L-3 Releases Second Quarter 2016 Results

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L-3 Communications Holdings, Inc. has reported diluted EPS from continuing operations of $1.88 for the quarter ended June 24, 2016 (2016 second quarter) compared to diluted EPS from continuing operations for the quarter ended June 26, 2015 (2015 second quarter) of $1.39. Net sales of $2,664 million for the 2016 second quarter increased by 5% compared to the 2015 second quarter. Excluding sales from divestitures and acquisitions⁽¹⁾, net sales (organic sales) increased 7%.

“We are pleased to report another quarter of progress on L-3’s strategy to drive growth through organic sales and higher operating income,” said Michael T. Strianese, chairman and chief executive officer. “Our initiatives to strengthen our core businesses and market-leading positions have led to solid results and higher operating margin across all segments. By focusing on performance and organic growth, we will continue to generate value to all of our stakeholders."

Second Quarter Results of Operations: For the 2016 second quarter, consolidated net sales of $2,664 million increased $121 million, or 5%, compared to the 2015 second quarter. Organic sales increased by $187 million, or 7%, for the 2016 second quarter. Organic sales exclude $90 million of sales declines related to business divestitures and $24 million of sales increases related to business acquisitions. For the 2016 second quarter, organic sales to the U.S. Government increased $104 million, or 6%, and organic sales to international and commercial customers increased $83 million, or 11%.

Segment operating income for the 2016 second quarter increased by $96 million, or 64%, compared to the 2015 second quarter. Segment operating income as a percentage of sales (segment operating margin) increased by 340 basis points to 9.3% for the 2016 second quarter, compared to 5.9% for the 2015 second quarter. Segment operating margin increased by: (1) 250 basis points primarily due to unfavorable contract performance adjustments related to cost growth in the 2015 second quarter that did not recur in the 2016 second quarter on international head-of-state aircraft modification contracts in the Aerospace Systems segment, (2) 50 basis points due to $14 million of charges in the Electronic Systems segment recorded in the 2015 second quarter in connection with a settlement with the U.S. Government related to the EoTech holographic weapons sight (HWS) product and an adverse arbitration ruling and (3) 40 basis points due to lower pension expense of $10 million. See the reportable segment results below for additional discussion of sales and operating margin trends.

Interest expense and other for the 2016 second quarter includes a $5 million debt retirement charge related to the redemption of $300 million aggregate principal amount of 3.95% Senior Notes due November 15, 2016.

The effective tax rate for the 2016 second quarter increased to 26.0% compared to a benefit of 3.4% for the same period last year. The 2016 second quarter includes a benefit from the reinstatement of the Federal Research and Experimentation (R&E) tax credit. The 2015 second quarter included tax benefits of: (1) $17 million related to a legal restructuring of foreign entities, (2) $10 million related to the resolution of various outstanding income tax matters with U.S. and foreign tax authorities and (3) $9 million primarily associated with the release of the valuation allowance for certain deferred tax assets.

Net income from continuing operations attributable to L-3 in the 2016 second quarter increased 27% compared to the 2015 second quarter and diluted EPS from continuing operations increased 35% to $1.88 from $1.39. Diluted weighted average common shares outstanding for the 2016 second quarter declined by 6% compared to the 2015 second quarter due to repurchases of L-3 common stock.

First Half Results of Operations: For the 2016 first half, consolidated net sales of $5,017 million decreased $14 million compared to the 2015 first half. Organic sales increased by $135 million, or 3%, for the 2016 first half. Organic sales exclude $204 million of sales declines related to business divestitures and $55 million of sales increases related to business acquisitions. For the 2016 first half, organic sales to the U.S. Government increased $166 million, or 5%, and organic sales to international and commercial customers decreased $31 million, or 2%.

Segment operating income for the 2016 first half increased by $139 million, or 39%, compared to the 2015 first half. Segment operating margin increased by 270 basis points to 9.9% for the 2016 first half, compared to 7.2% for the 2015 first half. Segment operating margin increased by: (1) 190 basis points primarily due to unfavorable contract performance adjustments related to cost growth in the 2015 first half that did not recur in the 2016 first half at Aerospace Systems on international head-of-state aircraft modification contracts, (2) 40 basis points due to higher margins resulting from acquisitions and divestitures and (3) 40 basis points due to lower pension expense of $21 million. See the reportable segment results below for additional discussion of sales and operating margin trends.

Interest expense and other for the 2016 first half includes a $5 million debt retirement charge related to the redemption of $300 million aggregate principal amount of 3.95% Senior Notes due November 15, 2016.

