonqualified Stock Option Agreement (2013 CEO Version) (incorporated by reference to Exhibit 10.4 of the Registrants’ Quarterly Report on Form 10-Q for the period ended March 29, 2013 (File Nos. 001-14141 and 333-46983)).

†10.14

   Form of L-3 Communications Holdings, Inc. 2008 Long Term Performance Plan Nonqualified Stock Option Agreement (2014 CEO Version) (incorporated by reference to Exhibit 10.3 of the Registrants’ Quarterly Report on Form 10-Q for the period ended June 27, 2014 (File Nos. 001-14141 and 333-46983)).

†10.15

   Form of L-3 Communications Holdings, Inc. 2008 Long Term Performance Plan Nonqualified Stock Option Agreement (2015 CEO Version) (incorporated by reference to Exhibit 10.1 of the Registrants’ Quarterly Report on Form 10-Q for the period ended March 27, 2015 (File Nos. 001-14141 and 333-46983)).

†10.16

   Form of L-3 Communications Holdings, Inc. 2008 Long Term Performance Plan Restricted Stock Unit Agreement (2009 Version) (incorporated by reference to Exhibit 10.17 of the Registrants’ Annual Report on Form 10-K for the year ended December 31, 2008 (File Nos. 001-14141 and 333-46983)).

†10.17

   Form of L-3 Communications Holdings, Inc. 2008 Long Term Performance Plan Restricted Stock Unit Agreement (2014 Version) (incorporated by reference to Exhibit 10.5 of the Registrants’ Quarterly Report on Form 10-Q for the period ended March 28, 2014 (File Nos. 001-14141 and 333-46983)).

†10.18

   Form of L-3 Communications Holdings, Inc. 2008 Long Term Performance Plan Restricted Stock Unit Agreement (2013 CEO Version) (incorporated by reference to Exhibit 10.5 of the Registrants’ Quarterly Report on Form 10-Q for the period ended March 29, 2013 (File Nos. 001-14141 and 333-46983)).

†10.19

   Form of L-3 Communications Holdings, Inc. 2008 Long Term Performance Plan Restricted Stock Unit Agreement (2014 CEO Version) (incorporated by reference to Exhibit 10.6 of the Registrants’ Quarterly Report on Form 10-Q for the period ended March 28, 2014 (File Nos. 001-14141 and 333-46983)).

†10.20

   Form of L-3 Communications Holdings, Inc. 2008 Long Term Performance Plan Restricted Stock Unit Agreement (2013 Senior Executive Version) (incorporated by reference to Exhibit 10.6 of the Registrants’ Quarterly Report on Form 10-Q for the period ended March 29, 2013 (File Nos. 001-14141 and 333-46983)).

†10.21

   Form of L-3 Communications Holdings, Inc. 2008 Long Term Performance Plan Restricted Stock Unit Agreement (2014 Senior Executive Version) (incorporated by reference to Exhibit 10.7 of the Registrants’ Quarterly Report on Form 10-Q for the period ended March 28, 2014 (File Nos. 001-14141 and 333-46983)).

†10.22

   Form of L-3 Communications Holdings, Inc. 2008 Long Term Performance Plan Restricted Stock Unit Agreement (2013 Non-Employee Directors Version) (incorporated by reference to Exhibit 10.7 of the Registrants’ Quarterly Report on Form 10-Q for the period ended March 29, 2013 (File Nos. 001-14141 and 333-46983)).

†10.23

   Form of L-3 Communications Holdings, Inc. 2008 Long Term Performance Plan Restricted Stock Unit Agreement (2014 Non-Employee Directors Annual Equity Award Version) (incorporated by reference to Exhibit 10.4 of the Registrants’ Quarterly Report on Form 10-Q for the period ended June 27, 2014 (File Nos. 001-14141 and 333-46983)).

 

78


Table of Contents

          Exhibit        
             No.        

  

Description of Exhibits

†10.24

   Form of L-3 Communications Holdings, Inc. 2008 Long Term Performance Plan Restricted Stock Unit Agreement (2014 Non-Employee Directors Deferred Compensation Version) (incorporated by reference to Exhibit 10.5 of the Registrants’ Quarterly Report on Form 10-Q for the period ended June 27, 2014 (File Nos. 001-14141 and 333-46983)).

†10.25

   Form of L-3 Communications Holdings, Inc. 2008 Long Term Performance Plan Performance Unit Agreement (2012 Version) (incorporated by reference to Exhibit 10.18 of the Registrants’ Annual Report on Form 10-K for the year ended December 31, 2011 (File Nos. 001-14141 and 333-46983)).

