Table of Contents

 

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

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 28, 2018
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 001-37975
L3 TECHNOLOGIES, INC.
(Exact name of registrant as specified in its charter)
Delaware
13-3937436
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
600 Third Avenue, New York, NY
10016
(Address of principal executive offices)
(Zip Code)
(212) 697-1111
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes  ¨ No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). x Yes  ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Accelerated filer
¨
Non-accelerated filer ¨
Smaller reporting company
¨
 
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  ¨ Yes  x No
There were 78,697,551 shares of the registrant’s common stock with a par value of $0.01 outstanding as of the close of business on October 19, 2018 .
 

Table of Contents

L3 TECHNOLOGIES, INC.
INDEX TO QUARTERLY REPORT ON FORM 10-Q
For the quarterly period ended September 28, 2018

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

Table of Contents

PART I — FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
L3 TECHNOLOGIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions, except share data)
 
(Unaudited)
 
 
 
September 28,
2018
 
December 31,
2017
ASSETS
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
507

 
$
662

Billed receivables, net of allowances of $12 in 2018 and $18 in 2017
900

 
723

Contract assets
1,707

 
—

Contracts in process
—

 
1,933

Inventories
911

 
389

Prepaid expenses and other current assets
410

 
300

Assets held for sale
—

 
135

Assets of discontinued operations
—

 
306

Total current assets
4,435


4,448

Property, plant and equipment, net
1,156

 
1,110

Goodwill
6,834

 
6,615

Identifiable intangible assets
414

 
292

Other assets
345

 
264

Total assets
$
13,184


$
12,729

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable, trade
$
619

 
$
531

Accrued employment costs
482

 
493

Accrued expenses
268

 
217

Contract liabilities
578

 
—

Advance payments and billings in excess of costs incurred
—

 
509

Income taxes payable
14

 
19

Other current liabilities
299

 
367

Liabilities held for sale
—

 
17

Liabilities of discontinued operations
—

 
226

Total current liabilities
2,260


2,379

Pension and postretirement benefits
1,230

 
1,313

Deferred income taxes
221

 
158

Other liabilities
442

 
398

Long-term debt
3,320

 
3,330

Total liabilities
7,473


7,578

Commitments and contingencies (see Note 19)


 


Equity:
 
 
 
Shareholders’ equity:
 
 
 
Common stock: $.01 par value; 300,000,000 shares authorized, 78,597,571 shares outstanding at September 28, 2018 and 77,876,687 shares outstanding at December 31, 2017
6,808

 
6,519

Treasury stock (at cost), 84,999,711 shares at September 28, 2018 and 83,362,412 shares at December 31, 2017
(7,726
)
 
(7,404
)
Retained earnings
7,263

 
6,659

Accumulated other comprehensive loss
(703
)
 
(691
)
Total shareholders’ equity
5,642


5,083

Noncontrolling interests
69

 
68

Total equity
5,711


5,151

Total liabilities and equity
$
13,184


$
12,729


See notes to unaudited condensed consolidated financial statements.
1
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L3 TECHNOLOGIES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share data)

 
Third Quarter Ended
 
September 28,
2018
 
September 29,
2017
Net sales:
 
 
 
Products
$
1,736

 
$
1,584

Services
783

 
709

Total net sales
2,519


2,293

Operating costs and expenses:
 
 
 
Cost of sales — Products
(1,324
)
 
(1,189
)
Cost of sales — Services
(518
)
 
(492
)
General and administrative expenses
(396
)
 
(380
)
Total operating costs and expenses
(2,238
)
 
(2,061
)
Loss on sale of the Crestview Aerospace and TCS businesses
(4
)
 
—

Merger, acquisition and divestiture related expenses
(5
)
 
—

Operating income
272

 
232

Interest expense
(40
)
 
(42
)
Interest and other income, net
15

 
2

Debt retirement charge
(21
)
 
—

Income from continuing operations before income taxes
226


192

Provision for income taxes
(18
)
 
(46
)
Income from continuing operations
208


146

Loss from discontinued operations, net of income taxes
—

 
(121
)
Net income
208


25

Net income from continuing operations attributable to noncontrolling interests
(6
)
 
(3
)
Net income attributable to L3
$
202


$
22

Basic earnings (loss) per share attributable to common shareholders:
 
 
 
Continuing operations
$
2.57

 
$
1.83

Discontinued operations
—

 
(1.55
)
Basic earnings per share
$
2.57


$
0.28

Diluted earnings (loss) per share attributable to common shareholders:
 
 
 
Continuing operations
$
2.54

 
$
1.79

Discontinued operations
—

 
(1.51
)
Diluted earnings per share
$
2.54


$
0.28

Cash dividends declared per common share
$
0.80

 
$
0.75

Weighted average common shares outstanding:
 
 
 
Basic
78.5

 
78.2

Diluted
79.4

 
79.8




See notes to unaudited condensed consolidated financial statements.
2
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L3 TECHNOLOGIES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share data)

 
Year-to-Date Ended
 
September 28,
2018
 
September 29,
2017
Net sales:
 
 
 
Products
$
5,168

 
$
4,868

Services
2,305

 
2,131

Total net sales
7,473

 
6,999

Operating costs and expenses:
 
 
 
Cost of sales — Products
(3,864
)
 
(3,630
)
Cost of sales — Services
(1,628
)
 
(1,509
)
General and administrative expenses
(1,176
)
 
(1,097
)
Total operating costs and expenses
(6,668
)
 
(6,236
)
Gain on sale of the Crestview Aerospace and TCS businesses
44

 
—

Merger, acquisition and divestiture related expenses
(5
)
 
—

Operating income
844

 
763

Interest expense
(125
)
 
(126
)
Interest and other income, net
29

 
8

Debt retirement charges
(69
)
 
—

Income from continuing operations before income taxes
679

 
645

Provision for income taxes
(90
)
 
(147
)
Income from continuing operations
589

 
498

Income (loss) from discontinued operations, net of income taxes
206

 
(98
)
Net income
795

 
400

Net income from continuing operations attributable to noncontrolling interests
(15
)
 
(12
)
Net income attributable to L3
$
780

 
$
388

Basic earnings (loss) per share attributable to common shareholders:
 
 
 
Continuing operations
$
7.32

 
$
6.23

Discontinued operations
2.63

 
(1.26
)
Basic earnings per share
$
9.95

 
$
4.97

Diluted earnings (loss) per share attributable to common shareholders:
 
 
 
Continuing operations
$
7.21

 
$
6.10

Discontinued operations
2.59

 
(1.23
)
Diluted earnings per share
$
9.80

 
$
4.87

Cash dividends declared per common share
$
2.40

 
$
2.25

Weighted average common shares outstanding:
 
 
 
Basic
78.4

 
78.0

Diluted
79.6

 
79.6





See notes to unaudited condensed consolidated financial statements.
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L3 TECHNOLOGIES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in millions)

 
Third Quarter Ended
 
Year-to-Date Ended
 
September 28,
2018
 
September 29,
2017
 
September 28,
2018
 
September 29,
2017
Net income
$
208

 
$
25

 
$
795

 
$
400

Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustments
(3
)
 
49

 
(42
)
 
120

Unrealized gains (losses) on hedging instruments (1)
2

 
6

 
(9
)
 
6

Pension and postretirement benefit plans:
 
 
 
 
 
 
 
Amortization of net loss and prior service cost previously recognized (2)
12

 
8

 
39

 
27

Total other comprehensive income (loss)
11

 
63

 
(12
)
 
153

Comprehensive income
219


88


783


553

Comprehensive income attributable to noncontrolling interests
(6
)
 
(3
)
 
(15
)
 
(12
)
Comprehensive income attributable to L3
$
213


$
85


$
768


$
541

__________________
(1)  
Net of income taxes of $1 million and $2 million for the quarterly periods ended September 28, 2018 and September 29, 2017 , respectively, and net of income tax benefit of $2 million and net of income taxes of $2 million for the year-to-date period s ended September 28, 2018 and September 29, 2017 , respectively.
(2)  
Net of income taxes of $4 million and $5 million for the quarterly periods ended September 28, 2018 and September 29, 2017 , respectively, and net of income taxes of $12 million and $16 million for the year-to-date period s ended September 28, 2018 and September 29, 2017 , respectively.

See notes to unaudited condensed consolidated financial statements.
4
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L3 TECHNOLOGIES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
(in millions, except per share data)

 
Common Stock
 
Additional Paid-in Capital
 
Treasury Stock
 
Retained   Earnings
 
Accumulated Other Comprehensive Loss
 
Noncontrolling Interests
 
Total Equity
 
Shares   Outstanding
 
Par Value
 
For the Year-to-Date Ended September 28, 2018:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Balance at December 31, 2017 - as reported
77.9

 
$
1

 
$
6,518

 
$
(7,404
)
 
$
6,659

 
$
(691
)
 
$
68

 
$
5,151

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

 
 
 
 
 
13

Net income
 
 
 
 
 
 
 
 
780

 
 
 
15

 
795

Other comprehensive loss
 
 
 
 
 
 
 
 
 
 
(12
)
 
 
 
(12
)
Distributions to noncontrolling interests
 
 
 
 
 
 
 
 
 
 
 
 
(14
)
 
(14
)
Cash dividends declared ($2.40 per share)
 
 
 
 
 
 
 
 
(189
)
 
 
 
 
 
(189
)
Shares issued:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Employee savings plans
0.5

 
 
 
98

 
 
 
 
 
 
 
 
 
98

Exercise of stock options
1.4

 
 
 
142

 
 
 
 
 
 
 
 
 
142

Employee stock purchase plan
0.2

 
 
 
17

 
 
 
 
 
 
 
 
 
17

Vesting of restricted stock and performance units
0.3

 
 
 
 
 
 
 
 
 
 
 
 
 
—

Repurchases of common stock to satisfy tax withholding obligations
(0.1
)
 
 
 
(24
)
 
 
 
 
 
 
 
 
 
(24
)
Stock-based compensation expense
 
 
 
 
47

 
 
 
 
 
 
 
 
 
47

Treasury stock purchased
(1.6
)
 
 
 
 
 
(322
)
 
 
 
 
 
 
 
(322
)
Other
 
 
 
 
9

 
 
 


 
 
 
 
 
9

Balance at September 28, 2018
78.6


$
1


$
6,807


$
(7,726
)

$
7,263


$
(703
)

$
69


$
5,711

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Year-to-Date Ended September 29, 2017:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
77.2

 
$
1

 
$
6,284

 
$
(7,224
)
 
$
6,218

 
$
(726
)
 
$
71

 
$
4,624

Net income
 
 
 
 
 
 
 
 
388

 
 
 
12

 
400

Other comprehensive income
 
 
 
 
 
 
 
 
 
 
153

 
 
 
153

Distributions to noncontrolling interests
 
 
 
 
 
 
 
 
 
 
 
 
(13
)
 
(13
)
Cash dividends declared ($2.25 per share)
 
 
 
 
 
 
 
 
(177
)
 
 
 
 
 
(177
)
Shares issued:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Employee savings plans
0.6

 
 
 
96

 
 
 
 
 
 
 
 
 
96

Exercise of stock options
0.4

 
 
 
36

 
 
 
 
 
 
 
 
 
36

Employee stock purchase plan
0.2

 
 
 
16

 
 
 
 
 
 
 
 
 
16

Vesting of restricted stock and performance units
0.3

 
 
 
 
 
 
 
 
 
 
 
 
 
—

Repurchases of common stock to satisfy tax withholding obligations
(0.1
)
 
 
 
(18
)
 
 
 
 
 
 
 
 
 
(18
)
Stock-based compensation expense
 
 
 
 
43

 
 
 
 
 
 
 
 
 
43

Treasury stock purchased
(0.5
)
 
 
 
 
 
(91
)
 
 
 
 
 
 
 
(91
)
Balance at September 29, 2017
78.1


$
1


$
6,457


$
(7,315
)

$
6,429


$
(573
)

$
70


$
5,069



See notes to unaudited condensed consolidated financial statements.
5
Table of Contents
L3 TECHNOLOGIES, INC.
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)

 
Year-to-Date Ended
 
September 28,
2018
 
September 29,
2017
Operating activities:
 
 
 
Net income
$
795

 
$
400

Less: (income) loss from discontinued operations, net of tax
(206
)
 
98

Income from continuing operations
589

 
498

Depreciation of property, plant and equipment
132

 
125

Amortization of intangibles and other assets
38

 
36

Deferred income tax provision
26

 
30

Stock-based employee compensation expense
47

 
43

Contributions to employee savings plans in common stock
94

 
90

Amortization of pension and postretirement benefit plans net loss and prior service cost
51

 
43

Loss (gain) on sale of property, plant and equipment
1

 
(42
)
Gain on sale of the Crestview Aerospace and TCS businesses
(44
)
 
—

Debt retirement charges
69

 
—

Other non-cash items
5

 
9

Changes in operating assets and liabilities, excluding amounts from acquisitions and divestitures, and discontinued operations:
 
 
 
Billed receivables
(166
)
 
3

Contract assets
(361
)
 
—

Contracts in process
—

 
(183
)
Inventories
28

 
(46
)
Prepaid expenses and other current assets
(127
)
 
(29
)
Accounts payable, trade
57

 
47

Accrued employment costs
(10
)
 
12

Accrued expenses
71

 
54

Contract liabilities
7

 
—

Advance payments and billing in excess of costs incurred
—

 
(18
)
Income taxes
(25
)
 
2

All other operating activities
(140
)
 
(93
)
Net cash from operating activities from continuing operations
342

 
581

 
 
 
 
Investing activities:
 
 
 
Business acquisitions, net of cash acquired
(368
)
 
(291
)
Proceeds from the sale of businesses, net of closing date cash balances
535

 
18

Capital expenditures
(167
)
 
(151
)
Dispositions of property, plant and equipment
2

 
67

Other investing activities
(28
)
 
(7
)
Net cash used in investing activities from continuing operations
(26
)
 
(364
)
 
 
 
 
Financing activities:
 
 
 
Proceeds from sale of senior notes
1,798

 
—

Repurchases and redemptions of senior notes
(1,865
)
 
—

Borrowings under revolving credit facility
501

 
1,265

Repayments of borrowings under revolving credit facility
(501
)
 
(1,265
)
Common stock repurchased
(322
)
 
(91
)
Dividends paid
(191
)
 
(178
)
Proceeds from exercises of stock options
142

 
36

Proceeds from employee stock purchase plan
25

 
24

Repurchases of common stock to satisfy tax withholding obligations
(24
)
 
(18
)
Debt issue costs
(16
)
 
—

Other financing activities
(16
)
 
(12
)
Net cash used in financing activities from continuing operations
(469
)
 
(239
)
Effect of foreign currency exchange rate changes on cash and cash equivalents
(9
)
 
16

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

 
84

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

 
82

Net (decrease) increase cash and cash equivalents
(155
)
 
76

Cash and cash equivalents, beginning of the period
662

 
363

Cash and cash equivalents, end of the period
$
507

 
$
439


See notes to unaudited condensed consolidated financial statements.
6
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L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS

1 . Description of Business
L3 Technologies, Inc. (L3 Technologies, Inc. and, together with its subsidiaries, referred to herein as L3 or the Company) is a prime contractor in Intelligence, Surveillance and Reconnaissance (ISR) systems, aircraft sustainment (including modifications and fleet management of special mission aircraft), simulation and training, night vision and image intensification equipment and security and detection systems. L3 is also a leading provider of a broad range of communication, electronic and sensor systems used on military, homeland security and commercial platforms. The Company’s customers include the United States (U.S.) Department of Defense (DoD) and its prime contractors, U.S. Government intelligence agencies, the U.S. Department of Homeland Security (DHS), foreign governments, and domestic and foreign commercial customers.
Effective in the third quarter of 2018, the Company realigned its reportable segments. Prior to the realignment the Company had the following four reportable segments: (1) Electronic Systems, (2) Aerospace Systems, (3) Communication Systems and (4) Sensor Systems. The realignment: (i) combined the Aerospace Systems segment with the Sensor Systems segment to form a new reportable segment named the ISR Systems (ISRS) segment, (ii) moved the Naval Power Systems businesses from the Electronic Systems segment to the Communication Systems segment and changed the name of the Communication Systems segment to the Communications & Networked Systems (C&NS) segment and (iii) moved the Maritime Sensor Systems businesses from the former Sensor Systems segment to the C&NS segment. Accordingly, the Company's current structure consists of the following three segments: (1) ISRS, (2) C&NS and (3) Electronic Systems.
ISRS provides products and services for the global ISR and Command, Control and Communications (C 3 ) markets, specializing in ISR mission solutions from seabed to space, signals intelligence (SIGINT) and multi-intelligence platforms, including engineering, modernization and sustainment solutions for military and various government aircraft, ground support equipment and other platforms. These strategic and tactical products and services provide warfighters with the ability to detect, collect, identify, analyze and disseminate information from command centers, communication nodes and air defense systems for real-time situational awareness and response. Other major capabilities and mission solutions include space avionics and imaging payloads, Counter Unmanned Aircraft Systems mission solutions, cyber and electronic warfare, special mission command & control, modeling & simulation and life cycle support. ISRS sells these products and services primarily to the DoD and select foreign governments. The ISRS business areas are ISR Systems, Aircraft Systems, Airborne Sensor Systems, Space & Sensor Systems, Warrior Sensor Systems, MAS, Advanced Programs and Intelligence & Mission Systems.
C&NS provides network and communication systems, secure communications products, radio frequency (RF) components, satellite communication terminals and space, microwave and telemetry products. These products include secure data links that are used to connect a variety of space, airborne, ground and sea-based communication systems and are used in transmission, processing, recording, monitoring and dissemination functions of these communication systems. Other major capabilities include integrated maritime mission solutions, directed energy, lightweight unmanned undersea vehicles and naval power delivery on submarines and surface ships. C&NS sells these products and services primarily to the DoD and select foreign governments. The C&NS business areas are Broadband Communication Systems, Naval Power Systems, Advanced Communications, Space & Power Systems and Maritime Sensor Systems.
Electronic Systems provides a broad range of products and services, including components, products, subsystems, systems and related services to military and commercial customers. These products and services serve niche markets, such as aircraft simulation and training, power and distribution, cockpit avionics, airport security and precision weapons. Electronic Systems sells these products and services primarily to the DoD and select foreign governments. The Electronic Systems business areas are Commercial Aviation Solutions, Precision Engagement Systems, Link Training & Simulation and Security & Detection Systems.
Financial information with respect to the Company’s segments is included in Note 23 to the unaudited condensed consolidated financial statements.
On June 29, 2018, the Company completed the sale of its Vertex Aerospace businesses for a sale price of $540 million subject to customary closing net working capital adjustments. In connection with the sale, the Company recognized: (1) a pre-tax gain from continuing operations of $44 million ( $22 million after income taxes) related to the Crestview Aerospace and TCS businesses (the "Crestview & TCS Businesses") and (2) a pre-tax gain from discontinued operations of $237 million ( $180 million after income taxes) related to the Vertex Aerospace business. The divestiture of the Vertex Aerospace business represents a strategic shift by the Company to exit the logistics solution and maintenance services business for military aircraft where the Company does not provide complex ISR systems integration and modification. The Vertex Aerospace business generated sales of $1.4 billion


7
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L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


for the year ended December 31, 2017. The assets and liabilities and results of operations of the Vertex Aerospace business are reported as discontinued operations for all periods presented. See Note 5 for additional information.
All references made to financial data in this Quarterly Report on Form 10-Q are to the Company’s continuing operations, unless specifically noted.
2 . Basis of Presentation
These unaudited condensed consolidated financial statements for the quarterly and year-to-date periods ended September 28, 2018 should be read in conjunction with the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 .
Principles of Consolidation and Reporting
The accompanying financial statements comprise the consolidated financial statements of L3. The consolidated financial statements of the Company include all wholly-owned and majority-owned subsidiaries and variable interest entities (VIEs) if the Company is the primary beneficiary. The Company also holds interests in certain VIEs for which it was determined the Company is not the primary beneficiary. All significant intercompany transactions are eliminated in consolidation. Investments in equity securities, joint ventures and limited liability corporations over which the Company has significant influence but does not have control are accounted for using the equity method. Investments over which the Company does not have significant influence are accounted for using the cost method. For the classification of certain current assets and liabilities, the Company uses the duration of the related contract or program as its operating cycle, which may be longer than one year.

Certain reclassifications have been made to conform prior-year amounts to the current-year presentation.
The unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission (SEC). Accordingly, they do not include all of the disclosures required by U.S. GAAP for a complete set of annual audited financial statements. The December 31, 2017 condensed consolidated balance sheet data was derived from audited financial statements but does not include all disclosures required by U.S. GAAP. In the opinion of management, all adjustments (consisting of normal and recurring adjustments) considered necessary for a fair statement of the results for the interim periods presented have been included. The results of operations for the interim periods are not necessarily indicative of results for the full year.
It is generally the Company’s established practice to close its books for the quarters ending March, June and September on the Friday preceding the end of the calendar quarter. The interim unaudited condensed consolidated financial statements included herein have been prepared and are labeled based on that convention. The Company closes its books for annual periods on December 31 regardless of what day it falls on.
Accounting Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of sales and costs of sales during the reporting period. The most significant of these estimates and assumptions for L3 relate to sales, profit and loss recognition related to performance obligations satisfied over time, fair values of assets acquired and liabilities assumed in business combinations and investments, market values for inventories reported at lower of cost or market, pension and postretirement benefit obligations, stock-based employee compensation expense, income taxes, including the valuations of deferred tax assets, litigation reserves, useful lives and valuation of recorded amounts of long-lived assets, identifiable intangible assets and goodwill. Changes in estimates are reflected in the periods during which they become known. Actual amounts may differ from these estimates and could differ materially.
Revenue Recognition
Effective January 1, 2018, the Company adopted Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers, as amended (commonly referred to as ASC 606) using the modified retrospective transition method. The cumulative effect of applying the standard was an increase of $13 million to shareholders' equity as of January 1, 2018. The Company’s statement of operations for the quarterly and year-to-date periods ended September 28, 2018 and the Company’s balance sheet as


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NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


of September 28, 2018 are presented under ASC 606, while the Company’s statement of operations for the quarterly and year-to-date periods ended September 29, 2017 and the Company’s balance sheet as of December 31, 2017 are presented under ASC 605, Revenue Recognition . See Note 3 for disclosure of the impact of the adoption of ASC 606 on the Company’s statement of operations for the quarterly and year-to-date periods ended September 28, 2018 and balance sheet as of September 28, 2018 and the effect of changes made to the Company’s consolidated balance sheet as of January 1, 2018.
A substantial majority of the Company’s consolidated net sales are generated from long-term contracts with customers that require it to design, develop, manufacture, modify, upgrade, test and integrate complex aerospace and electronic equipment and to provide engineering and technical services according to the customers’ specifications. These contracts are primarily with agencies of, and prime system contractors to, the U.S. Government and foreign governments and are generally priced on a fixed-price, cost-plus or time-and-material type basis. Substantially all of the Company's cost-plus and time-and-material type contracts are with the U.S. Government, primarily the DoD. Certain of the Company’s contracts with the U.S. Government are multi-year contracts incrementally funded by the customer. The transaction price on these incrementally funded contracts includes contract value amounts not yet funded by the U.S. Government when the Company has a firm order for the goods or services and it is probable that the customer will fund such amounts. In assessing probability, the Company considers, among other factors, the period of time before contract funding is expected, communication from the customer that indicates funding will be obtained and the Company's history of receiving funding under the current contract or previous similar contracts. The Company also generates sales to a lesser extent from contracts with commercial and government customers for standard product and service offerings, which are priced on a firm fixed basis. See Note 23 for additional information regarding the composition of the Company’s net sales.
The Company records sales for a contract when it has the approval and commitment of all parties, the contract identifies the rights of the parties and payment terms, the contract has commercial substance and collectability of the consideration is probable.
To determine the proper revenue recognition method, the Company first evaluates each of its contractual arrangements to identify its performance obligations. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer. The majority of the Company’s contracts have a single performance obligation because the promise to transfer the individual good or service is not separately identifiable from other promises within the contract and is, therefore, not distinct. These contractual arrangements either require the use of a highly specialized manufacturing process to provide goods according to customer specifications or represent a bundle of contracted goods and services that are integrated and together represent a combined output, which may include the delivery of multiple units. Some of the Company's contracts have multiple performance obligations, primarily (i) related to the provision of multiple goods or services that have alternative use to the Company or that are not substantially the same or (ii) due to the contract covering multiple phases of the product lifecycle (development and engineering, production, maintenance and support). For contracts with more than one performance obligation, the Company allocates the total transaction price in an amount based on the estimated relative standalone selling prices underlying each performance obligation. In cases where a contract requires a customized good or service, the primary method used to estimate standalone selling price is the expected cost plus a margin approach. In cases where the Company sells a standard product or service offering, the standalone selling price is based on an observable standalone selling price.
The majority of the Company's sales are from performance obligations satisfied over time and are primarily with agencies of, and prime system contractors to, the U.S. Government and foreign governments. Sales are recognized over time when control is continuously transferred to the customer during the contract. For U.S. Government contracts, the continuous transfer of control to the customer is supported by contract clauses that provide for (i) progress or performance-based payments or (ii) the unilateral right of the customer to terminate the contract for its convenience, in which case the Company has the right to receive payment for costs incurred plus a reasonable profit for products and services that do not have alternative use to the Company. Foreign government and certain commercial contracts contain similar termination for convenience clauses, or the Company has a legally enforceable right to receive payment for costs incurred and a reasonable profit for products or services that do not have alternative use to the Company. Sales on fixed price and cost-plus type contracts that include performance obligations satisfied over time are generally recorded at amounts equal to the ratio of actual cumulative costs incurred divided by total estimated costs at completion, multiplied by (i) the transaction price, less (ii) the cumulative sales recognized in prior periods (cost-to-cost method).
Accounting for the sales and profits on performance obligations for which progress is measured using the cost-to-cost method involves the preparation of estimates of: (1) transaction price and (2) total costs at completion, which is equal to the sum of the actual incurred costs to date on the contract and the estimated costs to complete the contract's statement of work. Incurred costs include labor, material, overhead and, for the Company's U.S. Government contractor businesses, general and administrative


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


(G&A) expenses. Incurred costs represent work performed, which corresponds with and thereby represents the transfer of control to the customer. The estimated profit or loss at completion on a contract is equal to the difference between the transaction price and the total estimated cost at completion. In the case of a contract related to complex aerospace or electronic equipment for which the total estimated costs exceed the total transaction price, a loss arises, and a provision for the entire loss is recorded in the period that the loss becomes evident. The unrecoverable costs on a loss contract that are expected to be incurred in the future periods are presented on the balance sheet as a component of other current liabilities entitled "Estimated cost in excess of estimated contract value to complete contracts in process in a loss position." See Note 10 for additional information.
The Company’s contracts give rise to variable consideration, including award and incentive fees, as well as amounts incrementally funded by the U.S. Government, or other provisions that can either increase or decrease the transaction price. Award fees provide for a fee based on actual performance relative to contractually specified performance criteria. Incentive fees provide for a fee based on the relationship between total allowable costs and target costs. Variable consideration may require the Company to exercise significant judgment to determine the total transaction price of the contract. The Company includes variable consideration in the transaction price when there is a basis to reasonably estimate the variable amount it will be entitled to receive and it is probable that a significant reversal in revenue recognized will not be required when the uncertainty is resolved. These estimates are based on historical experience, current and forecasted performance, and the Company’s judgment at the time of the evaluation.
Contract modifications routinely occur to account for changes in contract specifications or requirements. In most cases, contract modifications are for goods or services that are not distinct and, therefore, are accounted for as part of the existing contract. Transaction price estimates include additional consideration for submitted contract modifications or claims when the Company believes it has an enforceable right to the modification or claim, the amount can be reliably estimated and its realization is reasonably assured. Amounts representing modifications accounted for as part of the existing contract are included in the transaction price and recognized as an adjustment to sales on a cumulative catch-up basis.
The Company’s fixed-price type contracts with the U.S. Government typically allow for progress payments or performance-based payments. Progress payments are billed to the customer as contract costs are incurred at an amount generally equal to 80% of incurred costs. Performance based payments are billed to the customer upon the achievement of predetermined performance milestones at amounts not to exceed 90% of contract price. On contracts with progress or performance-based payments, the customer often retains a small portion of the contract price until satisfactory completion of the contractual statement of work. Since a small portion of the contract price is retained, the Company generally recognizes sales in excess of billings, which are presented as contract assets on the balance sheet. The portion of the contract price retained by the customer is a normal business practice to ensure satisfactory contract completion and, therefore, is not considered a significant financing component. Contract assets also arise from cost-plus type contracts, time-and-material type contracts and fixed-price services type contracts for revenue amounts that have not been billed by the end of the accounting period due to the timing of preparation of invoices to customers. For certain fixed-price contracts with foreign governments and commercial customers, the Company receives advance payments. Advanced payments are not considered a significant financing component because they are a negotiated contract term to ensure the customer meets its financial obligation, particularly when there are significant upfront working capital requirements. The Company records a liability for advance payments received in excess of sales recognized, which is presented as a contract liability on the balance sheet.
Revisions or adjustments to estimates of the transaction price, estimated costs at completion and estimated profit or loss of a performance obligation are often required as work progresses under a contract, as experience is gained, as facts and circumstances change and as new information is obtained, even though the scope of work required under the contract may not change. Revisions or adjustments may also be required if contract modifications occur. The impact of revisions in profit or loss estimates are recognized on a cumulative catch-up basis in the period in which the revisions are made. The revisions in contract estimates, if significant, can materially affect the Company’s results of operations and cash flows, as well as reduce the valuations of contract assets and inventories, and in some cases result in liabilities to complete contracts in a loss position. The aggregate impact of net changes in contract estimates is presented in the table below.
 
