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Table of Contents

 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
 
         
  x     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
        For the quarterly period ended September 25, 2009
  o     TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
        For the transition period from                    to
 
 
Commission file numbers 001-14141 and 333-46983
 
L-3 COMMUNICATIONS HOLDINGS, INC.
L-3 COMMUNICATIONS CORPORATION
(Exact names of registrants as specified in their charters)
 
 
     
Delaware
  13-3937434 and 13-3937436
(State or other jurisdiction of
incorporation or organization)

600 Third Avenue, New York, NY
(Address of principal executive offices)
 
(I.R.S. Employer
Identification Nos.)

10016
(Zip Code)
 
 
(212) 697-1111
(Telephone number)
 
 
Indicate by check mark whether the registrants (1) have filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrants were required to file such reports), and (2) have been subject to such filing requirements for the past 90 days. x Yes o No
 
 
Indicate by check mark whether the registrants have submitted electronically and posted on their corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrants were required to submit and post such files). x Yes o No
 
 
Indicate by check mark whether the registrants are large accelerated filers, accelerated filers, non-accelerated filers, or smaller reporting companies. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
 
Large accelerated filer x Accelerated filer o Non-accelerated filer o Smaller reporting company o
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrants are shell companies (as defined in Rule 12b-2 of the Act). o Yes x No
 
There were 116,225,477 shares of L-3 Communications Holdings, Inc. common stock with a par value of $0.01 outstanding as of the close of business on October 30, 2009.
 
 


 

 
L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

INDEX TO QUARTERLY REPORT ON FORM 10-Q
For the quarterly period ended September 25, 2009
 
                 
          Page  
          No.  
 
        PART I — FINANCIAL INFORMATION        
  ITEM 1.     Financial Statements        
        Unaudited Condensed Consolidated Balance Sheets as of September 25, 2009 and
   December 31, 2008
    1  
        Unaudited Condensed Consolidated Statements of Operations for the Quarterly
   periods and Year-to-Date periods ended September 25, 2009 and September 26,
   2008
    2  
        Unaudited Condensed Consolidated Statements of Equity for the Year-to-Date periods
   ended September 25, 2009 and September 26, 2008
    4  
        Unaudited Condensed Consolidated Statements of Cash Flows for the Year-to-Date
 periods ended September 25, 2009 and September 26, 2008
    5  
        Notes to Unaudited Condensed Consolidated Financial Statements     6  
  ITEM 2.     Management’s Discussion and Analysis of Financial Condition and Results of Operations     37  
  ITEM 3.     Quantitative and Qualitative Disclosures About Market Risk     56  
  ITEM 4.     Controls and Procedures     56  
 
PART II — OTHER INFORMATION
  ITEM 1.     Legal Proceedings     57  
  ITEM 1A.     Risk Factors     57  
  ITEM 2.     Unregistered Sales of Equity Securities and Use of Proceeds     59  
  ITEM 3.     Defaults Upon Senior Securities     59  
  ITEM 4.     Submission of Matters to a Vote of Security Holders     59  
  ITEM 5.     Other Information     59  
  ITEM 6.     Exhibits     59  
Signature     60  
 EX-4.4
 EX-4.6
 EX-4.8
 EX-4.10
 EX-4.12
 EX-4.14
 EX-4.15
 EX-12
 EX-31.1
 EX-31.2
 EX-32
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT


Table of Contents

 
PART I — FINANCIAL INFORMATION
ITEM 1.  FINANCIAL STATEMENTS
 
L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION
 
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(in millions, except share data)
 
                 
    September 25,
    December 31,
 
    2009     2008  
 
ASSETS
Current assets:
               
Cash and cash equivalents
  $   1,191     $   867  
Billed receivables, net of allowances, of $33 in 2009 and $26 in 2008
    1,270       1,226  
Contracts in process
    2,398       2,267  
Inventories
    258       259  
Deferred income taxes
    169       211  
Other current assets
    127       131  
                 
Total current assets
    5,413       4,961  
                 
Property, plant and equipment, net
    838       821  
Goodwill
    8,188       8,029  
Identifiable intangible assets
    390       417  
Deferred debt issue costs
    35       44  
Other assets
    204       212  
                 
Total assets
  $ 15,068     $ 14,484  
                 
LIABILITIES AND EQUITY
Current liabilities:
               
Current portion of long-term debt
  $ 650     $  
Accounts payable, trade
    593       602  
Accrued employment costs
    674       700  
Accrued expenses
    525       479  
Advance payments and billings in excess of costs incurred
    499       530  
Income taxes
    30       45  
Other current liabilities
    336       351  
                 
Total current liabilities
    3,307       2,707  
                 
Pension and postretirement benefits
    844       802  
Deferred income taxes
    179       127  
Other liabilities
    424       414  
Long-term debt
    3,860       4,493  
                 
Total liabilities
    8,614       8,543  
                 
Commitments and contingencies (see Note 16)
               
Equity:
               
L-3 shareholders’ equity:
               
L-3 Communications Holdings, Inc.’s common stock: $.01 par value; 300,000,000 shares authorized, 116,136,178 shares outstanding at September 25, 2009 and 118,633,746 shares outstanding at December 31, 2008 (L-3 Communications Corporation’s common stock: $.01 par value, 100 shares authorized, issued and outstanding)
    4,345       4,136  
L-3 Communications Holdings, Inc.’s treasury stock at cost, 19,633,649 shares at September 25, 2009 and 13,995,450 shares at December 31, 2008
    (1,715 )     (1,319 )
Retained earnings
    3,922       3,373  
Accumulated other comprehensive loss
    (190 )     (332 )
                 
Total L-3 shareholders’ equity
    6,362       5,858  
Noncontrolling interests
    92       83  
                 
Total equity
    6,454       5,941  
                 
Total liabilities and equity
  $ 15,068     $ 14,484  
                 
 
See notes to unaudited condensed consolidated financial statements.


1


Table of Contents

 
L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION
 
 
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share data)
 
                 
    Third Quarter Ended  
    September 25,
    September 26,
 
    2009     2008  
 
Net sales:
               
Products
  $   1,810     $   1,752  
Services
    2,032       1,910  
                 
Total net sales
    3,842       3,662  
                 
Cost of sales:
               
Products
    1,586       1,561  
Services
    1,838       1,701  
                 
Total cost of sales
    3,424       3,262  
                 
Operating income
    418       400  
Interest and other income, net
    3       7  
Interest expense
    68       72  
                 
Income before income taxes
    353       335  
Provision for income taxes
    100       123  
                 
Net income
  $ 253     $ 212  
Less: Net income attributable to noncontrolling interests
    3       2  
                 
Net income attributable to L-3
  $ 250     $ 210  
Less: Net income allocable to participating securities
    2       3  
                 
Net income allocable to L-3 Communications Holdings, Inc.’s common shareholders
  $ 248     $ 207  
                 
L-3 Communications Holdings, Inc.’s earnings per common share:
               
Basic
  $ 2.13     $ 1.71  
                 
Diluted
  $ 2.12     $ 1.70  
                 
L-3 Communications Holdings, Inc.’s weighted average common shares outstanding:
               
Basic
    116.4       121.0  
                 
Diluted
    117.0       122.0  
                 
 
See notes to unaudited condensed consolidated financial statements.


2


Table of Contents

 
L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION
 
 
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in millions, except per share data)
 
                 
    Year-to-Date Ended  
    September 25,
    September 26,
 
    2009     2008  
 
Net sales:
               
Products
  $   5,456     $   5,120  
Services
    5,951       5,770  
                 
Total net sales
    11,407       10,890  
                 
Cost of sales:
               
Products
    4,842       4,588  
Services
    5,354       5,159  
                 
Total cost of sales
    10,196       9,747  
                 
Litigation Gain
          126  
                 
Operating income
    1,211       1,269  
Interest and other income, net
    12       22  
Interest expense
    203       214  
                 
Income before income taxes
    1,020       1,077  
Provision for income taxes
    339       395  
                 
Net income
  $ 681     $ 682  
Less: Net income attributable to noncontrolling interests
    7       8  
                 
Net income attributable to L-3
  $ 674     $ 674  
Less: Net income allocable to participating securities
    6       6  
                 
Net income allocable to L-3 Communications Holdings, Inc.’s common shareholders
  $ 668     $ 668  
                 
L-3 Communications Holdings, Inc.’s earnings per common share:
               
Basic
  $ 5.70     $ 5.48  
                 
Diluted
  $ 5.68     $ 5.42  
                 
L-3 Communications Holdings, Inc.’s weighted average common shares outstanding:
               
Basic
    117.1       121.8  
                 
Diluted
    117.6       123.2  
                 
 
See notes to unaudited condensed consolidated financial statements.


3


Table of Contents

L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION
 
 
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
(in millions, except per share data)
                                                                 
    L-3
                                     
    Communications
                                     
    Holdings, Inc.’s
                      Accumulated
             
    Common Stock     Additional
                Other
             
    Shares
    Par
    Paid-in
    Treasury
    Retained
    Comprehensive
    Noncontrolling
    Total
 
    Issued     Value     Capital     Stock     Earnings     (Loss) Income     Interests     Equity  
 
For the Year-to-Date ended September 25, 2009:
                                                               
Balance at December 31, 2008
    118.6     $   1     $   4,135     $   (1,319 )   $   3,373     $   (332 )   $   83     $   5,941  
Comprehensive income:
                                                               
Net income
                                    674               7       681  
Pension and postretirement benefit plans:
                                                               
Amortization of net loss and prior service cost previously recognized, net of income taxes of $16
                                            23               23  
Unrealized gain on hedging instruments, net of income taxes of $1
                                            3               3  
Foreign currency translation adjustment
                                            116               116  
                                                                 
Total comprehensive income
                                                            823  
Distributions to noncontrolling interests
                                                    (6 )     (6 )
Cash dividends paid on common stock ($1.05 per share)
                                    (124 )                     (124 )
Recognition of non-controlling interest in consolidated subsidiary
                                                    8       8  
Shares issued:
                                                               
Employee savings plans
    1.6               110                                       110  
Exercise of stock options
    0.3               14                                       14  
Employee stock purchase plan
    1.1               34                                       34  
Stock-based compensation expense
                    53                                       53  
Treasury stock purchased
    (5.6 )                     (396 )                             (396 )
Other
    0.1               (2 )             (1 )                     (3 )
                                                                 
Balance at September 25, 2009
    116.1     $ 1     $ 4,344     $ (1,715 )   $ 3,922     $ (190 )   $ 92     $ 6,454  
                                                                 
For the Year-to-Date ended
September 26, 2008:
                                                               
Balance at December 31, 2007
    124.2     $ 1     $ 3,816     $ (525 )   $ 2,582     $ 153     $ 87     $ 6,114  
Comprehensive income:
                                                               
Net income
                                    674               8       682  
Pension and postretirement benefit plans:
                                                               
Amortization of net loss and prior service cost previously recognized, net of income taxes of $1
                                            2               2  
Unrealized gain on hedging instruments, net of income taxes of $2
                                            4               4  
Foreign currency translation adjustment
                                            (54 )             (54 )
                                                                 
Total comprehensive income
                                                            634  
Distributions to noncontrolling interests
                                                    (8 )     (8 )
Cash dividends paid on common stock
($0.90 per share)
                                    (111 )                     (111 )
Shares issued:
                                                               
Employee savings plans
    1.0               108                                       108  
Exercise of stock options
    0.7               50                                       50  
Employee stock purchase plan
    0.8               35                                       35  
Stock-based compensation expense
                    48                                       48  
Treasury stock purchased
    (5.6 )                     (573 )                             (573 )
Other
                    (5 )                                   (5 )
                                                                 
Balance at September 26, 2008
    121.1     $ 1     $ 4,052     $ (1,098 )   $ 3,145     $ 105     $ 87     $ 6,292  
                                                                 
 
See notes to unaudited condensed consolidated financial statements.


4


Table of Contents

L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION
 
UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in millions)
 
                 
    Year-to-Date Ended  
    September 25,
    September 26,
 
    2009     2008  
 
Operating activities:
               
Net income
  $   681     $ 682  
Depreciation of property, plant and equipment
    117       114  
Amortization of intangibles and other assets
    45       41  
Deferred income tax provision
    36       143  
Stock-based employee compensation expense
    53       48  
Contributions to employee savings plans in L-3 Communications Holdings, Inc.’s common stock
    110       108  
Amortization of pension and postretirement benefit plans net loss and prior service cost
    39       3  
Amortization of bond discounts (included in interest expense)
    17       15  
Amortization of deferred debt issue costs (included in interest expense)
    8       8  
Impairment charge
          28  
Gain on sale of a product line
          (12 )
Other non-cash items
    (2 )     (6 )
                 
Subtotal
    1,104       1,172  
                 
Changes in operating assets and liabilities, excluding acquired amounts:
               
Billed receivables
    (18 )     (2 )
Contracts in process
    (98 )     (161 )
Inventories
    (3 )     (32 )
Other assets
          (31 )
Accounts payable, trade
    10       171  
Accrued employment costs
    (44 )     (23 )
Accrued expenses
    1       30  
Advance payments and billings in excess of costs incurred
    (35 )     71  
Income taxes
    32       (10 )
Excess income tax benefits related to share-based payment arrangements
    (3 )     (10 )
Other current liabilities
    (20 )     (143 )
Pension and postretirement benefits
    40       17  
All other operating activities
    12       (18 )
                 
Subtotal
    (126 )     (141 )
                 
Net cash from operating activities
    978       1,031  
                 
Investing activities:
               
Business acquisitions, net of cash acquired
    (86 )     (224 )
Proceeds from sale of product lines
          12  
Capital expenditures
    (128 )     (139 )
Dispositions of property, plant and equipment
    3       5  
Other investing activities
          (6 )
                 
Net cash used in investing activities
    (211 )     (352 )
                 
Financing activities:
               
Common stock repurchased
    (396 )     (573 )
Dividends paid on L-3 Communications Holdings, Inc.’s common stock
    (124 )     (111 )
Proceeds from exercise of stock options
    11       38  
Proceeds from employee stock purchase plan
    51       52  
Excess income tax benefits related to share-based payment arrangements
    3       10  
Other financing activities
    (9 )     (11 )
                 
Net cash used in financing activities
    (464 )     (595 )
                 
Effect of foreign currency exchange rate changes on cash and cash equivalents
    21       (7 )
                 
Net increase in cash and cash equivalents
    324       77  
Cash and cash equivalents, beginning of the period
    867       780  
                 
Cash and cash equivalents, end of the period
  $   1,191     $ 857  
                 
 
See notes to unaudited condensed consolidated financial statements.