†10.26

   Form of Amended and Restated L-3 Communications Holdings, Inc. 2008 Long Term Performance Plan Performance Unit Award Notice (2013 Version) (incorporated by reference to Exhibit 10.8 to the Registrants’ Quarterly Report on Form 10-Q for the period ended March 29, 2013 (File Nos. 001-14141 and 333-46983)).

†10.27

   Form of L-3 Communications Holdings, Inc. 2008 Long Term Performance Plan Performance Unit Agreement (2014 Version) (incorporated by reference to Exhibit 10.8 of the Registrants’ Quarterly Report on Form 10-Q for the period ended March 28, 2014 (File Nos. 001-14141 and 333-46983)).

†10.28

   Form of L-3 Communications Holdings, Inc. 2008 Long Term Performance Plan Performance Unit Award Notice (2014 Version) (incorporated by reference to Exhibit 10.9 of the Registrants’ Quarterly Report on Form 10-Q for the period ended March 28, 2014 (File Nos. 001-14141 and 333-46983)).

†10.29

   Form of L-3 Communications Holdings, Inc. 2008 Long Term Performance Plan Performance Unit Award Notice (2015 Version) (incorporated by reference to Exhibit 10.2 of the Registrants’ Quarterly Report on Form 10-Q for the period ended March 27, 2015 (File Nos. 001-14141 and 333-46983)).

†10.30

   L-3 Communications Holdings, Inc. 2012 Cash Incentive Plan (incorporated by reference to Exhibit 10.1 to the Registrants’ Quarterly Report on Form 10-Q for the period ended March 30, 2012 (File Nos. 001-14141 and 333-46983)).

†10.31

   Form of L-3 Communications Holdings, Inc. 2012 Cash Incentive Plan Performance Cash Award Agreement (2012 version) (incorporated by reference to Exhibit 10.2 of the Registrants’ Quarterly Report on Form 10-Q for the period ended March 30, 2012 (File Nos. 001-14141 and 333-46983)).

†10.32

   Form of L-3 Communications Holdings, Inc. 2012 Cash Incentive Plan Performance Cash Award Notice (2013 Version) (incorporated by reference to Exhibit 10.9 of the Registrants’ Quarterly Report on Form 10-Q for the period ended March 29, 2013 (File Nos. 001-14141 and 333-46983)).

†10.33

   Form of L-3 Communications Holdings, Inc. 2012 Cash Incentive Plan Performance Cash Award Agreement (2014 Version) (incorporated by reference to Exhibit 10.10 of the Registrants’ Quarterly Report on Form 10-Q for the period ended March 28, 2014 (File Nos. 001-14141 and 333-46983)).

†10.34

   Form of L-3 Communications Holdings, Inc. 2012 Cash Incentive Plan Performance Cash Award Notice (2014 Version) (incorporated by reference to Exhibit 10.11 of the Registrants’ Quarterly Report on Form 10-Q for the period ended March 28, 2014 (File Nos. 001-14141 and 333-46983)).

†10.35

   Form of L-3 Communications Holdings, Inc. 2012 Cash Incentive Plan Performance Cash Award Notice (2015 Version) (incorporated by reference to Exhibit 10.3 of the Registrants’ Quarterly Report on Form 10-Q for the period ended March 27, 2015 (File Nos. 001-14141 and 333-46983)).

†10.36

   L-3 Communications Holdings, Inc. Amended and Restated 2008 Directors Stock Incentive Plan (incorporated by reference to Exhibit 10.24 of the Registrants’ Annual Report on Form 10-K for the year ended December 31, 2012 (File Nos. 001-14141 and 333-46983)).

 

79


Table of Contents

          Exhibit        
             No.        

  

Description of Exhibits

†10.37

   Form of L-3 Communications Holdings, Inc. 2008 Directors Stock Incentive Plan Restricted Stock Unit Agreement (incorporated by reference to Exhibit 10.2 of the Registrants’ Quarterly Report on Form 10-Q for the period ended March 27, 2009 (File Nos. 001-14141 and 333-46983)).

†10.38

   Global Spin-Off Amendment to Equity Award Agreements dated as of July 18, 2012 (incorporated by reference to Exhibit 10.26 of the Registrants’ Annual Report on Form 10-K for the year ended December 31, 2012 (File Nos. 001-14141 and 333-46983)).

