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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
----------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002
Commission file numbers 001-14141 and 333-46983
L-3 COMMUNICATIONS HOLDINGS, INC.
AND
L-3 COMMUNICATIONS CORPORATION
600 Third Avenue
New York, NY 10016
Telephone: (212) 697-1111
State of incorporation: Delaware
IRS Employer Identification Numbers: 13-3937434 and 13-3937436
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. X Yes No
--- ---
There were 93,973,927 shares of L-3 Communications Holdings, Inc. common
stock with a par value of $0.01 outstanding as of the close of business on July
31, 2002.
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L-3 COMMUNICATIONS HOLDINGS, INC. AND
L-3 COMMUNICATIONS CORPORATION
FORM 10-Q QUARTERLY REPORT FOR
QUARTER ENDED JUNE 30, 2002
PART I -- FINANCIAL INFORMATION:
PAGE NO.
---------
ITEM 1. Financial Statements
Unaudited Condensed Consolidated Balance Sheets as of June 30, 2002 and
December 31, 2001 ............................................................ 1
Unaudited Condensed Consolidated Statements of Operations for the Three and
Six Months ended June 30, 2002 and June 30, 2001 .............................. 2
Unaudited Condensed Consolidated Statements of Cash Flows for the Six
Months ended June 30, 2002 and June 30, 2001 .................................. 4
Notes to Unaudited Condensed Consolidated Financial Statements ................ 5
ITEM 2. Management's Discussion and Analysis of Results of Operations and
Financial Condition .......................................................... 23
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk .................... 40
PART II -- OTHER INFORMATION:
ITEM 4. Submission of Matters to a Vote of Security Holders ........................... 42
ITEM 6. Exhibits and Reports on Form 8-K .............................................. 43
L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
JUNE 30, DECEMBER 31,
2002 2001
-------------- -------------
ASSETS
Current assets:
Cash and cash equivalents ......................................... $ 466,118 $ 361,022
Contracts in process .............................................. 1,304,177 801,824
Deferred income taxes ............................................. 51,282 62,965
Other current assets .............................................. 22,239 16,590
---------- ----------
Total current assets............................................. 1,843,816 1,242,401
---------- ----------
Property, plant and equipment, net .................................. 385,201 203,374
Goodwill ............................................................ 2,474,221 1,707,718
Deferred income taxes ............................................... 125,711 97,883
Deferred debt issue costs ........................................... 51,573 40,190
Other assets ........................................................ 68,704 47,683
---------- ----------
Total assets .................................................... $4,949,226 $3,339,249
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt ................................. $ 48,075 $ --
Accounts payable, trade ........................................... 168,003 129,538
Accrued employment costs .......................................... 176,837 126,981
Accrued expenses .................................................. 58,616 38,823
Customer advances ................................................. 71,427 74,060
Accrued interest .................................................. 16,241 13,288
Income taxes ...................................................... 6,568 16,768
Other current liabilities ......................................... 73,701 125,113
---------- ----------
Total current liabilities ....................................... 619,468 524,571
---------- ----------
Pension and postretirement benefits ................................. 264,712 155,052
Other liabilities ................................................... 60,651 60,585
Long-term debt ...................................................... 1,844,332 1,315,252
---------- ----------
Total liabilities ............................................... 2,789,163 2,055,460
Minority interest ................................................... 71,839 69,897
Commitments and contingencies
Shareholders' equity:
L-3 Holdings' common stock $.01 par value; authorized 300,000,000
shares, issued and outstanding 93,707,083 and 78,496,626 shares
(L-3 Communications common stock: $.01 par value, 100 shares
authorized, issued and outstanding) ............................. 1,755,072 939,037
Retained earnings ................................................. 362,649 301,730
Unearned compensation ............................................. (4,541) (3,205)
Accumulated other comprehensive loss .............................. (24,956) (23,670)
---------- ----------
Total shareholders' equity .......................................... 2,088,224 1,213,892
---------- ----------
Total liabilities and shareholders' equity ...................... $4,949,226 $3,339,249
========== ==========
See notes to unaudited condensed consolidated financial statements.
1
L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED JUNE 30,
---------------------------
2002 2001
----------- -------------
Sales:
Contracts, primarily long-term U.S. Government .................. $862,122 $ 453,813
Commercial, primarily products .................................. 93,067 107,747
-------- ---------
Total sales ................................................. 955,189 561,560
-------- ---------
Costs and expenses:
Contracts, primarily long-term U.S. Government .................. 759,675 408,261
Commercial, primarily products:
Cost of sales ................................................. 62,620 59,850
Selling, general and administrative ........................... 35,206 32,982
-------- ---------
Total costs and expenses .................................... 857,501 501,093
-------- ---------
Operating income .................................................. 97,688 60,467
Interest and other income (expense) ............................... (203) 972
Interest expense .................................................. 31,570 22,031
Minority interest ................................................. 1,776 1,585
-------- ---------
Income before income taxes and extraordinary item ................. 64,139 37,823
Provision for income taxes ........................................ 22,641 14,487
-------- ---------
Income before extraordinary item .................................. 41,498 23,336
Extraordinary item -- loss on extinguishment of debt, net of income
taxes of $6,329.................................................. (9,858) --
-------- ---------
Net income ........................................................ $ 31,640 $ 23,336
======== =========
L-3 Holdings' earnings per common share before extraordinary item:
Basic ........................................................... $ 0.52 $ 0.31
======== =========
Diluted ......................................................... $ 0.49 $ 0.30
======== =========
L-3 Holdings' earnings per common share:
Basic ........................................................... $ 0.40 $ 0.31
======== =========
Diluted ......................................................... $ 0.38 $ 0.30
======== =========
L-3 Holdings' weighted average common shares outstanding:
Basic ........................................................... 79,968 74,770
======== =========
Diluted ......................................................... 90,719 78,026
======== =========
See notes to unaudited condensed consolidated financial statements.