Third Quarter Ended
 
Year-to-Date Ended
 
September 28,
2018
 
September 29,
2017
 
September 28,
2018
 
September 29,
2017
 
(in millions, except per share data)
Operating income
$
56

 
$
55

 
$
172

 
$
139

Diluted earnings per share
$
0.54

 
$
0.44

 
$
1.64

 
$
1.12



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


Net sales recognized from the Company's performance obligations partially satisfied in prior periods were $83 million and $213 million for the quarterly and year-to-date periods ended September 28, 2018 , respectively, and relate to revisions in contract estimates.
Sales from performance obligations satisfied at a point in time are typically for standard goods and are recognized when the customer obtains control, which is generally upon delivery and acceptance. The Company also records sales for performance obligations relating to standard services (i.e., maintenance and extended warranties covering standard goods sold by the Company) over time by using output measures of time elapsed to measure progress toward satisfying the performance obligation.
Sales on time-and-material type contracts are generally recognized each period based on the amount billable to the customer, which is based on direct labor hours expended multiplied by the contractual fixed rate per hour, plus the actual costs of materials and other direct non-labor costs.
The following table presents a summary of the Company’s net sales by revenue recognition method as a percentage of total net sales for the year-to-date period ended September 28, 2018 .
 
% of Total Net Sales
Cost to cost method
75
%
Point in time
18
%
Output method
4
%
Billing method
3
%
Total
100
%
Remaining Performance Obligations
On September 28, 2018 , the Company had $11.0 billion of remaining performance obligations, which represents the transaction price of firm orders less inception to date sales recognized. Remaining performance obligations exclude unexercised contract options and potential orders under basic ordering agreements or master-type contracts (i.e., indefinite-delivery, indefinite-quantity). The Company expects to recognize sales relating to existing performance obligations of approximately $2.5 billion during the remainder of 2018, $5.4 billion in 2019, $1.7 billion in 2020 and $1.4 billion in the periods thereafter.
General and Administrative Expenses
The Company accounts for the portion of their G&A, independent research and development (IRAD) and bids and proposal (B&P) costs that are allowable and reimbursable under U.S. Government procurement regulations on their U.S. Government contracts as contract costs which are charged to costs of sales when sales on the related contracts are recognized. The Company’s U.S. Government contractor businesses record the unallowable portion of their G&A, IRAD and B&P costs to expense as incurred. G&A expenses for the Company's commercial businesses are expensed as incurred. The total research and development expenses incurred were $82 million and $243 million for the quarterly and year-to-date period s ended September 28, 2018 , respectively. The total research and development expenses incurred were $75 million and $203 million for the quarterly and year-to-date period s ended September 29, 2017 , respectively.
The Company capitalizes the incremental costs of obtaining a contract with foreign governments and foreign and domestic commercial customers (third-party sales commissions) if the Company expects to recover the costs under the contract. The Company expenses the costs to obtain a contract as incurred when the expected amortization period is one year or less. The Company classifies the portion of capitalized costs of obtaining a contract to be amortized over the next 12 months within prepaid expense and other current assets and classifies the remaining amount within other assets in its consolidated balance sheets.
Investments in and Loans to Nonconsolidated Affiliates
The Company’s investments in nonconsolidated affiliates are primarily accounted for using the equity method of accounting and are carried at cost, plus or minus the Company’s share of net earnings or losses of the investment, subject to certain other adjustments. The cost of equity method investments includes transaction costs of the acquisition. As required by U.S. GAAP, to the extent that there is a basis difference between the cost and the underlying equity in the net assets of an equity investment, the Company allocates such differences between tangible and intangible assets. The Company’s share of net earnings or losses of


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


the investment, inclusive of amortization expense for any basis difference associated with the investment, are presented in interest and other income, net, on the Company’s consolidated statements of operations. Dividends received from the investee reduce the carrying amount of the investment. Due to the timing of receiving financial information from its nonconsolidated affiliates, the Company may record its share of net earnings or losses of such affiliates on a three -month lag basis, with the exception of the amortization expense of any basis difference related to tangible and intangible assets which are recorded currently.
3 . New Accounting Standards Implemented
Effective January 1, 2018, the Company adopted Financial Accounting Standards Board (FASB) ASU 2017-07, Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost . Defined benefit pension and postretirement benefit cost (net benefit cost) comprise several components that reflect different aspects of the Company’s financial arrangements as well as the cost of benefits provided to employees. Under previous U.S. GAAP, those components were aggregated for reporting in the financial statements and presented within the operating section of the income statement or capitalized into assets (inventories) when appropriate. The amendments in this update require the Company to report the service cost component in the same line item as other compensation costs arising from services rendered by the employees during the period. The other components of net benefit cost are required to be presented separately from the service cost component and below income from operations. Plan administrative expenses, which were previously included in service cost, are presented together with expected return on plan assets, as a component of Interest and other income, net. The amendments in this update also allow only the service cost component to be eligible for capitalization when applicable. The amendments in this update have been applied retrospectively for the presentation of the components of net benefit cost and prospectively for the capitalization of the service cost component of net benefit cost. The adoption of this standard decreased operating income and increased interest and other income, net, each by $4 million and $9 million for the quarterly and year-to-date periods ended September 28, 2018 , respectively, and increased operating income and decreased interest and other income, net, each by $3 million and $6 million for the quarterly and year-to-date periods ended September 29, 2017 , respectively. The adoption of this standard did not impact pre-tax income for the quarterly and year-to-date periods ended September 28, 2018 and September 29, 2017 .
In January 2017, the FASB issued ASU 2017-01, Clarifying the Definition of a Business , which provides additional guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The amendments in this update provide new guidance to determine when an integrated set of assets and activities (collectively referred to as a ‘‘set’’) is not a business. The new guidance requires that, when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. The new guidance reduces the number of transactions that need to be evaluated as a business. The Company adopted this amendment as of January 1, 2018. The adoption of ASU 2017-01 did not have a material impact on the Company's financial statements for the year-to-date period ended September 28, 2018 .
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers , as amended (commonly referred to as ASC 606), which replaces numerous requirements in U.S. GAAP, including industry-specific requirements, and provides companies with a single revenue recognition model for recognizing revenue from contracts with customers and significantly expanded the disclosure requirements for revenue arrangements. The new standard, as amended, was effective for the Company for interim and annual reporting periods beginning on January 1, 2018.
As discussed in Note 2 , the Company adopted ASC 606 using the modified retrospective transition method. Results for reporting periods beginning after December 31, 2017 are presented under ASC 606, while prior period comparative information has not been restated and continues to be reported in accordance with ASC 605, Revenue Recognition, the accounting standard in effect for periods ending prior to January 1, 2018. With the adoption of ASC 606, the Company recognizes sales over time by using the cost-to-cost method on most of its (i) contracts that were covered by the contract accounting standards under ASC 605 and (ii) fixed-price type contracts that require it to perform services that are not related to the production of tangible assets. Accordingly, the adoption of ASC 606 primarily impacted certain (i) contracts previously covered by contract accounting standards that recognized revenue using the units-of-delivery method and (ii) fixed-price type contracts for services that are not related to the production of tangible assets that recognized revenue on a straight-line basis over the contractual service period.
    
Based on contracts in process at December 31, 2017, the Company recorded, upon adoption of ASC 606, a net increase to retained earnings of $13 million , which includes the acceleration of net sales of approximately $380 million and the related cost of sales. The adjustment to retained earnings primarily relates to contracts previously accounted for under the units-of-delivery method, which is recognized under ASC 606 earlier in the performance period as costs are incurred, as opposed to when the units are delivered under ASC 605. In accordance with the modified retrospective transition provisions of ASC 606, the Company will


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


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


13
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L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


The table below presents the cumulative effect of the changes made to the consolidated January 1, 2018 balance sheet due to the adoption of ASC 606.
BALANCE SHEET
December 31, 2017
As Reported
Under ASC 605
 
Adjustments Due
to ASC 606
 
January 1, 2018
As Adjusted
Under ASC 606
 
 
 
(in millions)
 
 
Assets
 
 
 
 
 
Current assets:
 
 
 
 
 
Contract assets
$
—

 
$
1,349

 
$
1,349

Contracts in process
1,933

 
(1,933
)
 
—

Inventories
389

 
537

 
926

Prepaid expenses and other current assets
300

 
17

 
317

Assets held for sale
135

 
3

 
138

Assets of discontinued operations
306

 
(21
)
 
285

Total current assets
4,448

 
(48
)
 
4,400

Other assets
264

 
49

 
313

Total assets
$
12,729

 
$
1

 
$
12,730

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Current liabilities:
 
 
 
 
 
Accrued expenses
$
217

 
$
(13
)
 
$
204

Contract liabilities
—

 
565

 
565

Advance payments and billing in excess of costs incurred
509

 
(509
)
 
—

Other current liabilities
367

 
(49
)
 
318

Liabilities held for sale
17

 
(1
)
 
16

Liabilities of discontinued operations
226

 
(23
)
 
203

Total current liabilities
2,379

 
(30
)
 
2,349

Deferred income taxes
158

 
4

 
162

Other liabilities
398

 
14

 
412

Total liabilities
7,578

 
(12
)
 
7,566

Shareholders' Equity
 
 
 
 
 
Retained earnings
6,659

 
13

 
6,672

Total equity
$
5,151

 
$
13

 
$
5,164



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


The tables below present the impact of the adoption of ASC 606 on the Company's statement of operations.
 
Third Quarter Ended September 28, 2018
STATEMENT OF OPERATIONS
Under
ASC 605
 
Effect of
ASC 606
 
As Reported
Under ASC 606
 
 
 
(in millions)
 
 
Net Sales:
 
 
 
 
 
Products
$
1,723

 
$
13

 
$
1,736

Services
772

 
11

 
783

Total
2,495

 
24

 
2,519

 
 
 
 
 
 
Operating costs and expenses:
 
 
 
 
 
Cost of sales — Products
$
(1,271
)
 
$
(53
)
 
$
(1,324
)
Cost of sales — Services
(540
)
 
22

 
(518
)
 General and administrative expenses
(421
)
 
25

 
(396
)
 Loss on sale of the Crestview & TCS Businesses
(4
)
 
—

 
(4
)
 Merger, acquisition and divestiture related expenses
(5
)
 
—

 
(5
)
Operating income
254

 
18

 
272

Income from continuing operations before income taxes
208

 
18

 
226

Provision for income taxes
(14
)
 
(4
)
 
(18
)
Income from continuing operations
194

 
14

 
208

Income from discontinued operations, net of income taxes
2

 
(2
)
 
—

Net income
196

 
12

 
208

Net income attributable to L3
$
190

 
$
12

 
$
202

 
 
 
 
 
 
Basic earnings per share attributable to common shareholders:
 
 
 
 
 
Continuing operations
$
2.39

 
$
0.18

 
$
2.57

Discontinued operations
0.03

 
(0.03
)
 
—

Basic earnings per share
$
2.42

 
$
0.15

 
$
2.57

Diluted earnings per share attributable to common shareholders:
 
 
 
 
 
Continuing operations
$
2.37

 
$
0.17

 
$
2.54

Discontinued operations
0.02

 
(0.02
)
 
—

Diluted earnings per share
$
2.39

 
$
0.15

 
$
2.54



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


 
Year-to-Date Ended September 28, 2018
STATEMENT OF OPERATIONS
Under
ASC 605
 
Effect of
ASC 606
 
As Reported
Under ASC 606
 
 
 
(in millions)
 
 
Net Sales:
 
 
 
 
 
Products
$
5,038

 
$
130

 
$
5,168

Services
2,290

 
15

 
2,305

Total
7,328

 
145

 
7,473

 
 
 
 
 
 
Operating costs and expenses:
 
 
 
 
 
Cost of sales — Products
$
(3,732
)
 
$
(132
)
 
$
(3,864
)
Cost of sales — Services
(1,629
)
 
1

 
(1,628
)
 General and administrative expenses
(1,198
)
 
22

 
(1,176
)
 Gain on sale of the Crestview & TCS Businesses
43

 
1

 
44

 Merger, acquisition and divestiture related expenses
(5
)
 
—

 
(5
)
Operating income
807

 
37

 
844

Income from continuing operations before income taxes
642

 
37

 
679

Provision for income taxes
(81
)
 
(9
)
 
(90
)
Income from continuing operations
561

 
28

 
589

Income from discontinued operations, net of income taxes
208

 
(2
)
 
206

Net income
769

 
26

 
795

Net income attributable to L3
$
754

 
$
26

 
$
780

 
 
 
 
 
 
Basic earnings per share attributable to common shareholders:
 
 
 
 
 
Continuing operations
$
6.96

 
$
0.36

 
$
7.32

Discontinued operations
2.66

 
(0.03
)
 
2.63

Basic earnings per share
$
9.62

 
$
0.33

 
$
9.95

Diluted earnings per share attributable to common shareholders:
 
 
 
 
 
Continuing operations
$
6.86

 
$
0.35

 
$
7.21

Discontinued operations
2.61

 
(0.02
)
 
2.59

Diluted earnings per share
$
9.47

 
$
0.33

 
$
9.80

The following table quantifies the impact of adopting ASC 606 on segment net sales and segment operating income for the quarterly and year-to-date periods ended September 28, 2018 .
 
Effect of ASC 606
 
Third Quarter Ended September 28, 2018
 
Year-to-Date Ended September 28, 2018
 
Sales
 
Operating Income
 
Sales
 
Operating Income
 
(in millions)
ISRS
$
25

 
$
10

 
$
47

 
$
12

C&NS
(18
)
 
2

 
43

 
12

Electronic Systems
17

 
6

 
55

 
12

Segment totals
$
24

 
$
18

 
$
145

 
$
36



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


The table below presents the impact of the adoption of ASC 606 on the Company's balance sheet.
 
September 28, 2018
BALANCE SHEET
Under
ASC 605
 
Effect of
ASC 606
 
As Reported
Under ASC 606
 
 
 
(in millions)
 
 
Assets
 
 
 
 
 
Current assets:
 
 
 
 
 
Contract assets
$
—

 
$
1,707

 
$
1,707

Contracts in process
2,237

 
(2,237
)
 
—

Inventories
406

 
505

 
911

Prepaid expenses and other current assets
371

 
39

 
410

Total current assets
4,446

 
(11
)
 
4,435

Other assets
298

 
47

 
345

Total assets
$
13,148

 
$
36

 
$
13,184

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Current liabilities:
 
 
 
 
 
Accrued expenses
$
288

 
$
(20
)
 
$
268

Contract liabilities
—

 
578

 
578

Advance payments and billings in excess of costs incurred
536

 
(536
)
 
—

Other current liabilities
351

 
(52
)
 
299

Total current liabilities
2,290

 
(30
)
 
2,260

Deferred income taxes
209

 
12

 
221

Other liabilities
427

 
15

 
442

Total liabilities
7,476

 
(3
)
 
7,473

Shareholders' Equity
 
 
 
 
 
Retained earnings
7,224

 
39

 
7,263

Total equity
$
5,672

 
$
39

 
$
5,711

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


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FINANCIAL STATEMENTS — CONTINUED


2019. The Company does not expect the adoption of this standard to have a material effect on its financial position, results of operations or cash flows.
In February 2016, the FASB issued ASU 2016-02, Leas es, which updates the existing guidance on accounting for leases and requires new qualitative and quantitative disclosures about the Company’s leasing activities. The new standard requires the Company to recognize lease assets and lease liabilities on the balance sheet for all leases under which the Company is the lessee, including those classified as operating leases under previous accounting guidance. The Company will measure leases commencing after the adoption date based on the present value of the lease payments due over the lease term (as defined in ASU 2016-02). The Company will measure and recognize its existing leases on the date of adoption based on the present value of the remaining minimum lease payments, as defined in existing guidance on accounting for leases. The new standard, as amended, will be effective for the Company for interim and annual reporting periods beginning on January 1, 2019, with early adoption permitted. The standard currently allows two transition methods whereby the Company may elect either to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements, with certain practical expedients available, or to initially apply the new leases standard at January 1, 2019 and recognize a cumulative-effect adjustment to the opening balance of retained earnings. The Company expects to adopt the standard as of January 1, 2019, by recognizing a cumulative-effect adjustment to the opening balance of retained earnings at January 1, 2019, in the Company’s Quarterly Report on Form 10-Q for the first quarter of 2019.
Progress implementing the new standard to date includes: (1) selecting a lease accounting system, (2) electing to apply the transition practical expedients that allows the Company to rely on historical assessments of whether its contracts contain a lease and to use the same lease classifications applied under existing accounting guidance and (3) accumulating the data required to measure existing leases and prepare required disclosures. While the Company will complete its determination of the impact of adopting this standard on its consolidated financial statements in the first quarter of 2019, the Company does not expect ASU 2016-02 will have a material impact on its results of operations or cash flows. See Note 18 to the audited consolidated financial statements for the year ended December 31, 2017, included in the Company’s Annual Report on Form 10-K for additional information about the Company’s leases, including the future minimum lease payments of the Company's operating leases at December 31, 2017. In addition, the Company is in the process of redrafting its accounting policies and internal controls over financial reporting relating to lease accounting, and drafting the expanded disclosures.
Other accounting standard updates effective for interim and annual periods beginning after December 31, 2018 , are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
5 . Acquisitions, Divestitures and Discontinued Operations
Business Acquisitions
The Company continually evaluates potential acquisitions that either strategically fit within the Company’s existing portfolio or expand the Company’s portfolio into new product lines or adjacent markets. The Company has completed a number of acquisitions that have been accounted for as business combinations and have resulted in the recognition of goodwill in the Company’s financial statements. This goodwill includes the know-how of the assembled workforce, the ability of the workforce to further improve technology and product offerings and the expected cash flows resulting from these efforts. Goodwill may also include expected synergies resulting from the complementary strategic fit these businesses bring to existing operations. The business acquisitions discussed below are included in the Company’s results of operations from their respective dates of acquisition.
2018 Business Acquisitions
ASV Global, L.L.C. (ASV Global). On September 20, 2018, the Company acquired ASV Global, L.L.C., renamed L3 ASV, for a purchase price of $94 million , which was financed with cash on hand. ASV Global is a leading unmanned surface vessel (USV) and autonomous vessel control systems company. The goodwill recognized for this business was $63 million , of which $20 million is expected to be deductible for income tax purposes and was assigned to the C&NS segment. The Company also recognized a preliminary estimate for technology intangible assets of $30 million , which is expected to be amortized over 15 years. The final purchase price is subject to customary adjustments for final working capital. The final purchase price allocation, which is expected to be completed in the first quarter of 2019, will be based on final appraisals and other analysis of fair values of acquired assets and liabilities. The Company does not expect that differences between the preliminary and final purchase price allocation will have a material impact on its results of operations or financial position.


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FINANCIAL STATEMENTS — CONTINUED


C.K. Industrial Engineers Limited. (C.K. Industrial Engineers). On September 18, 2018, the Company acquired C.K. Industrial Engineers Limited, for a purchase price of £18 million (approximately $24 million ), excluding adjustments for £3 million (approximately $4 million ) of cash acquired, which was financed with cash on hand. C.K. Industrial Engineers is a U.K.-based provider of specialized tooling and equipment used primarily in robotic solutions for automotive manufacturing. The goodwill recognized for this business was $11 million , which was assigned to the Electronic Systems segment and is not expected to be deductible for income tax purposes. The final purchase price is subject to customary adjustments for final working capital. The final purchase price allocation, which is expected to be completed in the first quarter of 2019, will be based on final appraisals and other analysis of fair values of acquired assets and liabilities. The Company does not expect that differences between the preliminary and final purchase price allocation will have a material impact on its results of operations or financial position.
Azimuth Security and Linchpin Labs . (Azimuth Security and Linchpin Labs). On August 31, 2018, the Company acquired Azimuth Security and Linchpin Labs, renamed L3 Trenchant, for a combined purchase price of AUD $249 million (approximately $185 million ), net of cash acquired of AUD $21 million (approximately $15 million ), which was financed with cash on hand. The purchase price is subject to an upward adjustment for contingent consideration of up to AUD $43 million (approximately $31 million ), payable in a fixed number of shares of L3 common stock not to exceed 161,087 shares, based on L3 Trenchant's post-acquisition sales for each of the 12-month periods ending June 30, 2019, 2020 and 2021. Azimuth Security and Linchpin Labs are two information security businesses that significantly strengthen the Company's existing C 6 ISR (Command, Control, Communications, Computers, Cyber-Defense and Combat Systems, and Intelligence, Surveillance and Reconnaissance) capabilities and create synergies to drive future growth in cyber and international markets. The Company recorded a $6 million increase to equity for the preliminary acquisition date fair value of the contingent consideration . The goodwill recognized for this business was $108 million , of which $19 million is expected to be deductible for income tax purposes and was assigned to the ISRS segment. The Company also recognized a preliminary estimate for intangible assets of $98 million , primarily relating to technology and customer relationships. The technology and customer relationship intangibles are expected to be amortized over 5 years and 20 years, respectively. The final purchase price is subject to customary adjustments for final working capital. The final purchase price allocation, which is expected to be completed in the second quarter of 2019, will be based on final appraisals and other analysis of fair values of acquired assets and liabilities. The Company does not expect that differences between the preliminary and final purchase price allocation will have a material impact on its results of operations or financial position.
Applied Defense Solutions, Inc. (Applied Defense Solutions). On June 29, 2018, the Company acquired Applied Defense Solutions, Inc., renamed L3 ADS, Inc., for a purchase price of $53 million , excluding adjustments for approximately $1 million of cash acquired, which was financed with cash on hand. Applied Defense Solutions is a leading aerospace engineering, software development and space situational awareness company. The goodwill recognized for this business was $41 million , which was assigned to the ISRS segment, and is not expected to be deductible for income tax purposes. The final purchase price is subject to customary adjustments for final working capital. The final purchase price allocation, which is expected to be completed in the fourth quarter of 2018, will be based on final appraisals and other analysis of fair values of acquired assets and liabilities. The Company does not expect that differences between the preliminary and final purchase price allocation will have a material impact on its results of operations or financial position.
Latitude Engineering, LLC (Latitude Engineering). On June 28, 2018, the Company acquired Latitude Engineering, LLC, renamed L3 Latitude Engineering, Inc., for a purchase price of $15 million , which was financed with cash on hand. The purchase price is subject to additional contingent consideration not to exceed $20 million , $15 million of which is based on Latitude Engineering’s post-acquisition financial performance for the four year period ending December 31, 2021, and the remaining $5 million is based on certain post-acquisition milestone achievements through December 31, 2020. Latitude Engineering is engaged in the design, manufacturing, integration, servicing, operation and support of hybrid quadrotor unmanned aerial systems. The Company recorded a $5 million liability as of the acquisition date for the fair value of the contingent consideration. The goodwill recognized for this business was $14 million , of which $9 million is expected to be deductible for income tax purposes and was assigned to the Electronic Systems segment. The final purchase price is subject to customary adjustments for final working capital. The final purchase price allocation, which is expected to be completed in the fourth quarter of 2018, will be based on final appraisals and other analysis of fair values of acquired assets and liabilities. The Company does not expect that differences between the preliminary and final purchase price allocation will have a material impact on its results of operations or financial position.
2017 Business Acquisitions
The final purchase price and final purchase price allocations for the 2017 acquisitions of Kigre, Inc. (Kigre), Escola De Aviacao Aerocondor, S.A. (G-Air), Doss Aviation, Inc. (Doss Aviation) and Adaptive Methods, Inc. (Adaptive Methods) have been finalized as of the third quarter of 2018. The final purchase price allocations resulted in a $7 million increase to goodwill.


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NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


See Note 3 to the audited consolidated financial statements for the year ended December 31, 2017 , included in the Company’s Annual Report on Form 10-K for additional information about the Company’s 2017 business acquisitions.
Unaudited Pro Forma Statements of Operations Data
The following unaudited pro forma Statements of Operations data present the combined results of the Company and its business acquisitions completed during the year-to-date period ended September 28, 2018 and the year ended December 31, 2017 , assuming that the business acquisitions completed during 2018 and 2017 had occurred on January 1, 2017 and January 1, 2016 , respectively. The unaudited pro forma Statements of Operations data below include adjustments for additional amortization expense related to acquired intangible assets and depreciation assuming the 2018 and 2017 acquisitions had occurred on January 1, 2017 and January 1, 2016 , respectively.
 
Third Quarter Ended
 
Year-to-Date Ended
 
September 28,
2018
 
September 29,
2017
 
September 28,
2018
 
September 29,
2017
 
(in millions, except per share data)
Pro forma net sales
$
2,536

 
$
2,338

 
$
7,553

 
$
7,134

Pro forma income from continuing operations attributable to L3
$
204

 
$
144

 
$
577

 
$
486

Pro forma net income attributable to L3
$
204

 
$
23

 
$
783

 
$
388

Pro forma diluted earnings per share from continuing operations
$
2.57

 
$
1.80

 
$
7.25

 
$
6.10

Pro forma diluted earnings per share
$
2.57

 
$
0.29

 
$
9.84

 
$
4.87

The unaudited pro forma results disclosed in the table above are based on various assumptions and are not necessarily indicative of the results of operations that would have occurred had the Company completed these acquisitions on the dates indicated above.
Investments in Nonconsolidated Affiliates
Peak Nano Optics, LLC (Peak Nano). On February 6, 2018, the Company acquired a 25% interest in Peak Nano Optics, LLC, for a purchase price of $20 million . Peak Nano is a nanotechnology company, which allows for the design and manufacturing of polymer lenses for military, sporting and commercial optics applications using its nanolayer gradient refractive index technology. The purchase price included a contingent payment of $30 million based upon Peak Nano meeting certain technical milestones on or before August 5, 2018. The Company recorded $6 million for the fair value of the contingent consideration liability on the investment date. During the quarter ended September 28, 2018, the Company reduced the fair value of the contingent consideration liability to zero as the technical milestones were not met by the deadline. Notwithstanding that Peak Nano missed the contractual deadline to meet certain technical milestones, based on continued monitoring and interactions with Peak Nano, the Company anticipates Peak Nano will achieve the technical milestones by the end of 2018.
The Company determined Peak Nano is a VIE as it did not have sufficient equity at risk to finance its activities. The Company, however, is not the primary beneficiary because it does not have the power to direct the activities that are most significant to the economic performance of Peak Nano. Accordingly, Peak Nano is accounted for under the equity method of accounting.
As of the acquisition date, the carrying amount of the investment was greater than the Company's equity in the underlying assets of Peak Nano due primarily to the difference in the carrying amount of the indefinite-lived amortizable intangible assets including goodwill and in-process research and development (IPR&D). The basis difference attributable to goodwill and IPR&D is $11 million and $13 million , respectively.
Business Divestitures
2018 Divestitures
As discussed in Note 1 , on June 29, 2018, the Company completed the sale of its Crestview & TCS Businesses . The assets and liabilities of the Crestview & TCS Businesses are classified as held for sale in the Company’s audited consolidated balance sheet as of December 31, 2017. The Crestview & TCS Businesses , which were within the Company’s ISRS segment, primarily provided aircraft fabrication and assembly of fixed and rotary wing aero structures as well as avionics hardware and software


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NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


systems to address mission critical needs. The table below presents Crestview & TCS Businesses ’ results of operations and is included in continuing operations.
 