†10.39

   Global Amendment to Non-Employee Director RSU Agreements dated as of April 30, 2013 (incorporated by reference to Exhibit 10.10 of the Registrants’ Quarterly Report on Form 10-Q for the period ended March 29, 2013 (File Nos. 001-14141 and 333-46983)).

†10.40

   L-3 Communications Holdings, Inc. Amended and Restated Change in Control Severance Plan (incorporated by reference to Exhibit 10.21 of the Registrants’ Annual Report on Form 10-K for the year ended December 31, 2008 (File Nos. 001-14141 and 333-46983)).

†10.41

   L-3 Communications Corporation Amended and Restated Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.22 of the Registrants’ Annual Report on Form 10-K for the year ended December 31, 2008 (File Nos. 001-14141 and 333-46983)).

†10.42

   Amendment 2012-2 to the L-3 Communications Corporation Amended and Restated Supplemental Executive Retirement Plan (incorporated by reference to Exhibit 10.29 of the Registrants’ Annual Report on Form 10-K for the year ended December 31, 2012 (File Nos. 001-14141 and 333-46983)).

*†10.43

   Amendment 2015-1 to the L-3 Communications Corporation Amended and Restated Supplemental Executive Retirement Plan.

†10.44

   L-3 Communications Corporation Deferred Compensation Plan I (incorporated by reference to Exhibit 10.15 of the Registrants’ Annual Report on Form 10-K for the year ended December 31, 2007 (File Nos. 001-14141 and 333-46983)).

†10.45

   Amendment No. 1 to the L-3 Communications Corporation Deferred Compensation Plan I (incorporated by reference to Exhibit 10.16 of the Registrants’ Annual Report on Form 10-K for the year ended December 31, 2007 (File Nos. 001-14141 and 333-46983)).

†10.46

   L-3 Communications Corporation Deferred Compensation Plan II (incorporated by reference to Exhibit 10.25 of the Registrants’ Annual Report on Form 10-K for the year ended December 31, 2008 (File Nos. 001-14141 and 333-46983)).

10.47

   Tax Matters Agreement between L-3 Communications Holdings, Inc. and Engility Holdings, Inc. dated as of July 16, 2012 (incorporated by reference to Exhibit 10.2 to the Registrants’ Quarterly Report on Form 10-Q for the period ended September 28, 2012 (File Nos. 001-14141 and 333-46983)).

+10.48

   Master Supply Agreement between L-3 Communications Corporation (as Seller) and Engility Corporation (as Buyer) dated as of July 16, 2012 (incorporated by reference to Exhibit 10.4 to the Registrants’ Quarterly Report on Form 10-Q for the period ended September 28, 2012 (File Nos. 001-14141 and 333-46983)).

+10.49

   Master Supply Agreement between L-3 Communications Corporation (as Buyer) and Engility Corporation (as Seller) dated as of July 16, 2012 (incorporated by reference to Exhibit 10.5 to the Registrants’ Quarterly Report on Form 10-Q for the period ended September 28, 2012 (File Nos. 001-14141 and 333-46983)).

**11

   L-3 Communications Holdings, Inc. Computation of Basic Earnings Per Share and Diluted Earnings Per Common Share.

*21

   Subsidiaries of the Registrant.

*23

   Consent of PricewaterhouseCoopers LLP.

*31.1

   Certification of Chairman and Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.

 

80


Table of Contents

          Exhibit        
             No.        

  

Description of Exhibits

*31.2

   Certification of Senior Vice President and Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.

*32

   Section 1350 Certification.

***101.INS

   XBRL Instance Document

***101.SCH

   XBRL Taxonomy Extension Schema Document

***101.CAL

   XBRL Taxonomy Extension Calculation Linkbase Document

***101.DEF

   XBRL Taxonomy Extension Definition Linkbase Document

***101.LAB

   XBRL Taxonomy Extension Label Linkbase Document

***101.PRE

   XBRL Taxonomy Extension Presentation Linkbase Document

 

*

Filed herewith.

**

The information required in this exhibit is presented in Note 15 to the consolidated financial statements as of December 31, 2015 in accordance with the provisions of ASC 260, Earnings Per Share.

***

Filed electronically with this report.

Represents management contract, compensatory plan or arrangement in which directors and/or executive officers are entitled to participate.

+

Pursuant to a request for confidential treatment, portions of these exhibits have been redacted from the publicly filed document and have been furnished separately to the Securities and Exchange Commission as required by Rule 24b-2 under the Securities Exchange Act of 1934, as amended.