2
L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
SIX MONTHS ENDED JUNE 30,
------------------------------
2002 2001
------------- --------------
Sales:
Contracts, primarily long-term U.S. Government ................. $1,478,497 $ 825,057
Commercial, primarily products ................................. 173,532 198,404
---------- -----------
Total sales ................................................ 1,652,029 1,023,461
---------- -----------
Costs and expenses:
Contracts, primarily long-term U.S. Government ................. 1,304,734 746,121
Commercial, primarily products:
Cost of sales ................................................ 108,133 107,452
Selling, general and administrative .......................... 70,167 62,552
---------- -----------
Total costs and expenses ................................... 1,483,034 916,125
---------- -----------
Operating income ................................................. 168,995 107,336
Interest and other income ........................................ 824 1,454
Interest expense ................................................. 57,663 46,436
Minority interest ................................................ 2,764 1,585
---------- -----------
Income before income taxes and extraordinary item ................ 109,392 60,769
Provision for income taxes ....................................... 38,615 23,275
---------- -----------
Income before extraordinary item ................................. 70,777 37,494
Extraordinary item-loss on extinguishment of debt, net of income
taxes of $6,329................................................. (9,858) --
---------- -----------
Net income ....................................................... $ 60,919 $ 37,494
========== ===========
L-3 Holdings' earnings per common share before extraordinary item:
Basic .......................................................... $ 0.89 $ 0.52
========== ===========
Diluted ........................................................ $ 0.84 $ 0.50
========== ===========
L-3 Holdings' earnings per common share:
Basic .......................................................... $ 0.77 $ 0.52
========== ===========
Diluted ........................................................ $ 0.73 $ 0.50
========== ===========
L-3 Holdings' weighted average common shares outstanding:
Basic .......................................................... 79,436 71,486
========== ===========
Diluted ........................................................ 90,110 74,790
========== ===========
See notes to unaudited condensed consolidated financial statements.
3
L-3 COMMUNICATIONS HOLDINGS, INC.
AND L-3 COMMUNICATIONS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED JUNE 30,
------------------------------
2002 2001
--------------- ------------
OPERATING ACTIVITIES:
Net income .......................................................... $ 60,919 $ 37,494
Extraordinary item-loss on extinguishment of debt ................... 9,858 --
Depreciation ........................................................ 29,874 19,833
Goodwill amortization ............................................... -- 20,510
Amortization of deferred debt issue costs ........................... 3,470 3,642
Amortization of intangibles and other assets ........................ 4,546 2,293
Deferred income taxes ............................................... 29,619 16,467
Minority interest ................................................... 2,764 1,585
Other non-cash items ................................................ 9,109 8,306
Changes in operating assets and liabilities, net of amounts acquired:
Contracts in process .............................................. (103,971) (36,848)
Other current assets .............................................. 1,412 (2,584)
Other assets ...................................................... (6,006) (5,293)
Accounts payable .................................................. 17,951 (15,842)
Customer advances ................................................. (7,605) 5,982
Accrued expenses .................................................. 56,947 (2,819)
Other current liabilities ......................................... (19,569) (25,899)
Pension and postretirement benefits ............................... 19,846 3,864
Other liabilities ................................................. 3,212 2,534
All other operating activities, net ................................. 450 (547)
------------ ----------
Net cash from operating activities .................................. 112,826 32,678
------------ ----------
INVESTING ACTIVITIES:
Acquisition of businesses, net of cash acquired ..................... (1,316,105) (211,019)
Proceeds from sale of interest in subsidiary ........................ -- 72,060
Capital expenditures ................................................ (24,074) (20,517)
Disposition of property, plant and equipment ........................ 209 247
Other investing activities .......................................... 1,187 (5,001)
------------ ----------
Net cash used in investing activities ............................... (1,338,783) (164,230)
------------ ----------
FINANCING ACTIVITIES:
Borrowings under revolving credit facilities ........................ 566,000 235,200
Repayment of borrowings under revolving credit facilities ........... (566,000) (425,200)
Borrowings under bridge loan facility ............................... 500,000 --
Repayment of borrowings under bridge loan facility .................. (500,000) --
Proceeds from sale of senior subordinated notes ..................... 750,000 --
Redemption of senior subordinated notes ............................. (186,399) --
Proceeds from sale of common stock, net ............................. 768,435 353,783
Debt issuance costs ................................................. (18,571) (3,813)
Employee stock purchase plan contributions .......................... 7,625 --
Proceeds from exercise of stock options ............................. 14,390 10,044
Distributions paid to minority interest ............................. (822) --
Other financing activities, net ..................................... (3,605) (2,809)
------------ ----------
Net cash from financing activities .................................. 1,331,053 167,205
------------ ----------
Net increase in cash ................................................ 105,096 35,653
Cash and cash equivalents, beginning of the period .................. 361,022 32,680
------------ ----------
Cash and cash equivalents, end of the period ........................ $ 466,118 $ 68,333
============ ==========
See notes to unaudited condensed consolidated financial statements.
4
L-3 COMMUNICATIONS HOLDINGS, INC. AND
L-3 COMMUNICATIONS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
1. DESCRIPTION OF BUSINESS
L-3 Communications Holdings, Inc. derives all its operating income and
cash flow 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, "L-3" or "the Company") is a merchant supplier
of secure communications and intelligence, surveillance and reconnaissance
("ISR") systems, training, simulation and support services, aviation products
and aircraft modernization, as well as specialized products. The Company's
customers include the U.S. Department of Defense ("DoD"), prime contractors to
the DoD, certain U.S. Government intelligence agencies, major aerospace and
defense contractors, foreign governments, commercial customers and certain
other U.S. federal, state and local government agencies.
As a result of recently completed acquisitions (see Note 3) and their
effect on the Company's operations, effective January 1, 2002, the Company
began to present its businesses with the following four reportable segments:
(1) Secure Communications & ISR; (2) Training, Simulation & Support Services;
(3) Aviation Products & Aircraft Modernization and (4) Specialized Products.
Prior to December 31, 2001, the Company had two reportable segments: Secure
Communications Systems and Specialized Products. Prior year segment data have
been reclassified to conform to the current year presentation of segments.