Year-to-Date Ended
 
September 28, 2018
 
(in millions)
Net Sales
$
64

Gain on sale of businesses
$
44

Income from continuing operations before income taxes
$
47

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

Contracts in process
33

Total current assets
47

Property, plant and equipment, net
34

Goodwill
52

Identifiable intangible assets
2

Total assets classified as held for sale
$
135

 
 
Liabilities
 
Accounts payable, trade
$
3

Accrued employment costs
2

Accrued expenses
3

Other current liabilities
5

Total current liabilities
13

Deferred income taxes
4

Total liabilities classified as held for sale
$
17



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NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


Discontinued Operations
Vertex Aerospace. As discussed in Note 1 , on June 29, 2018, the Company completed the sale of its Vertex Aerospace business. The table below presents the statements of operations data for Vertex Aerospace. The amounts presented in discontinued operations include allocated interest expenses for debt not directly attributable or related to L3’s other operations. Interest expense was allocated in accordance with the accounting standards for discontinued operations and were based on the ratio of Vertex Aerospace’s net assets to the sum of: (1) L3 consolidated total net assets and (2) L3 consolidated total debt.
 
Third Quarter Ended
 
Year-to-Date Ended
 
September 28,
2018
 
September 29,
2017
 
September 28,
2018
 
September 29,
2017
 
(in millions)
Net sales
$
—

 
$
357

 
$
597

 
$
1,060

Operating costs and expenses (1)
—

 
(524
)
 
(561
)
 
(1,191
)
Operating (loss) income from discontinued operations
—

 
(167
)
 
36

 
(131
)
Interest expense allocated to discontinued operations
—

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

 
—

 
237

 
—

(Loss) income from discontinued operations before income taxes
—

 
(168
)
 
272

 
(132
)
Income tax benefit (expense)
—

 
47

 
(66
)
 
34

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

 
$
(121
)
 
$
206

 
$
(98
)
__________________
(1)  
The Company recognized $3 million and $1 million of trailing expenses related to the sale of National Security Solutions for the year-to-date period s ended September 28, 2018 and September 29, 2017 , respectively.
The major classes of assets and liabilities that were included in discontinued operations related to Vertex Aerospace are presented in the table below. These balances were classified as current at December 31, 2017 as the sale was expected to be completed within one year and the proceeds are not expected to be used to pay down long-term debt.
 
December 31,
2017
 
(in millions)
Assets
 
Current assets
$
284

Property, plant and equipment, net
13

Other intangible assets
7

Other assets
2

Total assets of discontinued operations
$
306

 
 
Liabilities
 
Accounts payable, trade
$
63

Other current liabilities
131

Current liabilities
194

Long-term liabilities
32

Total liabilities of discontinued operations
$
226




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NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


2017 Divestitures
During the year-to-date period ended September 29, 2017 , the Company completed the sales of the CTC Aviation Jet Services Limited (Aviation Jet Services) business, the L3 Coleman Aerospace (Coleman) business and the Display Product Line. The table below presents pre-tax (loss) gain recognized, the proceeds received and net sales included in continuing operations from these divestitures.
 
Year-to-Date Ended September 29, 2017
 
Pre-Tax (Loss) gain
 
Proceeds Received
 
Net Sales
 
(in millions)
Aviation Jet Services divestiture
$
(5
)
 
$
1

 
$
1

Coleman divestiture
(3
)
 
17

 
9

Display Product Line divestiture
4

 
7

 
—

Total
$
(4
)
 
$
25

 
$
10

Aviation Jet Services Divestiture.  On March 1, 2017, the Company divested its Aviation Jet Services business for a sales price of £1 million (approximately $1 million ). Aviation Jet Services provided non-core aircraft management and operational services as part of commercial training solutions based in the United Kingdom and was included in the Electronic Systems segment.
Coleman Divestiture.  On February 24, 2017, the Company divested its Coleman business for a sales price of $15 million . Coleman provided air-launch ballistic missile targets and was included in the Electronic Systems segment.
Display Product Line Divestiture.  On February 23, 2017, the Company divested its Display Product Line for a sales price of $7 million . The Display Product Line provided cockpits to various military aircraft and was included in the Electronic Systems segment.
Net sales and income before income taxes for Aviation Jet Services, Coleman and the Display Product Line, included in L3’s consolidated statements of operations, are presented in the table below on an aggregate basis and are included in income from continuing operations for all periods presented.
 
Year-to-Date Ended
 
September 29, 2017
 
(in millions)
Net sales
$
10

Income before income taxes
$
2

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


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NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


The table below presents the components of net contract assets.
 
September 28,
2018
 
January 1,
2018
 
(in millions)
Contract assets
$
1,707

 
$
1,349

Contract liabilities — current
(578
)
 
(565
)
Contract liabilities — non-current
(31
)
 
(28
)
Net contract assets
$
1,098

 
$
756

Contract assets increased from January 1, 2018 to September 28, 2018 by $358 million primarily due to sales exceeding billings due to contractual billing terms on U.S. Government contracts across all business areas, with the largest increases from ISR Systems, Link Training & Simulation, Space & Power Systems and Aircraft Systems. Contract liabilities increased by $16 million primarily due to advances received by ISR Systems for aircraft procurements related to U.S. and foreign government contracts and performance obligations assumed in connection with the acquisition of Trenchant, partially offset by decreases due to the liquidation of advances received by Link Training & Simulation and Advanced Communications resulting from performance on customer contracts.
The Company did not recognize any impairment losses on contract assets during the quarterly and year-to-date period s ended September 28, 2018 .
For the year-to-date period ended September 28, 2018 , the Company recognized sales of $403 million related to its contract liabilities at January 1, 2018.
The components of contract assets are presented in the table below.
 
September 28,
2018
 
January 1,
2018
 
(in millions)
Unbilled contract receivables, gross
$
2,827

 
$
2,232

Unliquidated progress payments and advances
(1,120
)
 
(883
)
Total contract assets
$
1,707

 
$
1,349

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

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

Inventoried contract costs, gross
891

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

Total contracts in process
$
1,933



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NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


The table below presents a summary of G&A, IRAD and B&P costs included in inventoried contract costs and the changes to them, including amounts charged to operating costs and expenses by the Company’s U.S. Government contractor businesses for the quarterly and year-to-date periods ended September 29, 2017 .
 
Third Quarter Ended
 
Year-to-Date Ended
 
September 29, 2017
 
September 29, 2017
 
(in millions)
Amounts included in inventoried contract costs at beginning of the period
$
174

 
$
173

Contract costs incurred:
 
 
 
IRAD and B&P
88

 
242

Other G&A
211

 
610

Total
299

 
852

Amounts charged to operating costs and expenses
(294
)
 
(846
)
Amounts included in inventoried contract costs at end of the period
$
179

 
$
179

8 . Inventories
Inventories at Lower of Cost or Realizable Value.  The table below presents the components of inventories at the lower of cost (first-in, first-out or average cost) or realizable value. The Company's inventories at December 31, 2017 were comprised primarily of amounts related to standard products. In addition, the Company classified inventories related to contracts for complex aerospace and electronic equipment and engineering and technical services according to the customers' specifications as inventoried contract costs, which was a component of contracts in process on the consolidated balance sheet at December 31, 2017. See Note 7 for additional information. In accordance with ASC 606, all work in process that customers do not currently control are classified within inventories on the Company's consolidated balance sheet at September 28, 2018 , without regard to whether the goods promised to the customer are standard or customized.
 
September 28,
2018
 
December 31,
2017
 
(in millions)
Raw materials, components and sub-assemblies
$
319

 
$
184

Work in process
404

 
98

Finished goods
188

 
107

Total
$
911


$
389

Inventories at September 28, 2018 included G&A costs of $53 million . G&A costs incurred and recorded in inventories totaled $887 million during the year-to-date period ended September 28, 2018 , and G&A costs charged to expense from inventories totaled $891 million during the year-to-date period ended September 28, 2018 . See Note 7 for information on G&A costs included in contracts in process for the quarterly and year-to-date periods ended September 29, 2017 .


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9 . Goodwill and Identifiable Intangible Assets
Goodwill.  In accordance with the accounting standards for business combinations, the Company records the assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition (commonly referred to as the purchase price allocation). The table below presents the changes in goodwill allocated to the Company’s reporting units in each reportable segment.
 
ISRS
 
C&NS
 
Electronic Systems
 
Consolidated Total
 
(in millions)
Goodwill
$
2,504

 
$
1,977

 
$
2,238

 
$
6,719

Accumulated impairment losses
(46
)
 
(15
)
 
(43
)
 
(104
)
December 31, 2017
2,458


1,962


2,195


6,615

Business acquisitions (1)
150

 
65

 
30

 
245

Foreign currency translation adjustments
(9
)
 
(4
)
 
(13
)
 
(26
)
September 28, 2018
2,599


2,023


2,212


6,834

Goodwill
2,645

 
2,038

 
2,255

 
6,938

Accumulated impairment losses
(46
)
 
(15
)
 
(43
)
 
(104
)
 
$
2,599


$
2,023


$
2,212


$
6,834

__________________
(1)  
The increase for the ISRS segment was due to the acquisitions of the Azimuth Security, Linchpin Labs and Applied Defense Solutions businesses and the purchase price allocation adjustments for the Kigre business acquisition. The increase for the C&NS segment was due to the acquisition of the ASV Global business and purchase price allocation adjustments for the Adaptive Methods business acquisition. The increase for the Electronic Systems segment was due to the acquisitions of the Latitude Engineering and C.K. Industrial Engineers businesses and the purchase price allocation adjustments for the G-Air and Doss Aviation business acquisitions.
Identifiable Intangible Assets.  The most significant identifiable intangible asset that is separately recognized for the Company’s business acquisitions is customer contractual relationships. All of the Company’s 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 for working capital) arising from the follow-on sales on contract (revenue arrangement) renewals expected from the customer contractual relationships over their estimated lives, including the probability of expected future contract renewals and sales, less a contributory assets charge, all of which is discounted to present value. The Company’s indefinite-lived intangible assets include IPR&D.
The table below presents information for the Company’s identifiable intangible assets that are subject to amortization and indefinite-lived intangible assets.
 
 
 
September 28, 2018
 
December 31, 2017
 
Weighted Average   Amortization Period
 
Gross   Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
 
(in years)
 
(in millions)
Customer contractual relationships
16
 
$
444

 
$
280

 
$
164

 
$
393

 
$
257

 
$
136

Technology
9
 
262

 
124

 
138

 
189

 
114

 
75

Other
10
 
61

 
15

 
46

 
29

 
14

 
15

Total subject to amortization

 
767


419


348


611


385


226

IPR&D
indefinite
 
66

 
—

 
66

 
66

 
—

 
66

Total
 
 
$
833


$
419


$
414


$
677


$
385


$
292



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NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


The table below presents amortization expense recorded by the Company for its identifiable intangible assets.
 
Third Quarter Ended
 
Year-to-Date Ended
 
September 28,
2018
 
September 29,
2017
 
September 28, 2018
 
September 29, 2017
 
(in millions)
Amortization expense
$
10

 
$
10

 
32

 
30

Based on gross carrying amounts at September 28, 2018 , the Company’s estimate of amortization expense for identifiable intangible assets for the years ending December 31, 2018 through 2022 is presented in the table below.
 
Year Ending December 31,
 
2018
 
2019
 
2020
 
2021
 
2022
 
(in millions)
Estimated amortization expense
$
49

 
$
59

 
$
52

 
$
45

 
$
38

10 . Other Current Liabilities and Other Liabilities
The table below presents the components of other current liabilities.
 
September 28,
2018
 
December 31,
2017
 
(in millions)
Other Current Liabilities:
 

 
 

Accrued product warranty costs
$
69

 
$
69

Estimated costs in excess of estimated contract value to complete contracts in process in a loss position
46

 
63

Accrued interest
39

 
43

Estimated contingent purchase price payable for acquired businesses (see Note 16)
5

 
11

Deferred revenues
—

 
38

Other
140

 
143

Total other current liabilities
$
299


$
367

The table below presents the components of other liabilities.
 
September 28,
2018
 
December 31,
2017
 
(in millions)
Other Liabilities:
 

 
 

Non-current income taxes payable (see Note 12)
$
180

 
$
164

Deferred compensation
53

 
49

Notes payable and capital lease obligations
38

 
16

Contract liabilities (see Note 6)
31

 
—

Accrued workers' compensation
24

 
23

Accrued product warranty costs
22

 
30

Estimated contingent purchase price payable for acquired businesses (see Note 16)
11

 
20

Deferred revenues
—

 
19

Other
83

 
77

Total other liabilities
$
442


$
398



27
Table of Contents
L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


The table below presents the changes in the Company’s accrued product warranty costs.
 
Year-to-Date Ended
 
September 28,
2018
 
September 29,
2017
 
(in millions)
Accrued product warranty costs:
 

 
 

Balance at January 1
$
99

 
$
109

Acquisitions during the period
—

 
3

Accruals for product warranties issued during the period
34

 
34

Changes to accruals for product warranties existing before January 1
(1
)
 
—

Settlements made during the period
(41
)
 
(52
)
Foreign currency translation adjustments
—

 
1

Balance at end of period
$
91

 
$
95

11 . Debt
The components of debt and a reconciliation to the carrying amount of long-term debt is presented in the table below.
 
September 28,
2018
 
December 31,
2017
 
(in millions)
Borrowings under Revolving Credit Facility (1)
$
—

 
$
—

5.20% Senior Notes due 2019
—

 
1,000

4.75% Senior Notes due 2020
—

 
800

4.95% Senior Notes due 2021
650

 
650

3.85% Senior Notes due 2023
800

 
—

3.95% Senior Notes due 2024
350

 
350

3.85% Senior Notes due 2026
550

 
550

4.40% Senior Notes due 2028
1,000

 
—

Principal amount of long-term debt  (2)
3,350


3,350

Unamortized discounts
(7
)
 
(7
)
Deferred debt issue costs
(23
)
 
(13
)
Carrying amount of long-term debt
$
3,320

 
$
3,330

__________________
(1)  
During the year-to-date period ended September 28, 2018 , L3’s aggregate borrowings and repayments under the Credit Facility were $501 million . At September 28, 2018 , L3 had the full availability of its $1 billion Credit Facility.
(2)  
With respect to the Company’s outstanding senior notes, including the senior notes issued on June 6, 2018, upon the occurrence of both a “change in control” (as defined in the indentures governing the senior notes) along with a “change of control triggering event” (generally described as the applicable series of senior notes ceasing to be rated investment grade, as defined in the indentures governing the senior notes), each holder of the notes will have the right to require L3 to repurchase all or any part of such holder’s notes at an offer price in cash equal to 101% of the aggregate principal amount plus accrued and unpaid interest, if any, to the date of purchase.


28
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L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


Issuance of Senior Notes
On June 6, 2018, L3 issued two series of senior notes, which are unsecured senior obligations of L3. The terms of each series of senior notes are presented in the table below.
Note
 
Date of Issuance
 
Amount
Issued
 
Discount (1)
 
Net
Cash
Proceeds (2)
 
Effective
Interest
Rate
 
Redemption
at Treasury
Rate (3)(4)
 
 
 
 
(dollars in millions)
 
 
 
 
3.85% Senior Notes due June 15, 2023 (the 2023 Notes)
 
June 6, 2018
 
$
800

 
$
2

 
$
792

 
3.89
%
 
20 bps
4.40% Senior Notes due June 15, 2028 (the 2028 Notes)
 
June 6, 2018
 
$
1,000

 
$
1

 
$
990

 
4.41
%
 
25 bps
__________________
(1)  
Bond discounts are recorded as a reduction to the principal amount of the notes and are amortized as interest expense over the term of the notes.  
(2)  
The net cash proceeds of $1,782 million (after deduction of the discount, underwriting expenses and commissions and other related expenses) plus cash on hand were used to fund the concurrent cash tender offers (the Tender Offers) for any and all of $1 billion aggregate principal amount of 5.20% Senior Notes due October 15, 2019 (the 2019 Notes) and $800 million aggregate principal amount of 4.75% Senior Notes due July 15, 2020 (the 2020 Notes) and any related redemption of notes not tendered in the Tender Offers.
(3)  
The 2023 Notes may be redeemed at any time prior to May 15, 2023 (one month prior to maturity), and the 2028 Notes may be redeemed at any time prior to March 15, 2028 (three months prior to maturity), at the option of L3, in whole or in part, at a redemption price equal to the greater of: (i) 100% of the principal amount, or (ii) the present value of the remaining principal and interest payments discounted to the date of redemption, on a semi-annual basis, at the Treasury Rate (as defined in the indentures governing the senior notes), plus the spread indicated in the table above. In addition, if the 2023 Notes and the 2028 Notes are redeemed at any time on or after May 15, 2023 and March 15, 2028, respectively, the redemption price would be equal to 100% of the principal amount.
(4)  
Upon the occurrence of a change in control (as defined in the indentures governing the senior notes) along with a “change of control triggering event” (generally described as the applicable series of senior notes ceasing to be rated investment grade, as defined in the indentures governing the senior notes), each holder of the notes will have the right to require L3 to repurchase all or any part of such holder’s notes at an offer price in cash equal to 101% of the aggregate principal amount plus accrued and unpaid interest, if any, to the date of purchase.
Repurchases and Redemptions of Senior Notes
The table below summarizes the Tender Offers with respect to the 2019 Notes and the 2020 Notes.
Note
 
Settlement Type
 
Date Settled
 
Aggregate
Principal
 
Principal
Tendered
 
Tender
Premium
 
Cash
Tendered (1)
 
Interest
 
Total Cash
Payments
 
Debt
Retirement
Charge (2)
 
 
 
 
 
 
(dollars in millions)
5.20% Senior Notes due 2019
 
Tender Offer
 
June 6, 2018
 
$
1,000

 
$
683

 
103.282
%
 
$
705

 
$
5

 
$
710

 
$
24

4.75% Senior Notes due 2020
 
Tender Offer
 
June 6, 2018
 
$
800

 
$
535

 
104.092
%
 
$
557

 
$
10

 
$
567

 
$
24

__________________
(1)  
Excludes $1 million of tender offer fees.
(2)  
The debt retirement charge includes $1 million of tender offer fees and $3 million which represents the non-cash retirement of associated unamortized debt issue costs and discounts.
On June 6, 2018, the Company initiated the redemption of the 2019 Notes and the 2020 Notes that remained outstanding subsequent to the expiration of the Tender Offers. On July 6, 2018, the Company completed the redemption of the 2019 Notes and the 2020 Notes. The terms of the 2019 Notes and the 2020 Notes redemption are presented in the table below.
Note
 
Settlement Type
 
Date Settled
 
Principal
Redeemed
 
Redemption
Premium
 
Cash
Payments
 
Interest
 
Total Cash
Payments
 
Debt
Retirement
Charge (1)
 
 
 
 
 
 
(dollars in millions)
5.20% Senior Notes due 2019
 
Redemption
 
July 6, 2018
 
$
317

 
103.048
%
 
$
327

 
$
4

 
$
331

 
$
10

4.75% Senior Notes due 2020
 
Redemption
 
July 6, 2018
 
$
265

 
103.818
%
 
$
275

 
$
6

 
$
281

 
$
11

__________________
(1)  
The debt retirement charge includes $1 million which represents the non-cash retirement of associated unamortized debt issue costs and discounts.


29
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L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


Guarantees. The borrowings under the Credit Facility are fully and unconditionally guaranteed by L3 and by substantially all of the material 100% owned domestic subsidiaries of L3 on an unsecured senior basis. The payment of principal and premium, if any, and interest on the senior notes is fully and unconditionally guaranteed, jointly and severally, by L3’s 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.
12 . Income Taxes
The Company and its subsidiaries file income tax returns in the U.S. Federal jurisdiction, which is the Company’s primary tax jurisdiction, and various state and foreign jurisdictions. At September 28, 2018 , the statutes of limitations for the Company’s U.S. Federal income tax returns for the years ended December 31, 2012, 2013, 2015 and 2016 were open.
The U.S. Internal Revenue Service (IRS) is auditing the Company’s U.S. Federal income tax returns for the years ended 2012 and 2013. The Company expects the audits to conclude within the next 12 months. The Company cannot predict the outcome of the audits at this time.
During the quarterly period ended September 28, 2018 , the statutes of limitations for several of the Company's tax returns, including its 2014 U.S. Federal income tax return as well as certain foreign tax returns expired. As a result, the Company reduced its income tax provision by $14 million for the reversal of previously accrued amounts.
The U.S. Government enacted U.S. Tax Reform on December 22, 2017, which made significant changes to the U.S. tax system. Significant changes under U.S. Tax Reform included, among other things, the reduction of the U.S. corporate income tax rate from 35% to 21%, the implementation of a modified territorial tax system and the imposition of a one-time repatriation tax on deemed repatriated earnings and profits of U.S. owned foreign subsidiaries (Toll Charge). As a result, the Company recorded an estimated tax benefit (Preliminary Net Tax Benefit) of $79 million from U.S. Tax Reform in its consolidated financial statements for the year ended December 31, 2017. In accordance with the Securities and Exchange Commission Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118), the Company increased the Preliminary Net Tax Benefit by $3 million during the quarterly and year-to-date periods ended September 28, 2018 . The adjusted Preliminary Net Tax Benefit of $82 million includes a $100 million estimated tax benefit related to the remeasurement of deferred taxes partially offset by an estimated tax provision of $18 million related to the Toll Charge. SAB 118 allows for a measurement period of up to one year after the enactment date of U.S. Tax Reform to finalize the recording of the related tax impacts. As such, the Preliminary Net Tax Benefit ultimately recorded may differ in the future due principally to changes to the interpretations of U.S. Tax Reform and legislative action to clarify the interpretation of U.S. Tax Reform. Additionally, the Company is still evaluating the Global Intangible Low-Taxed Income (GILTI) provisions enacted under U.S. Tax Reform, and the associated election to record its effects as a period cost or as a component of deferred taxes.
The effective income tax rate for the quarterly period ended September 28, 2018 decreased to 8.0% , compared to 24.0% for the quarterly period ended September 29, 2017 , due to the reversal of previously accrued amounts related to various U.S. Federal, foreign and state tax matters, tax benefits from U.S. Tax Reform and stock-based compensation expense.
The effective income tax rate for the year-to-date period ended September 28, 2018 decreased to 13.3% , compared to 22.8% for the same period last year, due to tax benefits of U.S. Tax Reform and stock-based compensation expense, partially offset by the related income tax impact of the sale of the Crestview & TCS Businesses.
At September 28, 2018 , the Company anticipates that unrecognized tax benefits will decrease by approximately $32 million over the next 12 months due to the potential resolution of unrecognized tax benefits involving several jurisdictions and tax periods. The actual amount of the decrease over the next 12 months could vary significantly depending on the ultimate timing and nature of any settlements.
Current and non-current income taxes payable include accrued potential interest of $16 million ( $12 million after income taxes) at September 28, 2018 and $15 million ( $11 million after income taxes) at December 31, 2017 , and potential penalties of $9 million at September 28, 2018 and $8 million at December 31, 2017 .


30
Table of Contents
L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


13 . Accumulated Other Comprehensive (Loss) Income (AOCI)
The changes in the AOCI balances, including amounts reclassified from AOCI into net income, are presented in the table below.
 
 
Foreign
currency
translation
 
Unrealized
gains (losses)
on hedging
instruments
 
Unrecognized
(losses) gains
and prior service
cost, net
 
Total
accumulated
other
comprehensive
loss
 
 
(in millions)
Balance at December 31, 2017
 
$
(54
)
 
$
9

 
$
(646
)
 
$
(691
)
Other comprehensive loss before reclassifications, net of tax
 
(42
)
 
(11
)
 
—

 
(53
)
Amounts reclassified from AOCI, net of tax
 
—

 
2

 
39

 
41

Net current period other comprehensive (loss) income
 
(42
)

(9
)

39


(12
)
Balance at September 28, 2018
 
$
(96
)
 
$
—

 
$
(607
)
 
$
(703
)
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
 
$
(178
)
 
$
6

 
$
(554
)
 
$
(726
)
Other comprehensive income before reclassifications, net of tax
 
120

 
8

 
—

 
128

Amounts reclassified from AOCI, net of tax
 
—

 
(2
)
 
27

 
25

Net current period other comprehensive income
 
120


6


27


153

Balance at September 29, 2017
 
$
(58
)

$
12


$
(527
)

$
(573
)
Further details regarding the amounts reclassified from AOCI into net income are presented in the table below.
 
 
Amount Reclassified from AOCI   (a)
 
Affected Line Item in the
  Unaudited Condensed Consolidated
  Statements of Operations
 
 
Third Quarter Ended
 
Year-to-Date Ended
 
Details About AOCI Components
 
September 28,
2018
 
September 29,
2017
 
September 28,
2018
 
September 29,
2017
 
 
 
(in millions)
 
 
(Loss) gain on hedging instruments
 
$
(3
)
 
$
2

 
$
(2
)
 
$
3

 
Cost of sales-products
 
 
(3
)
 
2

 
(2
)
 
3

 
Income from continuing operations before income taxes
 
 
—

 
(1
)
 
—

 
(1
)
 
Provision for income taxes
 
 
$
(3
)

$
1


$
(2
)

$
2

 
Income from continuing operations
 
 
 
 
 
 
 
 
 
 
 
Amortization of defined benefit   pension and postretirement items:
 
 
 
 
 
 
 
 
 
 
Net loss (b)
 
$
(16
)
 
$
(13
)
 
$
(51
)
 
$
(43
)
 
Income from continuing operations before income taxes
 
 
4

 
5

 
12

 
16

 
Provision for income taxes
 
 
$
(12
)

$
(8
)

$
(39
)

$
(27
)
 
Income from continuing operations
Total reclassification for the period
 
$
(15
)
 
$
(7
)
 
$
(41
)
 
$
(25
)
 
Income from continuing operations
__________________
(a)  
Amounts in parenthesis indicate charges to the unaudited condensed consolidated statements of operations.
(b)  
Amounts related to pension and postretirement benefit plans were reclassified from AOCI and recorded as a component of net periodic benefit cost (see Note 20 for additional information).
14 . Equity
On May 8, 2017, L3’s Board of Directors approved a share repurchase program that authorizes L3 to repurchase up to an additional $1.5 billion of its common stock. The program became effective on July 1, 2017 and has no set expiration date. Repurchases of L3’s common stock are made from time to time at management’s discretion in accordance with applicable U.S. Federal securities laws. The timing and actual number of shares to be repurchased in the future will depend on a variety of factors, including, but not limited to, the Company’s financial position, earnings, legal requirements, other investment opportunities (including acquisitions) and market conditions. L3 repurchased 1,637,299 shares of its common stock at an average price of $196.64


31
Table of Contents
L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


per share for an aggregate amount of $322 million from January 1, 2018 through September 28, 2018 . All share repurchases of L3’s common stock have been recorded as treasury shares.
The Company did not repurchase any shares of common stock from September 29, 2018 through October 19, 2018 . In connection with the planned merger with Harris Corporation (see Note 25 ), the Company suspended future share repurchases.
On July 10, 2018 , L3’s Board of Directors declared a quarterly cash dividend of $ 0.80 per share, paid on September 17, 2018 to shareholders of record at the close of business on August 17, 2018 . During the year-to-date period ended September 28, 2018 , the Company paid $191 million of cash dividends, including a $2 million net reduction of previously accrued dividends for employee-held stock awards.
On October 22, 2018 , L3’s Board of Directors declared a quarterly cash dividend of $0.80 per share, payable on December 17, 2018 to shareholders of record at the close of business on November 16, 2018 .
15 . L3’s Earnings Per Share
A reconciliation of basic and diluted Earnings Per Share (EPS) is presented in the table below.
 