5


Table of Contents

 
L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
 
1.  Description of Business
 
L-3 Communications Holdings, Inc. derives all of its operating income and cash flows from its wholly-owned subsidiary, L-3 Communications Corporation (L-3 Communications). L-3 Communications Holdings, Inc. (L-3 Holdings and, together with its subsidiaries, referred to herein as L-3 or the Company) is a prime system contractor in aircraft modernization and maintenance, Command, Control, Communications, Intelligence, Surveillance and Reconnaissance (C3ISR) systems, and government services. L-3 is also a leading provider of high technology products, subsystems and systems. The Company’s customers include the U.S. Department of Defense (DoD) and its prime contractors, U.S. Government intelligence agencies, the U.S. Department of Homeland Security (DHS), U.S. Department of State (DoS), U.S. Department of Justice (DoJ), allied foreign governments, domestic and foreign commercial customers and select other U.S. federal, state and local government agencies.
 
The Company has the following four reportable segments: (1) C3ISR, (2) Government Services, (3) Aircraft Modernization and Maintenance (AM&M), and (4) Specialized Products. Financial information with respect to each of the Company’s reportable segments is included in Note 20. C3ISR provides products and services for the global ISR market, C3 systems, networked communications systems and secure communications products. The Company believes that these products and services are critical elements for a substantial number of major command, control and communication, intelligence gathering and space systems. These products and services are used to connect a variety of airborne, space, ground and sea-based communication systems and are used in the transmission, processing, recording, monitoring, and dissemination functions of these communication systems. Government Services provides a full range of engineering, technical, information technology (IT), advisory, training and support services to the DoD, DoS, DoJ, and U.S. Government intelligence agencies and allied foreign governments. AM&M provides modernization, upgrades and sustainment, maintenance and logistics support services for military and various government aircraft and other platforms. The Company sells these services primarily to the DoD, the Canadian Department of Defense (DND) and other allied foreign governments. Specialized Products provides a broad range of products, including components, products, subsystems, systems, and related services to military and commercial customers in several niche markets across several business areas, including power & control systems, electro-optic/infrared (EO/IR), microwave, simulation & training, precision engagement, aviation products, security & detection, propulsion systems, displays, telemetry & advanced technology, undersea warfare, and marine services.
 
2.  Basis of Presentation
 
These unaudited condensed consolidated financial statements for the quarterly period and year-to-date period ended September 25, 2009 should be read in conjunction with the audited consolidated financial statements of L-3 Holdings and L-3 Communications included in their Annual Report on Form 10-K for the fiscal year ended December 31, 2008.
 
The Company adopted eight new accounting standards during the year-to-date period ended September 25, 2009, six of which were effective January 1, 2009. In accordance with the transition and disclosure provisions of three of these standards, the Company retrospectively applied those provisions and adjusted the prior period financial statements accordingly. See Note 3 for the standards adopted and their impact to the Company’s financial position and results of operations.
 
The accompanying financial statements comprise the consolidated financial statements of L-3 Holdings and L-3 Communications. L-3 Holdings’ only asset is its investment in the common stock of L-3 Communications, its wholly-owned subsidiary, and its only obligations are: (1) the 3% Convertible Contingent Debt Securities (CODES) due 2035, which were issued by L-3 Holdings on July 29, 2005, (2) its guarantee of borrowings under the senior credit facility of L-3 Communications and (3) its guarantee of other contractual obligations of L-3 Communications and its subsidiaries. L-3 Holdings’ obligations relating to the CODES have been jointly, severally, fully and


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
unconditionally guaranteed by L-3 Communications and certain of its wholly-owned domestic subsidiaries. Accordingly, such debt has been reflected as debt of L-3 Communications in its consolidated financial statements in accordance with the U.S. Securities and Exchange Commission’s (SEC) Staff Accounting Bulletin (SAB) No. 54. All issuances of and conversions into L-3 Holdings’ equity securities, including grants of stock options, restricted stock, restricted stock units and performance units by L-3 Holdings to employees and directors of L-3 Communications and its subsidiaries, have been reflected in the consolidated financial statements of L-3 Communications. As a result, the consolidated financial positions, results of operations and cash flows of L-3 Holdings and L-3 Communications are substantially the same. See Note 22 for additional information regarding the unaudited financial information of L-3 Communications and its subsidiaries.
 
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 SEC. Accordingly, they do not include all of the disclosures required by U.S. GAAP for a complete set of annual audited financial statements. In the opinion of management, all adjustments (consisting of normal and recurring adjustments) considered necessary for a fair presentation 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.
 
Certain reclassifications have been made to conform prior year amounts to the current year presentation.
 
It is the Company’s established practice to close its books for the quarters ending March, June and September on the Friday nearest to 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 annual books on December 31 regardless of what day it falls on.
 
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 relate to contract revenue, profit and loss recognition, fair values of assets acquired and liabilities assumed in business combinations, market values for inventories reported at lower of cost or market, pension and post-retirement benefit obligations, stock-based employee compensation expense, income taxes, including the valuations of deferred tax assets, litigation reserves and environmental obligations, accrued product warranty costs, and the recoverability, useful lives and valuation of recorded amounts of long-lived assets, identifiable intangible assets and goodwill. Changes in estimates are reflected in the periods during which they become known. Actual amounts will differ from these estimates and could differ materially. For a more complete discussion of these estimates and assumptions, see the Annual Report of L-3 Holdings and L-3 Communications on Form 10-K for the fiscal year ended December 31, 2008.
 
During the quarter ended March 27, 2009, the Company revised its reportable segment presentations to conform to certain re-alignments in the Company’s management and organization structure. Consequently, the Company made certain reclassifications between its C3ISR, Government Services, and AM&M reportable segments. See Note 20 for the prior period amounts reclassified between reportable segments.


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
 
3.  New Accounting Standards Implemented
 
In June 2009, the Financial Accounting Standards Board (FASB) issued the FASB Accounting Standards Codifications (Codification). The Codification has become the single source for all authoritative U.S. GAAP recognized by the FASB, does not change U.S. GAAP and did not impact the Company’s financial position, results of operations and cash flows. All references to U.S. GAAP in this report are in accordance with the Codification.
 
The Company adopted eight newly issued accounting standards during the year-to-date period ended September 25, 2009. The following six standards were effective January 1, 2009:
 
  •  Accounting for convertible debt instruments that may be settled in cash upon conversion (Convertible Debt). The new standard is contained in FASB Accounting Standards Codification (ASC) Topic 470, Debt;
 
  •  Determining whether instruments granted in share-based payment transactions are participating securities (Participating Securities). The new standard is contained in FASB ASC Topic 260, Earnings Per Share;
 
  •  Noncontrolling interests in consolidated financial statements (Noncontrolling Interests). The new standard is contained in FASB ASC Topic 810, Consolidation;
 
  •  Disclosures about derivative instruments and hedging activities (Derivative Disclosures). The new standard is contained in FASB ASC Topic 815, Derivatives and Hedging;
 
  •  Business combinations (Business Combinations). The new standard is contained in FASB ASC Topic 805, Business Combinations; and
 
  •  Fair value measurements and disclosures (Fair Value Measurements). The new standard is contained in FASB ASC Topic 820, Fair Value Measurements and Disclosures.
 
For the impact of the adoption of the newly issued standards for Convertible Debt, Participating Securities and Noncontrolling Interests on the Company’s: (1) Condensed Consolidated Balance Sheet, at December 31, 2008, (2) Consolidated Equity Account Balances, at December 31, 2007, and (3) Condensed Consolidated Statements of Operations for the quarter and year-to-date periods ended September 26, 2008, see pages 11-13. The adoption of the new accounting standards for Derivative Disclosures, Business Combinations and Fair Value Measurements did not have a material impact on the Company’s prior period financial statements.
 
Convertible Debt: In accordance with the provisions of the newly issued standard for convertible debt, the Company is separately accounting for the liability and equity (conversion option) components of the CODES in a manner that reflects the Company’s non-convertible debt borrowing rate when interest expense is recognized. Previously, the CODES were recorded at maturity value. The Convertible Debt standard does not apply to the Company’s other outstanding debt instruments because they are not convertible debt instruments within its scope. The Company has retrospectively applied the provisions of this standard and adjusted the prior period financial statements accordingly.


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
The following table presents the impact of the provisions of the Convertible Debt standard on the Statements of Operations for the quarter and year-to-date period ended September 25, 2009.
 
                 
    Third Quarter Ended     Year-to-Date Ended  
    September 25, 2009     September 25, 2009  
    (in millions, except per share data)  
 
Interest expense
  $ 5     $ 15  
Provision for income taxes
    (2 )     (6 )
Net income attributable to L-3
    (3 )     (9 )
L-3 Holdings’ earnings per common share:
               
Basic
  $ (0.03 )   $ (0.08 )
Diluted
  $   (0.02 )   $   (0.08 )
 
Participating Securities: In accordance with the provisions of the newly issued standard for participating securities, the Company is including the impact of restricted stock and restricted stock units that are entitled to receive non-forfeitable dividends when calculating both basic EPS and diluted EPS. The Company has retrospectively applied the provisions of this standard and adjusted the prior period financial statements accordingly. The adoption of the provisions of this standard decreased basic EPS by $0.02 and diluted EPS by $0.01 for the quarter ended September 25, 2009 and decreased basic EPS by $0.05 and diluted EPS by $0.02 for the year-to-date period ended September 25, 2009.
 
Noncontrolling Interests: The Company retrospectively applied the presentation requirements of the newly issued standard for noncontrolling interest by: (1) reclassifying noncontrolling interests (minority interests) to equity on the Company’s balance sheets, and (2) including net income attributable to noncontrolling interests in net income on the Company’s statements of operations.
 
Derivative Disclosures: The enhanced disclosures for derivative instruments and related hedging activities required in accordance with the provisions of this standard can be found in Note 15.
 
Business Combinations: The Company adopted the provisions of the newly issued standard for business combinations to its acquisition of Chesapeake Sciences Corporation (CSC), which was completed on January 30, 2009. See Note 4 for additional information regarding the CSC acquisition. There were no other material business acquisitions completed during the year-to-date period ended September 25, 2009. In accordance with the provisions of this standard, the Company is: (1) expensing transaction and restructuring costs, (2) recognizing and measuring contingent consideration at fair value, (3) measuring contingent assets and liabilities at fair value, or in accordance with FASB ASC Topic 450, Contingencies, as appropriate, and (4) capitalizing in-process research and development. In addition, the difference between the ultimate resolution and the amount recorded on the balance sheet for acquired uncertain tax positions is recorded through earnings. Previously, the difference would have been recorded through goodwill. Other than the net reversal of amounts previously accrued of $26 million disclosed in Note 11, the adoption of this standard did not have a material impact on the Company’s financial position, results of operations and cash flows for the quarter and year-to-date period ended September 25, 2009.


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
Fair Value Measurements: The Company applied the provisions of the standard for fair value measurements to non-financial assets and non-financial liabilities not recognized or disclosed at fair value in the financial statements on a recurring basis. The effective date for application of the provisions of this standard to all non-financial assets and non-financial liabilities not recognized or disclosed at fair value on a recurring basis was previously delayed until January 1, 2009. The application of the provisions of the fair value measurement standard had no impact on the Company’s financial position, results of operations and cash flows as the Company did not have any non-financial assets and non-financial liabilities that were recognized or disclosed at fair value on a non-recurring basis at September 25, 2009.
 
Effective June 26, 2009, the Company adopted the following two new accounting standards:
 
  •  Subsequent Events (Subsequent Events). The new standard is contained in FASB ASC Topic 855, Subsequent Events; and
 
  •  Interim Disclosures about Fair Value of Financial Instruments (Financial Instruments). The new standard is contained in FASB ASC Topic 825, Financial Instruments.
 
Subsequent Events: The adoption of the provisions of the newly issued standard for subsequent events requires the Company to evaluate events after the balance sheet date and disclose the date through which the evaluation is performed. The Company has evaluated subsequent events through the time of filing this Form 10-Q with the SEC on November 4, 2009.
 
Financial Instruments: The adoption of the provisions of the newly issued standard for financial instruments requires: (1) the fair value disclosures of an entity’s financial instruments for interim financial statements, and (2) disclosures about the methods and significant assumptions used to estimate the fair value of financial instruments. See Note 15 for the disclosures required by the provisions of the Financial Instruments standard.