Secure Communications & ISR. This segment provides products and services
for the global ISR market, specializing in signals intelligence (SIGINT) and
communications intelligence (COMINT) systems, which provide the unique ability
to collect and analyze unknown electronic signals from command centers,
communication nodes and air defense systems for real-time situation awareness
and response in real-time to the warfighter. This segment also provides secure,
high data rate communications systems for military and other U.S. Government
and foreign government reconnaissance and surveillance applications. These
systems and products are critical elements of virtually all major
communication, command and control, intelligence gathering and space systems.
The Company's systems and products 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. The major secure communication programs and
systems include:
o secure data links for airborne, satellite, ground and sea-based remote
platforms for real time information collection and dissemination to
users;
o highly specialized fleet management and support, including
procurement, systems integration, sensor development, modifications
and maintenance for signals intelligence and ISR special mission
aircraft and airborne surveillance systems;
o strategic and tactical signal intelligence systems that detect,
collect, identify, analyze and disseminate information;
o secure telephone and network equipment and encryption management; and
o communication systems for surface and undersea vessels and manned
space flights.
Training, Simulation & Support Services. This segment provides a full
range of services, including:
o services designed to meet customer training requirements for aircrews,
navigators, mission operators, gunners and maintenance technicians for
virtually any platform, including military fixed and rotary wing
aircraft, air vehicles and various ground vehicles;
o communication software support, information services and a wide range
of engineering development services and integration support;
5
L-3 COMMUNICATIONS HOLDINGS, INC. AND
L-3 COMMUNICATIONS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-- CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
o high-end engineering and information support services used for
command, control, communications and ISR architectures, as well as for
air warfare modeling and simulation tools for applications used by the
DoD and U.S. Government intelligence agencies, including missile and
space systems, Unmanned Aerial Vehicles (UAVs) and military aircraft;
o developing and managing extensive programs in the United States and
internationally, focusing on teaching, training and education,
logistics, strategic planning, organizational design, democracy
transition and leadership development; and
o design, prototype development and production of ballistic missile
targets for present and future threat scenarios.
Aviation Products & Aircraft Modernization. This segment provides aviation
products and aircraft modernization services including:
o airborne traffic and collision avoidance systems (TCAS);
o commercial, solid-state, crash-protected cockpit voice recorders and
flight data recorders (known as "black boxes") and cruise ship
hardened voyage recorders;
o ruggedized displays for military and high-end commercial applications;
o turnkey aviation life cycle management services that integrate custom
developed and commercial off-the-shelf products for various military
and commercial wide-body and rotary wing aircraft, including heavy
maintenance and structural modifications and Head-of-State and
commercial interior completions; and
o engineering, modification, maintenance, logistics and upgrades for
U.S. Special Operations Command aircraft, vehicles and personal
equipment.
Specialized Products. This segment supplies products to military and
commercial customers in several niche markets. The products include:
o ocean products, including acoustic undersea warfare products for mine
hunting, dipping sonars, anti-submarine and naval power distribution,
conditioning, switching and protection equipment for surface and
undersea platforms;
o telemetry, instrumentation, space and guidance products including
tracking and flight termination;
o premium fuzing products;
o microwave components;
o detection systems for aviation, port and border applications to detect
explosives, concealed weapons, contraband and illegal narcotics,
inspection of agricultural products and examination of cargo;
o high performance antennas and ground based radomes; and
o training devices and motion simulators which produce advanced virtual
reality simulation and high-fidelity representations of cockpits and
mission stations for aircraft and land vehicles.
6
L-3 COMMUNICATIONS HOLDINGS, INC. AND
L-3 COMMUNICATIONS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-- CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
2. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements
comprise the unaudited condensed consolidated financial statements of L-3
Holdings and L-3 Communications. The only obligations of L-3 Holdings are the
51/4% Convertible Senior Subordinated Notes due 2009 (the "Convertible Notes")
and the 4% Senior Subordinated Convertible Contingent Debt Securities due 2011
("CODES"). L-3 Holdings has also guaranteed the borrowings under the senior
credit facilities of L-3 Communications. Because the debt obligations of L-3
Holdings have been jointly, severally, fully and unconditionally guaranteed by
L-3 Communications and certain of its domestic subsidiaries, such debt
obligations have been reported as debt of L-3 Communications in its unaudited
condensed consolidated financial statements in accordance with the Securities
and Exchange Commission's Staff Accounting Bulletin No. 54. In addition, all
issuances of equity securities including grants of stock options and restricted
stock by L-3 Holdings to employees of L-3 Communications have also been
reported in the unaudited condensed consolidated financial statements of L-3
Communications. As a result, the unaudited condensed consolidated financial
positions, results of operations and cash flows of L-3 Holdings and L-3
Communications are substantially the same.
L-3 Holdings has no independent assets or operations other than through
its wholly owned subsidiary L-3 Communications. L-3 Communications and all of
the guarantor subsidiaries of L-3 Communications are guarantor subsidiaries of
L-3 Holdings. Financial information of the subsidiaries of L-3 Communications
is presented in Note 12.
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States of America for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities
and Exchange Commission. Accordingly, they do not include all of the
information and notes required by generally accepted accounting principles in
the United States of America for a complete set of financial statements. In the
opinion of management, all adjustments (consisting of normal recurring
accruals) 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.
The preparation of financial statements in conformity with generally
accepted accounting principles in the United States of America 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 and expenses during the reporting period. The most significant of these
estimates and assumptions relate to contract estimates of sales and estimated
costs to complete contracts in process, estimates of market values for
inventories reported at lower of cost or market, estimates of pension and
postretirement benefit obligations, recoverability of recorded amounts of fixed
assets and goodwill, income taxes, litigation and environmental obligations.
Changes in estimates are reflected in the periods during which they become
known. Actual results could differ from these estimates.
Certain reclassifications have been made to conform prior period amounts
to the current period presentation.
These interim financial statements should be read in conjunction with the
Consolidated Financial Statements of L-3 Holdings and L-3 Communications for
the fiscal year ended December 31, 2001, included in their Annual Reports on
Form 10-K for the fiscal year ended December 31, 2001.