Third Quarter Ended
 
Year-to-Date Ended
 
September 28,
2018
 
September 29,
2017
 
September 28,
2018
 
September 29,
2017
 
(in millions, except per share data)
Reconciliation of net income:
 
 
 
 
 
 
 
Net income
$
208

 
$
25

 
$
795

 
$
400

Net income from continuing operations attributable to noncontrolling interests
(6
)
 
(3
)
 
(15
)
 
(12
)
Net income attributable to L3’s common shareholders
$
202


$
22


$
780


$
388

Earnings (loss) attributable to L3’s common shareholders:
 
 
 
 
 
 
 
Continuing operations
$
202

 
$
143

 
$
574

 
$
486

Discontinued operations, net of income tax
—

 
(121
)
 
206

 
(98
)
Net income attributable to L3’s common shareholders
$
202


$
22


$
780


$
388

Earnings per share attributable to L3’s common   shareholders:
 
 
 
 
 
 
 
Basic:
 
 
 
 
 
 
 
Weighted average common shares outstanding
78.5

 
78.2

 
78.4

 
78.0

Basic earnings (loss) per share:
 
 
 
 
 
 
 
Continuing operations
$
2.57

 
$
1.83

 
$
7.32

 
$
6.23

Discontinued operations, net of income tax
—

 
(1.55
)
 
2.63

 
(1.26
)
Net income
$
2.57


$
0.28


$
9.95


$
4.97

Diluted:
 
 
 
 
 
 
 
Common and potential common shares:
 
 
 
 
 
 
 
Weighted average common shares outstanding
78.5

 
78.2

 
78.4

 
78.0

Effect of dilutive securities
0.9

 
1.6

 
1.2

 
1.6

Common and potential common shares
79.4


79.8


79.6


79.6

Diluted earnings (loss) per share:
 
 
 
 
 
 
 
Continuing operations
$
2.54

 
$
1.79

 
$
7.21

 
$
6.10

Discontinued operations, net of income tax
—

 
(1.51
)
 
2.59

 
(1.23
)
Net income
$
2.54


$
0.28


$
9.80


$
4.87



32
Table of Contents
L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


The computation of diluted EPS excludes 0.3 million shares for each of the quarterly and year-to-date periods ended September 28, 2018 and 0.4 million shares and 0.3 million shares for the quarterly and year-to-date periods ended September 29, 2017 , respectively, for share-based payment awards as they were anti-dilutive.
16 . Fair Value Measurements
Fair value is defined as the price that would be received for an asset or the exit price that would be paid to transfer a liability in the principal or most advantageous market in an orderly transaction between market participants. The standards establish a fair value hierarchy that gives the highest priority to observable inputs and the lowest priority to unobservable inputs.
The following table presents the fair value hierarchy level for each of the Company’s assets and liabilities that are measured and recorded at fair value on a recurring basis.
 
 
September 28, 2018
 
December 31, 2017
Description
 
Level 1   (1)
 
Level 2   (2)
 
Level 3   (3)
 
Level 1   (1)
 
Level 2   (2)
 
Level 3   (3)  
 
 
(in millions)
Assets
 
 

 
 

 
 

 
 

 
 

 
 

Cash equivalents
 
$
167

 
$
—

 
$
—

 
$
310

 
$
—

 
$
—

Derivatives (foreign currency forward contracts)
 
—

 
4

 
—

 
—

 
11

 
—

Total assets
 
$
167


$
4


$
—


$
310


$
11


$
—

 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 

 
 

 
 

 
 

 
 

 
 

Derivatives (foreign currency forward contracts)
 
$
—

 
$
6

 
$
—

 
$
—

 
$
1

 
$
—

Contingent consideration
 
—

 
—

 
16

 
—

 
—

 
31

Total liabilities
 
$
—


$
6


$
16


$
—


$
1


$
31

__________________
(1)  
Level 1 is based on quoted market prices available in active markets for identical assets or liabilities as of the reporting date. Cash equivalents are primarily held in registered money market funds, which are valued using quoted market prices.
(2)  
Level 2 is based on pricing inputs other than quoted prices in active markets, which are either directly or indirectly observable. The fair value is determined using a valuation model based on observable market inputs, including quoted foreign currency forward exchange rates and consideration of non-performance risk.
(3)  
Level 3 is based on pricing inputs that are not observable and not corroborated by market data.
The contingent consideration liabilities represent the future potential earn-out payments relating to the acquisitions of MacDonald Humfrey (Automation) Limited, renamed L3 MacDonald Humfrey (MacH), on November 22, 2016, Open Water Power, Inc., renamed L3 Open Water Power, Inc. (Open Water Power), on May 19, 2017 and Latitude Engineering, LLC, renamed L3 Latitude Engineering, Inc. (Latitude Engineering) on June 28, 2018 and the Peak Nano investment. The fair value of the MacH contingent consideration liability, and a portion of the Latitude Engineering contingent consideration liability is based on a Monte Carlo Simulation of the aggregate revenue of MacH for the three-year period ending December 31, 2019, and the aggregate revenue of Latitude Engineering as of each year within the four-year period ended December 31, 2021. The significant unobservable inputs used in calculating the fair value of the MacH contingent consideration and a portion of the Latitude Engineering contingent consideration include: (i) projected revenues of the acquired businesses, (ii) company specific risk premium, which is a component of the discount rate applied to the revenue projections and (iii) volatility. The fair value of the Open Water Power contingent consideration liability and a portion of the Latitude Engineering contingent consideration liability is based on the Scenario-Based Method of the income approach using post-acquisition milestone achievements of Open Water Power and Latitude Engineering through December 31, 2020. The significant unobservable inputs used in calculating the fair value of the Open Water Power contingent consideration and a portion of the Latitude Engineering contingent consideration include: (i) timing of achieving the milestones associated with the contingent consideration arrangement, (ii) probabilities of achieving each milestone and (iii) the discount rate. The fair value of the contingent consideration for potential earn-out payments is reassessed quarterly, including an analysis of the significant inputs used in the evaluation, as well as the accretion of the present value discount. Changes are reflected within operating costs and expenses in the unaudited condensed consolidated statements of operations.
The Peak Nano contingent consideration liability was recorded at fair value on the acquisition date based on a probability assessment of the likelihood of achieving certain technical milestones on or before August 5, 2018. During the quarter ended September 28, 2018, the Company reduced the fair value of the contingent consideration liability to zero as the technical milestones


33
Table of Contents
L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


were not met by the deadline. The fair value of the contingent consideration liability has been reassessed quarterly, and changes reflected within interest and other income, net, in the unaudited condensed consolidated statements of operations.
The table below presents the changes to contingent consideration obligations during the year-to-date period ended September 28, 2018 .
 
September 28, 2018
 
(in millions)
Balance at beginning of period
$
31

Acquisitions and investments
10

Cash payments
(7
)
Changes in fair value of contingent consideration, net
(18
)
Balance at end of period
$
16

17 . Financial Instruments
At September 28, 2018 and December 31, 2017 , the Company’s financial instruments consisted primarily of cash and cash equivalents, billed receivables, trade accounts payable, senior notes and foreign currency forward contracts. The carrying amounts of cash and cash equivalents, billed receivables and trade accounts payable are representative of their respective fair values because of the short-term maturities or the expected settlement dates of these instruments. The carrying amounts and estimated fair values of the Company’s other financial instruments are presented in the table below.
 
September 28, 2018
 
December 31, 2017
 
Carrying
  Amount
 
Estimated
  Fair Value
 
Carrying
  Amount
 
Estimated
  Fair Value
 
(in millions)
Senior notes (1)
$
3,320

 
$
3,338

 
$
3,330

 
$
3,502

Foreign currency forward contracts (2)
$
(2
)
 
$
(2
)
 
$
10

 
$
10

__________________
(1)  
The Company measures the fair value of its senior notes using Level 2 inputs based primarily on current market yields for its existing debt traded in the secondary market.
(2)  
The Company measures the fair values of foreign currency forward contracts based on forward exchange rates. See Note 18 for additional disclosures regarding the notional amounts and fair values of foreign currency forward contracts.


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


18 . Derivative Financial Instruments
The Company’s derivative financial instruments include foreign currency forward contracts, which are entered into for risk management purposes.
Foreign Currency Forward Contracts.  The Company’s 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, the Company enters into foreign currency forward contracts. The Company’s activities involving foreign currency forward contracts are designed to hedge the changes in the functional currency equivalent cash flows due to movements in foreign exchange rates compared to the functional currency. The foreign currencies hedged are primarily the Canadian dollar, the U.S. dollar, the Euro, the United Arab Emirates dirham, the British pound and the New Zealand dollar. The Company manages exposure to counterparty non-performance credit risk by entering into foreign currency forward contracts only with major financial institutions that are expected to fully perform under the terms of such contracts. Foreign currency forward contracts are recorded in the Company’s condensed consolidated balance sheets at fair value and are generally designated and accounted for as cash flow hedges in accordance with the accounting standards for derivative instruments and hedging activities. Gains and losses on designated foreign currency forward contracts that are highly effective in offsetting the corresponding change in the cash flows of the hedged transactions are recorded net of income taxes in AOCI and then recognized in income when the underlying hedged transaction affects income. Gains and losses on foreign currency forward contracts that do not meet hedge accounting criteria are recognized in income immediately. Notional amounts are used to measure the volume of foreign currency forward contracts and do not represent exposure to foreign currency losses. The table below presents the notional amounts of the Company’s outstanding foreign currency forward contracts by currency at September 28, 2018 .
Currency
 
Notional Amounts
 
 
(in millions)
Canadian dollar
 
$
155

U.S. dollar
 
141

Euro
 
97

United Arab Emirates dirham
 
12

British pound
 
10

New Zealand dollar
 
4

Total
 
$
419

At September 28, 2018 , the Company’s foreign currency forward contracts had maturities through 2023 .
The table below presents the location of the Company’s derivative instruments recorded at fair value on the condensed consolidated balance sheets.
 
September 28, 2018
 
December 31, 2017
 
Other
Current
Assets
 
Other
Assets
 
Other
Current
Liabilities
 
Other
Liabilities
 
Other
Current
Assets
 
Other
Assets
 
Other
Current
Liabilities
 
Other
Liabilities
 
(in millions)
Derivatives designated as   hedging instruments:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Foreign currency forward contracts (1)
$
3

 
$
1

 
$
5

 
$
1

 
$
11

 
$
—

 
$
1

 
$
—

Total derivative instruments
$
3


$
1


$
5


$
1

 
$
11

 
$
—


$
1


$
—

__________________
(1)  
See Note 16 for a description of the fair value hierarchy related to the Company’s foreign currency forward contracts.
The effects from foreign currency forward contracts on the unaudited condensed consolidated statements of operations were a pre-tax loss of $3 million and pre-tax gain of $2 million for the quarterly periods ended September 28, 2018 and September 29, 2017 , respectively, and a pre-tax loss of $2 million and pre-tax gain of $3 million for the year-to-date period s ended September 28, 2018 and September 29, 2017 , respectively. At September 28, 2018 , the estimated net amount of existing losses that are expected to be reclassified into income within the next 12 months was $3 million .


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


19 . Commitments and Contingencies
Procurement Regulations
A substantial majority of the Company’s revenues are generated from providing products and services under legally binding agreements or contracts with the U.S. Government, foreign government customers and state and local governments. 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. The Company is currently cooperating with the U.S. Government on several investigations from which civil, criminal or administrative proceedings have or could result and give rise to fines, penalties, compensatory and treble damages, restitution and/or forfeitures, including investigations into the pricing of certain contracts entered into by the C&NS segment. The Company does not currently anticipate that any of these investigations will have a material adverse effect, individually or in the aggregate, on its consolidated financial position, results of operations or cash flows. However, under U.S. Government regulations, an indictment of the Company by a federal grand jury, or an administrative finding against the Company as to its present responsibility to be a U.S. Government contractor or subcontractor, could result in the Company 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. A conviction, or an administrative finding against the Company that satisfies the requisite level of seriousness, could result in debarment from contracting with the federal government for a specified term. In addition, all of the Company’s U.S. Government contracts: (1) are subject to audit and various pricing and cost controls, (2) include standard provisions for termination for the convenience of the U.S. Government or for default and (3) are subject to cancellation if funds for contracts become unavailable. Foreign government contracts generally include comparable provisions relating to terminations for convenience or default, as well as other procurement clauses relevant to the foreign government.
Litigation Matters
The Company is also subject to litigation, proceedings, claims or assessments and various contingent liabilities incidental to its businesses, including the matter specified below. Furthermore, in connection with certain business acquisitions, the Company has assumed some or all claims against, and liabilities of, such acquired businesses, including both asserted and unasserted claims and liabilities.
In accordance with the accounting standard for contingencies, the Company records a liability when management believes that it is both probable that a liability has been incurred and the Company can reasonably estimate the amount of the loss. Generally, the loss is recorded at the amount the Company expects to resolve the liability. Amounts recoverable from insurance contracts or third parties are recorded as assets when deemed probable. At September 28, 2018 , the Company did not record any amounts for recoveries from insurance contracts or third parties in connection with the amount of liabilities recorded for pending and threatened litigation. Legal defense costs are expensed as incurred. The Company believes it has recorded adequate provisions for its litigation matters. The Company reviews these provisions to reflect the impact of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular matter. While it is reasonably possible that an unfavorable outcome may occur in the matter set forth below, unless otherwise stated, the Company believes that it is not probable that a loss has been incurred in such matter. With respect to any litigation matter below for which it is reasonably possible that an unfavorable outcome may occur, an estimate of loss or range of loss is disclosed when such amount or amounts can be reasonably estimated. Although the Company believes that it has valid defenses with respect to legal matters and investigations pending against it, the results of litigation can be difficult to predict, particularly those involving jury trials. Therefore, it is possible that any of the following or other contingencies could have a material impact on the financial position, results of operations or cash flows of the Company in future periods.
HVC Alkmaar . On July 23, 2014, a notice of claim was received by the Company’s former JovyAtlas business unit. The notice relates to losses resulting from a fire that occurred at an HVC Alkmaar bio-energy plant on July 21, 2013. The notice states that the fire resulted from the failure of an uninterruptible power supply (UPS) to provide sufficient power to act as a back-up energy supply, alleges that JovyAtlas was the manufacturer and service provider for the UPS and claims €11 million in estimated property damages and €35 million in estimated business interruption damages. The Company has tendered the notice of claim to its insurance carriers.


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


20 . Pension and Other Postretirement Benefits
The following table summarizes the components of net periodic benefit cost for the Company’s pension and other postretirement benefit plans.
 
Pension Plans
 
Postretirement Benefit Plans
 
Third Quarter Ended
 
Year-to-Date Ended
 
Third Quarter Ended
 
Year-to-Date Ended
 
September 28,
2018
 
September 29,
2017
 
September 28,
2018
 
September 29,
2017
 
September 28,
2018
 
September 29,
2017
 
September 28,
2018
 
September 29,
2017
 
(in millions)
Components of net   periodic benefit cost:
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Service cost
$
25

 
$
22

 
$
77

 
$
72

 
$
—

 
$
1

 
$
1

 
$
2

Interest cost
36

 
35

 
108

 
106

 
2

 
2

 
4

 
4

Expected return on plan assets
(56
)
 
(48
)
 
(168
)
 
(146
)
 
(2
)
 
(1
)
 
(4
)
 
(3
)
Amortization of prior service (credits) costs
(1
)
 
1

 
(1
)
 
1

 
(1
)
 
(1
)
 
(1
)
 
(1
)
Amortization of net loss (gains)
18

 
14

 
55

 
45

 
—

 
(1
)
 
(2
)
 
(2
)
Curtailment loss (1)
—

 
2

 
—

 
2

 
—

 
—

 
—

 
—

Net periodic benefit cost
$
22


$
26


$
71


$
80


$
(1
)

$
—


$
(2
)

$
—

__________________
(1)  
During the quarterly period ended September 29, 2017, the Company recognized a $2 million pension curtailment loss related to severance and restructuring activities in the ISRS segment.
The components of net periodic benefit cost other than the service cost component are included in interest and other income, net, in the unaudited condensed consolidated statements of operations. Service cost is included in operating costs and expenses in the unaudited condensed consolidated statements of operations.
Contributions.  The Company contributed cash of $94 million to its pension plans and $4 million to its other postretirement benefit plans during the year-to-date period ended September 28, 2018 . The Company expects to contribute an additional $6 million each to its pension plans and its other postretirement benefit plans during the remainder of 2018 .
21 . Stock-Based Compensation
During the year-to-date period ended September 28, 2018 , the Company granted stock-based awards under the Amended and Restated 2008 Long Term Performance Plan in the form of stock options, restricted stock units and performance units. The stock-based compensation awards granted during the year-to-date period ended September 28, 2018 are further discussed below.
Stock Options.  The Company granted 221,886 stock options with a weighted average exercise price of $208.92 per option, which was equal to the closing price of L3’s common stock on the date of grant. Options expire 10 years after the date of grant and vest ratably over a three -year period on the annual anniversary of the date of grant. The options granted to the Company’s Chairman, Chief Executive Officer and President are also subject to performance-based vesting conditions. The weighted average grant date fair value for the options of $37.72 per option was estimated using the Black-Scholes option-pricing model. The weighted average assumptions used in the valuation model for this grant are presented in the table below.
Expected holding period (in years)
5.2

Expected volatility
19.8
%
Expected dividend yield
1.8
%
Risk-free interest rate
2.7
%
Restricted Stock Units.  The Company granted 250,105 restricted stock units with a weighted average grant date fair value of $210.12 per share. Restricted stock units typically vest three years after the grant date for employees and one year after the grant date for non-employee directors, or if earlier, on the date of the first annual stockholders meeting held after the grant date. The restricted stock units automatically convert into shares of L3’s common stock upon vesting. The grant date fair value of the restricted stock unit awards is based on L3’s closing stock price at the date of grant and is generally recognized as compensation expense on a straight-line basis over the vesting period. However, for employees who attain retirement eligibility status prior to the end of the three -year cliff vesting period and who have provided at least one year of service after the date of grant, compensation


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


expense is recognized over the shorter period from the date of grant to the retirement eligibility date. For grants of restricted stock units made during the year-to-date period ended September 28, 2018 , retirement eligible employees are those employees that either: (1) have attained the age of 60 and completed at least five years of service (which service must be continuous through the date of termination except for a single break in service that does not exceed one year in length) or (2) have attained the age of 65 (without regard to their length of service at L3).
Performance Units.  The Company granted 22,325 performance units with a weighted average grant date fair value per unit of $209.91 . The final payout for these units is based on the achievement of pre-determined EPS goals established by the Compensation Committee of the Company’s Board of Directors for the three -year period ending December 31, 2020 . Units earned can range from zero to 200% of the original number of units awarded, which are converted into shares of L3’s common stock.
22 . Supplemental Cash Flow Information
 
Year-to-Date Ended
 
September 28,
2018
 
September 29,
2017
 
(in millions)
Interest paid
$
125

 
$
120

Income tax payments
$
93

 
$
129

Income tax refunds
$
4

 
$
14

23 . Segment Information and Disaggregation of Net Sales
The Company has three reportable segments, which are described in Note 1 . The Company evaluates the performance of its operating segments and reportable segments based on their sales, operating income and operating margin. Corporate expenses are allocated to the Company’s operating segments using an allocation methodology prescribed by U.S. Government regulations for government contractors. Accordingly, segment results include all costs and expenses, except for goodwill impairment charges and certain other items that are excluded by management for purposes of evaluating the operating performance of the Company’s business segments.


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


The tables below present net sales, operating income, depreciation and amortization and total assets by reportable segment.
 
Third Quarter Ended
 
Year-to-Date Ended
 
September 28,
2018
 
September 29,
2017
 
September 28,
2018
 
September 29,
2017
 
(in millions)
Net Sales:
 

 
 

 
 

 
 

ISRS
$
1,099

 
$
968

 
$
3,250

 
$
2,940

C&NS
745

 
759

 
2,270

 
2,290

Electronic Systems
703

 
584

 
2,047

 
1,839

Elimination of intercompany sales
(28
)
 
(18
)
 
(94
)
 
(70
)
Consolidated total
$
2,519


$
2,293


$
7,473


$
6,999

Operating Income:
 
 
 
 
 
 
 
ISRS
$
121

 
$
73

 
$
321

 
$
256

C&NS
69

 
81

 
208

 
277

Electronic Systems
91

 
78

 
276

 
230

Segment total
281


232


805


763

(Loss) gain on sale of the Crestview & TCS Businesses
(4
)
 
—

 
44

 
—

Merger, acquisition and divestiture related expenses
(5
)
 
—

 
(5
)
 
—

Consolidated total
$
272


$
232


$
844


$
763

Depreciation and amortization:
 
 
 
 
 
 
 
ISRS
$
20

 
$
21

 
$
64

 
$
63

C&NS
15

 
17

 
48

 
49

Electronic Systems
19

 
17

 
58

 
49

Consolidated total
$
54


$
55


$
170


$
161

 
September 28,
2018
 
December 31,
2017
 
(in millions)
Total Assets:
 
 
 

ISRS
$
4,813

 
$
4,164

C&NS
3,722

 
3,476

Electronic Systems
4,159

 
3,939

Corporate
490

 
709

Assets held for sale
—

 
135

Assets of discontinued operations
—

 
306

Consolidated total
$
13,184


$
12,729

Disaggregation of Total Net Sales . The Company disaggregates its sales from contracts with customers by end customer, contract type, deliverable type and revenue recognition method for each of its segments, as the Company believes these factors affect the nature, amount, timing and uncertainty of the Company’s revenue and cash flows.


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


Sales by End Customer. Direct sales to the end customer represented approximately 65% of the Company’s consolidated sales for the quarterly period ended September 28, 2018 , and indirect sales as a subcontractor or supplier represented the remaining 35% . Direct sales to the end customer represented approximately 64% of the Company’s consolidated sales for the year-to-date period ended September 28, 2018 , and indirect sales as a subcontractor or supplier represented the remaining 36% . The tables below present total net sales disaggregated by end customer.
 
 
Third Quarter Ended September 28, 2018
End Customer
 
ISRS
 
C&NS
 
Electronic Systems
 
Consolidated L3
 
 
(in millions)
Total DoD
 
$
709

 
$
561

 
$
309

 
$
1,579

Other U.S. Government
 
48

 
21

 
55

 
124

Total U.S. Government
 
757

 
582

 
364

 
1,703

Foreign governments (1)
 
293

 
71

 
48

 
412

Commercial — foreign
 
8

 
25

 
170

 
203

Commercial — domestic
 
38

 
56

 
107

 
201

Total
 
$
1,096

 
$
734

 
$
689

 
$
2,519

 
 
Year-to-Date Ended September 28, 2018
End Customer
 
ISRS
 
C&NS
 
Electronic Systems
 
Consolidated L3
 
 
(in millions)
Total DoD
 
$
2,227

 
$
1,679

 
$
968

 
$
4,874

Other U.S. Government
 
108

 
74

 
128

 
310

Total U.S. Government
 
2,335

 
1,753

 
1,096

 
5,184

Foreign governments (1)
 
733

 
242

 
140

 
1,115

Commercial — foreign
 
51

 
87

 
503

 
641

Commercial — domestic
 
102

 
161

 
270

 
533

Total
 
$
3,221

 
$
2,243

 
$
2,009

 
$
7,473

__________________
(1)  
Includes sales under foreign military sales agreements, which are made directly between the U.S. Government and foreign governments.
Sales by Contract Type. Generally, the sales price arrangements for the Company’s contracts are either fixed-price, cost-plus or time-and-material type. Fixed-price type contracts generally offer higher profit margin potential than cost-plus type or time-and-material type contracts due to the greater levels of risk assumed on a fixed-price type contract.
On a fixed-price type contract, the Company agrees to perform the contractual statement of work for a predetermined sales price. On a cost-plus type contract, the Company is paid its 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 the customer. Cost-plus type contracts with award and incentive fee provisions are the Company’s primary variable contract fee arrangement. On a time-and-material type contract, the Company is 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.


40
Table of Contents
L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


Substantially all of the Company’s cost-plus type contracts and time-and-material type contracts are with U.S. Government customers, while sales to foreign government and commercial customers are generally transacted under fixed-price sales arrangements and are included in the Company’s fixed-price contract type sales. The tables below present total net sales disaggregated by contract type.
 
 
Third Quarter Ended September 28, 2018
Contract Type
 
ISRS
 
C&NS
 
Electronic Systems
 
Consolidated L3
 
 
(in millions)
Fixed-price (1)
 
$
697

 
$
519

 
$
606

 
$
1,822

Cost-plus (2)
 
362

 
195

 
75

 
632

Time-and-material
 
37

 
20

 
8

 
65

Total sales
 
$
1,096

 
$
734

 
$
689

 
$
2,519

 
 
Year-to-Date Ended September 28, 2018
Contract Type
 
ISRS
 
C&NS
 
Electronic Systems
 
Consolidated L3
 
 
(in millions)
Fixed-price (1)
 
$
2,046

 
$
1,626

 
$
1,715

 
$
5,387

Cost-plus (2)
 
1,031

 
552

 
270

 
1,853

Time-and-material
 
144

 
65

 
24

 
233

Total sales
 
$
3,221

 
$
2,243

 
$
2,009

 
$
7,473

__________________
(1)  
Includes fixed-price incentive fee type contracts, which contributed approximately 1% to the Company's total net sales for the quarterly and year-to-date period s ended September 28, 2018 .
(2)  
Includes cost-plus award and incentive fee type contracts, which contributed approximately 2% and 3% to the Company's total net sales for the quarterly and year-to-date period s ended September 28, 2018 , respectively.
Sales by Deliverable Type: The tables below present total net sales disaggregated by the type of deliverable, which is determined by the Company at the performance obligation level.
 
 
Third Quarter Ended September 28, 2018
Sales by Deliverable Type
 
ISRS
 
C&NS
 
Electronic Systems
 
Consolidated L3
 
 
(in millions)
Products
 
$
712

 
$
543

 
$
481

 
$
1,736

Services
 
384

 
191

 
208

 
783

Total sales
 
$
1,096

 
$
734

 
$
689

 
$
2,519

 
 
Year-to-Date Ended September 28, 2018
Sales by Deliverable Type
 
ISRS
 
C&NS
 
Electronic Systems
 
Consolidated L3
 
 
(in millions)
Products
 
$
2,085

 
$
1,668

 
$
1,415

 
$
5,168

Services
 
1,136

 
575

 
594

 
2,305

Total sales
 
$
3,221

 
$
2,243

 
$
2,009

 
$
7,473



41
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L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


Revenue Recognition Method: The tables below present total net sales disaggregated based on the revenue recognition method applied.
 