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
The tables below present the Company’s As Previously Reported and As Currently Reported: (1) Condensed Consolidated Balance Sheet, at December 31, 2008, (2) Consolidated Equity Account Balances, at December 31, 2007, and (3) Condensed Consolidated Statement of Operations, for the quarter and year-to-date period ended September 26, 2008, in each case to reflect the adjustments made to adopt the provisions of the newly issued standards for Noncontrolling Interests, Convertible Debt and Participating Securities, as applicable.
 
                                 
          Adjustments for:        
    As Previously
    Noncontrolling
    Convertible
    As Currently
 
    Reported     Interests     Debt     Reported  
    (in millions)  
 
Condensed Consolidated Balance Sheet, at December 31, 2008:
                               
ASSETS                                
Total current assets
  $   4,961     $   —     $   —     $   4,961  
Property, plant and equipment, net
    821                   821  
Goodwill
    8,029                   8,029  
Identifiable intangible assets
    417                   417  
Deferred debt issue costs
    45             (1 )     44  
Other assets
    212                   212  
                                 
Total assets
  $ 14,485     $     $ (1 )   $ 14,484  
                                 
LIABILITIES AND EQUITY
                               
Total current liabilities
  $ 2,707     $     $     $ 2,707  
Pension and postretirement benefits
    802                   802  
Deferred income taxes
    110             17       127  
Other liabilities
    414                   414  
Long-term debt
    4,538             (45 )     4,493  
                                 
Total liabilities
    8,571             (28 )     8,543  
                                 
Minority interests
    83       (83 )            
                                 
Equity:
                               
L-3 shareholders’ equity:
                               
L-3 Communications Holdings Inc.’s common stock
    4,072             64       4,136  
L-3 Communications Holdings Inc.’s treasury stock at cost
    (1,319 )                 (1,319 )
Retained earnings
    3,410             (37 )     3,373  
Accumulated other comprehensive loss
    (332 )                 (332 )
                                 
Total L-3 shareholders’ equity
    5,831             27       5,858  
Noncontrolling interests
          83             83  
                                 
Total equity
    5,831       83       27       5,941  
                                 
Total liabilities and equity
  $      14,485     $      —     $      (1 )   $      14,484  
                                 
Consolidated Equity Account Balances, at December 31, 2007:
                               
L-3 Communications Holdings Inc.’s common stock, net of treasury stock
  $      3,228     $        —     $        64     $      3,292  
Retained earnings
    2,608             (26 )     2,582  
Accumulated other comprehensive income
    153                   153  
Noncontrolling interests
          87             87  
                                 
Total equity
  $ 5,989     $ 87     $ 38     $ 6,114  
                                 


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
                                         
          Adjustments for:        
    As Previously
    Noncontrolling
    Participating
    Convertible
    As Currently
 
    Reported     Interests     Securities     Debt     Reported  
    (in millions, except per share data)  
 
Condensed Consolidated Statement of Operations, for the quarter ended September 26, 2008:
                                       
Net sales
  $   3,662     $   —     $   —     $   —     $   3,662  
Cost of sales
    3,262                         3,262  
                                         
Operating income
    400                         400  
Interest and other income, net
    7                         7  
Interest expense
    68                   4       72  
Minority interests in net income of consolidated subsidiaries
    2       (2 )                  
                                         
Income before income taxes
    337       2             (4 )     335  
Provision for income taxes
    125                   (2 )     123  
                                         
Net income
  $ 212     $ 2     $     $ (2 )   $ 212  
Less: Net income attributable to noncontrolling interests
          2                   2  
                                         
Net income attributable to L-3
  $ 212     $     $     $ (2 )   $ 210  
Less: Net income allocable to participating securities
                3             3  
                                         
Net income allocable to L-3 Communications Holdings, Inc.’s common shareholders
  $ 212     $     $ (3 )   $ (2 )   $ 207  
                                         
L-3 Communications Holdings, Inc.’s earnings per common share:
                                       
Basic
  $ 1.75     $     $ (0.02 )   $ (0.02 )   $ 1.71  
                                         
Diluted
  $ 1.73     $     $ (0.01 )   $ (0.02 )   $ 1.70  
                                         
L-3 Communications Holdings, Inc.’s weighted average common shares outstanding:
                                       
Basic
    121.0                         121.0  
                                         
Diluted
    122.6             (0.6 )           122.0  
                                         
 


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
                                         
          Adjustments for:        
    As Previously
    Noncontrolling
    Participating
    Convertible
    As Currently
 
    Reported     Interests     Securities     Debt     Reported  
    (in millions, except per share data)  
 
Condensed Consolidated Statement of Operations, for the year-to-date period ended September 26, 2008:
                                       
Net sales
  $   10,890     $   —     $   —     $   —     $   10,890  
Cost of sales
    9,747                         9,747  
Litigation Gain
    126                         126  
                                         
Operating income
    1,269                         1,269  
Interest and other income, net
    22                         22  
Interest expense
    200                   14       214  
Minority interests in net income of consolidated subsidiaries
    8       (8 )                  
                                         
Income before income taxes
    1,083       8             (14 )     1,077  
Provision for income taxes
    401                   (6 )     395  
                                         
Net income
  $ 682     $ 8     $     $ (8 )   $ 682  
Less: Net income attributable to noncontrolling interests
          8                   8  
                                         
Net income attributable to L-3
  $ 682     $     $     $ (8 )   $ 674  
Less: Net income allocable to participating securities
                6             6  
                                         
Net income allocable to L-3 Communications Holdings, Inc.’s common shareholders
  $ 682     $     $ (6 )   $ (8 )   $ 668  
                                         
L-3 Communications Holdings, Inc.’s earnings per common share:
                                       
Basic
  $ 5.60     $     $ (0.05 )   $ (0.07 )   $ 5.48  
                                         
Diluted
  $ 5.51     $     $ (0.02 )   $ (0.07 )   $ 5.42  
                                         
L-3 Communications Holdings, Inc.’s weighted average common shares outstanding:
                                       
Basic
    121.8                         121.8  
                                         
Diluted
    123.7             (0.5 )           123.2  
                                         
 
4.  Acquisitions and Dispositions
 
All of the business acquisitions are included in the Company’s results of operations from their respective dates of acquisition.
 
2009 Business Acquisitions
 
On January 30, 2009, the Company acquired all of the outstanding stock of CSC for a preliminary purchase price of $92 million, consisting of: (1) $87 million in cash, including a $7 million net working capital adjustment, of which $6 million was for cash acquired, and (2) a purchase price payable of $5 million related to certain tax benefits acquired. CSC is a developer and manufacturer of anti-submarine warfare systems for use onboard submarines and surface ship combatants. Based on the preliminary purchase price allocation, the amount of goodwill recognized was $57 million, which was assigned to the Specialized Products reportable segment, and is not expected to be deductible for income tax purposes. The final purchase price allocation is expected to be completed during the

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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
fourth quarter of 2009, and will be based on final appraisals and other analyses of fair values for acquired assets and assumed liabilities. The Company does not expect any of the differences between the preliminary and final purchase price allocations to have a material impact on its results of operations and financial position. The acquisition was financed with cash on hand.
 
2008 Business Acquisitions
 
During the year-to-date period ended September 25, 2009, the Company completed the purchase price allocations for G.A. International (GAI) and International Resources Group, Ltd. (IRG), subject to the finalization of the purchase price for GAI. The purchase price for GAI is subject to additional consideration not to exceed $1 million that is contingent upon GAI’s post-acquisition financial performance through July 25, 2011. Any additional consideration paid that is contingent upon post-acquisition performance will be accounted for as goodwill. The final purchase price allocations for these business acquisitions compared to the preliminary purchase price allocations did not have a material impact on the Company’s results of operations or financial position.
 
Unaudited Pro Forma Statements of Operations Data
 
The following unaudited pro forma Statements of Operations data presents the combined results of the Company and its business acquisitions completed during the year-to-date period ended September 25, 2009 and the year ended December 31, 2008, in each case assuming that the business acquisitions that were completed during these periods had occurred on January 1, 2008.
 
                                 
    Third Quarter Ended   Year-to-Date Ended
    September 25,
  September 26,
  September 25,
  September 26,
    2009   2008   2009   2008
    (in millions, except per share data)
 
Pro forma net sales
  $   3,842     $   3,694     $  11,413     $  11,034  
Pro forma net income attributable to L-3
  $ 250     $ 212     $ 674     $ 676  
Pro forma diluted EPS
  $ 2.12     $ 1.71     $ 5.68     $ 5.43  
 
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 January 1, 2008.
 
2008 Business and Product Line Dispositions
 
On October 8, 2008, the Company divested its 85% ownership interest in Medical Education Technologies, Inc. (METI), which was within the Specialized Products reportable segment. The sale resulted in a fourth quarter 2008 after-tax gain of $20 million (pre-tax gain of $33 million). The gain was excluded from income from continuing operations for the 2008 fourth quarter in accordance with U.S. GAAP for impairment or disposal of long-lived assets (contained in FASB ASC Topic 360, Property, Plant, and Equipment and FASB ASC Topic 205, Presentation of Financial Statements).The revenues, operating results and net assets of METI for all periods presented were not material and, therefore, are not presented as discontinued operations. METI generated $17 million of sales and $2 million of operating income for the quarter ended September 26, 2008, $47 million of sales and $4 million of operating income for the year-to-date period ended September 26, 2008, and $48 million of sales and $4 million of operating income for the year ended December 31, 2008.
 
On May 9, 2008, the Company sold the Electron Technologies Passive Microwave Devices (PMD) product line, which was within the Specialized Products reportable segment. The sale resulted in a second quarter 2008 after-tax gain of approximately $7 million (pre-tax gain of $12 million), which was recorded as a reduction of cost


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
of sales for products in the Unaudited Condensed Consolidated Statement of Operations. The net proceeds from the sale are included in investing activities on the Unaudited Condensed Consolidated Statement of Cash Flows. The PMD product line generated $8 million of sales for both the year-to-date period ended September 26, 2008 and the year ended December 31, 2008.
 
5.    Contracts in Process
 
The components of contracts in process are presented in the table below.
 
                 
    September 25,
    December 31,
 
    2009     2008  
    (in millions)  
 
Unbilled contract receivables, gross
  $   2,318     $   2,079  
Less: unliquidated progress payments
    (629 )     (462 )
                 
Unbilled contract receivables, net
    1,689       1,617  
                 
Inventoried contract costs, gross
    846       754  
Less: unliquidated progress payments
    (137 )     (104 )
                 
Inventoried contract costs, net
    709       650  
                 
Total contracts in process
  $ 2,398     $ 2,267  
                 
 
Inventoried Contract Costs. In accordance with FASB ASC Topic 605-35-25, Revenue Recognition – Construction-Type and Production-Type Contracts – General, the Company accounts for the portion of its general and administrative (G&A) costs, independent research and development (IRAD) costs and bid and proposal (B&P) costs that are allowable and reimbursable indirect contract costs under U.S. Government procurement regulations on its U.S. Government contracts (revenue arrangements) as inventoried contract costs. G&A, IRAD and B&P costs are allocated to contracts for which the U.S. Government is the end customer and are charged to costs of sales when sales on the related contracts are recognized. The Company’s unallowable portion of its G&A, IRAD and B&P costs for its U.S. Government contractor businesses are expensed as incurred and are not included in inventoried contract costs.
 
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 cost of sales for U.S. Government contracts for the periods presented.
 
                                 
    Third Quarter Ended     Year-to-Date Ended  
    September 25,
    September 26,
    September 25,
    September 26,
 
    2009     2008     2009     2008  
    (in millions)  
 
Amounts included in inventoried contract costs at beginning of the period
  $   79     $   79     $   74     $   68  
Add: Contract costs incurred(1)
    305       335       951       935  
 Amounts included in acquired inventoried contract costs
                      7  
Less: Amounts charged to cost of sales
    (294 )     (339 )     (935 )     (935 )
                                 
Amounts included in inventoried contract costs at end of the period
  $ 90     $ 75     $ 90     $ 75  
                                 


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
 
(1) Incurred costs include IRAD and B&P costs of $76 million for the quarter ended September 25, 2009, $74 million for the quarter ended September 26, 2008, $232 million for the year-to-date period ended September 25, 2009 and $211 million for the year-to-date period ended September 26, 2008.
 
The table below presents a summary of selling, general and administrative expenses and research and development expenses for the Company’s commercial businesses, which are expensed as incurred and not included in inventoried contract costs.
 
                                 
    Third Quarter Ended     Year-to-Date Ended  
    September 25,
    September 26,
    September 25,
    September 26,
 
    2009     2008     2009     2008  
    (in millions)  
 
Selling, general and administrative expenses
  $   57     $   70     $   175     $   209  
Research and development expenses
    17       19       54       67  
                                 
Total
  $ 74     $ 89     $ 229     $ 276  
                                 
 
6.  Inventories
 
Inventories at Lower of Cost or Market. The table below presents the components of inventories at cost (first-in, first-out or average cost), but not in excess of realizable value.
 
                 
    September 25,
    December 31,
 
    2009     2008  
    (in millions)  
 
Raw materials, components and sub-assemblies
  $ 99     $ 95  
Work in process
    127       121  
Finished goods
    32       43  
                 
Total
  $  258     $  259  
                 
 
7.  Goodwill and Identifiable Intangible Assets
 
Goodwill. In accordance with U.S. GAAP for business combinations (contained in FASB ASC Topic 805, Business Combinations), the Company allocates the cost of business acquisitions to the assets acquired and liabilities assumed based on their 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 reportable segments.
 