7
L-3 COMMUNICATIONS HOLDINGS, INC. AND
L-3 COMMUNICATIONS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-- CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
3. ACQUISITIONS AND DIVESTITURES AND OTHER TRANSACTIONS
Aircraft Integration Systems. On March 8, 2002, the Company acquired the
assets of Aircraft Integration Systems ("AIS"), a division of Raytheon Company,
for $1,148,700 in cash which includes $1,130,000 for the original contract
purchase price, an increase to the contract purchase price of $18,700 related
to additional assets contributed by Raytheon to AIS, plus acquisition costs.
Following the acquisition, the Company changed AIS's name to L-3 Integrated
Systems ("IS"). The purchase price is subject to adjustment based on the IS
closing date net tangible book value, as defined. The acquisition was financed
using approximately $229,000 of cash on hand, borrowings under the Company's
senior credit facilities of $420,000 and a $500,000 senior subordinated bridge
loan. (See Note 5.)
The Company acquired IS because it is a long-standing, sole-source
business provider of critical communications intelligence (COMINT), signals
intelligence (SIGINT) and unique sensor systems for special customers within
the U.S. Government. The Company believes that IS has excellent operating
prospects as its major customers increasingly focus on intelligence gathering
and information distribution to the battlefield. The Company also believes
there are significant opportunities to apply its proven business integration
and cost control skills to further enhance IS's operating and financial
performance. The Company also believes that IS also creates significant
opportunities for the sale of the Company's secure communications and aviation
products, including communication links, signal processing, antennas, data
recorders, displays and traffic control and collision avoidance systems. The
table below presents a summary of the initial preliminary estimates of fair
values of the assets acquired and liabilities assumed on the acquisition date.
Contracts in process ............................................ $ 360,567
Other current assets ............................................ 1,678
Property, plant and equipment ................................... 182,307
Goodwill ........................................................ 663,215
Other non-current assets ........................................ 54,852
----------
Total assets acquired ........................................ 1,262,619
----------
Current liabilities ............................................. 17,020
Long-term liabilities ........................................... 96,279
----------
Total liabilities assumed .................................... 113,299
----------
Net assets acquired .......................................... $1,149,320
==========
Based on the initial preliminary purchase price allocation for IS, goodwill, of
which approximately $611,000 is expected to be deductible for income tax
purposes, in the amount of $464,250 was assigned to the Secure Communications &
ISR segment and $198,965 was assigned to the Aviation Products & Aircraft
Modernization segment.
Detection Systems. On June 14, 2002, the Company successfully completed
the acquisition of the detection systems business of PerkinElmer ("Detection
Systems") for $100,000 in cash plus acquisition costs, subject to adjustment
based on closing date net working capital, as defined. Detection Systems
business offers X-ray screening for several major security applications: (1)
aviation systems for checked and oversized baggage, break bulk cargo and air
freight; (2) port and border applications including pallets, break bulk and air
freight; and (3) facility protection such as parcels, mail and cargo. Detection
Systems has a broad range of systems and technology, and an installed base of
over 16,000 units. Detection Systems' customer base includes major airlines and
airports, a number of domestic agencies, such as the U.S. Customs Service, U.S.
Marshals Service, U.S. Department of Agriculture and U.S. Department of
8
L-3 COMMUNICATIONS HOLDINGS, INC. AND
L-3 COMMUNICATIONS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-- CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
State, and international authorities throughout Europe, Asia and South America.
The acquisition broadens L-3's capabilities and product offerings in the
rapidly growing areas of airport security and other homeland defense markets,
including explosive detection systems ("EDS"). The acquisition provides L-3
with enhanced manufacturing and marketing capabilities, which will be used as
the Company works to meet growing demand for its EDS products.
In connection with a letter of intent entered into with OSI Systems, Inc.
("OSI"), the Company intends to sell the ARGUS and conventional product lines
of Detection Systems to OSI. The sale is subject to clearance under the
Hart-Scott-Rodino Antitrust Improvements Act.
Spar Aerospace. At December 31, 2001, the Company had acquired 70.3% of
the outstanding common stock of Spar Aerospace Limited ("Spar"), a leading
provider of high-end aviation product modernization, for $105,078 in cash and
acquired control of Spar and the ability to require the remaining stockholders
to tender their shares. During January 2002, the Company completed the
acquisition and paid $43,641 for the remaining outstanding common stock of Spar
which was not tendered to the Company at December 31, 2001.
SY Tech, BT Fuze and Emergent. During the fourth quarter of 2001, the
Company acquired three other businesses for an aggregate purchase price of
$147,695 in cash plus acquisition costs, reflecting net purchase price
increases of $8,605 based on the closing date balance sheets of the acquired
businesses and, $1,800 of additional purchase price based on the financial
performance of the acquired companies for the year ended December 31, 2001. The
Company acquired:
(1) the net assets of SY Technology, Inc. ("SY"), a provider of air
warfare simulation services, on December 31, 2001. This acquisition is
subject to additional purchase price not to exceed $3,000 which is
contingent upon the financial performance of SY for the years ending
December 31, 2002 and 2003;
(2) the net assets of Bulova Technologies, a producer of military fuzes
that prevent the inadvertent firing and detonation of weapons during
handling, on December 19, 2001. Bulova Technologies was later renamed
BT Fuze Products ("BT Fuze"). The purchase price is subject to
adjustment based on the closing date net assets of BT Fuze; and
(3) the common stock of Emergent Government Services Group ("Emergent"), a
provider of engineering and information services to the U.S. Air
Force, Army, Navy and intelligence agencies, on November 30, 2001.
Following the acquisition, the Company changed Emergent's name to L-3
Communications Analytics.
KDI and EER. On May 4, 2001, the Company acquired all of the outstanding
common stock of KDI Precision Products ("KDI") for $79,460 in cash including
acquisition costs. On May 31, 2001, the Company acquired all of the outstanding
common stock of EER Systems ("EER") for $119,774 in cash including acquisition
costs, and additional purchase price not to exceed $5,000 which is contingent
upon the financial performance of EER for the year ending December 31, 2002.