The agreements and other documents filed as exhibits to this report are not intended to provide factual information or other disclosure other than the terms of the agreements or other documents themselves, and you should not rely on them for that purpose. In particular, any representations and warranties made by the Company in these agreements or other documents were made solely within the specific context of the relevant agreement or document and may not describe the actual state of affairs at the date they were made or at any other time.

 

81


Table of Contents

Signatures

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrants have duly caused this report to be signed on their behalf by the undersigned, thereunto duly authorized.

 

L-3 COMMUNICATIONS HOLDINGS, INC.

L-3 COMMUNICATIONS CORPORATION

By: /s/ RALPH G. D’AMBROSIO

Title: Senior Vice President and Chief Financial Officer

Date: February 26, 2016

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrants in the capacities indicated on February 26, 2016.

 

Signature       Title
/S/ MICHAEL T. STRIANESE    

Chairman and Chief Executive Officer

Michael T. Strianese    

(Principal Executive Officer) and Director

/S/ RALPH G. D’AMBROSIO    

Senior Vice President and Chief Financial Officer

Ralph G. D’Ambrosio    

(Principal Financial Officer)

/S/ DAN AZMON    

Vice President, Controller and Principal Accounting Officer

Dan Azmon    
/S/ ROBERT B. MILLARD    

Lead Director

Robert B. Millard    
/S/ CLAUDE R. CANIZARES    

Director

Claude R. Canizares    
/S/ THOMAS A. CORCORAN    

Director

Thomas A. Corcoran    
/S/ ANN E. DUNWOODY    

Director

Ann E. Dunwoody    
/S/ LEWIS KRAMER    

Director

Lewis Kramer    
/S/ LLOYD W. NEWTON    

Director

Lloyd W. Newton    
/S/ VINCENT PAGANO, JR.    

Director

Vincent Pagano, Jr.    
/S/ H. HUGH SHELTON    

Director

H. Hugh Shelton    
/S/ ARTHUR L. SIMON    

Director

Arthur L. Simon    

 

82


Table of Contents

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

Consolidated Financial Statements as of December 31, 2015 and 2014 and for the years ended December 31, 2015, 2014 and 2013.

 

     Page
        No.        
 

Report of Independent Registered Public Accounting Firm

     F-2  

Consolidated Balance Sheets as of December 31, 2015 and December 31, 2014

     F-3  

Consolidated Statements of Operations for the years ended December 31, 2015, 2014 and 2013

     F-4  

Consolidated Statements of Comprehensive Income for the years ended December 31, 2015, 2014 and 2013

     F-5  

Consolidated Statements of Equity for the years ended December 31, 2015, 2014 and 2013

     F-6  

Consolidated Statements of Cash Flows for the years ended December 31, 2015, 2014 and 2013

     F-7  

Notes to Consolidated Financial Statements

     F-8  

 

F-1


Table of Contents

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of L-3 Communications Holdings, Inc. and L-3 Communications Corporation:

In our opinion, the accompanying (1) consolidated balance sheets of L-3 Communications Holdings, Inc., and the related consolidated statements of operations, comprehensive income, equity, and cash flows, and (2) consolidated balance sheets of L-3 Communications Corporation, and the related consolidated statements of operations, comprehensive income, equity, and cash flows present fairly, in all material respects, the financial positions of (1) L-3 Communications Holdings, Inc. and its subsidiaries and (2) L-3 Communications Corporation and its subsidiaries as of December 31, 2015 and 2014, and the results of the operations and the cash flows of (1) L-3 Communications Holdings, Inc. and its subsidiaries and (2) L-3 Communications Corporation and its subsidiaries for each of the three years in the period ended December 31, 2015 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, L-3 Communications Holdings, Inc. and L-3 Communications Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The management of L-3 Communications Holdings, Inc. and L-3 Communications Corporation are responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements and on the internal control over financial reporting of L-3 Communications Holdings, Inc. and of L-3 Communications Corporation based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

As discussed in Notes 2 and 19 to the consolidated financial statements, L-3 Communications Holdings, Inc. and L-3 Communications Corporation changed the manner in which they classify and present deferred income taxes and the manner in which they present the leveling classification of pension assets in 2015.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP

New York, New York

February 26, 2016

 

F-2


Table of Contents

L-3 COMMUNICATIONS HOLDINGS, INC.