                                         
          Government
          Specialized
    Consolidated
 
    C3ISR     Services     AM&M     Products     Total  
                (in millions)              
 
Balance at December 31, 2008(1)
  $ 862     $ 2,313     $ 1,121     $ 3,733     $ 8,029  
Business acquisition
          5             57       62  
Foreign currency translation adjustments(2)
    14       2       30       51       97  
                                         
Balance at September 25, 2009
  $  876     $  2,320     $  1,151     $  3,841     $  8,188  
                                         
 
 
(1) As a result of certain re-alignments in the Company’s management and organization structure as discussed in Note 2, $17 million of goodwill was reclassified from the C3ISR reportable segment to the Government Services reportable segment, and $17 million of goodwill was reclassified from the C3ISR reportable segment to the AM&M reportable segment.


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
 
 
(2) The increase in goodwill from foreign currency translation adjustments is due to the weakening of the U.S. dollar during the year-to-date period ended September 25, 2009 against the functional currencies of L-3’s foreign subsidiaries, primarily in Canada, Germany and the United Kingdom.
 
Identifiable Intangible Assets. Information on the Company’s identifiable intangible assets that are subject to amortization is presented in the table below.
 
                                                         
    September 25, 2009                    
    Weighted
                      December 31, 2008  
    Average
    Gross
          Net
    Gross
          Net
 
    Amortization
    Carrying
    Accumulated
    Carrying
    Carrying
    Accumulated
    Carrying
 
    Period     Amount     Amortization     Amount     Amount     Amortization     Amount  
    (in years)     (in millions)  
 
Customer contractual relationships
    23     $ 515     $ 154     $ 361     $ 505     $ 124     $ 381  
Technology
    8       78       55       23       76       47       29  
Other, primarily favorable leasehold interests
    7       14       8       6       14       7       7  
                                                         
Total
    22     $  607     $  217     $  390     $  595     $  178     $  417  
                                                         
 
Amortization expense recorded by the Company for its identifiable intangible assets is presented in the table below.
 
                                 
    Third Quarter Ended     Year-to-Date Ended  
    September 25,
    September 26,
    September 25,
    September 26,
 
    2009     2008     2009     2008  
    (in millions)  
 
Amortization expense
  $  13     $  12     $  39     $  34  
                                 
 
Based on gross carrying amounts at September 25, 2009, the Company’s estimate of amortization expense for identifiable intangible assets for the years ending December 31, 2009 through 2013 are presented in the table below.
 
                                         
    Years Ending December 31,  
     2009      2010      2011      2012     2013  
    (in millions)  
 
Estimated amortization expense
  $  52     $  52     $  47     $  39     $  30  
                                         
 
At September 25, 2009 and December 31, 2008, the Company had $1 million of indefinite-lived identifiable intangible assets.


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
 
8.  Other Current Liabilities and Other Liabilities
 
The table below presents the components of other current liabilities.
 
                 
    September 25,
    December 31,
 
    2009     2008  
    (in millions)  
 
Other Current Liabilities:
               
Accruals for pending and threatened litigation (see Note 16)
  $ 3     $ 5  
Accrued product warranty costs
    91       97  
Accrued interest
    65       66  
Estimated costs in excess of estimated contract value to complete contracts in process in a loss position
    58       58  
Deferred revenues
    27       25  
Aggregate purchase price payable for acquired businesses
    5        
Other
    87       100  
                 
Total other current liabilities
  $  336     $  351  
                 
 
The table below presents the components of other liabilities.
 
                 
    September 25,
    December 31,
 
    2009     2008  
    (in millions)  
 
Other Liabilities:
               
Non-current income taxes payable (see Note 11)
  $ 176     $ 177  
Deferred compensation
    87       79  
Accrued workers compensation
    51       45  
Unfavorable lease obligations
    6       8  
Non-current portion of net deferred gains from terminated interest rate swap agreements
    6       9  
Notes payable and capital lease obligations
    10       10  
Accrued product warranty costs
    7       5  
Other non-current liabilities
    81       81  
                 
Total other liabilities
  $  424     $  414  
                 
 
The table below presents the changes in the Company’s accrued product warranty costs.
 
                 
    Year-to-Date Ended  
    September 25,
    September 26,
 
    2009     2008  
    (in millions)  
 
Accrued product warranty costs(1):
               
Balance at January 1
  $   102     $   98  
Acquisitions during the period
          5  
Accruals for product warranties issued during the period
    36       27  
Foreign currency translation adjustments
    2       (1 )
Settlements made during the period
    (42 )     (30 )
                 
Balance at end of period
  $  98     $ 99  
                 
 
 
(1) Warranty obligations incurred in connection with long-term production contracts are accounted for within the contract estimates at completion (EACs) and are excluded from the above amounts. Balances include both long-term and short-term amounts.


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
 
9.  Debt
 
The components of debt and a reconciliation to the carrying amount of current and long-term debt are presented in the table below.
 
                 
    September 25,
    December 31,
 
    2009     2008  
    (in millions)  
 
L-3 Communications:
               
Borrowings under Revolving Credit Facility(1)
  $     $  
Borrowings under Term Loan Facility(2)
    650       650  
7 5/8% Senior Subordinated Notes due 2012
    750       750  
6 1/8% Senior Subordinated Notes due 2013
    400       400  
6 1/8% Senior Subordinated Notes due 2014
    400       400  
5 7/8% Senior Subordinated Notes due 2015
    650       650  
6 3/8% Senior Subordinated Notes due 2015
    1,000       1,000  
                 
Subtotal
    3,850       3,850  
                 
L-3 Holdings:
               
3% Convertible Contingent Debt Securities due 2035(3)
    700       700  
                 
Principal amount of long-term debt
    4,550       4,550  
Less: Unamortized discounts
    (40 )     (57 )
                 
Carrying amount of long-term debt
    4,510       4,493  
Less: Current portion of long-term debt
    (650 )      
                 
Carrying amount of long-term debt, excluding current portion
  $  3,860     $  4,493  
                 
 
 
(1) The Company’s five-year revolving credit facility, which was replaced on October 23, 2009 by a new $1 billion three-year revolving credit facility maturing on October 23, 2012, allowed for total aggregate borrowings of up to $1 billion. At September 25, 2009, available borrowings under the revolving credit facility were $965 million after reductions for outstanding letters of credit of $35 million.
 
(2) The interest rate at September 25, 2009 and December 31, 2008 was 1.12% and 2.70%, respectively, and was based on the LIBOR rate (as defined in the credit agreement) plus a spread. See Note 10 to the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 for additional information regarding the interest on borrowings under the term loan facility. Borrowings under the term loan facility were repaid on October 7, 2009 and are classified as a current liability as of September 25, 2009.
 
(3) Under select conditions, including if L-3 Holdings common stock price is more than 120% (currently $120.17) of the then current conversion price (currently $100.14) for a specified period, the conversion feature of the CODES will require L-3 Holdings, upon conversion, to pay the $700 million principal amount in cash, and if the settlement amount exceeds the principal amount, the excess will be settled in cash or stock or a combination thereof, at the Company’s option. At the current conversion price of $100.14, the aggregate consideration to be delivered upon conversion would be determined based on 7.0 million shares of L-3 Holdings’ common stock. See Note 10 to the audited consolidated financial statements for the year ended December 31, 2008, included in the Company’s Annual Report on Form 10-K for additional information regarding the CODES, including conditions for conversion. L-3’s stock price on October 30, 2009 was $72.29 per share. The effective interest rate on the CODES is 6.33%. Interest expense relates to both the contractual coupon interest and amortization of the discount on the liability components. Interest expense recognized was $11 million and $10 million for the third quarter periods ended September 25, 2009 and September 26, 2008, respectively, and $31 million and $30 million for the year-to-date periods ended September 25, 2009 and September 26, 2008, respectively. The following table provides additional information about the Company’s CODES:
 
                 
    September 25,
  December 31,
    2009   2008
    (in millions)
 
Carrying amount of the equity component (conversion feature)
  $ 64     $ 64  
Unamortized discount of liability component being amortized through February 1, 2011
  $ 29     $ 45  
Net carrying amount of liability component
  $   671     $   655  


19


Table of Contents

 
L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
On October 2, 2009, L-3 Communications issued $1 billion in aggregate principal amount of 5.20% Senior Notes due October 15, 2019 (2009 Notes). The 2009 Notes have an effective interest rate of 5.25% and were issued at a discount of $4 million. The discount was recorded as a reduction to the principal amount of the notes and will be amortized as an interest expense over the term of the notes. Interest on the 2009 Notes is payable semi-annually on April 15 and October 15 of each year, commencing on April 15, 2010. The net cash proceeds from this offering amounted to approximately $988 million after deducting the discounts, commissions and estimated expenses, and were used, together with cash on hand, to redeem L-3 Communications’ $750 million 75/8% Senior Subordinated Notes due in 2012 (2002 Notes) on November 2, 2009 and to repay L-3 Communications’ outstanding $650 million term loan on October 7, 2009. In connection with the redemption of the 2002 Notes, the Company will record a debt retirement charge in the fourth quarter of 2009 of approximately $9 million ($6 million after income tax, or $0.05 per diluted share). The 2009 Notes are unsecured senior obligations of L-3 Communications, rank equal in right of payment with all of L-3 Communications’ existing and future senior indebtedness and rank senior in right of payment to all of L-3 Communications’ existing and future senior subordinated indebtedness. The 2009 Notes are also guaranteed on a senior, unsecured basis by each of L-3 Communications’ material domestic subsidiaries that guarantee any of L-3 Communications’ other indebtedness. The 2009 Notes may be redeemed at any time prior to their maturity at the option of L-3 Communications, in whole or in part, at a redemption price equal to the greater of: (1) 100% of the principal amount, or (2) 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 credit agreement) plus 0.30%. For additional information on the terms of L-3 Communications’ 2009 Notes, including restrictive covenants, see the Company’s Current Report on Form 8-K dated October 2, 2009 and the indenture governing the terms of the 2009 Notes, which is filed as an exhibit to this report.
 
On October 23, 2009, L-3 Communications replaced its $1 billion revolving credit facility with a new $1 billion three-year revolving credit facility maturing on October 23, 2012. Borrowings under the new revolving credit facility bear interest, at L-3 Communications’ option, at either (i) a “base rate” equal to the higher of (a) 0.50% per annum above the latest federal funds rate, (b) the Bank of America “prime rate” (as defined in the credit agreement), and (c) 1.00% per annum above a “LIBOR rate” (as defined in the credit agreement), plus a spread ranging from 1.25% to 3.00% per annum, or (ii) a “LIBOR rate” (as defined in the credit agreement) plus a spread ranging from 2.25% to 4.00% per annum. The spread, in both cases, depends on L-3 Communications’ debt rating at the time of determination. L-3 Communications pays: (1) commitment fees calculated on the daily amounts of the available unused commitments at a rate ranging from 0.375% to 0.75% per annum, (2) letter of credit fees ranging from 1.50% to 2.67% per annum for performance and commercial letters of credit and (3) letter of credit fees ranging from 2.25% to 4.00% for financial letters of credit. The fee rate, in all cases, depends on L-3 Communications’ debt rating at the time of determination. The debt rating is based on the ratings as determined by Standard & Poor’s Rating Services, Moody’s Investors Service, Inc. and Fitch Ratings of L-3 Communications’ non-credit enhanced senior, unsecured long-term debt. For additional information on the terms of L-3 Communications’ new $1 billion three-year revolving credit facility, including the financial and other restrictive covenants, see the Company’s Current Report on Form 8-K dated October 23, 2009, and the credit agreement governing the terms of the new $1 billion three-year revolving credit facility, which is incorporated by reference as an exhibit to this report.


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
 
10.  Comprehensive Income
 
A reconciliation of net income to comprehensive income attributable to L-3 is presented in the table below.
 
                                 
    Third Quarter Ended     Year-to-Date Ended  
    September 25,
    September 26,
    September 25,
    September 26,
 
    2009     2008     2009     2008  
          (in millions)        
 
Net income
  $ 253     $ 212     $ 681     $ 682  
Other comprehensive income (loss):
                               
Foreign currency translation adjustments
    66       (57 )     116       (54 )
Unrealized gains on hedging instruments(1)
    4       3       3       4  
Amortization of pension and postretirement benefit plans net loss (gain) and prior service cost(2)
    8       (1 )     23       2  
                                 
Total comprehensive income
    331       157       823       634  
Less: Comprehensive income attributable to noncontrolling interests
    3       2       7       8  
                                 
Comprehensive income attributable to L-3
  $  328     $  155     $  816     $  626  
                                 
 
 
(1) Amounts are net of income taxes of $2 million and $1 million for the quarterly periods ended September 25, 2009 and September 26, 2008, respectively, and $1 million and $2 million for the year-to-date periods ended September 25, 2009 and September 26, 2008, respectively.
(2) Amounts are net of income taxes of $5 million for the quarterly period ended September 25, 2009, and $16 million and $1 million for the year-to-date periods ended September 25, 2009 and September 26, 2008, respectively. See Note 17.
 
11.  Income Taxes
 
The U.S. Federal income tax jurisdiction is the Company’s major tax jurisdiction. The statute of limitations for the 2004 and 2005 tax years of the Company and certain of its acquired subsidiaries expired during the third quarter of 2009. The statute of limitations for the Company’s U.S. Federal income tax returns for the years ended December 31, 2006 through 2008 remain open. The Internal Revenue Service (IRS) began its audit of the Company’s 2006 and 2007 U.S. Federal income tax returns in April 2009. In addition, the Company has numerous state and foreign income tax audits currently in process. As of September 25, 2009, the Company anticipates that unrecognized tax benefits will decrease by approximately $15 million over the next 12 months.
 