All of the Company's acquisitions have been accounted for as purchase
business combinations and are included in the Company's results of operations
from their respective effective dates. The Company values acquired contracts in
process at their estimated contract selling prices less the estimated costs to
complete and a reasonable profit allowance for the Company's effort to complete
such contracts. The assets and liabilities recorded in connection with the
purchase price allocations for the acquisitions of Spar, Emergent, BT Fuze, SY,
IS and Detection Systems are based upon preliminary estimates of fair values
for contracts in process, estimated costs in excess of billings to complete
contracts in process,
9
L-3 COMMUNICATIONS HOLDINGS, INC. AND
L-3 COMMUNICATIONS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-- CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
inventories, identifiable intangibles and deferred income taxes. Actual
adjustments will be based on the final purchase prices and final appraisals and
other analyses of fair values which are in process, as well as audited
historical net assets acquired for the IS acquisition as of March 8, 2002. With
the exception of the IS acquisition, the Company does not expect the
differences between the preliminary and final purchase price allocations for
the acquisitions to be material. Material differences between the preliminary
and final purchase price allocations for the IS acquisition could result from
the valuation of contracts in process, including the recoverability of unbilled
contract receivables and inventories, estimated costs in excess of billings to
complete acquired contracts in process in a loss position, capitalized costs
for internal-use software and management information systems, identifiable
intangibles, goodwill, deferred income taxes and pension and postretirement
benefits liabilities. The Company expects to complete the purchase price
allocation for IS in the second half of 2002.
Had the acquisitions of IS and Detection Systems and the related financing
transactions occurred on January 1, 2002, the unaudited pro forma sales, net
income and diluted earnings per share for the six months ended June 30, 2002,
would have been approximately $1,928,600, $56,500 and $0.68. Had the
acquisitions of KDI, EER, SY, BT Fuze, Emergent, Spar, IS and Detection Systems
and the related financing transactions occurred on January 1, 2001, the
unaudited pro forma sales, net income and diluted earnings per share for the
six months ended June 30, 2001, would have been approximately $1,690,700,
$26,600 and $0.33. The pro forma results are based on various assumptions and
are not necessarily indicative of the result of operations that would have
occurred had the acquisitions and the related financing transactions occurred
on January 1, 2001 and 2002.
In March 2001, the Company settled certain items with a third party
provider related to a services agreement. In connection with the settlement,
L-3 received a net cash payment of $14,200. The payment represents a credit for
fees paid over the term of the services agreement and incremental costs
incurred by the Company over the same period arising from performance
deficiencies under the services agreement. These incremental costs included
additional operating costs for material management, vendor replacement, rework,
warranty, manufacturing and engineering support, and administrative activities.
The credit was amortized in 2001 as a reduction to costs and expenses over the
period in which the services were provided.
4. CONTRACTS IN PROCESS
The components of contracts in process are presented in the table below.
JUNE 30, 2002 DECEMBER 31, 2001
--------------- ------------------
Billed receivables, less allowances of $15,045
and $11,649..................................... $ 466,070 $ 330,795
---------- ----------
Unbilled contract receivables .................... 750,057 353,262
Less: unliquidated progress payments ............. (221,405) (102,739)
---------- ----------
Unbilled contract receivables, net ............. 528,652 250,523
---------- ----------
Inventoried contract costs, gross ................ 203,800 122,211
Less: unliquidated progress payments ............. (38,887) (6,575)
---------- ----------
Inventoried contract costs, net ................ 164,913 115,636
Inventories at lower of cost or market ........... 144,542 104,870
---------- ----------
Total contracts in process ..................... $1,304,177 $ 801,824
========== ==========
10
L-3 COMMUNICATIONS HOLDINGS, INC. AND
L-3 COMMUNICATIONS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-- CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
5. DEBT
The components of long-term debt are presented in the table below.
JUNE 30, 2002 DECEMBER 31, 2001
--------------- ------------------
Borrowings under Senior Credit Facilities ................ $ -- $ --
10 3/8% Senior Subordinated Notes due 2007 ................ 48,075 225,000
8 1/2% Senior Subordinated Notes due 2008 ................. 180,000 180,000
8% Senior Subordinated Notes due 2008 .................... 200,000 200,000
7 5/8% Senior Subordinated Notes due 2012 ................. 750,000 --
5 1/4% Convertible Senior Subordinated Notes due
2009 ................................................... 300,000 300,000
4% Senior Subordinated Convertible Contingent Debt
Securities due 2011 (CODES) ............................ 420,000 420,000
---------- ----------
Principal amount of long-term debt ....................... $1,898,075 $1,325,000
---------- ----------
Less: Current portion of long-term debt ................. 48,075 --
Unamortized discount on CODES ..................... 2,375 2,502
Fair value of interest rate swap agreements ....... 3,293 7,246
---------- ----------
Carrying amount of long-term debt ........................ $1,844,332 $1,315,252
========== ==========
On February 26, 2002, the Company's lenders approved a $150,000 increase
in the amount of the senior credit facilities. The five-year revolving credit
facility which matures on May 15, 2006 was increased by $100,000 to $500,000
and the 364-day revolving credit facility increased by $50,000 to $250,000.
Additionally, the maturity date of the $250,000 364-day revolving credit
facility was extended to February 25, 2003.
Available borrowings under the Company's senior credit facilities at June
30, 2002 were $577,707, after reductions for outstanding letters of credit of
$172,293. There were no outstanding borrowings under the senior credit
facilities at June 30, 2002.
In June 2002, L-3 Communications sold $750,000 of 7 5/8% Senior
Subordinated Notes due June 15, 2012 (the "June 2002 Notes") with interest
payable semi-annually on June 15 and December 15 of each year commencing
December 15, 2002. The net proceeds from this offering and the concurrent sale
of common stock by L-3 Holdings (see Note 7) were used to (1) repay $500,000
borrowed on March 8, 2002, under the Company's senior subordinated bridge loan
facility, (2) repay the indebtedness outstanding under the Company's senior
credit facilities, (3) repurchase and redeem the 10 3/8% Senior Subordinated
Notes due 2007 and (4) increase cash and cash equivalents. The June 2002 Notes
are general unsecured obligations of L-3 Communications and are subordinated in
right of payment to all existing and future senior debt of L-3 Communications.