 
Third Quarter Ended September 28, 2018
Revenue Recognition Method
 
ISRS
 
C&NS
 
Electronic Systems
 
Consolidated L3
 
 
(in millions)
Cost to cost method
 
$
813

 
$
678

 
$
374

 
$
1,865

Point in time
 
220

 
38

 
173

 
431

Output method
 
18

 
4

 
130

 
152

Billing method
 
45

 
14

 
12

 
71

Total sales
 
$
1,096

 
$
734

 
$
689

 
$
2,519

 
 
Year-to-Date Ended September 28, 2018
Revenue Recognition Method
 
ISRS
 
C&NS
 
Electronic Systems
 
Consolidated L3
 
 
(in millions)
Cost to cost method
 
$
2,456

 
$
1,932

 
$
1,221

 
$
5,609

Point in time
 
604

 
238

 
505

 
1,347

Output method
 
47

 
17

 
250

 
314

Billing method
 
114

 
56

 
33

 
203

Total sales
 
$
3,221

 
$
2,243

 
$
2,009

 
$
7,473

24 . Severance and Restructuring Related Costs
Consistent with the Company’s strategy to continuously improve its cost structure and right-size its businesses, L3 is completing employment reduction actions across several of its businesses to reduce both direct and indirect costs, including overhead and general and administrative costs. As a result of these initiatives, the Company recorded a total of $4 million and $18 million of severance and restructuring related costs with respect to approximately 500 employees during the quarterly and year-to-date periods ended September 28, 2018 , respectively. During the year ended December 31, 2017 , the Company recorded a total of $101 million of severance and restructuring related costs with respect to approximately 1,500 employees. Severance and restructuring related costs are reported within operating costs and expenses on the unaudited condensed consolidated statements of operations. Severance and restructuring related costs incurred by reportable segment are presented in the table below.
 
Third Quarter Ended
 
Year-to-Date Ended
 
September 28,
2018
 
September 29,
2017
 
September 28,
2018
 
September 29,
2017
 
(in millions)
Reportable Segment
 
 
 
 
 
 
 
ISRS (1)
$
2

 
$
15

 
$
4

 
$
17

C&NS
—

 
17

 
9

 
36

Electronic Systems
2

 
2

 
5

 
7

Consolidated
$
4


$
34


$
18


$
60

__________________
(1)  
The severance and restructuring related costs incurred during the quarterly period ended September 29, 2017 includes $2 million of pension curtailment losses. See Note 20 for additional information.


42
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L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


The Company had severance and restructuring related liabilities of $13 million and $23 million included in other current liabilities on the Company’s balance sheets at September 28, 2018 and December 31, 2017 , respectively. The remaining liability balance at September 28, 2018 is expected to be paid primarily by the third quarter of 2019. The table below presents the change to the Company’s severance and restructuring related liability during the year-to-date period ended September 28, 2018 .
 
September 28, 2018
 
(in millions)
Balance at beginning of period
$
23

Additional provisions
18

Cash payments
(28
)
Balance at end of period
$
13

25 . Subsequent Event
On October 14, 2018, L3 and Harris Corporation (“Harris”) announced an agreement to combine in an all stock merger of equals. Under the terms of the Agreement and Plan of Merger (the “Merger Agreement”) governing the proposed transaction, which was unanimously approved by the boards of directors of both companies, L3 shareholders will receive a fixed exchange ratio of 1.30 shares of Harris common stock for each share of L3 common stock they hold. Upon completion of the merger, Harris shareholders will own approximately 54% and L3 shareholders will own approximately 46% of the combined company, which will be renamed L3 Harris Technologies, Inc. The merger is expected to close in the middle of 2019, subject to customary closing conditions, including the receipt of regulatory approvals and approval by the shareholders of both L3 and Harris.


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


26 . Condensed Combining Financial Information of L3 and Its Subsidiaries
The debt of L3, including the senior notes and borrowings under amounts drawn against the Credit Facility, are guaranteed, on a joint and several, full and unconditional basis, by certain of its 100% owned domestic subsidiaries (the Guarantor Subsidiaries). See Note 9 to the audited consolidated financial statements for the year ended December 31, 2017 , included in the Company’s Annual Report on Form 10-K for additional information. The foreign subsidiaries and certain domestic subsidiaries of L3 (the Non-Guarantor Subsidiaries) do not guarantee the debt of L3. None of the debt of L3 has been issued by its subsidiaries.
Under the terms of the indentures governing the senior notes, the guarantees of the senior notes will automatically and unconditionally be released and discharged: (1) upon the release of all guarantees of all other outstanding indebtedness of L3 or (2) upon the determination that such guarantor is no longer a “domestic subsidiary.” In addition, the guarantees of the senior notes will be automatically and unconditionally released and discharged in the event of a sale or other disposition of all of the assets of any guarantor, by way of merger, consolidation or otherwise, or a sale of all of the capital stock of such guarantor. There are no restrictions on the payment of dividends from the Guarantor Subsidiaries to L3.
The following unaudited condensed combining financial information presents the results of operations, financial position and cash flows of: (1) L3 excluding its consolidated subsidiaries (the Parent), (2) the Guarantor Subsidiaries, (3) the Non-Guarantor Subsidiaries and (4) the eliminations to arrive at the information for L3 on a consolidated basis.
 
L3
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated L3
 
(in millions)
Condensed Combining Balance Sheets:
 
 
 
 
 
 
 
 
 
At September 28, 2018
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
258

 
$
21

 
$
251

 
$
(23
)
 
$
507

Billed receivables, net
302

 
322

 
276

 
—

 
900

Contract assets
612

 
878

 
217

 
—

 
1,707

Inventories
382

 
294

 
235

 
—

 
911

Prepaid expenses and other current assets
133

 
199

 
78

 
—

 
410

Total current assets
1,687


1,714


1,057


(23
)

4,435

Goodwill
2,124

 
3,011

 
1,699

 
—

 
6,834

Other assets
695

 
767

 
453

 
—

 
1,915

Investment in and amounts due from consolidated subsidiaries
6,144

 
6,695

 
—

 
(12,839
)
 
—

Total assets
$
10,650


$
12,187


$
3,209


$
(12,862
)

$
13,184

Current liabilities
$
751

 
$
900

 
$
632

 
$
(23
)
 
$
2,260

Amounts due to consolidated subsidiaries
—

 
—

 
444

 
(444
)
 
—

Other long-term liabilities
937

 
791

 
165

 
—

 
1,893

Long-term debt
3,320

 
—

 
—

 
—

 
3,320

Total liabilities
5,008


1,691


1,241


(467
)

7,473

L3 shareholders’ equity
5,642

 
10,496

 
1,968

 
(12,464
)
 
5,642

Noncontrolling interests
—

 
—

 
—

 
69

 
69

Total equity
5,642


10,496


1,968


(12,395
)

5,711

Total liabilities and equity
$
10,650


$
12,187


$
3,209


$
(12,862
)

$
13,184




44
Table of Contents
L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


 
L3
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated L3
 
(in millions)
At December 31, 2017
 

 
 

 
 

 
 

 
 

Current assets:
 

 
 

 
 

 
 

 
 

Cash and cash equivalents
$
432

 
$
16

 
$
285

 
$
(71
)
 
$
662

Billed receivables, net
266

 
244

 
213

 
—

 
723

Contracts in process
706

 
912

 
315

 
—

 
1,933

Prepaid expenses and other current assets
330

 
235

 
124

 
—

 
689

Assets held for sale
—

 
135

 
—

 
—

 
135

Assets of discontinued operations
306

 
—

 
—

 
—

 
306

Total current assets
2,040


1,542


937


(71
)

4,448

Goodwill
2,099

 
2,932

 
1,584

 
—

 
6,615

Other assets
658

 
687

 
321

 
—

 
1,666

Investment in and amounts due from consolidated subsidiaries
5,662

 
6,310

 
—

 
(11,972
)
 
—

Total assets
$
10,459


$
11,471


$
2,842


$
(12,043
)

$
12,729

Current liabilities
$
811

 
$
832

 
$
564

 
$
(71
)
 
$
2,136

Liabilities held for sale
—

 
17

 
—

 
—

 
17

Liabilities of discontinued operations
226

 
—

 
—

 
—

 
226

Amounts due to consolidated subsidiaries
—

 
—

 
391

 
(391
)
 
—

Other long-term liabilities
1,009

 
729

 
131

 
—

 
1,869

Long-term debt
3,330

 
—

 
—

 
—

 
3,330

Total liabilities
5,376


1,578


1,086


(462
)

7,578

L3 shareholders’ equity
5,083

 
9,893

 
1,756

 
(11,649
)
 
5,083

Noncontrolling interests
—

 
—

 
—

 
68

 
68

Total equity
5,083


9,893


1,756


(11,581
)

5,151

Total liabilities and equity
$
10,459


$
11,471


$
2,842


$
(12,043
)

$
12,729




45
Table of Contents
L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


 
L3
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated L3
 
(in millions)
Condensed Combining Statements of Operations:
 

 
 

 
 

 
 

 
 

For the quarter ended September 28, 2018:
 

 
 

 
 

 
 

 
 

Total net sales
$
872

 
$
1,274

 
$
456

 
$
(83
)
 
$
2,519

Total operating costs and expenses
(759
)
 
(1,200
)
 
(362
)
 
83

 
(2,238
)
Loss on sale of the Crestview & TCS Businesses
—

 
(4
)
 
—

 
—

 
(4
)
Merger, acquisition and divestiture related expenses
(5
)
 
—

 
—

 
—

 
(5
)
Operating income
108


70


94


—


272

Interest expense
(40
)
 
—

 
—

 
—

 
(40
)
Interest and other income, net
14

 
1

 
—

 
—

 
15

Debt retirement charge
(21
)
 
—

 
—

 
—

 
(21
)
Income from continuing operations before income taxes
61


71


94


—


226

Provision for income taxes
(6
)
 
(4
)
 
(8
)
 
—

 
(18
)
Equity in net income of consolidated subsidiaries
147

 
48

 
—

 
(195
)
 
—

Net income
202


115


86


(195
)

208

Net income attributable to noncontrolling interests
—

 
—

 
—

 
(6
)
 
(6
)
Net income attributable to L3
$
202


$
115


$
86


$
(201
)

$
202

Comprehensive income attributable to L3
$
213

 
$
115

 
$
83

 
$
(198
)
 
$
213

 
 
 
 
 
 
 
 
 
 
For the quarter ended September 29, 2017:
 
 
 
 
 
 
 
 
 
Total net sales
$
836

 
$
1,157

 
$
386

 
$
(86
)
 
$
2,293

Total operating costs and expenses
(747
)
 
(1,081
)
 
(319
)
 
86

 
(2,061
)
Operating income
89


76


67


—


232

Interest expense
(41
)
 
—

 
(1
)
 
—

 
(42
)
Interest and other income, net
1

 
—

 
1

 
—

 
2

Income from continuing operations before income taxes
49


76


67


—


192

Provision for income taxes
(11
)
 
(19
)
 
(16
)
 
—

 
(46
)
Equity in net income of consolidated subsidiaries
105

 
34

 
—

 
(139
)
 
—

Income from continuing operations
143

 
91

 
51

 
(139
)
 
146

Income from discontinued operations, net of income taxes
(121
)
 
—

 
—

 
—

 
(121
)
Net income
22


91


51


(139
)

25

Net income attributable to noncontrolling interests
—

 
—

 
—

 
(3
)
 
(3
)
Net income attributable to L3
$
22


$
91


$
51


$
(142
)

$
22

Comprehensive income attributable to L3
$
85

 
$
139

 
$
101

 
$
(240
)
 
$
85




46
Table of Contents
L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


 
L3
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated L3
 
(in millions)
Condensed Combining Statements of Operations:
 

 
 

 
 

 
 

 
 

For the year-to-date period ended September 28, 2018:
 

 
 

 
 

 
 

 
 

Total net sales
$
2,598

 
$
3,841

 
$
1,309

 
$
(275
)
 
$
7,473

Total operating costs and expenses
(2,300
)
 
(3,594
)
 
(1,049
)
 
275

 
(6,668
)
Gain on sale of the Crestview & TCS Businesses
—

 
44

 
—

 
—

 
44

Merger, acquisition and divestiture related expenses
(5
)
 
—

 
—

 
—

 
(5
)
Operating income
293

 
291

 
260

 
—

 
844

Interest expense
(124
)
 
—

 
(1
)
 
—

 
(125
)
Interest and other income, net
25

 
2

 
2

 
—

 
29

Debt retirement charge
(69
)
 
—

 
—

 
—

 
(69
)
Income from continuing operations before income taxes
125

 
293

 
261

 
—

 
679

Provision for income taxes
(16
)
 
(39
)
 
(35
)
 
—

 
(90
)
Equity in net income of consolidated subsidiaries
465

 
141

 
—

 
(606
)
 
—

Income from continuing operations
574

 
395

 
226

 
(606
)
 
589

Income from discontinued operations, net of income tax
206

 
—

 
—

 
—

 
206

Net income
780

 
395

 
226

 
(606
)
 
795

Net income attributable to noncontrolling interests
—

 
—

 
—

 
(15
)
 
(15
)
Net income attributable to L3
$
780

 
$
395

 
$
226

 
$
(621
)
 
$
780

Comprehensive income attributable to L3
$
768

 
$
353

 
$
180

 
$
(533
)
 
$
768

 
 
 
 
 
 
 
 
 
 
For the year-to-date period ended September 29, 2017:
 
 
 
 
 
 
 
 
 
Total net sales
$
2,580

 
$
3,546

 
$
1,136

 
$
(263
)
 
$
6,999

Total operating costs and expenses
(2,328
)
 
(3,226
)
 
(945
)
 
263

 
(6,236
)
Operating income
252

 
320

 
191

 
—

 
763

Interest expense
(125
)
 
—

 
(1
)
 
—

 
(126
)
Interest and other income, net
6

 
—

 
2

 
—

 
8

Income from continuing operations before income taxes
133

 
320

 
192

 
—

 
645

Provision for income taxes
(30
)
 
(73
)
 
(44
)
 
—

 
(147
)
Equity in net income of consolidated subsidiaries
383

 
92

 
—

 
(475
)
 
—

Income from continuing operations
486

 
339

 
148

 
(475
)
 
498

Income from discontinued operations, net of income tax
(98
)
 
—

 
—

 
—

 
(98
)
Net income
388

 
339

 
148

 
(475
)
 
400

Net income attributable to noncontrolling interests
—

 
—

 
—

 
(12
)
 
(12
)
Net income attributable to L3
$
388

 
$
339

 
$
148

 
$
(487
)
 
$
388

Comprehensive income attributable to L3
$
541

 
$
447

 
$
271

 
$
(718
)
 
$
541





47
Table of Contents
L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


 
L3
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
Consolidated L3
 
(in millions)
Condensed Combining Statements of Cash Flows
 

 
 

 
 

 
 

 
 

For the year-to-date period ended September 28, 2018:
 

 
 

 
 

 
 

 
 

Operating activities:
 

 
 

 
 

 
 

 
 

Net cash from (used in) operating activities from continuing operations
$
248

 
$
(30
)
 
$
131

 
$
(7
)
 
$
342

Investing activities:
 
 
 
 
 
 
 
 
 
Business acquisitions, net of cash acquired
(192
)
 
—

 
(176
)
 
—

 
(368
)
Proceeds from sale of businesses, net of closing date cash balances
360

 
175

 
—

 
—

 
535

Other investing activities
(99
)
 
(59
)
 
(35
)
 
—

 
(193
)
Net cash from (used in) investing activities from continuing operations
69

 
116

 
(211
)
 
—

 
(26
)
Financing activities:
 
 
 
 
 
 
 
 
 
Proceeds from sale of senior notes
1,798

 
—

 
—

 
—

 
1,798

Repurchases and redemptions of senior notes
(1,865
)
 
—

 
—

 
—

 
(1,865
)
Common stock repurchased
(322
)
 
—

 
—

 
—

 
(322
)
Dividends paid
(191
)
 
—

 
—

 
—

 
(191
)
Other financing activities
82

 
(81
)
 
55

 
55

 
111

Net cash (used in) from financing activities from continuing operations
(498
)
 
(81
)
 
55

 
55

 
(469
)
Effect of foreign currency exchange rate changes on cash
—

 
—

 
(9
)
 
—

 
(9
)
Net increase in cash and cash equivalents of discontinued operations
7

 
—

 
—

 
—

 
7

Net (decrease) increase in cash
(174
)
 
5

 
(34
)
 
48

 
(155
)
Cash and cash equivalents, beginning of the period
432

 
16

 
285

 
(71
)
 
662

Cash and cash equivalents, end of the period
$
258

 
$
21

 
$
251

 
$
(23
)
 
$
507

For the year-to-date period ended September 29, 2017:
 

 
 

 
 

 
 

 
 

Operating activities:
 

 
 

 
 

 
 

 
 

Net cash from operating activities from continuing operations
$
248

 
$
187

 
$
187

 
$
(41
)
 
$
581

Investing activities:
 
 
 
 
 
 
 
 
 
Business acquisitions, net of cash acquired
(291
)
 
—

 
—

 
—

 
(291
)
Proceeds from sale of businesses, net of closing date cash balances
17

 
—

 
1

 
—

 
18

Other investing activities
(67
)
 
(5
)
 
(19
)
 
—

 
(91
)
Net cash used in investing activities from continuing operations
(341
)
 
(5
)
 
(18
)
 
—

 
(364
)
Financing activities:
 
 
 
 
 
 
 
 
 
Common stock repurchased
(91
)
 
—

 
—

 
—

 
(91
)
Dividends paid
(178
)
 
—

 
—

 
—

 
(178
)
Other financing activities
211

 
(174
)
 
(137
)
 
130

 
30

Net cash used in financing activities from continuing operations
(58
)
 
(174
)
 
(137
)
 
130

 
(239
)
Effect of foreign currency exchange rate changes on cash
—

 
—

 
16

 
—

 
16

Net increase in cash and cash equivalents of discontinued operations
82

 
—

 
—

 
—

 
82

Net (decrease) increase in cash
(69
)
 
8

 
48

 
89

 
76

Cash and cash equivalents, beginning of the period
262

 
5

 
203

 
(107
)
 
363

Cash and cash equivalents, end of the period
$
193

 
$
13

 
$
251

 
$
(18
)
 
$
439



48
Table of Contents
L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


The Company has revised the reported amounts for L3, Guarantor Subsidiaries, Non-Guarantor Subsidiaries and Eliminations in the Condensed Combining Statements of Operations for the quarterly period ended September 29, 2017 and for the year-to-date period ended September 29, 2017 , to retrospectively reflect: (a) changes in Guarantor Subsidiaries resulting from the elimination of Vertex Aerospace as a guarantor due to its sale which occurred on June 29, 2018; (b) additional legal entities included as Guarantor Subsidiaries as the result of the Third Supplemental Indenture dated March 30, 2018; and (c) correction of an error related to the understatement of equity in net income of certain Guarantor Subsidiaries. As a result of the error identification discussed in (c) above, Equity in net income of consolidated subsidiaries and Net income of Guarantor Subsidiaries in the Condensed Combining Statements of Operations for the quarter ended September 29, 2017 and for the year-to-date period ended September 29, 2017 was understated by $34 million and $92 million respectively. The Company assessed the materiality of the error on previously issued financial statements in accordance with SEC Staff Accounting Bulleting No. 99 and No. 108, and concluded that the disclosure error is not material to the Company's previously issued financial statements taken as a whole. The impact of the items referred to above to the reported columnar amounts for L3, Guarantor Subsidiaries, Non-Guarantor Subsidiaries and Eliminations are enumerated below.
Condensed Combining Statement of Operations ( Third Quarter Ended September 29, 2017 )
 
As Reported
 
Adjustment
 
As Adjusted
 
L3
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
L3
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
L3
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
(in millions)
Total net sales
$
840

 
$
1,481

 
$
408

 
$
(83
)
 
$
(4
)
 
$
(324
)
 
$
(22
)
 
$
(3
)
 
$
836

 
$
1,157

 
$
386

 
$
(86
)
Total operating costs and expenses
(746
)
 
(1,390
)
 
(343
)
 
83

 
(1
)
 
309

 
24

 
3

 
(747
)
 
(1,081
)
 
(319
)
 
86

Goodwill impairment charge
—

 
(187
)
 
—

 
—

 
—

 
187

 
—

 
—

 
—

 
—

 
—

 
—

Operating income (loss)
94

 
(96
)
 
65

 
—

 
(5
)
 
172

 
2

 
—

 
89

 
76

 
67

 
—

Interest expense
(42
)
 
—

 
(1
)
 
—

 
1

 
—

 
—

 
—

 
(41
)
 
—

 
(1
)
 
—

Interest and other income (loss), net
7

 
—

 
(1
)
 
—

 
(6
)
 
—

 
2

 
—

 
1

 
—

 
1

 
—

Income (loss) from continuing operations before income taxes
59

 
(96
)
 
63

 
—

 
(10
)
 
172

 
4

 
—

 
49

 
76

 
67

 
—

(Provision) benefit for income taxes
(12
)
 
24

 
(12
)
 
—

 
1

 
(43
)
 
(4
)
 
—

 
(11
)
 
(19
)
 
(16
)
 
—

Equity in net (loss) income of consolidated subsidiaries
(24
)
 
—

 
—

 
24

 
129

 
34

 
—

 
(163
)
 
105

 
34

 
—

 
(139
)
Income (loss) from continuing operations
23

 
(72
)
 
51

 
24

 
120

 
163

 
—

 
(163
)
 
143

 
91

 
51

 
(139
)
Loss from discontinued operations, net of taxes
(1
)
 
—

 
—

 
—

 
(120
)
 
—

 
—

 
—

 
(121
)
 
—

 
—

 
—

Net income (loss)
22

 
(72
)
 
51

 
24

 
—

 
163

 
—

 
(163
)
 
22

 
91

 
51

 
(139
)
Net income attributable to noncontrolling interests
—

 
—

 
—

 
(3
)
 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(3
)
Net income (loss) attributable to L3
$
22

 
$
(72
)
 
$
51

 
$
21

 
$
—

 
$
163

 
$
—

 
$
(163
)
 
$
22

 
$
91

 
$
51

 
$
(142
)
Comprehensive income (loss) attributable to L3
$
85

 
$
(67
)
 
$
100

 
$
(33
)
 
$
—

 
$
206

 
$
1

 
$
(207
)
 
$
85

 
$
139

 
$
101

 
$
(240
)


49
Table of Contents
L3 TECHNOLOGIES, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS — CONTINUED


Condensed Combining Statement of Operations ( Year-to-Date Ended September 29, 2017 )
 
As Reported
 
Adjustment
 
As Adjusted
 
L3
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
L3
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
L3
 
Guarantor Subsidiaries
 
Non-Guarantor Subsidiaries
 
Eliminations
 
 
 
(in millions)
Total net sales
$
2,603

 
$
4,500

 
$
1,201

 
$
(257
)
 
$
(23
)
 
$
(954
)
 
$
(65
)
 
$
(6
)
 
$
2,580

 
$
3,546

 
$
1,136

 
$
(263
)
Total operating costs and expenses
(2,334
)
 
(4,146
)
 
(1,009
)
 
257

 
6

 
920

 
64

 
6

 
(2,328
)
 
(3,226
)
 
(945
)
 
263

Goodwill impairment charge
—

 
(187
)
 
—

 
—

 
—

 
187

 
—

 
—

 
—

 
—

 
—

 
—

Operating income
269

 
167

 
192

 
—

 
(17
)
 
153

 
(1
)
 
—

 
252

 
320

 
191

 
—

Interest expense
(126
)
 
(1
)
 
(1
)
 
—

 
1

 
1

 
—

 
—

 
(125
)
 
—

 
(1
)
 
—

Interest and other income, net
12

 
—

 
3

 
—

 
(6
)
 
—

 
(1
)
 
—

 
6

 
—

 
2

 
—

Income from continuing operations before income taxes
155

 
166

 
194

 
—

 
(22
)
 
154

 
(2
)
 
—

 
133

 
320

 
192

 
—

Provision for income taxes
(34
)
 
(37
)
 
(43
)
 
—

 
4

 
(36
)
 
(1
)
 
—

 
(30
)
 
(73
)
 
(44
)
 
—

Equity in net income of consolidated subsidiaries
268

 
—

 
—

 
(268
)
 
115

 
92

 
—

 
(207
)
 
383

 
92

 
—

 
(475
)
Income from continuing operations
389

 
129

 
151

 
(268
)
 
97

 
210

 
(3
)
 
(207
)
 
486

 
339

 
148

 
(475
)
Loss from discontinued operations, net of taxes
(1
)
 
—

 
—

 
—

 
(97
)
 
—

 
—

 
—

 
(98
)
 
—

 
—

 
—

Net income
388

 
129

 
151

 
(268
)
 
—

 
210

 
(3
)
 
(207
)
 
388

 
339

 
148

 
(475
)
Net income attributable to noncontrolling interests
—

 
—

 
—

 
(12
)
 
—

 
—

 
—

 
—

 
—

 
—

 
—

 
(12
)
Net income attributable to L3
$
388

 
$
129

 
$
151

 
$
(280
)
 
$
—

 
$
210

 
$
(3
)
 
$
(207
)
 
$
388

 
$
339

 
$
148

 
$
(487
)
Comprehensive income attributable to L3
$
541

 
$
134

 
$
273

 
$
(407
)
 
$
—

 
$
313

 
$
(2
)
 
$
(311
)
 
$
541

 
$
447

 
$
271

 
$
(718
)




50
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ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Overview and Outlook
L3’s Business
L3 is a prime contractor in Intelligence, Surveillance and Reconnaissance (ISR) systems, aircraft sustainment (including modifications and fleet management of special mission aircraft), simulation and training, night vision and image intensification equipment and security and detection systems. L3 is also a leading provider of a broad range of communication, electronic and sensor systems used on military, homeland security and commercial platforms. 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 foreign commercial customers.
Effective in the third quarter of 2018, we realigned our reportable segments. Prior to the realignment we had the following four reportable segments: (1) Electronic Systems, (2) Aerospace Systems, (3) Communication Systems and (4) Sensor Systems. The realignment: (i) combined the Aerospace Systems segment with the Sensor Systems segment to form a new reportable segment named the ISR Systems (ISRS) segment, (ii) moved the Naval Power Systems businesses from the Electronic Systems segment to the Communication Systems segment and changed the name of the Communication Systems segment to the Communications & Networked Systems (C&NS) segment and (iii) moved the Maritime Sensor Systems businesses from the former Sensor Systems segment to the C&NS segment. Accordingly, our current structure consists of the following three segments: (1) ISRS, (2) C&NS and (3) Electronic Systems.
ISRS provides products and services for the global ISR and Command, Control and Communications (C 3 ) markets, specializing in ISR mission solutions from seabed to space, signals intelligence (SIGINT) and multi-intelligence platforms, including engineering, modernization and sustainment solutions for military and various government aircraft, ground support equipment and other platforms. These strategic and tactical products and services provide warfighters with the ability to detect, collect, identify, analyze and disseminate information from command centers, communication nodes and air defense systems for real-time situational awareness and response. Other major capabilities and mission solutions include space avionics and imaging payloads, Counter Unmanned Aircraft Systems mission solutions, cyber and electronic warfare, special mission command & control, modeling & simulation and life cycle support. ISRS sells these products and services primarily to the DoD and select foreign governments. The ISRS business areas are ISR Systems, Aircraft Systems, Airborne Sensor Systems, Space & Sensor Systems, Warrior Sensor Systems, MAS, Advanced Programs and Intelligence & Mission Systems.
C&NS provides network and communication systems, secure communications products, radio frequency (RF) components, satellite communication terminals and space, microwave and telemetry products. These products include secure data links that are used to connect a variety of space, airborne, ground and sea-based communication systems and are used in transmission, processing, recording, monitoring and dissemination functions of these communication systems. Other major capabilities include integrated maritime mission solutions, directed energy, lightweight unmanned undersea vehicles and naval power delivery on submarines and surface ships. C&NS sells these products and services primarily to the DoD and select foreign governments. The C&NS business areas are Broadband Communication Systems, Naval Power Systems, Advanced Communications, Space & Power Systems and Maritime Sensor Systems.
Electronic Systems provides a broad range of products and services, including components, products, subsystems, systems and related services to military and commercial customers. These products and services serve niche markets, such as aircraft simulation and training, power and distribution, cockpit avionics, airport security and precision weapons. Electronic Systems sells these products and services primarily to the DoD and select foreign governments. The Electronic Systems business areas are Commercial Aviation Solutions, Precision Engagement Systems, Link Training & Simulation and Security & Detection Systems.
Financial information with respect to our segments is included in Results of Operations within this section, Note 23 to our unaudited condensed consolidated financial statements.
We adopted Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (commonly known as ASC 606), effective January 1, 2018 using the modified retrospective transition method. In accordance with the modified retrospective transition method, the quarter ended September 28, 2018 ( 2018 third quarter ) and the year-to-date period ended September 28, 2018 ( 2018 year-to-date period ) are presented under ASC 606, while the quarter ended September 29, 2017 ( 2017 third quarter ) and the year-to-date period ended September 29, 2017 ( 2017 year-to-date period ) are presented under ASC 605,


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Revenue Recognition , the accounting standard in effect for periods ending prior to January 1, 2018. The cumulative effect of the change in accounting for periods prior to January 1, 2018 was recognized through retained earnings at the date of adoption.
Vertex Aerospace Divestiture: On June 29, 2018, we completed the sale of the Vertex Aerospace businesses for a sale price of $540 million subject to customary closing net working capital adjustments. In connection with the sale, we recognized: (1) a pre-tax gain from continuing operations of $44 million ( $22 million after income taxes) related to the Crestview Aerospace and TCS businesses (the "Crestview & TCS Businesses") and (2) a pre-tax gain from discontinued operations of $237 million ( $180 million after income taxes) related to the Vertex Aerospace business. The divestiture of the Vertex Aerospace business represents a strategic shift by us to exit the logistics solution and maintenance services business for military aircraft where we do not provide complex ISR systems integration and modification. The Vertex Aerospace business generated sales of $1.4 billion for the year ended December 31, 2017. The assets and liabilities and results of operations of the Vertex Aerospace business are reported as discontinued operations for all periods presented.
All references made to financial data in this Quarterly Report on Form 10-Q are to L3’s continuing operations, unless specifically noted.
For the year ended December 31, 2017 , we generated sales of $9,573 million and our primary end customer was the DoD. The table below presents a summary of our consolidated 2017 sales by major category of end customer and the percent contributed by each to our consolidated 2017 sales.
 