Current and non-current income taxes payable include potential interest of $18 million ($11 million after income taxes) at September 25, 2009 and December 31, 2008, and potential penalties of $8 million at September 25, 2009 and $7 million at December 31, 2008.
 
During the third quarter of 2009, the Company recorded a tax benefit of $26 million for a net reversal of amounts previously accrued, related to the 2004 and 2005 tax years, for which the statute of limitations has expired.


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Table of Contents

 
L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
 
12.  L-3 Holdings’ Earnings Per Common Share
 
A reconciliation of basic EPS and diluted EPS is presented in the table below.
 
                                 
    Third Quarter Ended     Year-to-Date Ended  
    September 25,
    September 26,
    September 25,
    September 26,
 
    2009     2008     2009     2008  
    (in millions, except per share data)  
 
Basic:
                               
Net income allocable to L-3 Holdings’ common shareholders
  $ 248     $ 207     $ 668     $ 668  
                                 
Weighted average common shares outstanding
    116.4       121.0       117.1       121.8  
                                 
Basic EPS
  $ 2.13     $ 1.71     $ 5.70     $ 5.48  
                                 
Diluted:
                               
Net income allocable to L-3 Holdings’ common shareholders
  $ 248     $ 207     $ 668     $ 668  
                                 
Common and potential common shares:
                               
Weighted average common shares outstanding
    116.4       121.0       117.1       121.8  
Assumed exercise of stock options
    3.5       4.0       3.5       4.3  
Unvested restricted stock awards
    0.6             0.3        
Employee stock purchase plan contributions
          0.4       0.3       0.4  
Performance unit awards
                       
Assumed purchase of common shares for treasury
    (3.5 )     (3.4 )     (3.6 )     (3.5 )
Assumed conversion of the CODES
    (1)     (1)     (1)     0.2  
                                 
Common and potential common shares
    117.0       122.0       117.6       123.2  
                                 
Diluted EPS
  $      2.12     $      1.70     $      5.68     $      5.42  
                                 
 
 
(1) L-3 Holdings’ CODES had no impact on diluted EPS for the quarter and year-to-date period ended September 25, 2009 and the quarter ended September 26, 2008, because the average market price of L-3 Holdings’ common stock during these periods was less than the price at which the CODES would have been convertible into L-3 Holdings’ common stock. As of September 25, 2009, the conversion price was $100.14.
 
Excluded from the computations of diluted EPS are shares related to stock options, restricted stock, and restricted stock units underlying employee stock-based compensation of 3.5 million and 3.0 million for the quarter and year-to-date period ended September 25, 2009, respectively, and 2.4 million and 1.9 million for the quarter and year-to-date period ended September 26, 2008, respectively, because they were anti-dilutive.
 
EPS for the year-to-date period ended September 26, 2008 includes: (1) a gain of $0.65 per diluted share for the reversal of a current liability for pending and threatened litigation as a result of a June 27, 2008 decision by the U.S. Court of Appeals vacating an adverse 2006 jury verdict, (2) a gain of $0.06 per diluted share for the sale of the PMD product line (see Note 4), and (3) a non-cash charge of $0.14 per diluted share related to a write-down of capitalized software development costs.


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
 
13.  Equity
 
Repurchases of L-3 Holdings common stock under the $1 billion share repurchase program, approved by the Board of Directors in November 2008, are made from time to time at management’s discretion in accordance with applicable U.S. federal securities laws in the open market or otherwise. All share repurchases of L-3 Holdings common stock have been recorded as treasury shares. At September 25, 2009, the remaining dollar value under the share repurchase program was $535 million.
 
From September 26, 2009 through November 4, 2009, L-3 repurchased 324,207 shares of L-3 Holdings’ common stock at an average price of $74.10 per share for an aggregate amount of $24 million.
 
On October 6, 2009, L-3 Holdings’ Board of Directors declared a quarterly cash dividend of $0.35 per share, payable on December 15, 2009 to shareholders of record at the close of business on November 17, 2009.
 
14.  Fair Value Measurements
 
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 25, 2009     December 31, 2008  
Description
  Level 1(a)     Level 2(b)     Level 3(c)     Level 1(a)     Level 2(b)     Level 3(c)  
    (in millions)  
 
Assets
                                               
Cash equivalents
  $  958     $     $  —     $  794     $     $  —  
Derivative instruments
          18                   22     $  
                                                 
Total Assets
  $ 958     $  18     $     $ 794     $  22     $  
                                                 
Liabilities
                                               
Derivative instruments
  $     $ 9     $     $     $ 21     $  
 
 
(a) Level 1 is based on quoted market prices available in active markets for identical assets or liabilities as of the reporting date.
 
(b) 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.
 
(c) Level 3 is based on pricing inputs that are not observable and not corroborated by market data. The Company has no Level 3 assets or liabilities.
 
15.  Financial Instruments
 
Fair Value of Financial Instruments. At September 25, 2009 and December 31, 2008, the Company’s financial instruments consisted primarily of cash and cash equivalents, billed receivables, trade accounts payable, borrowings under the term loan facility, senior subordinated notes, CODES 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 expected settlement dates of these instruments. The fair value of borrowings under the term loan facility are based on similar debt issued. The senior subordinated notes are registered, unlisted public debt traded in the over-the-counter market and their fair values are based on quoted trading activity. The fair values of the CODES are based on quoted prices for the same or similar issues. The fair values of foreign currency


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
forward contracts were estimated based on forward exchange rates at September 25, 2009 and December 31, 2008. The carrying amounts and estimated fair values of the Company’s financial instruments are presented in the table below.
 
                                 
    September 25, 2009     December 31, 2008  
    Carrying
    Estimated
    Carrying
    Estimated
 
    Amount     Fair Value     Amount     Fair Value  
    (in millions)  
 
Borrowings under the Term Loan Facility
  $  650     $  643     $  650     $  608  
Senior Subordinated Notes
    3,189       3,172       3,188       2,916  
CODES
    671       717       655       697  
Foreign currency forward contracts(1)
    9       9       1       1  
 
 
(1) Notional amounts of foreign currency forward contracts were $359 million at September 25, 2009 and $414 million at December 31, 2008.
 
Derivative Financial Instruments. The Company’s derivative financial instruments include foreign currency forward contracts, which are entered into for risk management purposes, and an embedded derivative representing the contingent interest payment provision related to the CODES.
 
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, Euro, British pound and U.S. dollar. The Company manages exposure to counterparty 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 Consolidated Balance Sheets at fair value and are generally designated and accounted for as cash flow hedges in accordance with U.S. GAAP for derivative instruments and hedging activities (contained in FASB ASC Topic 815, Derivatives and Hedging). Gains and losses on designated foreign currency forward contracts that are considered highly effective in offsetting the corresponding change in the cash flows of the hedged transaction are recorded net of income taxes in accumulated other comprehensive income (loss) (accumulated OCI) and then recognized in income when the underlying hedged transaction affects income. The estimated net amount of existing gains at September 25, 2009 that are expected to be reclassified into income within the next 12 months is $5 million. Gains and losses on foreign currency forward contracts that do not meet hedge accounting criteria are recognized in income immediately.
 
The table below presents the notional amounts of the Company’s outstanding foreign currency forward contracts by currency as of September 25, 2009:
 
         
Currency   Notional Amount  
    (in millions)  
 
U.S. dollar
  $  130  
Canadian dollar
    105  
British pound
    99  
Euro
    14  
Other
    11  
         
Total
  $ 359  
         


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
The notional amounts are used to measure the volume of these contracts and do not represent exposure to foreign currency losses. At September 25, 2009, the Company’s foreign currency forward contracts had maturities through 2016.
 
The table below presents the fair values and the location of the Company’s derivative instruments in the Unaudited Condensed Consolidated Balance Sheet as of September 25, 2009.
 
                                 
    Fair Values of Derivative Instruments(1)  
    Other
          Other
       
    Current
    Other
    Current
    Other
 
    Assets     Assets     Liabilities     Liabilities  
          (in millions)        
 
Derivatives designated as hedging instruments:
                               
Foreign currency forward contracts
  $ 6     $ 9     $ 3     $ 2  
Derivatives not designated as hedging instruments:
                               
Foreign currency forward contracts
    2       1       3       1  
Embedded derivative related to the CODES
                       
                                 
Total derivative instruments
  $   8     $  10     $   6     $   3  
                                 
 
 
(1) See Note 14 for a description of the fair value hierarchy related to the Company’s foreign currency forward contracts.
 
The tables below present the effects of the Company’s derivative instruments on the Unaudited Condensed Consolidated Statement of Operations.
 
                                 
                    Gain or (Loss) Recognized
 
    Amount of
              in Income on Derivative
 
    Gain or (Loss)
    Gain or (Loss) Reclassified from Accumulated
    (Ineffective Portion and
 
    Recognized in
    OCI into Income
    Amount Excluded from
 
    OCI on Derivative
    (Effective Portion)     Effectiveness Testing)  
Derivatives Designated as Hedging Instruments
  (Effective Portion)     Location   Amount     Location   Amount  
          ($ in millions)            
 
For the quarter ended September 25, 2009:
                               
Foreign currency forward contracts
  $ 5     Cost of Sales   $     Cost of Sales   $   —  
For the year-to-date ended September 25, 2009:
                               
Foreign currency forward contracts
  $   —     Cost of Sales   $   (3 )   Cost of Sales   $  
 
             
    Gain or (Loss) Recognized in Income on Derivative  
Derivatives not Designated as Hedging Instruments
  Location   Amount  
        (in millions)  
 
For the quarter ended September 25, 2009:
           
Foreign currency forward contracts
  Cost of Sales   $   2  
For the year-to-date ended September 25, 2009:
           
Foreign currency forward contracts
  Cost of Sales   $   2  
 
16.  Commitments and Contingencies
 
U.S. and Foreign Government Procurement Regulations
 
A substantial majority of the Company’s revenues are generated from providing products and services under legally binding agreements, or contracts, with U.S. Government and foreign government customers. 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


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
requirements. The Company is currently cooperating with the U.S. Government on several investigations from which civil, criminal or administrative proceedings could result and give rise to fines, penalties, compensatory and treble damages, restitution and/or forfeitures. 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 could result in the Company being suspended for a period of time from eligibility for awards of new government contracts or in a loss of export privileges. A conviction 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 and default, as well as other procurement clauses relevant to the foreign government.
 
Litigation Matters
 
The Company has been subject to and is involved in litigation, government investigations, proceedings, claims or assessments and various contingent liabilities incidental to its businesses, including those specified below. Furthermore, in connection with certain business acquisitions, the Company has assumed some or all claims against, and liabilities of, the acquired business, including both asserted and unasserted claims and liabilities. In accordance with U.S. GAAP for contingencies (contained in FASB ASC Topic 450, 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. The estimated amounts of liabilities recorded for pending and threatened litigation is disclosed in Note 8. Amounts recoverable from insurance contracts or third parties are recorded as assets when deemed probable. At September 25, 2009, 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 quarterly and adjusts 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 one or more of the following matters, unless otherwise stated below, the Company believes that it is not probable that a loss has been incurred in any of these matters. An estimate of loss or range of loss is disclosed for a particular litigation matter when such amount or amounts can be reasonably estimated and no loss has been accrued. The Company believes that any damage amounts claimed in the specific matters discussed below are not meaningful indicators of potential liability. Although the Company believes that it has valid defenses with respect to legal matters and investigations pending against it, litigation is inherently unpredictable. Therefore, it is possible that the financial position, results of operations or cash flows of the Company could be materially adversely affected in any particular period by the unfavorable resolution of one or more of these contingencies.
 
Kalitta Air. L-3 Integrated Systems and its predecessors have been involved in litigation with Kalitta Air arising from a contract to convert Boeing 747 aircraft from passenger configuration to cargo freighters. The lawsuit was brought in the United States District Court for the Northern District of California (the trial court) on January 31, 1997. The aircraft were modified using Supplemental Type Certificates (STCs) issued in 1988 by the Federal Aviation Administration (FAA) to Hayes International, Inc. (Hayes/Pemco) as a subcontractor to GATX/Airlog Company (GATX). Between 1988 and 1990, Hayes/Pemco modified five aircraft as a subcontractor to GATX using the STCs. Between 1990 and 1994, Chrysler Technologies Airborne Systems, Inc. (CTAS), a predecessor to L-3 Integrated Systems, performed as a subcontractor to GATX and modified an additional five aircraft using the STCs. Two of the aircraft modified by CTAS were owned by American International Airways, the predecessor to Kalitta


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
Air. In 1996, the FAA determined that the engineering data provided by Hayes/Pemco supporting the STCs was inadequate and issued an Airworthiness Directive that effectively grounded the ten modified aircraft. The Kalitta Air aircraft have not been in revenue service since that date. The matter was tried in January 2001 against GATX and CTAS with the jury finding fault on the part of GATX, but rendering a unanimous defense verdict in favor of CTAS. Certain co-defendants had settled prior to trial. The U.S. Court of Appeals for the Ninth Circuit subsequently reversed and remanded the trial court’s summary judgment rulings in favor of CTAS regarding a negligence claim by Kalitta Air, which asserts that CTAS as an expert in aircraft modification should have known that the STCs were deficient. The retrial began on January 18, 2005, and ended on March 2, 2005 with a deadlocked jury and mistrial. At the retrial, Kalitta Air claimed damages of $235 million plus interest. By order dated July 22, 2005, the trial court granted the Company’s motion for judgment as a matter of law as to negligence dismissing that claim, denied the Company’s motion for judgment as a matter of law as to negligent misrepresentation, and certified the decision for interlocutory appeal to the U.S. Court of Appeals for the Ninth Circuit. On October 8, 2008, the Ninth Circuit reversed the trial court’s dismissal of the negligence claim and affirmed the trial court’s ruling as to the negligent misrepresentation claim. The case has been remanded to the trial court to reconsider the negligence claim and for further proceedings on the negligent misrepresentation claim. A court-ordered mediation held on March 18, 2009 was unsuccessful. A hearing on the Company’s motion to dismiss the negligence claim was held on April 30, 2009, after which the trial court determined to take the matter under advisement and ordered the parties to attend another mediation, which has yet to be scheduled. The case is currently scheduled to go to a third trial on November 1, 2010. CTAS’ insurance carrier has accepted defense of the matter and has retained counsel, subject to a reservation of rights by the insurer to dispute its obligations under the applicable insurance policies in the event of an adverse finding.
 