The June 2002 Notes are subject to redemption at any time, at the option of L-3
Communications, in whole or in part, on or after June 15, 2007 at redemption
prices (plus accrued and unpaid interest) starting at 103.813% of the principal
amount (plus accrued and unpaid interest) during the 12-month period beginning
June 15, 2007 and declining annually to 100% of principal (plus accrued and
unpaid interest) on June 15, 2010 and thereafter. Prior to June 15, 2005, L-3
Communications may redeem up to 35% of the June 2002 Notes with the proceeds of
certain equity offerings at a redemption price of 107.625% of the principal
amount (plus accrued and unpaid interest).
On June 6, 2002, L-3 Communications commenced a tender offer to purchase
any and all of its $225,000 aggregate principal amount of 10 3/8% Senior
Subordinated Notes due 2007. The tender offer
11
L-3 COMMUNICATIONS HOLDINGS, INC. AND
L-3 COMMUNICATIONS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-- CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
expired on July 3, 2002. On June 25, 2002, L-3 Communications sent a notice of
redemption for all of its $225,000 aggregate principal amount of 10 3/8% Senior
Subordinated Notes due 2007 that remained outstanding after the expiration of
the tender offer. Upon sending the notice, the remaining notes became due and
payable at the redemption price as of July 25, 2002. At June 30, 2002, L-3
Communications had purchased for cash $176,925 of these notes plus premiums,
fees and other transaction costs of $9,474 and accrued interest. The remaining
principal amount of these notes of $48,075 was purchased and redeemed in July
2002 plus premiums, fees and other transaction costs of $2,995 and accrued
interest. In connection with the extinguishment of these notes, L-3
Communications recorded a pre-tax extraordinary loss of $16,187 ($9,858
after-tax), including premiums, fees and other transaction costs of $12,469 and
$3,718 to write-off the remaining balance of debt issue costs relating to these
notes.
In June 2002, L-3 Communications unwound the interest rate swap agreements
on $200,000 of its 8% Senior Subordinated Notes due 2008 and received cash of
$8,675. L-3 Communications recorded a reduction in interest expense for the six
months ended June 30, 2002 of $3,446, which represented the value of the
interest savings that was earned prior to the unwinding of these swap
agreements. The remaining $5,229 was recorded as a deferred gain and will be
amortized as a reduction of interest expense over the remaining life of the
$200,000 of 8% Senior Subordinated Notes due 2008 at an amount of $215 per
quarter, or $860 annually.
In June 2002, L-3 Communications entered into interest rate swap
agreements on $200,000 of its 7 5/8% Senior Subordinated Notes due 2012. These
swap agreements exchange the fixed interest rate for a variable interest rate
on $200,000 of the $750,000 principal amount outstanding. Under these swap
agreements, L-3 Communications will pay or receive the difference between the
fixed interest rate of 7 5/8% on the senior subordinated notes and a variable
interest rate determined two business days prior to the beginning of the
interest period equal to (1) the six month LIBOR rate, plus (2) 215.25 basis
points. The difference to be paid or received on these swap agreements as
interest rates change is recorded as an adjustment to interest expense. The
swap agreements are accounted for as fair value hedges.
Pursuant to a registration rights agreement that L-3 Communications
entered into with the initial purchasers of the June 2002 Notes, L-3
Communications agreed to file a registration statement with the SEC within 90
days after the closing of the offering to exchange the June 2002 Notes for
substantially identical notes that are registered under the Securities Act. If
L-3 Communications does not file the registration statement with the SEC on or
before September 26, 2002, L-3 Communications will pay to each holder of the
June 2002 Notes an amount equal to $0.05 per week per $1,000 principal amount
for the first 90-day period until all registration defaults have been cured.
The amount that L-3 Communications will pay will increase by an additional
$0.05 per week per $1,000 principal amount for each subsequent 90-day period
until all registration defaults have been cured, up to a maximum amount of
$0.50 per week per $1,000 principal amount.
12
L-3 COMMUNICATIONS HOLDINGS, INC. AND
L-3 COMMUNICATIONS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-- CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
6. COMPREHENSIVE INCOME
Comprehensive income for the three and six months ended June 30, 2002 and
2001 is presented in the tables below.
THREE MONTHS ENDED JUNE
30,
-----------------------
2002 2001
---------- ----------
Net income ............................................................. $31,640 $23,336
Other comprehensive income (loss):
Foreign currency translation adjustments, net of tax benefits ........ (812) (242)
Unrealized gains (losses) on securities:
Unrealized losses arising during the period, net of tax
benefit of $45.................................................... -- (66)
Reclassification adjustment for losses included in net
income, net of tax expense of $2,323.............................. -- 3,743
Unrealized gains (losses) on hedging instruments:
Unrealized gains (losses) arising during the period, net of
tax benefit of $156 and tax expense of $131....................... (290) 213
------- -------
Comprehensive income ................................................... $30,538 $26,984
======= =======
SIX MONTHS ENDED JUNE 30,
-------------------------
2002 2001
---- ----
Net income ............................................................. $ 60,919 $ 37,494
Other comprehensive income (loss):
Foreign currency translation adjustments, net of tax benefits ........ (1,245) (540)
Unrealized gains (losses) on securities:
Unrealized losses arising during the period, net of tax
benefit of $111................................................... -- (180)
Reclassification adjustment for losses included in net
income, net of tax expense of $2,274.............................. -- 3,632
Unrealized gains (losses) on hedging instruments:
Cumulative adjustment at January 1, 2001, net of tax benefit
of $25............................................................ -- (41)
Unrealized gains (losses) arising during the period, net of
tax benefit of $196 and tax expense of $116 ...................... (364) 189
Reclassification adjustment for losses included in net
income, net of tax expense of $198................................ 323 --
-------- --------
Comprehensive income ................................................... $ 59,633 $ 40,554
======== ========
13
L-3 COMMUNICATIONS HOLDINGS, INC. AND
L-3 COMMUNICATIONS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-- CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
Accumulated other comprehensive balances at June 30, 2002 and December 31,
2001 are presented in the table below.