2017 Sales
 
% of
2017 Sales
 
(in millions)
 
 
DoD
$
6,329

 
66
%
Other U.S. Government
368

 
4

Total U.S. Government
6,697

 
70

Foreign governments
1,420

 
15

Commercial — foreign
809

 
8

Commercial — domestic
647

 
7

Total sales
$
9,573

 
100
%
We currently expect the composition of our 2018 consolidated sales to the U.S. Government and to international and commercial customers to remain approximately the same as compared to 2017 .
Business Environment
U.S. Government Markets.  Sales to U.S. Government customers represented 70% of our 2017 sales and were primarily to DoD customers, which comprised 66% of our sales. Therefore, our annual sales are generally highly correlated to changes in U.S. Government spending levels, especially DoD budget levels.
The total DoD budget for FY 2016 was $581 billion, an increase of 4% compared to FY 2015. The increase was due to a higher base budget of $522 billion, representing an increase of $25 billion compared to FY 2015. The FY 2016 Overseas Contingency Operations (OCO) budget declined slightly to $59 billion compared to $63 billion for FY 2015. The total DoD budget for FY 2017 was $606 billion ($523 billion base budget, $83 billion OCO), an increase of 4% compared to the appropriated FY 2016 DoD budget.
Because the FY 2018 DoD Appropriations bill was not enacted into law prior to start of fiscal year 2018 (October 1, 2017), the DoD’s FY 2018 funding was addressed through a series of Continuing Resolutions (CR). However, on February 9, 2018, President Trump signed into law the Bipartisan Budget Act of 2018 (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 fiscal years (FYs 2018 and 2019). The BBA included a short-term CR extension to March 23, 2018, to allow for completion of the FY 2018 appropriations process (including enactment of the FY 2018 DoD Appropriations bill). On March 23, 2018, Congress passed and President Trump signed into law the Consolidated Appropriations Act, 2018 (2018 Appropriations Act), a $1.3 trillion spending package that funds the government through September 30, 2018. The 2018 Appropriations Act includes $665 billion for the DoD ($599 billion base budget, $66 billion OCO). While 2018 BBA does raise the spending caps for FY 2018 and FY 2019 previously constrained by the


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Budget Control Act of 2011 (BCA) and temporarily suspends the statutory debt ceiling through March 1, 2019, it does not modify the BCA’s spending caps or sequestration mechanism beyond FY 2019.
On February 12, 2018, the Trump Administration submitted its FY 2019 DoD budget request to Congress, totaling $686 billion ($617 billion base budget, $69 billion OCO funding) and representing an increase of 3% compared to FY 2018 enacted levels. On May 24, 2018, the House passed its version of the FY 2019 National Defense Authorization Act (NDAA), and on June 18, 2018, the Senate passed its version of the FY19 NDAA. Both the House and Senate versions of the FY19 NDAA authorized a base DoD budget of $617 billion and $69 billion in OCO funding, consistent with the President’s FY 2019 budget request. The final versions of the FY19 NDAA were passed by the House and Senate on July 26 and August 1, 2018, respectively, and President Trump signed it into law on August 13, 2018.
On June 28, 2018, the House passed its version of the Fiscal Year 2019 Defense Appropriations Bill, providing $674.4 billion for the Department of Defense and the Intelligence Community - funding levels aligned to those authorized in the NDAA.  On August 23, 2018, the Senate passed its version of the Fiscal Year 2019 Defense Appropriations Bill, consistent with the total funding level included in the House’s version. On September 13, 2018, House and Senate conferees announced a final conference agreement on the Fiscal Year 2019 Defense Appropriations Bill, and on September 28, 2018, the President signed the conference agreement into law. The enactment of the annual Defense Appropriations bill prior to the beginning of the Fiscal Year had not occurred in over a decade.
While the BBA and the 2018 Appropriations Act provide 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, the U.S. Government’s overall fiscal challenges remain, including uncertainties regarding BCA sequestration cuts after FY 2019, and, therefore, future DoD budgets and spending levels are difficult to predict. Although uncertainty exists, we believe that L3 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. For more information on the risks and uncertainties related to our U.S. Government contracts, see “Part I - Item 1A - Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2017 .
International and Commercial Markets. Sales to end customers other than the U.S. Government represented 30% of our 2017 sales. These sales are generally affected by global economic conditions, geopolitical and security conditions and commodity prices, as well as our competitive success in winning new business and increasing our market share. We believe that L3 will benefit from a large addressable international market with sales directly to foreign allied governments and under foreign military sales agreements between the U.S. Government and foreign governments. Although our international sales are experiencing near-term softness, we believe the focus of our international markets in areas such as ISR, simulators, communication systems, night vision products and sensors systems will benefit L3 in the long term. We also believe that the commercial markets in which we participate, such as aviation products, security and screening, simulation and training, and RF microwave and power, have long term favorable fundamentals.
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 the financial performance measure of Operating Cash Flow, and not the type or amount of operating costs.
One of our primary business objectives is to increase sales organically and through select business acquisitions. We define organic sales as net sales excluding the sales impact of acquisitions and divestitures. Sales declines related to business divestitures are sales from divestitures that are included in our actual results for the twelve-month period prior to the divestitures. Sales increases related to acquired businesses are sales from acquisitions that are included in our actual results for less than a twelve-month period. 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.


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Sales Trends.  For the 2018 third quarter , consolidated net sales of $2,519 million increased by $226 million , or 10% , compared to the 2017 third quarter . Organic sales increased by $236 million, or 10%, to $2,494 million for the 2018 third quarter . Organic sales exclude $24 million of sales increases related to business acquisitions and $34 million of sales declines related to business divestitures.
For the 2018 year-to-date period , consolidated net sales of $7,473 million increased by $474 million , or 7% , compared to the 2017 year-to-date period . Organic sales increased by $452 million, or 7%, to $7,407 million for the 2018 year-to-date period . Organic sales exclude $66 million of sales increases related to business acquisitions and $44 million of sales declines related to business divestitures. See “Results of Operations”, including segment results below, for a further discussion of sales.
We derived approximately 66% of our 2017 sales from DoD customers; 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 L3’s future results of operations, including our sales and operating income growth rates. Additionally, L3’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 and those with clearances of top-secret and above. We expect our 2018 consolidated sales to increase by approximately 6% compared to 2017 , including an organic sales increase of 5%. We expect organic sales to the DoD and U.S. Government to increase by approximately 5% and organic international sales to increase by approximately 1% . We expect organic commercial sales to increase by approximately 11% primarily for commercial aviation products.
Operating Income and Margin Trends.  For the 2018 third quarter , our consolidated operating income was $272 million , and our consolidated operating margin was 10.8% . Our consolidated operating income and consolidated operating margin for the 2018 third quarter were impacted by merger, acquisition and divestiture related expenses of $9 million, which are further discussed below. The merger, acquisition and divestiture related expenses are excluded from segment operating income because they are excluded by management for purposes of evaluating the operating performance of our business segments. Our segment operating income was $281 million for the 2018 third quarter , an increase of 21% from $232 million for the 2017 third quarter , and our segment operating income as a percentage of sales (segment operating margin) was 11.2% for the 2018 third quarter , an increase of 110 basis points from 10.1% for the 2017 third quarter . In addition, general and administrative expenses as a percentage of sales was 15.7% for the 2018 third quarter , compared to 16.6% for the 2017 third quarter . The decrease was primarily due to general and administrative expenses increasing at a slower rate than sales increased.
For the 2018 year-to-date period , our consolidated operating income was $844 million , and our consolidated operating margin was 11.3% . Our consolidated operating income and consolidated operating margin for the 2018 year-to-date period were impacted by the gain on sale of the Crestview & TCS Businesses of $44 million and merger and acquisition related expenses of $5 million . Our segment operating income was $805 million for the 2018 year-to-date period , an increase of 6% from $763 million for the 2017 year-to-date period , and our segment operating margin was 10.8% for the 2018 year-to-date period , a decrease of 10 basis points from 10.9% for the 2017 year-to-date period . See “Results of Operations”, including segment results below, for a further discussion of operating margin. In addition, general and administrative expenses as a percentage of sales was 15.7% for the 2018 and 2017 year-to-date period s.
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, curtailing pension benefits for salaried employees, 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. Furthermore, as a U.S. Government contractor, we do not retain the benefit of all cost management actions, particularly on cost-plus type contracts or on contracts where we are the sole-source provider. Although we expect our 2018 annual operating margin to increase as compared to 2017 , changes in the competitive environment and DoD procurement practices 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


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business acquisitions and new business, including contract renewals and new contracts, could have lower future operating margins compared to our operating margins on existing contracts and could reduce future operating margins.
Operating Cash Flow Trends.  We generated $342 million of Operating Cash Flow during the 2018 year-to-date period , a decrease of $239 million compared with $581 million generated during the 2017 year-to-date period . The decrease in Operating Cash Flow was primarily due to higher working capital requirements, primarily contract assets and milestone payments for aircraft procurements related to U.S. and foreign government contracts.
Other Events
Subsequent Event. On October 14, 2018, L3 and Harris Corporation (“Harris”) announced an agreement to combine in an all stock merger of equals. Under the terms of the Agreement and Plan of Merger (the “Merger Agreement”) governing the proposed transaction, which was unanimously approved by the boards of directors of both companies, L3 shareholders will receive a fixed exchange ratio of 1.30 shares of Harris common stock for each share of L3 common stock they hold. Upon completion of the merger, Harris shareholders will own approximately 54% and L3 shareholders will own approximately 46% of the combined company, which will be renamed L3 Harris Technologies, Inc. The merger is expected to close in the middle of 2019, subject to customary closing conditions, including the receipt of regulatory approvals and approval by the shareholders of both L3 and Harris.
U.S. Tax Reform. The U.S. Government enacted the U.S. Tax Cuts and Jobs Act (U.S. Tax Reform) on December 22, 2017, which made significant changes to the U.S. tax system. Significant changes under U.S. Tax Reform included, among other things, the reduction of the U.S. corporate income tax rate from 35% to 21%, the implementation of a modified territorial tax system and the imposition of a one-time repatriation tax on deemed repatriated earnings and profits of U.S. owned foreign subsidiaries (Toll Charge). As a result, we recorded an estimated tax benefit (Preliminary Net Tax Benefit) of $79 million from U.S. Tax Reform in our consolidated financial statements for the year ended December 31, 2017. In accordance with the Securities and Exchange Commission Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118), we increased the Preliminary Net Tax Benefit by $3 million during the 2018 third quarter and the 2018 year-to-date period . The adjusted Preliminary Net Tax Benefit of $82 million includes a $100 million estimated tax benefit related to the remeasurement of deferred taxes partially offset by an estimated tax provision of $18 million related to the Toll Charge. SAB 118 allows for a measurement period of up to one year after the enactment date of U.S. Tax Reform to finalize the recording of the related tax impacts. As such, the Preliminary Net Tax Benefit ultimately recorded may differ in the future due principally to changes to the interpretations of U.S. Tax Reform and legislative action to clarify the interpretation of U.S. Tax Reform. Additionally, we are still evaluating the Global Intangible Low-Taxed Income (GILTI) provisions enacted under U.S. Tax Reform, and the associated election to record its effects as a period cost or as a component of deferred taxes.
Discontinued Operations. As discussed in Note 1 to our unaudited condensed consolidated financial statements, on June 29, 2018, we completed the sale of the Vertex Aerospace business. The table below presents the statements of operations data for Vertex Aerospace. The amounts presented in discontinued operations include allocated interest expenses for debt not directly attributable or related to L3’s other operations. Interest expense was allocated in accordance with the accounting standards for discontinued operations and were based on the ratio of Vertex Aerospace’s net assets to the sum of: (1) L3 consolidated total net assets and (2) L3 consolidated total debt. See Note 5 to the unaudited condensed consolidated financial statements for additional information.
 
Third Quarter Ended
 
Year-to-Date Ended
 
September 28,
2018
 
September 29,
2017
 
September 28,
2018
 
September 29,
2017
 
(in millions)
Net sales
$
—

 
$
357

 
$
597

 
$
1,060

Operating costs and expenses (1)
—

 
(524
)
 
(561
)
 
(1,191
)
Operating (loss) income from discontinued operations
—

 
(167
)
 
36

 
(131
)
Interest expense allocated to discontinued operations
—

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

 
—

 
237

 
—

(Loss) income from discontinued operations before income taxes
—

 
(168
)
 
272

 
(132
)
Income tax benefit (expense)
—

 
47

 
(66
)
 
34

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

 
$
(121
)
 
$
206

 
$
(98
)
__________________
(1)  
We recognized $3 million and $1 million of trailing expenses related to the sale of National Security Solutions for the year-to-date period s ended September 28, 2018 and September 29, 2017 , respectively.


55
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Business Acquisitions and Divestitures
All of our business acquisitions are included in our consolidated results of operations from their dates of acquisition. The table below summarizes the acquisitions that we have completed during the 2018 year-to-date period .
Business Acquisitions
 
Date Acquired
 
Segment
 
Purchase Price (1)
 
 
 
 
 
 
(in millions)
2018
 
 
 
 
 
 
 
Latitude Engineering, LLC
 
June 28, 2018
 
Electronic Systems
 
$
15

(2)
Applied Defense Solutions, Inc.
 
June 29, 2018
 
ISRS
 
53

(3)
Azimuth Security and Linchpin Labs
 
August 31, 2018
 
ISRS
 
200

(4)
C.K. Industrial Engineers Limited
 
September 18, 2018
 
Electronic Systems
 
24

(5)
ASV Global, L.L.C.
 
September 20, 2018
 
C&NS
 
94

 
Total 2018
 
 
 
 
 
$
386

 
__________________
(1)  
The purchase price represents the contractual consideration for the acquired business, excluding adjustments for net cash acquired and acquisition transaction costs.
(2)  
Excludes additional purchase price, not to exceed $20 million, $15 million of which is based on Latitude Engineering’s post-acquisition financial performance for the four-year period ending December 31, 2021, and the remaining $5 million is based on certain post-acquisition milestone achievements through December 31, 2020.
(3)  
The purchase price net of cash acquired of approximately $1 million was $52 million.
(4)  
The purchase price net of cash acquired of approximately $15 million was $185 million and excludes additional purchase price, not to exceed AUD $43 million (approximately $31 million), payable in L3 common stock, based on the combined company’s post-acquisition sales for each of the 12-month periods ending June 30, 2019, 2020, and 2021.
(5)  
The purchase price net of cash acquired of approximately $4 million was $20 million.
See Note 5 to our unaudited condensed consolidated financial statements for additional information regarding our acquisitions and divestitures.
Results of Operations
The following information should be read in conjunction with our unaudited condensed consolidated financial statements contained in this quarterly report. Our results of operations for the periods presented are affected by our business acquisitions and divestitures.


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Consolidated Results of Operations
The table below provides L3’s selected financial data, excluding discontinued operations, for the 2018 third quarter compared with the 2017 third quarter and the 2018 year-to-date period compared with the 2017 year-to-date period .
 
 
Third Quarter Ended
 
 
 
 
Year-to-Date Ended
 
 
 
 
 
(in millions, except per share data)
September 28,
2018
 
September 29,
2017
 
Increase/(decrease)
 
September 28,
2018
 
September 29,
2017
 
Increase/(decrease)
 
 
Net sales (1)
$
2,519

 
$
2,293

 
10
%
 
$
7,473

 
$
6,999

 
7
%
 
 
Operating income (1)
272

 
232

 
17
%
 
844

 
763

 
11
%
 
 
Loss (gain) on sale of the Crestview & TCS Businesses
4

 
—

 
nm
 
 
(44
)
 
—

 
nm
 
 
 
Merger, acquisition and divestiture related expenses
5

 
—

 
nm
 
 
5

 
—

 
nm
 
 
 
Segment operating income (2)
$
281

 
$
232

 
21
%
 
$
805

 
$
763

 
6
%
 
 
Operating margin
10.8
%
 
10.1
%
 
70
bpts
 
11.3
%
 
10.9
%
 
40
bpts
 
 
Segment operating margin
11.2
%
 
10.1
%
 
110
bpts
 
10.8
%
 
10.9
%
 
(10)
bpts
 
 
Interest expense and other
$
(25
)
 
$
(40
)
 
(38)
%
 
$
(96
)
 
$
(118
)
 
(19)
%
 
 
Debt retirement charges
$
(21
)
 
$
—

 
nm
 
 
$
(69
)
 
$
—

 
nm
 
 
 
Effective income tax rate
8.0
%
 
24.0
%
 
nm
 
 
13.3
%
 
22.8
%
 
nm
 
 
 
Net income from continuing operations attributable to L3
$
202

 
$
143

 
41
%
 
$
574

 
$
486

 
18
%
 
 
Diluted earnings per share from continuing operations
$
2.54

 
$
1.79

 
42
%
 
$
7.21

 
$
6.10

 
18
%
 
 
Adjusted diluted earnings per share from continuing operations  (3)
$
2.85

 
$
1.79

 
59
%
 
$
7.64

 
$
6.10

 
25
%
 
 
Diluted weighted average common shares outstanding
79.4

 
79.8

 
(1)
%
 
79.6

 
79.6

 
—
%
 
 
__________________
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1) ___ The adoption of ASC 606 resulted in net increases to sales and operating income of approximately $24 million and $18 million, respectively, for the 2018 third quarter and resulted in net increases to sales and operating income of approximately $145 million and $36 million, respectively, for the 2018 year-to-date period. Under ASC 606, sales from certain contracts previously accounted for under the units-of-delivery method are recognized earlier in the performance period as costs are incurred as opposed to when the units are delivered under ASC 605. See Note 3 to our unaudited condensed consolidated financial statements for additional information on the impact by segment.
 
 
(2) ___ Results for the 2017 year-to-date period include the sale of the company's property in San Carlos, California, which resulted in a pre-tax gain of $42 million ($26 million after-tax or $0.33 per share) and $64 million of cash proceeds.
 
 
(3) ___ For the 2018 third quarter, adjusted diluted EPS from continuing operations represents diluted EPS from continuing operations excluding: (i) a debt retirement charge of $0.21 per diluted share and (ii) merger, acquisition and divestiture related expenses of $0.10 per diluted share. For the 2018 year-to-date period, adjusted diluted EPS from continuing operations represents diluted EPS from continuing operations excluding: (i) the $0.29 gain related to the sale of the company's Crestview & TCS Businesses, (ii) $0.06 of merger and acquisition related expenses and (iii) $0.66 of debt retirement charges. Adjusted diluted EPS from continuing operations is not calculated in accordance with U.S. GAAP. We believe that the gain relating to the Crestview & TCS Businesses divestiture, merger and acquisition related expenses and the debt retirement charge affect the comparability of the results of operations and that disclosing diluted EPS from continuing operations excluding these items is useful to investors as it allows investors to more easily compare the 2018 results to the 2017 results. However, this non- GAAP financial measure may not be defined or calculated by other companies in the same manner.
 
 
nm - not meaningful
 
Net Sales: For the 2018 third quarter , consolidated net sales of $2,519 million increased $226 million , or 10% , compared to the 2017 third quarter . Organic sales increased by $236 million, or 10%, to $2,494 million for the 2018 third quarter . Organic sales exclude $24 million of sales increases related to business acquisitions and $34 million of sales declines related to business divestitures. For the 2018 third quarter , organic sales to the U.S. Government increased $108 million, or 7%, to $1,686 million and organic sales to international and commercial customers increased $128 million, or 19%, to $808 million.
Sales from products increased by $152 million to $1,736 million for the 2018 third quarter , compared to $1,584 million for the 2017 third quarter . Sales from products represented approximately 69% of consolidated net sales for the 2018 and 2017 third quarter s. The increase in sales from products is due to: (1) $44 million due to increased deliveries of airborne turret systems, primarily to foreign militaries, (2) $44 million due to increased deliveries of night vision products, (3) $44 million related to ISR Systems primarily due to higher volume related to missionization of small ISR aircraft systems for the U.S. Air Force (USAF) EC-37B aircraft and a foreign military customer, and the Presidential Aircraft Recap program, (4) $33 million due to increased deliveries for airport screening devices, (5) $29 million increase at Maritime Sensor Systems due to increased volume for new commercial contracts, (6) $15 million due to increased deliveries of electronic warfare countermeasures products, (7) $15 million for Commercial Aviation Solutions due to higher volume on commercial flight simulators and (8) $10 million at Precision Engagement Systems due to increased deliveries and volume on fuzing and ordnance and guidance systems products primarily to


57

the U.S. Army. The increases were partially offset by: (1) $50 million of lower production volume for Unmanned Aerial Vehicle (UAV) communication systems for the U.S. DoD, (2) $24 million due to business acquisitions, net of divestitures and (3) $8 million due to lower volume for Aircraft Systems related to international aircraft modifications primarily the Australian Defence Force C-27J aircraft.
Sales from services increased by $74 million to $783 million for the 2018 third quarter , compared to $709 million for the 2017 third quarter . Sales from services represented approximately 31% of consolidated net sales for the 2018 and 2017 third quarter s. The increase in sales for services is due to: (1) $30 million at Broadband Communication Systems primarily due to operational and sustainment services on U.S. Army satellite communication systems, (2) $14 million due to business acquisitions, net of divestitures, (3) $12 million due to higher volume related to commercial training and simulation, (4) $12 million for support services on airport screening devices and (5) $6 million due to higher volume for mission management systems. See reportable segment results below for additional detail.
Cost of Sales: Cost of sales from products increased by $135 million to $1,324 million for the 2018 third quarter , compared to $1,189 million for the 2017 third quarter . The increase was primarily due to higher products cost of sales of $85 million at Warrior Systems, $59 million at Security & Detection Systems and $46 million at ISR Systems. These increases were partially offset by lower cost of sales of $34 million primarily at Advanced Communications and $21 million due to business acquisitions, net of divestitures, consistent with the change in sales from products described above.
Cost of sales from services increased by $26 million to $518 million for the 2018 third quarter , compared to $492 million for the 2017 third quarter . The increase was primarily due to higher services cost of sales of $52 million at Space & Power Systems, $30 million at Advanced Communications and $9 million due to business acquisitions, net of divestitures. These increases were partially offset by lower cost of sales from services of $65 million at Broadband Communication Systems. These changes are consistent with the change in sales from services described above.
Net Sales: For the 2018 year-to-date period , consolidated net sales of $7,473 million increased $474 million , or 7% , compared to the 2017 year-to-date period . Organic sales increased by $452 million, or 7%, to $7,407 million for the 2018 year-to-date period . Organic sales exclude $66 million of sales increases related to business acquisitions and $44 million of sales declines related to business divestitures. For the 2018 year-to-date period , organic sales to the U.S. Government increased $283 million, or 6%, to $5,136 million, and organic sales to international and commercial customers increased $169 million, or 8%, to $2,271 million.

Sales from products increased by $300 million to $5,168 million for the 2018 year-to-date period , compared to $4,868 million for the 2017 year-to-date period . Sales from products represented approximately 69% of consolidated net sales for the 2018 year-to-date period compared to 70% for the 2017 year-to-date period . The increase in sales from products is due to: (1) the procurement and missionization of USAF EC-37B aircraft, higher volume related to missionization of small ISR aircraft for a foreign military customer and the Presidential Aircraft Recap Program, (2) increased deliveries of night vision products, precision engagement systems, electronic warfare countermeasures, airborne turret systems and airport screening devices, and (3) higher volume of space products and systems and compact towed arrays. These increases were partially offset by lower volume for UAV communication systems. See reportable segment results below for additional detail.

Sales from services increased by $174 million to $2,305 million for the 2018 year-to-date period , compared to $2,131 million for the 2017 year-to-date period . Sales from services represented approximately 31% of consolidated net sales for the 2018 year-to-date period compared to 30% for the 2017 year-to-date period . The increase in sales for services is due to: (1) $70 million at Broadband Communication Systems primarily due to operational and sustainment services on U.S. Army satellite communication systems, (2) $38 million due to business acquisitions, net of divestitures, (3) $24 million due to higher volume for commercial and military training and simulation, (4) $21 million for support services on airport screening devices and (5) $21 million increase due to higher volume for mission management systems. See reportable segment results below for additional detail.

Cost of Sales: Cost of sales from products increased by $234 million to $3,864 million for the 2018 year-to-date period , compared to $3,630 million for the 2017 year-to-date period . The increase was primarily due to higher products cost of sales of $125 million at ISR Systems, $90 million at Warrior Systems, $90 million at Security & Detection Systems and $83 million at Space & Power Systems. These increases were partially offset by $70 million at Aircraft Systems, $60 million at Broadband Communication Systems and $24 million due to business acquisitions, net of divestitures. These changes are consistent with the change in sales from products described above.
    