Korean Lot II Program. On April 4, 2005, Lockheed Martin Corporation (Lockheed) filed a lawsuit in the Federal District Court for the Northern District of Georgia alleging misappropriation of proprietary information and breach of a license agreement. The complaint alleges that L-3 Integrated Systems (L-3 IS) is in breach of its license agreement with Lockheed and is infringing on Lockheed’s intellectual property rights as a result of its performance of a subcontract awarded to L-3 IS for the Korean Lot II program. On May 21, 2009, a jury found in favor of Lockheed and awarded $30 million on the misappropriation claim, $7.28 million on the breach of license agreement claim, plus legal fees and expenses. On July 3, 2009, Lockheed filed a motion with the court seeking a final judgment, approximately $17 million in legal fees and expenses and an injunction prohibiting L-3’s further use of the intellectual property that was the basis of the jury’s award. On August 7, 2009, L-3 IS filed a motion for judgment in its favor notwithstanding the verdict and opposing the relief sought by Lockheed in its July 3rd motion. The court held a hearing on the motions on September 2, 2009, and the parties are awaiting the court’s decision. L-3 IS has also filed a motion seeking dismissal or a retrial of the case on various grounds. The motion is subject to further briefing by the parties and has not yet been considered by the court. The Company believes that the verdict and the damages awarded are inconsistent with the law and evidence presented, and intends to appeal in the event of an adverse decision on the motions.
 
Aircrew Training and Rehearsal Support (ATARS) Investigation. Following a lawsuit filed by Lockheed on April 6, 2006 in the U.S. District Court for the Middle District of Florida against the Company and certain individuals related to the ATARS II Program (which was settled in November 2007), the Company received Grand Jury subpoenas in connection with an investigation being conducted by the United States Attorney for the Middle District of Florida, Orlando Division. The subpoenas request the production of documents related to Lockheed’s allegations or produced in the civil litigation settled in November 2007. The Company is cooperating fully with the U.S. Government.
 
Titan Government Investigation. In October 2002, The Titan Corporation (Titan) received a grand jury subpoena from the Antitrust Division of the DoJ requesting the production of documents relating to information technology services performed for the U.S. Air Force at Hanscom Air Force Base in Massachusetts and Wright-


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
Patterson Air Force Base in Ohio. Titan was informed that other companies who have performed similar services had received subpoenas as well. The Company acquired Titan in July 2005. On September 20, 2006, counsel for the Company was informed by the New York Field Office of the DoJ’s Criminal Antitrust Division that it was considering indictment. Additionally, a former Titan employee received a letter from the DoJ indicating that he was a target of the investigation. If the Field Office recommends indictment then, under normal DoJ procedures, Titan (now known as L-3 Services) will be afforded an opportunity to make a presentation to the Criminal Antitrust Division in Washington, D.C. before the DoJ acts on the recommendation. It is not known whether an indictment of L-3 Services or any of its employees will occur. If it does occur, it is possible that L-3 Services could be suspended or debarred from conducting business with the U.S. Government. In December 2008, the DoJ indicated its interest in conducting additional employee interviews concerning a teaming agreement relating to the Wright Patterson Air Force Base procurement. The Company is cooperating fully with the DoJ.
 
SEC Inquiry. In March 2007, the Company was contacted by the U.S. Securities and Exchange Commission (SEC), Enforcement Division, requesting that the Company provide certain information relating to its previously disclosed review of its historical stock option granting practices. On September 3, 2009, the Company was notified by the SEC staff that it had completed its inquiry and did not intend to recommend that any enforcement action be taken against the Company.
 
CyTerra Government Investigation. Since November 2006, CyTerra has been served with civil and Grand Jury subpoenas by the DoD Office of the Inspector General and the DoJ. The Company is cooperating fully with the Government. The Company believes that it is entitled to indemnification for any course of defense related to this matter and has made a claim against the escrow under the purchase agreement by which the Company acquired CyTerra in March 2006.
 
Bashkirian Airways. On July 1, 2004, lawsuits were filed on behalf of the estates of 31 Russian children in the state courts of Washington, Arizona, California, Florida, New York and New Jersey against Honeywell, Honeywell TCAS, Thales USA, Thales France, the Company and Aviation Communications & Surveillance Systems (ACSS), which is a joint venture of L-3 and Thales. The suits relate to the crash over southern Germany of Bashkirian Airways Tupelov TU 154M aircraft and a DHL Boeing 757 cargo aircraft. On-board the Tupelov aircraft were 9 crew members and 60 passengers, including 45 children. The Boeing aircraft carried a crew of two. Both aircraft were equipped with Honeywell/ACSS Model 2000, Change 7 Traffic Collision and Avoidance Systems (TCAS). Sensing the other aircraft, the on-board DHL TCAS instructed the DHL pilot to descend, and the Tupelov on-board TCAS instructed the Tupelov pilot to climb. However, the Swiss air traffic controller ordered the Tupelov pilot to descend. The Tupelov pilot disregarded the on-board TCAS and put the Tupelov aircraft into a descent striking the DHL aircraft in midair at approximately 35,000 feet. All crew and passengers of both planes were lost. Investigations by the National Transportation Safety Board after the crash revealed that both TCAS units were performing as designed. The suits allege negligence and strict product liability based upon the design of the units and the training provided to resolve conflicting commands and seek approximately $315 million in damages, including $150 million in punitive damages. The Company’s insurers have accepted defense of the matter and retained counsel, subject to a reservation of rights by the insurers to dispute their obligations under the applicable insurance policies in the event of an adverse finding. The matters were consolidated in the Federal Court in New Jersey, which has dismissed the actions on the basis of forum non conveniens. The plaintiffs re-filed a complaint on April 23, 2007 with the Barcelona Court’s Registry in Spain. The trial for this matter was completed on April 22, 2009, and the parties are awaiting the Court’s decision.
 
Gol Airlines. The Company was served with complaints filed in the U.S. District Court for the Eastern District of New York against ExcelAire, Joseph Lepore, Jan Paul Paladino, Honeywell, Lockheed, Raytheon, and Amazon Technologies and ACSS. The complaints relate to the September 29, 2006 airplane crash over Brazil of a Boeing 737-800 operated by GOL Linhas Aereas Inteligentes, S.A. and an Embraer 600 business jet operated by ExcelAire.


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
The complaints allege that ACSS designed the Traffic Collision and Avoidance System (TCAS) on the ExcelAire jet, and assert claims of negligence, strict products liability and breach of warranty against ACSS based on the design of the TCAS and the instructions provided for its use. The complaints seek unspecified monetary damages, including punitive damages. The Company’s insurers have accepted defense of this matter and have retained counsel, subject to a reservation of rights by the insurers to dispute their obligations under the applicable insurance policies in the event of an adverse finding. On July 3, 2008, the District Court dismissed the actions on the basis of forum non conveniens on the grounds that Brazil was the location of the accident and is more convenient for witnesses and document availability. On August 1, 2008, the plaintiffs filed an appeal of this ruling with the U.S. Court of Appeals for the Second Circuit. Oral argument on the appeal has been scheduled for November 12, 2009. Although the appeal is still pending, some of the plaintiffs re-filed their complaints in the Lower Civil Court in the Judicial District of Peixoto de Azevedo in Brazil on July 3, 2009.
 
Pilatus PC-12 Aircraft. On July 6, 2007, the Company was served with an amended complaint filed in the U.S. District Court for the Eastern District of Pennsylvania against Pilatus Aircraft, Ltd., Pilatus Flugzeuweke Aktiengellschaft, Rosemont Aerospace, Inc., Revue Thommen AC, EMCA, Goodrich Corp., Goodrich Avionics Systems, Inc. (the predecessor to L-3 Avionics) and the Company. The amended complaint relates to the March 26, 2005 crash of a Pilatus PC-12 aircraft near Belafonte, Pennsylvania in which all six on board were lost. The amended complaint alleges that L-3 Avionics (and/or its predecessor company, Goodrich Avionics) designed, manufactured, tested, marketed, and sold the stick shaker/pusher servo actuator on the Pilatus PC-12, and asserts claims against L-3 Avionics and the Company based on negligence, breach of warranty, and strict liability. The amended complaint seeks unspecified monetary damages, including punitive damages. On October 1, 2009, the court issued an order severing the claims against Pilatus Aircraft, Ltd. and transferring those claims to the U.S. District Court for the District of Colorado. The Company’s insurers have accepted defense of the matter and have retained counsel, subject to a reservation of rights by the insurers to dispute their obligations under the applicable insurance policies in the event of an adverse finding.
 
T-39 Sabreliner Aircraft. On January 16, 2008, the Company was served with three wrongful death lawsuits filed in the U.S. District Court for the Southern District of New York arising from the crash of a T-39 Sabreliner Aircraft near Rome, GA on January 10, 2006. The Plaintiffs allege that L-3 Vertex employed the pilot in command, David Roark, and maintained the aircraft, and are seeking unspecified monetary damages. The cases have been consolidated and transferred to the U.S. District Court for the Northern District of Florida. The Company’s insurers have accepted defense of the matter and have retained counsel, subject to a reservation of rights by the insurers to dispute their obligations under the applicable insurance policies in the event of an adverse finding. Two out of the three lawsuits have been settled. The remaining lawsuit is currently scheduled to go to trial in July of 2010.
 
Blackhawk Helicopter. On August 7, 2008, a lawsuit was filed in the U.S. District Court for the Southern District of Texas relating to the August 22, 2007 crash of a U.S. Army Blackhawk helicopter near Kirkuk, Iraq. The complaint, which was brought on behalf of 14 passengers who were killed in the crash, alleges that the crash was the result of L-3 Vertex’s negligence in connection with a phased maintenance inspection performed approximately one week before the crash, and seeks unspecified monetary damages, including punitive damages. Discovery is expected to be finished by the end of February 2010, and the case is currently scheduled to go to trial in May 2010. The Company’s insurers have accepted defense of this matter and have retained counsel, subject to a reservation of rights by the insurers to dispute their obligations under the applicable insurance policies in the event of an adverse finding.


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
 
17.  Pension and Other Postretirement Benefits
 
The following table summarizes the components of net periodic benefit cost for the Company’s pension and postretirement benefit plans.
 
                                                                 
    Pension Plans     Postretirement Benefit Plans  
    Third Quarter Ended     Year-to-Date Ended     Third Quarter Ended     Year-to-Date Ended  
    September 25,
    September 26,
    September 25,
    September 26,
    September 25,
    September 26,
    September 25,
    September 26,
 
    2009     2008     2009     2008     2009     2008     2009     2008  
    (in millions)  
 
Components of net periodic benefit cost:
                                                               
Service cost
  $ 22     $ 21     $ 67     $ 67     $ 1     $ 1     $ 3     $ 4  
Interest cost
    29       26       84       79       2       3       8       8  
Expected return on plan assets
    (22 )     (29 )     (67 )     (89 )     (1 )           (2 )     (1 )
Amortization of prior service costs (credits)
    1             3       2       (1 )           (2 )     (2 )
Amortization of net losses (gains)
    13       1       39       5             (2 )     (1 )     (2 )
Curtailment loss
          1       1       1                          
                                                                 
Net periodic benefit cost
  $     43     $     20     $     127     $     65     $     1     $     2     $     6     $     7  
                                                                 
 
Contributions. For the year ending December 31, 2009, the Company currently expects to contribute cash of approximately $65 million to its pension plans, and approximately $13 million to its postretirement benefit plans. The Company contributed cash of $46 million to its pension plans and $8 million to its postretirement benefit plans during the year-to-date period ended September 25, 2009.
 
 
18.  Employee Stock-Based Compensation
 
At its Annual Meeting of Stockholders held on April 28, 2009, the stockholders of L-3 Holdings approved the L-3 Communications Corporation 2009 Employee Stock Purchase Plan (2009 ESPP), which became effective on July 1, 2009. As a result, no new options to purchase shares of L-3 Holdings’ common stock will be granted under the Company’s prior employee stock purchase plan (2001 ESPP).
 