UNREALIZED
FOREIGN GAINS UNREALIZED MINIMUM ACCUMULATED
CURRENCY (LOSSES) LOSSES ON PENSION OTHER
TRANSLATION ON HEDGING LIABILITY COMPREHENSIVE
ADJUSTMENTS SECURITIES INSTRUMENTS ADJUSTMENTS LOSS
------------- ------------ ------------- ------------- --------------
JUNE 30, 2002
Balance January 1, 2002 ............ $ (2,852) $ (246) $ (163) $ (20,409) $ (23,670)
Period change ...................... (1,245) -- (41) -- (1,286)
-------- -------- ------ ---------- ---------
Balance June 30, 2002 .............. $ (4,097) $ (246) $ (204) $ (20,409) $ (24,956)
======== ======== ====== ========== =========
DECEMBER 31, 2001
Balance January 1, 2001 ............ $ (2,584) $ (3,698) $ -- $ (890) $ (7,172)
Period change ...................... (268) 3,452 (163) (19,519) (16,498)
-------- -------- ------ ---------- ---------
Balance December 31, 2001. ......... $ (2,852) $ (246) $ (163) $ (20,409) $ (23,670)
======== ======== ====== ========== =========
7. L-3 HOLDINGS EARNINGS PER SHARE
A reconciliation of basic and diluted earnings per share ("EPS") is
presented in the table below.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------- ----------------------------
2002 2001 2002 2001
------------ ------------- ------------ -------------
BASIC:
Income before extraordinary item ............ $ 41,498 $ 23,336 $ 70,777 $ 37,494
Extraordinary item, net of income taxes ..... (9,858) -- (9,858) --
-------- --------- -------- ---------
Net income .................................. $ 31,640 $ 23,336 $ 60,919 $ 37,494
======== ========= ======== =========
Weighted average common shares
outstanding ................................ 79,968 74,770 79,436 71,486
======== ========= ======== =========
Basic earnings per share before
extraordinary item ......................... $ 0.52 $ 0.31 $ 0.89 $ 0.52
======== ========= ======== =========
Basic earnings per share .................... $ 0.40 $ 0.31 $ 0.77 $ 0.52
======== ========= ======== =========
DILUTED:
Income before extraordinary item ............ $ 41,498 $ 23,336 $ 70,777 $ 37,494
After-tax interest expense savings on the
assumed conversion of Convertible
Notes ...................................... 2,579 -- 5,158 --
-------- --------- -------- ---------
Income before extraordinary item
including assumed conversion ............... 44,077 23,336 75,935 37,494
Extraordinary item, net of income taxes ..... (9,858) -- (9,858) --
-------- --------- -------- ---------
Net income including assumed conversion...... $ 34,219 $ 23,336 $ 66,077 $ 37,494
======== ========= ======== =========
Common and potential common shares:
Weighted average common shares
outstanding .............................. 79,968 74,770 79,436 71,486
Assumed exercise of stock options .......... 8,887 7,470 8,465 7,634
Assumed purchase of common shares
for treasury ............................. (5,498) (4,214) (5,153) (4,330)
Assumed conversion of Convertible
Notes .................................... 7,362 -- 7,362 --
-------- --------- -------- ---------
Common and potential common shares ......... 90,719 78,026 90,110 74,790
======== ========= ======== =========
Diluted earnings per share before
extraordinary item ......................... $ 0.49 $ 0.30 $ 0.84 $ 0.50
======== ========= ======== =========
Diluted earnings per share .................. $ 0.38 $ 0.30 $ 0.73 $ 0.50
======== ========= ======== =========
14
L-3 COMMUNICATIONS HOLDINGS, INC. AND
L-3 COMMUNICATIONS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-- CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The 7,361,964 shares of L-3 Holdings common stock that are issuable upon
conversion of the Convertible Notes were not included in the computation of
diluted EPS for the three and six months ended June 30, 2001 because the effect
of the assumed conversion would have been anti-dilutive.
The 7,804,878 shares of L-3 Holdings' common stock that are issuable upon
conversion of the CODES were not included in the computation of diluted EPS for
the three and six months ended June 30, 2002 because the conditions required
for the CODES to become convertible were not satisfied.
On April 23, 2002, the Company announced that its Board of Directors had
authorized a two-for-one stock split on all shares of L-3 Holdings common
stock. The stock split entitled all shareholders of record at the close of
business on May 6, 2002 to receive one additional share of L-3 Holdings common
stock for every share held on that date. The additional shares were distributed
to shareholders in the form of a stock dividend on May 20, 2002. Upon
completion of the stock split, L-3 Holdings had approximately 80 million shares
of common stock outstanding. All of L-3 Holdings' historical as reported share
and EPS data has been restated to give effect to the stock split
On June 28, 2002, L-3 Holdings sold 14,000,000 shares of its common stock
in a public offering for $56.60 per share. Upon closing, L-3 Holdings received
net proceeds after deducting discounts, commissions and estimated expenses of
$768,435. The net proceeds of this offering and the concurrent sale of senior
subordinated notes by L-3 Communications (see Note 5) were used to (1) repay
$500,000 borrowed on March 8, 2002, under the Company's senior subordinated
bridge loan facility, (2) repay the indebtedness outstanding under the
Company's senior credit facilities, (3) repurchase and redeem the 103/8% Senior
Subordinated Notes due 2007 and (4) increase cash and cash equivalents.
8. TRANSITIONAL DISCLOSURE REQUIRED BY SFAS NO. 142
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 142, Goodwill and
Other Intangible Assets, which supersedes Accounting Principles Board ("APB")
Opinion No. 17, Intangible Assets. SFAS No. 142 revised the standards for
accounting for goodwill and other intangible assets. SFAS No. 142 requires that
goodwill and indefinite lived identifiable intangible assets no longer be
amortized, but be tested for impairment at least annually based on their
estimated fair values. The provisions of SFAS No. 142 became effective on
January 1, 2002, and require full implementation of the impairment measurement
provisions by December 31, 2002. Effective January 1, 2002, the Company is not
recording goodwill amortization expense. Based on the estimated fair values of
the Company's reporting units using a discounted cash flows valuation, the
goodwill for certain space and broadband commercial communications businesses
included in the Specialized Products segment may be impaired. The aggregate
amount of goodwill recorded for these businesses is approximately $21.0
million, net of related income taxes. The Company expects to complete the
valuation of the assets and liabilities for these businesses and to determine
the amount of the goodwill impairment in the second half of 2002. Any resulting
impairment would be a non-cash charge, recorded effective January 1, 2002, as a
cumulative effect of a change in accounting principle in accordance with the
adoption provisions of SFAS No. 142.