The effective tax rate for the 2016 first half increased to 24.1% from 15.7% for the same period last year. The 2016 first half included a $12 million reduction to income tax expense due to the early adoption of a new accounting standard related to income tax benefits from employee stock-based compensation awards, which increased diluted EPS by $0.15, and a benefit from the reinstatement of the Federal R&E tax credit. The 2015 first half included $36 million of tax benefits, discussed above.

Net income from continuing operations attributable to L-3 in the 2016 first half increased 43% to $311 million compared to the 2015 first half, and diluted EPS from continuing operations increased 52% to $3.95 from $2.60. Diluted EPS from continuing operations increased 44% compared to adjusted diluted EPS of $2.74 for the 2015 first half. The 2015 first half adjusted diluted EPS from continuing operations excludes a pre-tax loss of $20 million ($12 million after income taxes), or $0.14 per diluted share, related to the divestitures of Marine Systems International and Broadcast Sports, Inc. Diluted weighted average common shares outstanding for the 2016 first half declined by 6% compared to the 2015 first half due to repurchases of L-3 common stock.

Orders: Funded orders for the 2016 second quarter were $2,136 million compared to $2,512 million for the 2015 second quarter. Funded orders for the 2016 first half were $4,727 million compared to $5,101 million for the 2015 first half. The book-to-bill ratio was 0.80x for the 2016 second quarter and 0.94x for the 2016 first half. Excluding the impacts of business divestitures and acquisitions, orders decreased by $338 million, or 14% for the 2016 second quarter and $265 million, or 5% for the 2016 first half. The decrease is primarily due to award delays and timing. Funded backlog declined 4% to $8,125 million at June 24, 2016, compared to $8,423 million at December 31, 2015.

Electronic Systems

Second Quarter: Electronic Systems net sales for the 2016 second quarter decreased by $23 million, or 2%, compared to the 2015 second quarter. Excluding $90 million of sales declines related to business divestitures (primarily MSI divestiture in May 2015) and $20 million of sales increases related to business acquisitions, organic sales increased by $47 million, or 5%. The increase was driven by: (1) $35 million for Aviation Products & Security primarily due to increased deliveries of cargo and airport security screening systems to international customers and timing of deliveries of cockpit displays for the CH-47 aircraft, (2) $18 million for Warrior Systems primarily due to increased deliveries of night vision products to the U.S. Army and foreign militaries and (3) $8 million for Sensor Systems due to deliveries of electronic warfare products to foreign militaries. These increases were partially offset by a decrease of $14 million for Precision Engagement & Training due to lower volume for civil aviation simulation and training devices for commercial customers as contracts near completion.

Electronic Systems operating income for the 2016 second quarter increased by $7 million, or 6%, compared to the 2015 second quarter. Operating margin increased by 90 basis points to 12.2%. Operating margin increased by: (1) 140 basis points due to $14 million of charges recorded during the 2015 second quarter that did not recur in 2016 in connection with (i) a settlement with the U.S. Government relating to the EoTech HWS product in Warrior Systems and (ii) an adverse arbitration ruling to resolve a dispute for the termination of a supply arrangement in Aviation Products & Security, (2) 60 basis points due to higher margins resulting from acquisitions and divestitures, all of which were completed in 2015, and (3) 30 basis points due to lower pension expense of $3 million. These increases were partially offset by 140 basis points primarily due to higher net aggregate favorable contract performance adjustments in the 2015 second quarter compared to the 2016 second quarter.

First Half: Electronic Systems net sales for the 2016 first half decreased by $163 million, or 8%, compared to the 2015 first half. Excluding $204 million of sales declines related to business divestitures (primarily MSI divestiture in May 2015) and $46 million of sales increases related to business acquisitions, organic sales decreased by $5 million. The decrease was driven by: (1) $20 million for Power & Propulsion Systems due to decreased volume on contracts nearing completion for U.S. government and foreign government customers and (2) $16 million primarily for Precision Engagement & Training due to lower volume of ordnance products for the U.S. military, and civil aviation simulation and training devices for commercial customers as contracts near completion. These decreases were partially offset by an increase of $31 million primarily for Aviation Products & Security due to increased deliveries of cargo and airport security screening systems to international customers, and commercial and military cockpit display products and repair services.

Electronic Systems operating income for the 2016 first half decreased by $11 million, or 5%, compared to the 2015 first half. Operating margin increased by 40 basis points to 11.6%. Operating margin increased by 110 basis points due to higher margins resulting from acquisitions and divestitures and 30 basis points due to lower pension expense of $6 million. These increases were partially offset by a decrease of 60 basis points due to sales mix changes, primarily for Aviation Products & Security Systems, and 40 basis points due to higher net aggregate favorable contract performance adjustments in the 2015 first half compared to the 2016 first half.

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