Under the 2009 ESPP, eligible employees are offered options to purchase shares of L-3 Holdings’ common stock at 85% of the fair market value of L-3 Holdings’ common stock on the last day of each six-month offering period. Eligible employees include all employees of the Company, or of a subsidiary or affiliate of the Company that has been designated to participate in the 2009 ESPP. Offering periods begin on the first trading day in January and July of each calendar year and end on the last trading day in June and December of each calendar year. Fair market value is defined as the average of the highest and lowest sales price of a share of L-3 Holdings’ common stock on the last trading day of the trading period. Share purchases are funded through payroll deductions of up to 10% of a participating employee’s compensation for each payroll period, or $21,250 each calendar year. Employees may not purchase more than $25,000 worth of L-3 Holdings’ common stock for each year based on the value of the common stock at the beginning of each offering period during the year. After adjustment for the shares issued under the 2001 ESPP, the 2009 ESPP authorizes L-3 Holdings to issue up to 7.4 million shares. No shares will be issued under the 2009 ESPP until the conclusion of the first six-month offering period, which began on July 1, 2009 and ends on December 31, 2009.


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
 
19.  Supplemental Cash Flow Information
 
                 
    Year-to-Date Ended  
    September 25,
    September 26,
 
    2009     2008  
    (in millions)  
 
Interest paid on outstanding debt
  $      181     $      198  
Income tax payments
    271       265  
Income tax refunds
    3       6  
 
20.  Segment Information
 
The Company has four reportable segments, which are described in Note 1. 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 25,
    September 26,
    September 25,
    September 26,
 
    2009     2008(1)     2009     2008(1)  
          (In millions)        
 
Net Sales:
                               
C3ISR
  $ 772     $ 622     $ 2,258     $ 1,794  
Government Services
    1,012       1,045       3,089       3,259  
AM&M
    775       636       2,176       1,956  
Specialized Products
    1,369       1,401       4,090       3,987  
Elimination of intercompany sales
    (86 )     (42 )     (206 )     (106 )
                                 
Consolidated total
  $  3,842     $  3,662     $  11,407     $  10,890  
                                 
Operating Income:
                               
C3ISR
  $ 78     $ 56     $ 251     $ 185  
Government Services
    103       100       295       322  
AM&M
    67       70       184       178  
Specialized Products
    170       174       481       458 (2)
                                 
Segment total
  $ 418     $ 400     $ 1,211     $ 1,143  
Litigation gain
                      126 (3)
                                 
Consolidated total
  $ 418     $ 400     $ 1,211     $ 1,269  
                                 
Depreciation and amortization:
                               
C3ISR
  $ 11     $ 10     $ 32     $ 30  
Government Services
    10       8       29       26  
AM&M
    5       7       15       19  
Specialized Products
    29       27       86       80  
                                 
Consolidated total
  $ 55     $ 52     $ 162     $ 155  
                                 
 


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
                 
    September 25,
    December 31,
 
    2009     2008(1)  
    (in millions)  
 
Total Assets:
               
C3ISR
  $   1,877     $   1,755  
Government Services
    3,458       3,494  
AM&M
    1,968       1,836  
Specialized Products
    6,590       6,319  
Corporate
    1,175       1,080  
                 
Consolidated total
  $ 15,068     $ 14,484  
                 
 
 
(1) As a result of certain re-alignments in the Company’s management and organization structure as discussed in Note 2, sales of $4 million and $11 million and operating income of $1 million and $2 million were reclassified from the C3ISR reportable segment to the Government Services reportable segment for the quarter and year-to-date period ended September 26, 2008, and sales of $4 million and $16 million and operating income of less than $1 million and $2 million were reclassified from the C3ISR reportable segment to the AM&M reportable segment for the quarter and year-to-date period ended September 26, 2008. At December 31, 2008, $30 million of total assets was reclassified from the C3ISR reportable segment to the Government Services reportable segment and $29 million of total assets was reclassified from the C3ISR reportable segment to the AM&M reportable segment.
(2) Operating income for the Specialized Products reportable segment includes: (i) a gain of $12 million from the sale of the PMD product line (see Note 4) and (ii) a non-cash impairment charge of $28 million related to a write-down of capitalized software development costs, which were both recorded in the second quarter of 2008.
(3) Represents a gain recorded in the second quarter of 2008 for the reversal of a current liability for pending and threatened litigation as a result of a June 27, 2008 decision by the U.S. Court of Appeals vacating an adverse 2006 jury verdict.
 
21.  Accounting Standards Issued and Not Yet Implemented
 
In October 2009, the FASB revised the accounting guidance for revenue arrangements with multiple deliverables. The revision: (1) removes the objective-and-reliable-evidence-of-fair-value criterion from the separation criteria used to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting, (2) provides a hierarchy that entities must use to estimate the selling price, (3) eliminates the use of the residual method for allocation, and (4) expands the ongoing disclosure requirements. This update is effective for the Company beginning January 1, 2011 and can be applied prospectively or retrospectively. The Company is currently assessing the impact of the revised accounting guidance.
 
In June 2009, the FASB issued an accounting standard for variable interest entities which changes the approach to determining the primary beneficiary of a variable interest entity (VIE) and requires companies to assess more frequently whether they must consolidate VIEs. The new accounting standard is effective for the Company beginning on January 1, 2010. The Company is currently assessing the impact of the new accounting standard.
 
In December 2008, the FASB issued an accounting standard that expands the disclosure requirements for pension and other postretirement plan assets and is effective for the Company beginning December 31, 2009. The adoption of this standard will not have a material effect on the Company’s financial position, results of operations and cash flows, but will enhance the Company’s pension and other postretirement benefit plan assets disclosures.

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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
 
22.  Unaudited Financial Information of L-3 Communications and Its Subsidiaries
 
L-3 Communications is a wholly-owned subsidiary of L-3 Holdings. The debt of L-3 Communications, including the Senior Subordinated Notes and borrowings under amounts drawn against the Senior Credit Facility, are guaranteed, on a joint and several, full and unconditional basis, by certain of its domestic subsidiaries (the “Guarantor Subsidiaries”). The foreign subsidiaries and certain domestic subsidiaries of L-3 Communications (the “Non-Guarantor Subsidiaries”) do not guarantee the debt of L-3 Communications. None of the debt of L-3 Communications has been issued by its subsidiaries. There are no restrictions on the payment of dividends from the Guarantor Subsidiaries to L-3 Communications.
 
The following unaudited condensed combining financial information presents the results of operations, financial position and cash flows of: (1) L-3 Holdings, excluding L-3 Communications and its consolidated subsidiaries (the “Parent”), (2) L-3 Communications, excluding its consolidated subsidiaries, (3) the Guarantor Subsidiaries, (4) the Non-Guarantor Subsidiaries, and (5) the eliminations to arrive at the information for L-3 on a consolidated basis.
 
                                                 
    L-3
                Non-
             
    Holdings
    L-3
    Guarantor
    Guarantor
          Consolidated
 
    (Parent)     Communications     Subsidiaries     Subsidiaries     Eliminations     L-3  
    (in millions)  
 
Condensed Combining Balance Sheets:
                                               
At September 25, 2009:
                                               
Current assets:
                                               
Cash and cash equivalents
  $     $ 887     $ 12     $ 337     $ (45 )   $ 1,191  
Billed receivables, net
          303       765       202             1,270  
Contracts in process
          641       1,494       263             2,398  
Other current assets
          250       176       128             554  
                                                 
Total current assets
          2,081       2,447       930       (45 )     5,413  
Goodwill
          1,144       5,876       1,168             8,188  
Other assets
    5       461       823       183       (5 )     1,467  
Investment in and amounts due from consolidated subsidiaries
    7,057       8,869       1,721             (17,647 )      
                                                 
Total assets
  $  7,062     $  12,555     $  10,867     $  2,281     $  (17,697 )   $  15,068  
                                                 
Current portion of long-term debt
  $     $ 650     $     $     $     $ 650  
Other current liabilities
          732       1,362       608       (45 )     2,657  
Amounts due to consolidated subsidiaries
                      3       (3 )      
Other long-term liabilities
          951       230       266             1,447  
Long-term debt
    700       3,860                   (700 )     3,860  
                                                 
Total liabilities
    700       6,193       1,592       877       (748 )     8,614  
                                                 
L-3 shareholders’ equity
    6,362       6,362       9,275       1,404       (17,041 )     6,362  
Noncontrolling interests
                            92       92  
                                                 
Total equity
    6,362       6,362       9,275       1,404       (16,949 )     6,454  
                                                 
Total liabilities and equity
  $ 7,062     $ 12,555     $ 10,867     $ 2,281     $ (17,697 )   $ 15,068  
                                                 
At December 31, 2008:
                                               
Current assets:
                                               
Cash and cash equivalents
  $     $ 720     $ 2     $ 228     $ (83 )   $ 867  
Billed receivables, net
          324       701       201             1,226  
Contracts in process
          587       1,461       219             2,267  
Other current assets
          291       170       140             601  
                                                 
Total current assets
          1,922       2,334       788       (83 )     4,961  
Goodwill
          1,171       5,746       1,112             8,029  
Other assets
    8       475       837       182       (8 )     1,494  
Investment in and amounts due from consolidated subsidiaries
    6,550       8,489       1,283       80       (16,402 )      
                                                 
Total assets
  $ 6,558     $ 12,057     $ 10,200     $ 2,162     $ (16,493 )   $ 14,484  
                                                 
Current liabilities
  $     $ 824     $ 1,395     $ 571     $ (83 )   $ 2,707  
Other long-term liabilities
          882       219       242             1,343  
Long-term debt
    700       4,493                   (700 )     4,493  
                                                 
Total liabilities
    700       6,199       1,614       813       (783 )     8,543  
                                                 
L-3 shareholders’ equity
    5,858       5,858       8,586       1,349       (15,793 )     5,858  
Noncontrolling interests
                            83       83  
                                                 
Total equity
    5,858       5,858       8,586       1,349       (15,710 )     5,941  
                                                 
Total liabilities and equity
  $ 6,558     $ 12,057     $ 10,200     $ 2,162     $ (16,493 )   $ 14,484  
                                                 


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
                                                 
    L-3
                Non-
             
    Holdings
    L-3
    Guarantor
    Guarantor
          Consolidated
 
    (Parent)     Communications     Subsidiaries     Subsidiaries     Eliminations     L-3  
    (in millions)  
 
Condensed Combining Statements of Operations:
                                               
For the quarter ended September 25, 2009:
                                               
Net sales
  $     $ 789     $ 2,627     $ 459     $ (33 )   $ 3,842  
Cost of sales
    18       678       2,377       402       (51 )     3,424  
                                                 
Operating (loss) income
    (18 )     111       250       57       18       418  
Interest and other income, net
          31                   (28 )     3  
Interest expense
    11       68       27       1       (39 )     68  
                                                 
(Loss) income before income taxes
    (29 )     74       223       56       29       353  
(Benefit) provision for income taxes
    (9 )     27       53       20       9       100  
Equity in net income of consolidated subsidiaries
    270       203                   (473 )      
                                                 
Net income
    250       250       170       36       (453 )     253  
Net income attributable to noncontrolling interests
                            3       3  
                                                 
Net income attributable to L-3
  $  250     $ 250     $ 170     $ 36     $ (456 )   $ 250  
                                                 
For the quarter ended September 26, 2008:
                                               
Net sales
  $     $ 803     $ 2,408     $ 489     $ (38 )   $ 3,662  
Cost of sales
    18       689       2,161       450       (56 )     3,262  
                                                 
Operating (loss) income
    (18 )     114       247       39       18       400  
Interest and other income, net
            32       2       2       (29 )     7  
Interest expense
    11       71       28       2       (40 )     72  
                                                 
(Loss) income before income taxes
    (29 )     75       221       39       29       335  
(Benefit) provision for income taxes
    (10 )     25       83       15       10       123  
Equity in net income of consolidated subsidiaries
    229       160                   (389 )      
                                                 
Net income
    210       210       138       24       (370 )     212  
Net income attributable to noncontrolling interests
                            2       2  
                                                 
Net income attributable to L-3
  $ 210     $ 210     $ 138     $ 24     $ (372 )   $ 210  
                                                 


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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
                                                 
    L-3
                Non-
             
    Holdings
    L-3
    Guarantor
    Guarantor
          Consolidated
 
    (Parent)     Communications     Subsidiaries     Subsidiaries     Eliminations     L-3  
    (in millions)  
 
Condensed Combining Statements of Operations:
                                               
For the year-to-date period ended
                                               
September 25, 2009:
                                               
Net sales
  $     $  2,476     $  7,659     $  1,369     $ (97 )   $ 11,407  
Cost of sales
    53       2,163       6,913       1,217       (150 )     10,196  
                                                 
Operating (loss) income
    (53 )     313       746       152       53       1,211  
Interest and other income, net
          94       1       2       (85 )     12  
Interest expense
    33       202       82       4       (118 )     203  
                                                 
(Loss) income before income taxes
    (86 )     205       665       150       86       1,020  
(Benefit) provision for income taxes
    (29 )     71       214       54       29       339  
Equity in net income of consolidated subsidiaries
    731       540                   (1,271 )      
                                                 
Net income
    674       674       451       96       (1,214 )     681  
Net income attributable to noncontrolling interests
                            7       7  
                                                 
Net income attributable to L-3
  $ 674     $ 674     $ 451     $ 96     $  (1,221 )   $ 674  
                                                 
For the year-to-date period ended
                                               
September 26, 2008:
                                               
Net sales
  $     $ 2,204     $ 7,277     $ 1,494     $ (85 )   $  10,890  
Cost of sales
    48       1,894       6,588       1,350       (133 )     9,747  
Litigation gain
          126                         126  
                                                 
Operating (loss) income
    (48 )     436       689       144       48       1,269  
Interest and other income, net
          99       4       5       (86 )     22  
Interest expense
    32       213       82       5       (118 )     214  
                                                 