AND L-3 COMMUNICATIONS CORPORATION

CONSOLIDATED BALANCE SHEETS

(in millions, except share data)

 

     December 31,  
     2015      2014  
ASSETS      

Current assets:

     

Cash and cash equivalents

     $ 207          $ 442    

Billed receivables, net of allowances of $15 in 2015 and $13 in 2014

     746          803    

Contracts in process

     2,081          2,148    

Inventories

     333          288    

Other current assets

     201          175    

Assets held for sale

     —          547    

Assets of discontinued operations

     664           1,262     
  

 

 

    

 

 

 

Total current assets

     4,232          5,665    
  

 

 

    

 

 

 

Property, plant and equipment, net

     1,097          1,061    

Goodwill

     6,281          6,512    

Identifiable intangible assets

     199          195    

Deferred debt issue costs

     18          27    

Deferred income taxes

     3          15    

Other assets

     255          240    
  

 

 

    

 

 

 

Total assets

     $ 12,085          $ 13,715    
  

 

 

    

 

 

 
LIABILITIES AND EQUITY      

Current liabilities:

     

Current portion of long-term debt

     $ 499          $ —    

Accounts payable, trade

     297          346    

Accrued employment costs

     504          474    

Accrued expenses

     390          370    

Advance payments and billings in excess of costs incurred

     562          565    

Income taxes

     13          23    

Other current liabilities

     394          389    

Liabilities held for sale

     —          237    

Liabilities of discontinued operations

     220           230    
  

 

 

    

 

 

 

Total current liabilities

     2,879          2,634    
  

 

 

    

 

 

 

Pension and postretirement benefits

     1,047          1,187    

Deferred income taxes

     219          235     

Other liabilities

     368          360    

Long-term debt

     3,143          3,939    
  

 

 

    

 

 

 

Total liabilities

     7,656          8,355    
  

 

 

    

 

 

 

Commitments and contingencies (see Note 18)

     

Equity:

     

L-3 shareholders’ equity:

     

L-3   Communications Holdings, Inc.’s common stock: $.01 par value; 300,000,000 shares authorized, 78,133,763 shares outstanding at December 31, 2015 and 82,040,525 shares outstanding at December 31, 2014 (L-3 Communications Corporation’s common stock: $.01 par value, 100 shares authorized, issued and outstanding)

     6,052          5,799    

L-3   Communications Holdings, Inc.’s treasury stock (at cost), 79,375,063 shares at December 31, 2015 and 73,005,891 shares at December 31, 2014

     (6,851)         (6,111)    

Retained earnings

     5,728          6,181     

Accumulated other comprehensive loss

     (574)         (584)   
  

 

 

    

 

 

 

Total L-3 shareholders’ equity

     4,355          5,285     

Noncontrolling interests

     74          75     
  

 

 

    

 

 

 

Total equity

     4,429          5,360     
  

 

 

    

 

 

 

Total liabilities and equity

     $         12,085            $         13,715     
  

 

 

    

 

 

 

See notes to consolidated financial statements.

 

F-3


Table of Contents

L-3 COMMUNICATIONS HOLDINGS, INC.

AND L-3 COMMUNICATIONS CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(in millions, except per share data)

 

     Year Ended December 31,  
                 2015                              2014                              2013              

Net sales:

        

Products

     $         6,589            $         6,839            $         7,129        

Services

     3,877            4,147            4,291        
  

 

 

    

 

 

    

 

 

 

Total net sales

     10,466            10,986            11,420        
  

 

 

    

 

 

    

 

 

 

Cost of sales:

        

Products

     (6,007)           (6,161)           (6,366)       

Services

     (3,569)           (3,813)           (3,937)       
  

 

 

    

 

 

    

 

 

 

Total cost of sales

     (9,576)           (9,974)           (10,303)       
  

 

 

    

 

 

    

 

 

 

Loss related to business divestitures

     (31)            —             —         

Impairment charges

     (384)            —             —         
  

 

 

    

 

 

    

 

 

 

Operating income

     475            1,012            1,117        

Interest expense

     (169)           (158)           (157)       

Interest and other income, net

     17            18            20        

Debt retirement charge

     (1)           —             —         
  

 

 

    

 

 

    

 

 

 

Income from continuing operations before income taxes

     322            872            980        

Provision for income taxes

     (25)           (227)           (264)       
  

 

 

    

 

 

    

 

 

 

Income from continuing operations

     297            645            716        

(Loss) income from discontinued operations, net of income taxes

     (522)            32            44        
  

 

 

    

 

 

    

 

 

 

Net (loss) income

     $ (225)            $ 677            $ 760        

Net income from continuing operations attributable to noncontrolling interests

     (15)           (13)           (9)       
  

 

 

    

 