Cost of sales from services increased by $119 million to $1,628 million for the 2018 year-to-date period , compared to $1,509 million for the 2017 year-to-date period . The increase was primarily due to higher services cost of sales of $37 million at


58

MAS, $30 million due to business acquisitions, net of divestitures, $18 million at Link Training & Simulation, $18 million at Space & Power Systems, $17 million at Advanced Communications, $17 million at Advanced Programs and $13 million at Commercial Aviation Solutions. These increases were partially offset by lower cost of sales from services of $31 million at Broadband Communication Systems. These changes are consistent with the change in sales from services described above.
Operating income and operating margin: Consolidated operating income for the 2018 third quarter increased $40 million , or 17% , compared to the 2017 third quarter . Segment operating income increased by $49 million , or 21% , compared to the 2017 third quarter . Segment operating margin increased by 110 basis points to 11.2% for the 2018 third quarter , compared to 10.1% for the 2017 third quarter . Lower severance and restructuring costs, at C&NS and ISRS, and lower pension costs, primarily at ISRS, were partially offset by unfavorable contract performance adjustments, primarily at C&NS.
Consolidated operating income for the 2018 year-to-date period increased by $81 million , or 11% , compared to the 2017 year-to-date period . Segment operating income for the 2018 year-to-date period increased by $42 million , or 6% , compared to the 2017 year-to-date period . Segment operating margin decreased by 10 basis points to 10.8% for the 2018 year-to-date period from 10.9% for the 2017 year-to-date period . The 2017 year-to-date period included a pre-tax gain of $42 million ($26 million after-tax, or $0.33 per share) on the sale of the company’s property in San Carlos, California in connection with the consolidation of the EDD/ETI Traveling Wave Tube (TWT) businesses in the C&NS segment. Excluding this gain, segment operating margin would have been 10.3% for the 2017 year-to-date period. Lower severance and restructuring costs, primarily at C&NS, were partially offset by higher research and development costs, primarily at ISRS. See the reportable segment results below for additional discussion of sales and operating margin trends.
Effective income tax rate: The effective tax rate for the 2018 third quarter decreased to 8.0% compared to 24.0% for the 2017 third quarter , due to the reversal of previously accrued amounts related to various U.S. Federal, foreign and state tax matters, tax benefits from U.S. Tax Reform and stock-based compensation expense.
The effective tax rate for the 2018 year-to-date period decreased to 13.3% compared to 22.8% for the 2017 year-to-date period , due to tax benefits of U.S. Tax Reform and stock-based compensation expense, partially offset by the related income tax impact of the sale of the Crestview & TCS Businesses.
Net income from continuing operations attributable to L3 and diluted EPS from continuing operations: Net income from continuing operations attributable to L3 for the 2018 third quarter increased 41% to $202 million , compared to $143 million for the 2017 third quarter . Diluted EPS from continuing operations was $2.54 for the 2018 third quarter , compared to $1.79 for the 2017 third quarter . The 2018 third quarter includes: (1) a debt retirement charge of $0.21 per diluted share, and (2) merger, acquisition and divestiture related expenses of $0.10 per diluted share .
Net income from continuing operations attributable to L3 for the 2018 year-to-date period increased 18% to $574 million , compared to $486 million for the 2017 year-to-date period . Diluted EPS from continuing operations was $7.21 for the 2018 year-to-date period , compared to $6.10 for the 2017 year-to-date period . The 2018 year-to-date period includes: (1) merger, acquisition and divestiture related expenses of $0.23 per diluted share and (2) a debt retirement charge of $0.66 per diluted share. The 2017 year-to-date period includes a gain of $0.33 per diluted share in connection with the sale of the company's property in San Carlos, California.
Diluted weighted average common shares outstanding: Diluted weighted average common shares outstanding for the 2018 third quarter declined 1% compared to the 2017 third quarter due to changes in the dilutive impact of common share equivalents.
Diluted weighted average common shares outstanding for the 2018 year-to-date period remained unchanged compared to the 2017 year-to-date period .


59

Reportable Segment Results of Operations
The table below presents selected data by reportable segment reconciled to consolidated totals.
 
Third Quarter Ended
 
Year-to-Date Ended
 
September 28,
2018
 
September 29,
2017
 
September 28,
2018
 
September 29,
2017
 
(dollars in millions)
Net sales:   (1)
 
 
 
 
 
 
 
ISRS
$
1,096

 
$
963

 
$
3,221

 
$
2,924

C&NS
734

 
752

 
2,243

 
2,271

Electronic Systems
689

 
578

 
2,009

 
1,804

Consolidated net sales
$
2,519


$
2,293


$
7,473


$
6,999

Operating income:
 
 
 
 
 
 
 
ISRS
$
121

 
$
73

 
$
321

 
$
256

C&NS
69

 
81

 
208

 
277

Electronic Systems
91

 
78

 
276

 
230

Total segment operating income
281


232


805


763

(Loss) gain on sale of the Crestview & TCS Businesses
(4
)
 
—

 
44

 
—

Merger, acquisition and divestiture related expenses
(5
)
 
—

 
(5
)
 
—

Consolidated operating income
$
272


$
232


$
844


$
763

Operating margin:
 
 
 
 
 
 
 
ISRS
11.0
 %
 
7.6
%
 
10.0
 %
 
8.8
%
C&NS
9.4
 %
 
10.8
%
 
9.3
 %
 
12.2
%
Electronic Systems
13.2
 %
 
13.5
%
 
13.7
 %
 
12.7
%
Total segment operating margin
11.2
 %
 
10.1
%
 
10.8
 %
 
10.9
%
(Loss) gain on sale of the Crestview & TCS Businesses
(0.2
)%
 
—

 
0.6
 %
 
—

Merger, acquisition and divestiture related expenses
(0.2
)%
 
—

 
(0.1
)%
 
—

Consolidated operating margin
10.8
 %

10.1
%

11.3
 %

10.9
%
__________________
(1)  
Net sales after intercompany eliminations.
ISRS
 
 
Third Quarter Ended
 
 
 
 
Year-to-Date Ended
 
 
 
 
 
 
September 28,
2018
 
September 29,
2017
 
Increase
 
September 28,
2018
 
September 29,
2017
 
Increase
 
 
 
(dollars in millions)
 
 
Net sales
$
1,096

 
$
963

 
14

%
 
$
3,221

 
$
2,924

 
10

%
 
 
Operating income
$
121

 
$
73

 
66

%
 
$
321

 
$
256

 
25

%
 
 
Operating margin
11.0
%
 
7.6
%
 
340

bpts
 
10.0
%
 
8.8
%
 
120

bpts
 
ISRS net sales for the 2018 third quarter increased by $133 million , or 14% , compared to the 2017 third quarter . Organic sales increased by $158 million, or 17%, compared to the 2017 third quarter . Organic sales exclude $9 million of sales increases related to business acquisitions and $34 million of sales declines related to business divestitures. Organic sales increased by: (1) $51 million for ISR Systems primarily due to higher volume related to ISR missionization of business jet aircraft systems for the U.S. Air Force (USAF) EC-37B aircraft and a foreign military customer, and the Presidential Aircraft Recap program, (2) $44 million for Warrior Systems due to increased deliveries of night vision products, primarily to foreign military customers, (3) $42 million due to increased deliveries at Airborne Sensor Systems, primarily to foreign militaries, (4) $16 million for Intelligence & Mission Systems primarily due to increased deliveries of electronic warfare countermeasures products to foreign militaries and (5) $5 million for Space Systems due to higher volume for optical systems, and space electronics and infrared detection products.
ISRS operating income for the 2018 third quarter increased by $48 million , or 66% , compared to the 2017 third quarter . Operating margin increased by 340 basis points to 11.0% . Operating margin increased by: (1) 180 basis points due to higher volume primarily at Airborne Sensor Systems and Warrior Sensor Systems, (2) 100 basis points due to lower severance and restructuring


60

costs of $11 million, (3) 100 basis points due to lower pension costs and (4) 50 basis points related to business divestitures. These increases were partially offset by 90 basis points due to higher research and development expenses of $12 million, primarily related to imaging and space growth investments.
ISRS net sales for the 2018 year-to-date period increased by $297 million , or 10% , compared to the 2017 year-to-date period . Organic sales increased by $317 million, or 11%, compared to the 2017 year-to-date period . Organic sales exclude $14 million of sales increases related to business acquisitions and $34 million of sales declines related to business divestitures. Organic sales increased by: (1) $126 million for ISR Systems primarily due to the procurement and ISR missionization of business jet aircraft systems for the USAF EC-37B aircraft and for a foreign military customer, and the Presidential Aircraft Recap Program, (2) $85 million primarily due to increased deliveries of airborne turret systems, primarily to foreign militaries, (3) $78 million for Warrior Systems primarily due to increased deliveries of night vision products to foreign military customers, (4) $31 million for Intelligence & Mission Systems primarily due to increased deliveries of electronic warfare countermeasures products primarily to foreign militaries, (5) $27 million for Space Systems primarily due to higher volume for optical systems, and space electronics and infrared detection products to the U.S. military and (6) $20 million for Advanced Programs primarily due to higher volume for mission management systems. These increases were partially offset by lower volume of: (1) $50 million for Aircraft Systems related to international aircraft modifications primarily the Australian Defence Force C-27J aircraft.
ISRS operating income for the 2018 year-to-date period increased by $65 million , or 25% , compared to the 2017 year-to-date period . Operating margin increased by 120 basis points to 10.0% due to trends similar to the 2018 third quarter. Higher research and development expenses for $25 million reduced operating margin by 70 basis points.
C&NS
 
 
Third Quarter Ended
 
 
 
 
Year-to-Date Ended
 
 
 
 
 
 
September 28,
2018
 
September 29,
2017
 
Decrease
 
September 28,
2018
 
September 29,
2017
 
Decrease
 
 
 
(dollars in millions)
 
 
Net sales
$
734

 
$
752

 
(2
)
%
 
$
2,243

 
$
2,271

 
(1
)
%
 
 
Operating income
$
69

 
$
81

 
(15
)
%
 
$
208

 
$
277

 
(25
)
%
 
 
Operating margin
9.4
%
 
10.8
%
 
(140
)
bpts
 
9.3
%
 
12.2
%
 
(290
)
bpts
 
C&NS net sales for the 2018 third quarter decreased by $18 million , or 2% , compared to the 2017 third quarter . Organic sales decreased by $22 million, or 3%, compared to the 2017 third quarter. Organic sales exclude $4 million of sales increases related to business acquisitions. Sales decreased by: (1) $20 million for Broadband Communication Systems due to lower production volume for UAV communication systems for the U.S. DoD, (2) $17 million for Advanced Communications primarily due to lower volume for the F-35 Joint Strike Fighter and (3) $14 million for Naval Power Systems primarily due to lower volume on the landing craft, air cushion (LCAC) service life extension program and lower volume for power conversion systems for the U.S. Navy. These decreases were partially offset by $29 million for Maritime Sensor Systems due to increased volume for new commercial contracts.
C&NS operating income for the 2018 third quarter decreased by $12 million , or 15% , compared to the 2017 third quarter . Operating margin decreased by 140 basis points to 9.4% . Operating margin decreased by 240 basis points due to lower manufacturing yields and unfavorable contract performance at the recently consolidated traveling wave tube (TWT) businesses in Space & Power Systems, and 120 basis points primarily due to lower volume at Broadband Communication Systems. This decrease was partially offset by lower severance and restructuring costs of $16 million for the 2018 third quarter compared to the 2017 third quarter, primarily at Space & Power Systems, which increased operating margin by 220 basis points.
C&NS net sales for the 2018 year-to-date period decreased by $28 million , or 1% , compared to the 2017 year-to-date period . Organic sales decreased by $44 million, or 2%, compared to the 2017 third quarter. Organic sales exclude $16 million of sales increases related to business acquisitions. Sales decreased by: (1) $84 million for Broadband Communication Systems due to lower production volume for UAV communication systems for the U.S. DoD, (2) $20 million for Advanced Communications primarily due to fewer deliveries of manpack satellite communication systems to the U.S. Special Operations Command and (3) $16 million primarily for Naval Power Systems due to lower volume on the LCAC service life extension program and lower volume for power conversion systems for the U.S. Navy. These decreases were partially offset by $47 million for Maritime Sensor Systems primarily due to increased volume for new commercial contracts and $29 million for Space & Power Systems due to higher volume on power devices for commercial and military satellites.


61

C&NS operating income for the 2018 year-to-date period decreased by $69 million , or 25% , compared to the 2017 year-to-date period . Operating margin decreased by 290 basis points to 9.3% . Operating margin decreased by: (1) 190 basis points due to a pre-tax gain of $42 million related to the sale of the company’s property in San Carlos, California in connection with the consolidation of the EDD/ETI TWT businesses in the 2017 year-to-date period that did not recur, (2) 150 basis points due to lower manufacturing yields and unfavorable contract performance primarily at the TWT business in Space & Power Systems and (3) 70 basis points primarily due to lower volume at Broadband Communication Systems and Naval Power Systems. These decreases were partially offset by 120 basis points due to lower severance and restructuring costs of $26 million.
Electronic Systems
 
 
Third Quarter Ended
 
 
 
 
Year-to-Date Ended
 
 
 
 
 
 
September 28,
2018
 
September 29,
2017
 
Increase/ (decrease)
 
September 28,
2018
 
September 29,
2017
 
Increase
 
 
 
(dollars in millions)
 
 
Net sales
$
689

 
$
578

 
19

%
 
$
2,009

 
$
1,804

 
11

%
 
 
Operating income
$
91

 
$
78

 
17

%
 
$
276

 
$
230

 
20

%
 
 
Operating margin
13.2
%
 
13.5
%
 
(30
)
bpts
 
13.7
%
 
12.7
%
 
100

bpts
 
Electronic Systems net sales for the 2018 third quarter increased by $111 million , or 19% , compared to the 2017 third quarter . Organic sales increased by $100 million, or 17%, compared to the 2017 third quarter. Organic sales exclude $11 million of sales increases related to business acquisitions. Organic sales increased by: (1) $45 million for Security & Detection Systems due to increased deliveries for airport screening devices primarily to the U.S. Transportation Security Administration (TSA) and higher volume on an industrial automation control contract for a commercial customer, (2) $28 million primarily for Precision Engagement Systems due to increased deliveries and volume on fuzing and ordnance and guidance systems products primarily to the U.S. Army and (3) $27 million for Commercial Aviation Solutions due to higher volume on commercial flight simulators.
Electronic Systems operating income for the 2018 third quarter increased by $13 million , or 17% , compared to the 2017 third quarter . Operating margin decreased by 30 basis points to 13.2% . Operating margin decreased by: (1) 70 basis points primarily due to product sales mix changes at Security & Detection Systems and Link Training & Simulation and (2) 60 basis points due to acquisitions. These decreases were partially offset by 100 basis points primarily due to favorable contract performance across all business areas.
Electronic Systems net sales for the 2018 year-to-date period increased by $205 million , or 11% , compared to the 2017 year-to-date period . Organic sales increased by $179 million, or 10%, compared to the 2017 year-to-date period. Organic sales exclude $36 million of sales increases related to business acquisitions and $10 million of sales declines related to business divestitures. Organic sales increased by: (1) $78 million for Precision Engagement Systems due to increased deliveries and volume on fuzing and ordnance and guidance systems products primarily to the U.S. Army, (2) $66 million for Security & Detection Systems due to increased deliveries for airport screening devices primarily to the U.S. TSA and higher volume on an industrial automation control contract for a commercial customer, (3) $21 million for Commercial Aviation Solutions due to higher volume on commercial flight simulators and (4) $14 million primarily for Link Training & Simulation due to higher volume for training systems to the U.S. Air Force and U.S. Navy.
Electronic Systems operating income for the 2018 year-to-date period increased by $46 million , or 20% , compared to the 2017 year-to-date period . Operating margin increased by 100 basis points to 13.7% . Operating margin increased by; (1) 150 basis points primarily due to favorable contract performance across all business areas, (2) 30 basis points due to higher margins related to acquisitions and (3) 10 basis points due to lower severance costs. These increases were partially offset by 90 basis points primarily due to higher research and technology development expenses.
Liquidity and Capital Resources
Anticipated Sources and Uses of Cash Flow
At September 28, 2018 , we had total cash and cash equivalents of $507 million as compared to $662 million at December 31, 2017 . While no amounts of the cash and cash equivalents are considered restricted, $252 million of cash was held by our foreign subsidiaries at September 28, 2018 . The repatriation of cash held in non-U.S. jurisdictions is subject to local capital requirements. Our primary sources of liquidity are cash flow generated from operations, cash on hand and our five-year unsecured $1 billion revolving credit facility (Credit Facility), which we entered into on October 31, 2016. At September 28, 2018 , we had the full availability of our Credit Facility. We generated $342 million of net cash from operating activities from continuing operations.


62

We currently believe that our cash from operating activities generated during the year, together with our cash on hand and available borrowings under our Credit Facility, will be adequate for the foreseeable future to meet our anticipated uses of cash flow, including 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, L3 dividends and share repurchases.
Balance Sheet
We made certain presentation changes to our consolidated balance sheet on January 1, 2018 to comply with ASC 606. The components of contracts in process as reported under ASC 605, which included unbilled contract receivables and inventoried contract costs, have been reclassified to contract assets and inventories, respectively, after certain adjustments described below under ASC 606. The adoption of ASC 606 resulted in an increase in unbilled contract receivables (referred to as contract assets under ASC 606) primarily from converting contracts previously applying the units-of-delivery method to the cost-to-cost method with a corresponding reduction in inventoried contract costs. The remainder of inventoried contract costs, primarily related to inventories not controlled by our customers, were reclassified to inventories. Additionally, under ASC 606, we capitalize costs to fulfill a contract (i.e., non-recurring costs for contract-related activities that do not transfer a good or service to the customer) and costs to obtain a contract (i.e., commissions paid to third-party agents or representatives) to prepaid expense and other current assets or other assets (non-current). We previously accounted for costs to fulfill a contract either as inventoried contract costs or expensed them as incurred. Costs to obtain a contract were generally expensed as incurred. Advance payments and billings in excess of costs and deferred revenue, previously classified in other current liabilities, have been combined and are presented as contract liabilities.
Billed receivables increased by $177 million to $900 million at September 28, 2018 , from $723 million at December 31, 2017 , primarily due to the timing of billings and collections for Warrior Sensor Systems, Security & Detection Systems and Airborne Sensor Systems and $12 million from acquisitions, partially offset by $6 million for foreign currency translation adjustments.
Contract assets increased by $358 million to $1,707 million at September 28, 2018 , from $1,349 million at January 1, 2018 , primarily due to sales exceeding billings for ISR Systems, Link Training & Simulation, Space & Power Systems, Aircraft Systems, Precision Engagement Systems, Maritime Sensor Systems and Naval Power Systems, partially offset by $6 million for foreign currency translation adjustments.
Inventories increased by $522 million to $911 million at September 28, 2018 from $389 million at December 31, 2017 , primarily due to reclassifications related to the adoption of ASC 606.
The increase in prepaid expenses and other current assets was primarily due to milestone payments for aircraft procurements related to U.S. and foreign government contracts at ISR Systems.
The increase in net property, plant and equipment (PP&E) was primarily due to capital expenditures and $14 million of acquired PP&E from completed business acquisitions, primarily ASV Global and fair value purchase price adjustments for Doss Aviation, partially offset by depreciation expense.
Goodwill increased by $219 million to $6,834 million at September 28, 2018 from $6,615 million at December 31, 2017 . The table below presents the changes in goodwill by segment.
 
ISRS
 
C&NS
 
Electronic Systems
 
Consolidated Total
 
(in millions)
December 31, 2017
$
2,458

 
$
1,962

 
$
2,195

 
$
6,615

Business acquisitions (1)
150

 
65

 
30

 
245

Foreign currency translation adjustments
(9
)
 
(4
)
 
(13
)
 
(26
)
September 28, 2018
$
2,599

 
$
2,023

 
$
2,212

 
$
6,834

__________________
(1)  
The increase for the ISRS segment was due to the acquisitions of the Azimuth Security, Linchpin Labs and Applied Defense Solutions businesses and the purchase price allocation adjustments for the Kigre business acquisition. The increase for the C&NS segment was due to the acquisition of the ASV Global business and purchase price allocation adjustments for the Adaptive Methods business acquisition. The increase for the Electronic Systems segment was due to the acquisitions of the Latitude Engineering and C.K. Industrial Engineers businesses and the purchase price allocation adjustments for the G-Air and Doss Aviation business acquisitions.


63

The increase in identifiable intangible assets was primarily due to $156 million of intangible assets recognized for the Azimuth Security and Linchpin Labs, ASV Global, Applied Defense Solutions, C.K. Industrial Engineers and Latitude Engineering business acquisitions and purchase price allocation adjustments for Doss Aviation, partially offset by amortization expense and by $2 million for foreign currency translation adjustments.
The increase in other assets from January 1, 2018 was primarily due to investments in nonconsolidated affiliates made during the 2018 year-to-date period .
The increase in accounts payable and accrued expenses was primarily due to the timing of when invoices for purchases from third party vendors and subcontractors were received and payments were made.
Deferred income taxes increased primarily due to: (1) the amortization of certain goodwill and other identifiable assets for tax purposes, (2) U.S. Tax Reform and (3) equity compensation.
Statement of Cash Flows
2018 year-to-date period Compared with the 2017 year-to-date period
The table below provides a summary of our cash flows from (used in) operating, investing and financing activities for the periods indicated.
 
Year-to-Date Ended
 
September 28,
2018
 
September 29,
2017
 
Cash Flow
  Increase/
  (decrease)
 
(in millions)
Net cash from operating activities from continuing operations
$
342

 
$
581

 
$
(239
)
Net cash used in investing activities from continuing operations
(26
)
 
(364
)
 
338

Net cash used in financing activities from continuing operations
(469
)
 
(239
)
 
(230
)
Operating Activities
We generated $342 million of cash from operating activities during the 2018 year-to-date period , a decrease of $239 million compared with $581 million generated during the 2017 year-to-date period . The decrease in the 2018 year-to-date period was primarily due to higher working capital requirements, primarily contract assets and milestone payments for aircraft procurements related to U.S. and foreign government contracts. The net cash from changes in operating assets and liabilities is further discussed above under “Liquidity and Capital Resources - Balance Sheet”.
Investing Activities
During the 2018 year-to-date period , we used $26 million of cash from investing activities, which included $535 million of cash received from the sale of Vertex Aerospace and Crestview & TCS Businesses , partially offset by acquisitions of Azimuth Security and Linchpin Labs for $179 million (net of cash acquired), ASV Global for $98 million, Applied Defense Solutions for $52 million, C.K. Industrial Engineers for $24 million and Latitude Engineering for $15 million. Furthermore, we used cash of $167 million for capital expenditures and $30 million from investments in nonconsolidated affiliates, primarily Peak Nano. During the 2017 year-to-date period , we used $364 million of cash from investing activities, which included $291 million used for business acquisitions and $151 million for capital expenditures, partially offset by $67 million of cash generated substantially from the sale of the property in San Carlos, California and $18 million for business divestitures.
Financing Activities
Debt
At September 28, 2018 , total outstanding debt was $3,320 million , compared to $3,330 million at December 31, 2017 , all of which was senior debt. The decrease was due to the completion of our tender offers for $1,215 million and our redemptions for $581 million in carrying value of the 2019 Senior Notes and 2020 Senior Notes, partially offset by the issuance of $1,782 million of the 2023 Senior Notes and 2028 Senior Notes. See tables below for additional details. At September 28, 2018 , there were no borrowings or letters of credit outstanding under our Credit Facility. Accordingly, we had the full availability of our $1 billion facility for future borrowings. We also had $383 million of outstanding standby letters of credit with financial institutions covering performance and financial guarantees per contractual requirements with certain customers at September 28, 2018 . These


64

standby letters of credit may be drawn upon in the event that we do not perform on certain of our contractual requirements. At September 28, 2018 , our outstanding debt matures between February 15, 2021 and June 15, 2028. See Note 11 to our unaudited condensed consolidated financial statements contained in this quarterly report for the components of our debt at September 28, 2018 .
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. Effective October 16, 2018, our senior unsecured credit rating from both Standard and Poor’s and Fitch Ratings of BBB- was placed on CreditWatch Positive. Our senior unsecured credit rating from Moody’s Investors Service remains at Baa3 with a stable outlook.
Issuance of Senior Notes
On June 6, 2018, L3 issued two series of senior notes, which are unsecured senior obligations of L3. The terms of each series of senior notes are presented in the table below.
Note
 
Date of Issuance
 
Amount
Issued
 
Discount (1)
 
Net
Cash
Proceeds (2)
 
Effective
Interest
Rate
 
Redemption
at Treasury
Rate (3)(4)
 
 
 
 
(dollars in millions)
 
 
 
 
3.85% Senior Notes due June 15, 2023 (the 2023 Notes)
 
June 6, 2018
 
$
800

 
$
2

 
$
792

 
3.89
%
 
20 bps
4.40% Senior Notes due June 15, 2028 (the 2028 Notes)
 
June 6, 2018
 
$
1,000

 
$
1

 
$
990

 
4.41
%
 
25 bps
__________________
(1)  
Bond discounts are recorded as a reduction to the principal amount of the notes and are amortized as interest expense over the term of the notes.  
(2)  
The net cash proceeds of $1,782 million (after deduction of the discount, underwriting expenses and commissions and other related expenses) plus cash on hand were used to fund the concurrent cash tender offers (the Tender Offers) for any and all of $1 billion aggregate principal amount of 5.20% Senior Notes due October 15, 2019 (the 2019 Notes) and $800 million aggregate principal amount of 4.75% Senior Notes due July 15, 2020 (the 2020 Notes) and any related redemption of notes not tendered in the Tender Offers.
(3)  
The 2023 Notes may be redeemed at any time prior to May 15, 2023 (one month prior to maturity), and the 2028 Notes may be redeemed at any time prior to March 15, 2028 (three months prior to maturity), at the option of L3, in whole or in part, at a redemption price equal to the greater of: (i) 100% of the principal amount, or (ii) the present value of the remaining principal and interest payments discounted to the date of redemption, on a semi-annual basis, at the Treasury Rate (as defined in the indentures governing the senior notes), plus the spread indicated in the table above. In addition, if the 2023 Notes and the 2028 Notes are redeemed at any time on or after May 15, 2023 and March 15, 2028, respectively, the redemption price would be equal to 100% of the principal amount.
(4)  
Upon the occurrence of a change in control (as defined in the indentures governing the senior notes) along with a “change of control triggering event” (generally described as the applicable series of senior notes ceasing to be rated investment grade, as defined in the indentures governing the senior notes), each holder of the notes will have the right to require L3 to repurchase all or any part of such holder’s notes at an offer price in cash equal to 101% of the aggregate principal amount plus accrued and unpaid interest, if any, to the date of purchase.
Repurchases and Redemptions of Senior Notes
The table below summarizes the Tender Offers with respect to the 2019 Notes and the 2020 Notes.
Note
 
Settlement Type
 
Date Settled
 
Aggregate
Principal
 
Principal
Tendered
 
Tender
Premium
 
Cash
Tendered (1)
 
Interest
 
Total Cash
Payments
 
Debt
Retirement
Charge (2)
 
 
 
 
 
 
(dollars in millions)
5.20% Senior Notes due 2019
 
Tender Offer
 
June 6, 2018
 
$
1,000

 
$
683

 
103.282
%
 
$
705

 
$
5

 
$
710

 
$
24

4.75% Senior Notes due 2020
 
Tender Offer
 
June 6, 2018
 
$
800

 
$
535

 
104.092
%
 
$
557

 
$
10

 
$
567

 
$
24

__________________
(1)  
Excludes $1 million of tender offer fees.
(2)  
The debt retirement charge includes $1 million of tender offer fees and $3 million which represents the non-cash retirement of associated unamortized debt issue costs and discounts.