(Loss) income before income taxes
    (80 )     322       611       144       80       1,077  
(Benefit) provision for income taxes
    (29 )     112       229       54       29       395  
Equity in net income of consolidated subsidiaries
    725       464                   (1,189 )      
                                                 
Net income
    674       674       382       90       (1,138 )     682  
Net income attributable to noncontrolling interests
                            8       8  
                                                 
Net income attributable to L-3
  $   674     $   674     $   382     $   90     $   (1,146 )   $   674  
                                                 

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L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)
 
                                                 
    L-3
                Non-
             
    Holdings
    L-3
    Guarantor
    Guarantor
          Consolidated
 
    (Parent)     Communications     Subsidiaries     Subsidiaries     Eliminations     L-3  
    (in millions)  
 
Condensed Combining Statements of Cash Flows:
                                               
For the year-to-date period ended
September 25, 2009:
                                               
Operating activities:
                                               
Net cash from operating activities
  $  520     $ 30     $  753     $  157     $  (482 )   $  978  
                                                 
Investing activities:
                                               
Business acquisitions, net of cash acquired
          (86 )                       (86 )
Other investing activities
    (55 )     (31 )     (85 )     (9 )     55       (125 )
                                                 
Net cash used in investing activities
    (55 )     (117 )     (85 )     (9 )     55       (211 )
                                                 
Financing activities:
                                               
Common stock repurchased
    (396 )                             (396 )
Other financing activities
    (69 )     254       (658 )     (60 )     465       (68 )
                                                 
Net cash (used in) from financing activities
    (465 )     254       (658 )     (60 )     465       (464 )
                                                 
Effect of foreign currency exchange rate on cash
                      21             21  
                                                 
Net increase in cash
          167       10       109       38       324  
Cash and cash equivalents, beginning of the period
          720       2       228       (83 )     867  
                                                 
Cash and cash equivalents, end of the period
  $     $ 887     $ 12     $ 337     $ (45 )   $ 1,191  
                                                 
For the year-to-date period ended
September 26, 2008:
                                               
Operating activities:
                                               
Net cash from operating activities
  $ 684     $ 13     $ 848     $ 140     $ (654 )   $ 1,031  
                                                 
Investing activities:
                                               
Business acquisitions, net of cash acquired
          (224 )                       (224 )
Other investing activities
    (87 )     (38 )     (76 )     (14 )     87       (128 )
                                                 
Net cash used in investing activities
    (87 )     (262 )     (76 )     (14 )     87       (352 )
                                                 
Financing activities:
                                               
Common stock repurchased
    (573 )                             (573 )
Other financing activities
    (24 )     256       (770 )     (121 )     637       (22 )
                                                 
Net cash (used in) from financing activities
    (597 )     256       (770 )     (121 )     637       (595 )
                                                 
Effect of foreign currency exchange rate on cash
                      (7 )           (7 )
                                                 
Net increase (decrease) in cash
          7       2       (2 )     70       77  
Cash and cash equivalents, beginning of the period
          632       7       237       (96 )     780  
                                                 
Cash and cash equivalents, end of the period
  $     $  639     $ 9     $ 235     $ (26 )   $ 857  
                                                 

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ITEM 2.
 
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
 
Financial Section Roadmap
 
Management’s discussion and analysis (MD&A) can be found on pages 37 to 54, and our unaudited condensed consolidated financial statements and related notes contained in this quarterly report can be found on pages 1 to 36. The following table is designed to assist in your review of MD&A.
 
     
Topic   Location
 
Overview and Outlook:
   
L-3’s Business
  Pages 37 – 38
Key Performance Measures
  Pages 38 – 39
Other Events
  Pages 39 – 40
Business Acquisitions and Business and Product Line Dispositions
  Page 40
Critical Accounting Policies
  Pages 40 – 43
Results of Operations (includes business segments)
  Pages 43 – 49
Liquidity and Capital Resources:
   
Anticipated Sources of Cash Flow
  Page 50
Balance Sheet
  Pages 50 – 51
Statement of Cash Flows
  Pages 51 – 54
Legal Proceedings and Contingencies
  Page 54
 
Overview and Outlook
 
L-3’s Business
 
L-3 is a prime system contractor in aircraft modernization and maintenance, Command, Control, Communications, Intelligence, Surveillance and Reconnaissance (C3ISR) systems, and government services. L-3 is also a leading provider of high technology products, subsystems and systems. Our customers include the U.S. Department of Defense (DoD) and its prime contractors, U.S. Government intelligence agencies, the U.S. Department of Homeland Security (DHS), U.S. Department of State (DoS), U.S. Department of Justice (DoJ), allied foreign governments, domestic and foreign commercial customers, and select other U.S. federal, state and local government agencies.
 
For the year ended December 31, 2008, we generated sales of $14.9 billion. The table below presents a summary of our 2008 sales by major category of end customer and the percent contributed by each end customer to our total 2008 sales. We currently do not anticipate significant changes to our end customer sales mix for the year ending December 31, 2009.
 
                 
          % of
 
    2008 Sales     2008 Sales  
    (in millions)        
 
DoD
  $ 11,059       74 %
Other U.S. Government
    1,067       7  
                 
Total U.S. Government
    12,126       81 %
Foreign governments
    1,099       7  
Commercial – foreign
    987       7  
Commercial – domestic
    689       5  
                 
Total sales
  $   14,901       100 %
                 


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We have the following four reportable segments: (1) C3ISR, (2) Government Services, (3) Aircraft Modernization and Maintenance (AM&M), and (4) Specialized Products. Financial information with respect to each of our reportable segments is included in Note 20 to our unaudited condensed consolidated financial statements contained in this quarterly report. C3ISR provides products and services for the global ISR market, C3 systems, networked communications systems and secure communications products. We believe that these products and services are critical elements for a substantial number of major command, control and communication, intelligence gathering and space systems. These products and services are used to connect a variety of airborne, space, ground and sea-based communication systems and are used in the transmission, processing, recording, monitoring, and dissemination functions of these communication systems. Government Services provides a full range of engineering, technical, information technology (IT), advisory, training and support services to the DoD, DoS, DoJ, and U.S. Government intelligence agencies and allied foreign governments. AM&M provides modernization, upgrades and sustainment, maintenance and logistics support services for military and various government aircraft and other platforms. We sell these services primarily to the DoD, the Canadian Department of Defense (DND) and other allied foreign governments. Specialized Products provides a broad range of products, including components, products, subsystems, systems, and related services to military and commercial customers in several niche markets across several business areas, including power & control systems, electro-optic/infrared (EO/IR), microwave, simulation & training, precision engagement, aviation products, security & detection, propulsion systems, displays, telemetry & advanced technology, undersea warfare, and marine services. During the quarter ended March 27, 2009, we revised our reportable segment presentations to conform to certain re-alignments in our management and organization structure. Consequently, we made certain reclassifications between our C3ISR, Government Services and AM&M reportable segments. See Note 20 to our unaudited condensed consolidated financial statements contained in this quarterly report for the prior period amounts reclassified between reportable segments.
 
Key Performance Measures
 
The primary financial performance measures that L-3 uses to manage its businesses and monitor results of operations are sales growth and operating income growth. Management believes that these financial performance measures are the primary growth drivers for L-3’s earnings per common share and net cash from operating activities. L-3’s business strategy is focused on increasing sales from organic growth and select business acquisitions that add important new products, services, technologies, programs, contract vehicles or customers in areas that complement L-3’s existing businesses. We define organic sales growth as the increase or decrease in sales for the current period compared to the prior period, excluding sales in the: (1) current period from business and product line acquisitions that are included in L-3’s actual results of operations for less than twelve months, and (2) prior period from business and product line divestitures that are included in L-3’s actual results of operations for the twelve-month period prior to the divestiture date. The two main determinants of our operating income growth are sales growth and improvements in operating margin. We define operating margin as operating income as a percentage of sales.
 
Sales Growth. Sales growth for the year ended December 31, 2008 was 7%, comprised of organic sales growth of 5%, and sales growth from business acquisitions, net of divestitures, of 2%. Sales growth for the quarter ended September 25, 2009 (2009 Third Quarter) was 4.9%, comprised of organic sales growth of 4.1%, and sales growth from business acquisitions, net of divestitures, of 0.8%. Sales growth for the year-to-date period ended September 25, 2009 (2009 Year-to-Date Period) was 4.7%, comprised of organic sales growth of 3.4%, and sales growth from business acquisitions, net of divestitures, of 1.3%.
 
For the year ended December 31, 2008, our Special Operations Forces Support Activity (SOFSA) contract generated approximately $400 million, or 2.7% of our sales. On March 3, 2009, SOFSA announced that L-3 was not selected to perform on the follow-on contract. L-3 subsequently protested and, as a consequence, SOFSA has taken corrective action, which will include the issuance of a revised solicitation. Once a new solicitation is issued, proposals will be requested from all bidders. In the interim, L-3’s incumbent contract has been extended until February 2010. We can provide no assurance as to the outcome of the competition for the next SOFSA contact.
 
As is the case with most other U.S. defense contractors, we have benefited from the upward trend in DoD budget authorization and spending outlays over recent years, including supplemental appropriations for military


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operations in Iraq and Afghanistan. We expect future DoD budgets, including supplemental appropriations, to grow at a significantly slower pace than the past several years, and to possibly flatten or decline. However, we believe that our businesses should be able to continue to generate modest organic sales growth because we anticipate the defense budget and spending priorities will continue to focus on several areas that match L-3’s core competencies, such as communications and ISR, sensors, special operations support, helicopter crew training and maintenance and simulation & training.
 
The 2008 Year-to-Date Period results were impacted by three items that, in the aggregate, increased operating income for that period by $110 million. These three items are collectively referred to as the Q2 2008 Items and are further discussed below under the caption “Other Events.” In addition, higher pension expense for the 2009 Third Quarter compared to the 2008 Third Quarter reduced operating income by $21 million ($13 million after income taxes, or $0.11 per diluted share) and $56 million ($34 million after income taxes, or $0.29 per diluted share) for the 2009 Year-to-Date Period compared to the 2008 Year-to-Date Period. The Q2 2008 items increased the 2008 Year-to-Date Period operating margin by 110 basis points. The increase in pension expense reduced operating margin by 50 basis points for both the 2009 Third Quarter and 2009 Year-to-Date Period. The pension expense increase is primarily due to the actuarial loss that we experienced in 2008 as a result of the decline in the fair value of our pension plan assets, which is being amortized as a component of pension expense. See segment results below for additional discussion of segment operating margin results.
 
Excluding the Q2 2008 Items and the increase in our 2009 pension expense, we expect to continue to generate modest annual increases in operating margin. We expect to increase sales, grow sales at a rate faster than the increase in our indirect costs, and improve our overall contract performance. However, we may not be able to continue to expand our operating margin at the rates we expect and our operating margin could also decrease. Additionally, in the future, select business acquisitions and select new business, including contract renewals and new contracts, while increasing or maintaining our operating income could also reduce our operating margin if their margins are lower than L-3’s existing operating margin. Our business objectives include growing earnings per common share and net cash from operating activities.
 
Other Events
 
Accounting Standards Implemented. We adopted eight newly issued accounting standards during the 2009 Year-to-Date Period, six of which were effective January 1, 2009. In accordance with the transition and disclosure provisions of three of these standards, we retrospectively applied those provisions and adjusted the prior period financial statements accordingly. The adoption of these standards reduced net income attributable to L-3 by $3 million ($0.03 per diluted share) for the 2009 Third Quarter and $9 million ($0.10 per diluted share) for the 2009 Year-to-Date Period. See Note 3 to our unaudited condensed consolidated financial statements contained in this quarterly report for the standards adopted and their impact to our financial position and results of operations.
 
Debt Refinancing. On October 2, 2009, L-3 Communications successfully completed a $1 billion offering of 5.20% senior notes. The net cash proceeds from the offering, together with cash on hand, were used by L-3 Communications to repay its outstanding $650 million term loan on October 7, 2009 and to redeem its outstanding $750 million 75/8% senior subordinated notes on November 2, 2009. On October 23, 2009, L-3 Communications also replaced its $1 billion senior revolving credit facility, which was due to expire on March 9, 2010, with a new $1 billion three-year senior revolving credit facility that expires on October 23, 2012. See “Liquidity and Capital Resources – Debt” on page 52 for a further discussion.
 
2008 Year-to-Date Events. As discussed above, our 2008 Year-to-Date period results were affected by three matters, which increased consolidated operating income by $110 million, income before taxes by $117 million, net income by $71 million and diluted earnings per share (EPS) by $0.57, which are collectively referred to as the Q2 2008 Items:
 
  •   A gain of $133 million ($81 million after income taxes, or $0.65 per diluted share) relating to the reversal of a $126 million liability as a result of a June 27, 2008 decision by the U.S. Court of Appeals vacating an adverse 2006 jury verdict and the reversal of $7 million of related accrued interest (the “Litigation Gain”),
 
  •   A gain of $12 million ($7 million after income taxes, or $0.06 per diluted share) relating to the sale of a product line (the “Product Line Divestiture Gain”), and


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  •   A non-cash impairment charge of $28 million ($17 million after income taxes, or $0.14 per diluted share) relating to a write-down of capitalized software development costs associated with a general aviation product (the “Impairment Charge”).
 
Business Acquisitions and Business and Product Line Dispositions
 
Our Annual Report on Form 10-K for the fiscal year ended December 31, 2008 summarizes the business acquis