 

    

 

 

 

Net (loss) income attributable to L-3

     $ (240)            $ 664            $ 751        
  

 

 

    

 

 

    

 

 

 

Basic earnings (loss) per share attributable to L-3 Holdings’ common shareholders:

        

Continuing operations

     $ 3.49            $ 7.40             $ 7.91        

Discontinued operations

     (6.46)            0.38             0.49         
  

 

 

    

 

 

    

 

 

 

Basic (loss) earnings per share

     $ (2.97)            $ 7.78            $ 8.40        
  

 

 

    

 

 

    

 

 

 

Diluted earnings (loss) per share attributable to L-3 Holdings’ common shareholders:

        

Continuing operations

     $ 3.44            $ 7.20            $ 7.76        

Discontinued operations

     (6.37)            0.36             0.48        
  

 

 

    

 

 

    

 

 

 

Diluted (loss) earnings per share

     $ (2.93)            $ 7.56            $ 8.24        
  

 

 

    

 

 

    

 

 

 

Cash dividends declared per common share

     $ 2.60            $ 2.40            $ 2.20        
  

 

 

    

 

 

    

 

 

 

L-3 Holdings’ weighted average common shares outstanding:

        

Basic

     80.7            85.4            89.4        
  

 

 

    

 

 

    

 

 

 

Diluted

     81.9            87.8            91.1        
  

 

 

    

 

 

    

 

 

 

See notes to consolidated financial statements.

 

F-4


Table of Contents

L-3 COMMUNICATIONS HOLDINGS, INC.

AND L-3 COMMUNICATIONS CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in millions)

 

    Year Ended December 31,  
    2015     2014     2013  

Net (loss) income

      $       (225)              $ 677               $       760       

Other comprehensive (loss) income:

     

Foreign currency translation adjustments

    (120)           (123)            (25)      

Unrealized losses on hedging instruments(1)

    (3)           (6)            (2)      

Pension and postretirement benefit plans:

     

Amortization of net loss and prior service cost previously recognized(2)

    43            9             53       

Net prior service costs arising during the period(3)

    —            —            (9)      

Net gain (loss) arising during the period(4)

    90             (354)            423       
 

 

 

   

 

 

   

 

 

 

Net change in pension and postretirement benefit plans

    133             (345)            467       
 

 

 

   

 

 

   

 

 

 

Total other comprehensive income (loss)

    10             (474)            440       
 

 

 

   

 

 

   

 

 

 

Comprehensive (loss) income

    (215)            203            1,200       

Comprehensive income attributable to noncontrolling interests

    (15)            (13)            (9)      
 

 

 

   

 

 

   

 

 

 

Comprehensive (loss) income attributable to L-3

      $ (230)              $         190               $ 1,191       
 

 

 

   

 

 

   

 

 

 

 

 

  (1) 

Net of income tax benefits of $2 million in 2015, $1 million in 2014 and $3 million in 2013.

  (2) 

Net of income taxes of $24 million in 2015, $6 million in 2014 and $30 million in 2013.

  (3) 

Net of an income tax benefit of $5 million in 2013.

  (4) 

Net of income taxes of $49 million in 2015, an income tax benefit of $211 million in 2014 and income taxes of $243 million in 2013. The 2015 amount includes $9 million (net of income taxes of $5 million) for the reclassification of actuarial losses into net income related to the Marine Systems International business divestiture in accordance with Accounting Standards Codification 715 Defined Benefit Plans – Pension.

 

See notes to consolidated financial statements.

 

F-5


Table of Contents

L-3 COMMUNICATIONS HOLDINGS, INC.

AND L-3 COMMUNICATIONS CORPORATION

CONSOLIDATED STATEMENTS OF EQUITY

(in millions, except per share data)

 

    L-3 Holdings’
Common Stock
    Additional
Paid-in
Capital
    Treasury
Stock
    Retained
Earnings
   

Accumulated

Other
Comprehensive

Loss

  Noncontrolling
Interests
    Total
Equity
 
    Shares
Outstanding
    Par
Value
             

Balance at December 31, 2012

    90.4     $ 1     $ 5,313     $ (4,488 )   $ 5,175     $    (550)   $ 76     $ 5,527  

Net income

            751         9       760  

Other comprehensive income

            440        440  

Distributions to noncontrolling interests

                (10 )     (10 )

Cash dividends declared ($2.20 per share)

            (201 )         (201 )

Shares issued:

               

Employee savings plans

    1.5         121               121  

Exercise of stock options

    1.8