65

On June 6, 2018, we initiated the redemption of the 2019 Notes and the 2020 Notes that remained outstanding subsequent to the expiration of the Tender Offers. On July 6, 2018, we completed the redemption of the 2019 Notes and the 2020 Notes. The terms of the 2019 Notes and the 2020 Notes redemption are presented in the table below.
Note
 
Settlement Type
 
Date Settled
 
Principal
Redeemed
 
Redemption
Premium
 
Cash
Payments
 
Interest
 
Total Cash
Payments
 
Debt
Retirement
Charge (1)
 
 
 
 
 
 
(dollars in millions)
5.20% Senior Notes due 2019
 
Redemption
 
July 6, 2018
 
$
317

 
103.048
%
 
$
327

 
$
4

 
$
331

 
$
10

4.75% Senior Notes due 2020
 
Redemption
 
July 6, 2018
 
$
265

 
103.818
%
 
$
275

 
$
6

 
$
281

 
$
11

__________________
(1)  
The debt retirement charge includes $1 million which represents the non-cash retirement of associated unamortized debt issue costs and discounts.
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 the year ended December 31, 2017 , included in our Annual Report on Form 10-K, for a description of our debt, related financial covenants and cross default provisions. We were in compliance with our financial and other restrictive covenants at September 28, 2018 .
Guarantees. The borrowings under the Credit Facility are fully and unconditionally guaranteed by L3 and by substantially all of the material 100% owned domestic subsidiaries of L3 on an unsecured senior basis. The payment of principal and premium, if any, and interest on the senior notes is fully and unconditionally guaranteed, jointly and severally, by L3’s 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.     
Equity
Repurchases of L3’s common stock under the current share repurchase program are made from time to time at management’s discretion, in accordance with applicable U.S. Federal securities laws. The timing and actual number of shares to be repurchased in the future will depend on a variety of factors, including, but not limited to, our financial position, earnings, legal requirements, other investment opportunities (including acquisitions) and market conditions. All share repurchases of L3’s common stock have been recorded as treasury shares.
The table below presents our repurchases of L3’s common stock during the 2018 year-to-date period .
 
Total Number of
  Shares Purchased
 
Average Price Paid
  Per Share
 
Treasury Stock
 
 
 
 
 
(at cost in millions)
January 1 — March 30, 2018
581,229

 
$
203.93

 
$
119

March 31 — June 29, 2018
878,188

 
$
192.35

 
$
168

June 30 — September 28, 2018
177,882

 
$
193.95

 
$
35

On May 8, 2017, L3’s Board of Directors approved a share repurchase program that authorizes L3 to repurchase up to an additional $1.5 billion of its common stock. The program became effective on July 1, 2017 and has no set expiration date. We did not repurchase any shares of common stock from September 29, 2018 through October 19, 2018 . In connection with the planned merger with Harris Corporation, we suspended future share repurchases.
During the 2018 year-to-date period , our Board of Directors authorized the quarterly cash dividends in the table below.
Date Declared
 
Record Date
 
Cash Dividend
Per Share
 
Total Cash
Dividends
Declared
 
Date Paid
 
 
 
 
 
 
(in millions)
 
 
February 12, 2018
 
March 1, 2018
 
$
0.80

 
$
63

(1)  
 
March 15, 2018
May 8, 2018
 
May 18, 2018
 
$
0.80

 
$
63

(1)  
 
June 15, 2018
July 10, 2018
 
August 17, 2018
 
$
0.80

 
$
63

(1)  
 
September 17, 2018
__________________
(1)  
During the 2018 year-to-date period , we paid $191 million of cash dividends, including a $2 million net reduction of previously accrued dividends for employee-held stock awards.


66

On October 22, 2018 , our Board of Directors declared a quarterly cash dividend of $0.80 per share, payable on December 17, 2018 to shareholders of record at the close of business on November 16, 2018 .
Legal Proceedings and Contingencies
For a discussion of legal proceedings and contingencies that could impact our results of operations, financial condition or cash flows, see Note 19 to our unaudited condensed consolidated financial statements contained in this quarterly report.
Forward-Looking Statements
Certain of the matters discussed in this report, including information regarding the Company’s 2018 financial outlook, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements other than historical facts may be forward-looking statements; words, 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: the occurrence of any event, change or other circumstances that could give us or Harris the right to terminate the definitive merger agreement between us and Harris; the outcome of any legal proceedings that may be instituted against us, Harris or our respective directors with respect to the merger; the risk that we or Harris may not obtain the required stockholder approvals on the expected schedule or at all; the ability to obtain regulatory approvals and satisfy other closing conditions to the merger in a timely manner or at all, including the risk that regulatory approvals required for the merger are not obtained or are obtained subject to conditions that are not anticipated; delay in closing the merger; difficulties and delays in integrating our business with Harris’s business or fully realizing anticipated cost savings and other benefits; business disruptions from the proposed merger that may harm our business or Harris’s business, including current plans and operations; any announcement relating to the proposed transaction could have adverse effects on our ability or the ability of Harris to retain and hire key personnel or maintain relationships with suppliers and customers, including the U.S. government and other governments, or on our or Harris’s operating results and businesses generally; the risk that the announcement of the proposed transaction could have adverse effects on the market price of our common stock or Harris’s common stock and the uncertainty as to the long-term value of the common stock of the combined company following the merger; certain restrictions during the pendency of the merger that may impact our ability or the ability of Harris to pursue certain business opportunities or strategic transactions; the business, economic and political conditions in the markets in which we and Harris operate; 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; 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; the outcome of litigation matters; results of audits by U.S. Government agencies and of ongoing governmental investigations; 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 should they arise; the business, economic and political conditions in the markets in which we operate; the risk that our commercial aviation products and services businesses are affected by a downturn in global demand for air travel or a reduction in commercial aircraft Original Equipment Manufacturer (OEM) production rates; 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 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 “Part II — Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2017 and in this quarterly report on Form 10-Q, and any material updates to these factors contained in any of our future filings.


67

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.


68

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
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,” of our Annual Report on Form 10-K for the year ended December 31, 2017 for a discussion of our exposure to market risks. There were no material changes to our disclosure about market risks during the 2018 year-to-date period . See Notes 16 and 18 to our unaudited condensed consolidated financial statements contained in this quarterly report for the aggregate fair values and notional amounts of our foreign currency forward contracts at September 28, 2018 .
ITEM 4.

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 L3 Technologies, Inc. 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, Chief Executive Officer and President 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, Chief Executive Officer and President 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 September 28, 2018 . Based upon that evaluation, our Chairman, Chief Executive Officer and President and our Senior Vice President and Chief Financial Officer concluded that, as of September 28, 2018 , the design and operation of our disclosure controls and procedures were effective to accomplish their objectives at the reasonable assurance level.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the quarter ended September 28, 2018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



69
Table of Contents

PART II — OTHER INFORMATION
ITEM 1.
LEGAL PROCEEDINGS
The information required with respect to this item can be found in Note 19 to our unaudited condensed consolidated financial statements contained in this quarterly report and is incorporated by reference into this Item 1.
ITEM 1A.

RISK FACTORS
In addition to the other information set forth in this report, you should carefully consider the factors discussed in “Part I — Item 1A — Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2017 , and “Part II — Item 7 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Overview and Outlook — Business Environment” in our Annual Report on Form 10-K, which could materially affect our business, financial condition or future results. Except for the risks described below, here have been no material changes to the risk factors disclosed in “Part I — Item 1A — Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2017 . The risks described below and in our Annual Report on Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.
There are risks and uncertainties associated with our planned Merger with Harris.
Completion of the proposed Merger is subject to various conditions, and the proposed Merger may not occur even if we obtain stockholder approval.
The completion of the proposed Merger is subject to certain conditions, including, among others, the (i) the adoption of the Merger Agreement by our stockholders; (ii) the approval of the issuance of Harris Common Stock pursuant to the Merger Agreement and adoption of an amendment of the charter of Harris by the stockholders of Harris; (iii) the approval for listing on the NYSE of the shares of Harris Common Stock to be issued pursuant to the Merger Agreement; (iv) the expiration or earlier termination of any applicable waiting period, and the receipt of approvals under, domestic and certain foreign antitrust and competition laws; (v) the absence of governmental restraints or prohibitions preventing the consummation of the Merger; and (vi) the effectiveness of the registration statement on Form S-4 registering the Harris Common Stock issuable in the Merger and absence of any stop order or proceedings by the SEC with respect thereto. The obligation of each of us and Harris to consummate the proposed Merger is also conditioned on, among other things, the receipt of a tax representation letter from the other party the purpose of which is to permit each party’s counsel to render a tax opinion as to the tax-free nature of the Merger, the absence of a material adverse effect on the other party, the truth and correctness of the representations and warranties made by the other party on the date of the Merger Agreement and on the closing date (subject to certain “materiality” and “material adverse effect” qualifiers), and the performance by the other party in all material respects of its obligations under the Merger Agreement.. We cannot provide any assurance that these conditions will be met or waived, or that we will be able to successfully consummate the proposed Merger as provided for under the Merger Agreement, or at all.
If the proposed Merger is not completed, our stock price will likely fall to the extent that the current market price of our common stock reflects an assumption that a transaction will be completed. In addition, we may be required to pay a termination fee of $590 million if the Merger Agreement is terminated under circumstances specified in the Merger Agreement.
In this regard, we face risks and uncertainties due both to the pendency of the proposed Merger as well as the potential failure to consummate the proposed Merger, including:
•
the occurrence of any event, change or other circumstances that could give us or Harris the right to terminate the Merger Agreement;
•
the outcome of any legal proceedings that may be instituted against us, Harris or our respective directors with respect to the proposed Merger;
•
the risk that we or Harris may not obtain the required stockholder approvals on the expected schedule or at all;


70
Table of Contents

•
the ability to obtain regulatory approvals and satisfy other closing conditions to the proposed Merger in a timely manner or at all, including the risk that regulatory approvals required for the proposed Merger are not obtained or are obtained subject to conditions that are not anticipated;
•
delay in closing the proposed Merger;
•
difficulties and delays in integrating our business with Harris’s business or fully realizing anticipated cost savings and other benefits expected from the proposed Merger;
•
business disruptions from the proposed Merger that may harm our business or Harris’s business, including current plans and operations;
•
any announcement relating to the proposed transaction could have adverse effects on our ability or the ability of Harris to retain and hire key personnel or maintain relationships with suppliers and customers, including the U.S. government and other governments, or on our or Harris’s operating results and businesses generally;
•
the risk that the announcement of the proposed transaction could have adverse effects on the market price of our common stock or Harris’s common stock and the uncertainty as to the long-term value of the common stock of the combined company following the proposed Merger; and
•
certain restrictions during the pendency of the proposed Merger that may impact our ability or the ability of Harris to pursue certain business opportunities or strategic transactions.
In addition, we have incurred, and will continue to incur, significant costs, expenses and fees for professional services and other transaction costs in connection with the proposed Merger, and these fees and costs are payable by us regardless of whether the proposed Merger is consummated.


71
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ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Issuer Purchases of Equity Securities
The following table provides information about repurchases of L3’s common stock made during the 2018 third quarter . Repurchases are made from time to time at management’s discretion in accordance with applicable U.S. Federal securities laws. All share repurchases of L3’s 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 Plans
   or Programs   (1)
 
 
 
 
 
 
 
 
(in millions)
June 30 — July 31, 2018
 
177,882

 
$
193.95

 
177,882

 
$
1,025

August 1 — August 31, 2018
 
—

 
—

 
—

 
1,025

September 1 — September 28, 2018
 
—

 
—

 
—

 
1,025

Total
 
177,882

 
193.95

 
177,882

 
 
__________________
(1)  
The share repurchases described in the table above were made pursuant to the $1.5 billion share repurchase program authorized by L3’s Board of Directors on May 8, 2017 and has no set expiration date. In connection with entering into the Merger Agreement, we suspended future share repurchases. See Note 25 to our unaudited condensed consolidated financial statements contained in this quarterly report for additional information.
ITEM 6.
EXHIBITS
For a list of exhibits, see the Exhibit Index in this Form 10-Q.


72
Table of Contents

EXHIBIT INDEX
Exhibits identified in parentheses below are on file with the SEC and are incorporated herein by reference to such previous filings.
Exhibit
  No.
 
Description of Exhibit
 
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 Registrant’s Quarterly Report on Form 10-Q for the period ended September 28, 2012 (File No. 333-46983)).
 
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 Registrant’s Current Report on Form 8-K filed on December 11, 2015 (File No. 333-46983)).
 
Stock and Asset Purchase Agreement, dated as of May 1, 2018, by and among L-3 Communications Integrated Systems L.P., L3 Technologies, Inc. and 450 Madison Acquireco LLC (incorporated by reference to Exhibit 2.1 to the Registrant’s Current Report on Form 8-K filed on May 2, 2018 (File No. 001-37975)).
 
Agreement and Plan of Merger, dated as of October 12, 2018, by and among Harris Corporation, L3 Technologies, Inc. and Leopard Merger Sub Inc. (incorporated by reference to Exhibit 2.1 to the Registrant’s Current Report on Form 8-K filed on October 15, 2018 (File No. 001-37975)).
 
Restated Certificate of Incorporation of L3 Technologies, Inc. (incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on January 3, 2017 (File No. 001-37975)).
 
Amended and Restated Bylaws of L3 Technologies, Inc. (incorporated by reference to Exhibit 3.2 to the Registrant’s Current Report on Form 8-K filed on February 13, 2018 (File No. 333-46983)).
 
Form of Common Stock Certificate of L3 Technologies, Inc. (incorporated by reference to Exhibit 4.1 to the Registrant’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016 (File No. 001-37975)).
 
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 Registrant’s Current Report on Form 8-K dated May 24, 2010 (File No. 333-46983)).
 
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 Registrant’s Current Report on Form 8-K dated February 8, 2011 (File No. 333-46983)).
 
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 Registrant’s Current Report on Form 8-K dated November 22, 2011 (File No. 333-46983)).
 
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 Registrant’s Annual Report on Form 10‑K for the fiscal year ended December 31, 2011 (File No. 333-46983)).
 
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 Registrant’s Current Report on Form 8-K dated May 28, 2014 (File No. 333-46983)).
 
Sixth Supplemental Indenture, dated as of June 21, 2016, 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 L-3 Communications Corporation’s Registration Statement on Form S-3ASR filed on June 21, 2016 (File No. 333-212152)).
 
Seventh Supplemental Indenture, dated as of October 31, 2016, 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 of the Registrant’s Annual Report on Form 10‑K for the period ended December 31, 2016 (File No. 001-37975)).
 
Eighth Supplemental Indenture, dated as of December 5, 2016, 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 4.6 to the Registrant’s Current Report on Form 8-K dated December 5, 2016 (File No. 333-46983)).
 
Ninth Supplemental Indenture, dated as of March 30, 2018 among L3 Technologies, Inc., The Bank of New York Mellon Trust Company, N.A., as Trustee, and the guarantors named therein (incorporated by reference to Exhibit 4.15 to the Registrant’s Quarterly Report on Form 10-Q for the period ended March 30. 2018 (File No. 001-37975)).


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Tenth Supplemental Indenture, dated as of June 6, 2018, among L3 Technologies, Inc., The Bank of New York Mellon Trust Company, N.A., as Trustee, and the guarantors named therein (incorporated by reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K filed on June 6, 2018 (File No. 001-37975)).
 
Eleventh Supplemental Indenture, dated as of September 27, 2018, among L3 Technologies, Inc., The Bank of New York Mellon Trust Company, N.A., as Trustee, and the guarantors named therein.
 
L3 Technologies, Inc. Computation of Basic Earnings Per Share and Diluted Earnings Per Common Share.
 
Certification of Chairman, Chief Executive Officer and President pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act of 1934, as amended.
 
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.
 
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 unaudited condensed consolidated financial statements as of September 28, 2018 contained in this quarterly report in accordance with the provisions of ASC 260, Earnings Per Share .
***
Filed electronically with this report.
+
Certain schedules and exhibits to this agreement have been omitted in accordance with Item 601(b)(2) of Regulation S-K. The descriptions of the omitted schedules and exhibits are contained within the relevant agreement. A copy of any omitted schedule and/or exhibit will be furnished supplementally to the SEC upon request.
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 as of the date they were made or at any other time.



74
Table of Contents


SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
L3 TECHNOLOGIES, INC.
 
 
 
 
By:
/s/ Ralph G. D’Ambrosio
 
Title:
Senior Vice President and Chief Financial Officer
 
 
(Principal Financial Officer and Authorized Signatory)
 
 
 
Date: October 25, 2018
 
 



75
Exhibit 4.12

ELEVENTH SUPPLEMENTAL INDENTURE
ELEVENTH SUPPLEMENTAL INDENTURE (this “Eleventh Supplemental Indenture”) , dated as of September 27, 2018, among L3 Technologies, Inc., (formerly known as L-3 Communications Corporation) (or its permitted successor), a Delaware corporation (the “Company”) , each direct or indirect subsidiary of the Company signatory hereto (each, a “Guaranteeing Subsidiary”, and collectively, the “Guaranteeing Subsidiaries”) , and The Bank of New York Mellon Trust Company, N.A., as trustee under the indenture referred to below (the “Trustee”) .
W I T N E S S E T H :
WHEREAS, the Company and the Guaranteeing Subsidiaries party thereto have heretofore executed and delivered to the Trustee (1) an indenture dated May 21, 2010 (the “Base Indenture”), (2) a first supplemental indenture dated as of May 21, 2010 (the “First Supplemental Indenture”), providing for the issuance of $800,000,000 4.750% Senior Notes due 2020 (the “2020 Notes”), (3) a second supplemental indenture dated as of February 7, 2011 (the “Second Supplemental Indenture”), providing for the issuance of $650,000,000 4.95% Senior Notes due 2021 (the “2021 Notes”), (4) a third supplemental indenture dated as of November 22, 2011 (the “Third Supplemental Indenture”), providing for the issuance of $500,000,000 3.95% Senior Notes due 2016 (the “2016 Notes”), (5) a fourth supplemental indenture dated as of February 3, 2012 (the “Fourth Supplemental Indenture”), providing for the accession of certain Guaranteeing Subsidiaries, (6) a fifth supplemental indenture dated as of May 28, 2014 (the “Fifth Supplemental Indenture”), providing for the issuance of $350,000,000 1.50% Senior Notes due 2017 (the “2017 Notes”) and the issuance of $650,000,000 3.95% Senior Notes due 2024 (the “2024 Notes”), (7) a sixth supplemental indenture dated as of June 21, 2016 (the “Sixth Supplemental Indenture”), (8) a seventh supplemental indenture dated as of October 31, 2016 (the “Seventh Supplemental Indenture”), (9) an eighth supplemental indenture dated as of December 5, 2016 (the “Eighth Supplemental Indenture”), providing for the issuance of $550,000,000 3.85% Senior Notes due 2026 (the “2026 Notes”), (10) a ninth supplemental indenture dated as of March 29, 2018 (the “Ninth Supplemental Indenture”) and (11) a tenth supplemental indenture dated as of June 6, 2018 (the “Tenth Supplemental Indenture” together with the First Supplemental Indenture, the Second Supplemental Indenture, the Third Supplemental Indenture, the Fourth Supplemental Indenture, the Fifth Supplemental Indenture, the Sixth Supplemental Indenture, the Seventh Supplemental Indenture, the Eighth Supplemental Indenture, the Ninth Supplemental Indenture and the Base Indenture, collectively, the “Indenture”), providing for the issuance of $800,000,000 3.85% Senior Notes due 2023 (the “2023 Notes”) and the issuance of $1,000,000,000 4.40% Senior Notes due 2028 (the “2028 Notes”, together with the 2020 Notes, the 2021 Notes, the 2016 Notes, the 2017 Notes, the 2024 Notes, the 2026 Notes and the 2023 Notes, collectively, the “Notes”), effecting certain amendments to the Indenture;
WHEREAS, the Indenture provides that under certain circumstances the Guaranteeing Subsidiaries shall execute and deliver to the Trustee a supplemental indenture pursuant to which the Guaranteeing Subsidiaries shall unconditionally guarantee all of the Company’s Obligations (as defined in the Indenture) under the Notes and the Indenture on the terms and conditions set forth herein (the “Subsidiary Guarantee”); and
WHEREAS, pursuant to Section 9.1 of the Indenture, the Trustee is authorized to execute and deliver this Eleventh Supplemental Indenture.

1

NOW THEREFORE, in consideration of the foregoing and for other good and valuable consideration, the receipt of which is hereby acknowledged, the parties mutually covenant and agree for the equal and ratable benefit of the Holders of the Notes as follows:
1.
CAPITALIZED TERMS . Capitalized terms used herein without definition shall have the meanings assigned to them in the Indenture.
2.
SUBSIDIARY GUARANTOR . The Guaranteeing Subsidiaries hereby agree to each be Guarantors under the Indenture and to be bound by, and in accordance with, the terms of the Indenture applicable to Guarantors, including Article 10 thereof.
3.
RELEASES . The Guarantees of the Guaranteeing Subsidiaries shall be unconditionally released and discharged as provided in Section 10.4 of the Indenture.
4.
NO RECOURSE AGAINST OTHERS . No past, present or future director, officer, employee, incorporator, stockholder or agent of any Guarantor, as such, shall have any liability for any Obligations of the Company or any Guarantor under the Notes, any Guarantee, the Indenture or this Eleventh Supplemental Indenture or for any claim based on, in respect of, or by reason of, such Obligations or their creation. Each Holder of the Notes by accepting a Note waives and releases all such liability. The waiver and release are part of the consideration for issuance of the Notes. Such waiver may not be effective to waive liabilities under the federal securities laws and it is the view of the SEC that such a waiver is against public policy.
5.
NEW YORK LAW TO GOVERN . THIS ELEVENTH SUPPLEMENTAL INDENTURE SHALL BE GOVERNED BY, AND CONSTRUED IN ACCORDANCE WITH, THE LAWS OF THE STATE OF NEW YORK.
6.
COUNTERPARTS . The parties may sign any number of copies of this Eleventh Supplemental Indenture. Each signed copy shall be an original, but all of them together represent the same agreement.
7.
EFFECT OF HEADINGS . The Section headings herein are for convenience only and shall not affect the construction hereof.
8.
THE TRUSTEE . The Trustee shall not be responsible in any manner whatsoever for or in respect of the validity or sufficiency of this Eleventh Supplemental Indenture or for or in respect of the recitals contained herein, all of which recitals are made solely by the Guaranteeing Subsidiaries and the Company.
9.
BENEFITS ACKNOWLEDGED . Each Guaranteeing Subsidiary’s Guarantee is subject to the terms and conditions set forth in the Indenture. Each Guaranteeing Subsidiary acknowledges that it will receive direct and indirect benefits from the financing arrangements contemplated by the Indenture and this Eleventh Supplemental Indenture and that the guarantee and waivers made by it pursuant to this Guarantee are knowingly made in contemplation of such benefits.
10.
SUCCESSORS . All agreements of the Guaranteeing Subsidiaries in this Eleventh Supplemental Indenture shall bind its successors, except as otherwise provided in Section 10.4 of the Indenture. All agreements of the Trustee in this Eleventh Supplemental Indenture shall bind its successors.

2



IN WITNESS WHEREOF , the parties hereto have caused this Eleventh Supplemental Indenture to be duly executed, all as of the date first above written.
Dated: September 27, 2018
L3 TECHNOLOGIES, INC.

 
 
 
By: /s/ James P. Blair Jr.                      
Name: James P. Blair Jr.
Title: Vice President and Treasurer

[Signature Page to Eleventh Supplemental Indenture]




Electrodynamics, Inc.
Interstate Electronics Corporation
L3 Advanced Programs, Inc. (f/k/a L-3 Advanced Programs, Inc.)
L3 Applied Technologies, Inc. (f/k/a L-3 Applied Technologies, Inc.)
L3 Chesapeake Sciences Corporation (f/k/a L-3 Chesapeake Sciences Corporation)
L-3 Communications AIS GP Corporation
L3 Aviation Products, Inc. (f/k/a L-3 Communications Avionics Systems, Inc.)
L3 Cincinnati Electronics Corporation (f/k/a L-3 Communications Cincinnati Electronics Corporation)
L3 Electron Devices, Inc. (f/k/a L-3 Communications Electron Technologies, Inc.)
Wescam USA, Inc. (f/k/a L-3 Communications EO/IR, Inc.)
L3 ESSCO, Inc. (f/k/a L-3 Communications ESSCO, Inc.)
L-3 Communications Flight Capital LLC
L3 Foreign Holdings, Inc. (f/k/a L-3 Communications Foreign Holdings, Inc.)
L-3 Communications Investments Inc.
L3 MariPro, Inc. (f/k/a L-3 Communications MariPro, Inc.)
L3 Mobile-Vision, Inc. (f/k/a L-3 Communications Mobile-Vision, Inc.)
L3 Security & Detection Systems, Inc. (f/k/a L-3 Communications Security And Detection Systems, Inc.)
L3 Westwood Corporation (f/k/a L-3 Communications Westwood Corporation)
L-3 Domestic Holdings, Inc.
L3 Fuzing and Ordnance Systems, Inc. (f/k/a L-3 Fuzing And Ordnance Systems, Inc.)
L3 Unidyne, Inc. (f/k/a L-3 Unidyne, Inc.)
L3 Unmanned Systems, Inc. (f/k/a L-3 Unmanned Systems, Inc.)
Power Paragon, Inc.
SPD Electrical Systems, Inc.
SPD Switchgear Inc.
L-3 Afghanistan, LLC
L-3 Centaur, LLC
L-3 Investments, LLC
Aerosim Academy, Inc.
Aerosim Technologies, Inc.
Flight Training Acquisitions LLC
ForceX, Inc.
L3 Kigre, Inc.
L3 Adaptive Methods, Inc.
L3 Doss Aviation, Inc.
L3 OceanServer, Inc.
L3 Open Water Power, Inc.
Applied Defense Solutions, Inc.
Azimuth Security, LLC
L3 Latitude, LLC
Linchpin Labs Inc.
ASV Global, L.L.C.
Autonomous Surface Vehicles, LLC
 
As Guaranteeing Subsidiaries

 
 
 
By: /s/ James P. Blair Jr.                                   
Name: James P. Blair Jr.
Title: Vice President and Treasurer

[Signature Page to Eleventh Supplemental Indenture]




 
L-3 COMMUNICATIONS INTEGRATED SYSTEMS L.P. , a Delaware limited partnership
 
 
 
By: L-3 COMMUNICATIONS AIS GP   CORPORATION, as General Partner  
 
By: /s/ James P. Blair Jr.                                   
Name: James P. Blair Jr.
Title: Vice President and Treasurer
 
 
 
MUSTANG TECHNOLOGY GROUP, L.P. , a Texas limited partnership
 
 
 
By: L3 TECHNOLOGIES, INC., as General Partner  
 
By: /s/ James P. Blair Jr.                                   
Name: James P. Blair Jr.
Title: Vice President and Treasurer


[Signature Page to Eleventh Supplemental Indenture]




Dated: September 27, 2018
THE BANK OF NEW YORK MELLON TRUST COMPANY, N.A. ,
as Trustee
 


 
By: /s/ Karen Yu                                   
Name: Karen Yu
Title: Vice President



[Signature Page to Eleventh Supplemental Indenture]
Exhibit 31.1


CERTIFICATION
I, Christopher E. Kubasik, certify that:
1.
I have reviewed this report on Form 10-Q for the quarter ended September 28, 2018 of L3 Technologies, Inc.;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;
c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.    
Date: October 25, 2018
/s/ Christopher E. Kubasik
 
Christopher E. Kubasik
 
Chairman, Chief Executive Officer and President
 



Exhibit 31.2


CERTIFICATION
I, Ralph G. D’Ambrosio, certify that:
1.
I have reviewed this report on Form 10-Q for the quarter ended September 28, 2018 of L3 Technologies, Inc.;
2.
Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3.
Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4.
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
b)
Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, 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;
c)
Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
d)
Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
Date: October 25, 2018
/s/ Ralph G. D’Ambrosio
 
Ralph G. D’Ambrosio
 
Senior Vice President and Chief Financial Officer
 







Exhibit 32


CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of L3 Technologies, Inc. (“L3”) on Form 10-Q for the quarter ended September 28, 2018 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), Christopher E. Kubasik, Chief Executive Officer and President and Ralph G. D’Ambrosio, Senior Vice President and Chief Financial Officer, of L3, each certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2)
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of L3.
Date: October 25, 2018
/s/ Christopher E. Kubasik 
 
/s/ Ralph G. D’Ambrosio
Christopher E. Kubasik
 
Ralph G. D’Ambrosio
Chairman, Chief Executive Officer and President
 
Senior Vice President and Chief Financial Officer