The table below presents net income and basic and diluted EPS for the
three and six months ended June 30, 2002 compared with those amounts for the
same periods in 2001, adjusted to exclude goodwill amortization expense, net of
income taxes.
15
L-3 COMMUNICATIONS HOLDINGS, INC. AND
L-3 COMMUNICATIONS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-- CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- ---------------------------
2002 2001 2002 2001
------------- ----------- ------------ ------------
Reported income before extraordinary
item ........................................ $ 41,498 $23,336 $ 70,777 $ 37,494
Add: Goodwill amortization expense, net
of tax ...................................... -- 8,482 -- 15,855
Less: Incremental minority interest .......... -- (80) -- (80)
--------- ------- -------- --------
Adjusted income before extraordinary
item ........................................ $ 41,498 $31,738 $ 70,777 $ 53,269
========= ======= ======== ========
Adjusted net income .......................... $ 31,640 $31,738 $ 60,919 $ 53,269
========= ======= ======== ========
BASIC EPS:
Reported before extraordinary item ........... $ 0.52 $ 0.31 $ 0.89 $ 0.52
Goodwill amortization expense, net of tax..... -- 0.11 -- 0.23
Incremental minority interest ................ -- -- -- --
--------- ------- -------- --------
Adjusted before extraordinary item ........... $ 0.52 $ 0.42 $ 0.89 $ 0.75
========= ======= ======== ========
Adjusted after extraordinary item ............ $ 0.40 $ 0.42 $ 0.77 $ 0.75
========= ======= ======== ========
DILUTED EPS:
Reported before extraordinary item ........... $ 0.49 $ 0.30 $ 0.84 $ 0.50
Goodwill amortization expense, net of tax..... -- 0.11 -- 0.21
Incremental minority interest ................ -- -- -- --
--------- ------- -------- --------
Adjusted before extraordinary item ........... $ 0.49 $ 0.41 $ 0.84 $ 0.71
========= ======= ======== ========
Adjusted after extraordinary item ............ $ 0.38 $ 0.41 $ 0.73 $ 0.71
========= ======= ======== ========
9. CONTINGENCIES
The Company is engaged in providing products and services under contracts
with the U.S. Government and to a lesser degree, under foreign government
contracts, some of which are funded by the U.S. Government. All such contracts
are subject to extensive legal and regulatory requirements, and, from time to
time, agencies of the U.S. Government investigate whether such contracts were
and are being conducted in accordance with these requirements. Under U.S.
Government procurement regulations, an indictment 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. A conviction could
result in debarment from contracting with the federal government for a
specified term. Additionally, in the event that U.S. Government expenditures
for products and services of the type manufactured and provided by the Company
are reduced, and not offset by greater commercial sales or other new programs
or products, or acquisitions, there may be a reduction in the volume of
contracts or subcontracts awarded to the Company.
Management continually assesses the Company's obligations with respect to
applicable environmental protection laws. While it is difficult to determine
the timing and ultimate cost to be incurred by the Company in order to comply
with these laws, based upon available internal and external assessments, with
respect to those environmental loss contingencies of which management is aware,
the Company believes that even without considering potential insurance
recoveries, if any, there are no environmental loss contingencies that,
individually or in the aggregate, would be material to the Company's results of
16
L-3 COMMUNICATIONS HOLDINGS, INC. AND
L-3 COMMUNICATIONS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-- CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
operations. The Company accrues for these contingencies when it is probable
that a liability has been incurred and the amount of the loss can be reasonably
estimated.
The Company has been periodically subject to litigation, claims or
assessments and various contingent liabilities incidental to its business. With
respect to those investigative actions, items of litigation, claims or
assessments of which they are aware, management of the Company is of the
opinion that the probability is remote that, after taking into account certain
provisions that have been made with respect to these matters, the ultimate
resolution of any such investigative actions, items of litigation, claims or
assessments will have a material adverse effect on the financial position,
results of operations or cash flows of the Company.
10. SEGMENT INFORMATION
The Company has four reportable segments: (1) Secure Communications & ISR,
(2) Training, Simulation & Support Services (3) Aviation Products & Aircraft
Modernization and (4) Specialized Products which are described in Note 1. The
Company evaluates the performance of its operating segments and reportable
segments based on their sales and operating income.
The table below presents sales, operating income and assets by reportable
segment.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------- ---------------------------------
2002 2001 2002 2001
------------ ------------- --------------- ---------------
SALES:
Secure Communications & ISR ................ $ 278,570 $ 89,404 $ 436,306 $ 172,689
Training, Simulation & Support Services..... 201,000 151,774 398,302 268,760
Aviation Products & Aircraft
Modernization ............................ 203,483 70,873 310,792 131,454
Specialized Products ....................... 277,213 251,756 514,926 454,387
Elimination of intersegment sales .......... (5,077) (2,247) (8,297) (3,829)
--------- --------- ----------- -----------
Consolidated total ....................... $ 955,189 $ 561,560 $ 1,652,029 $ 1,023,461
========= ========= =========== ===========
OPERATING INCOME:
Secure Communications & ISR ................ $ 29,656 $ 4,824 $ 46,065 $ 11,144
Training, Simulation & Support Services..... 22,315 19,344 43,785 28,510
Aviation Products & Aircraft
Modernization ............................ 32,252 24,866 49,722 47,545
Specialized Products ....................... 13,465 11,433 29,423 20,137
--------- --------- ----------- -----------
Consolidated total ....................... $ 97,688 $ 60,467 $ 168,995 $ 107,336
========= ========= =========== ===========
JUNE 30, 2002 DECEMBER 31, 2001
--------------- ------------------
ASSETS:
Secure Communications & ISR ........................ $1,108,705 $ 366,482
Training, Simulation & Support Services ............ 544,497 497,368
Aviation Products & Aircraft Modernization ......... 1,047,348 545,517
Specialized Products ............................... 1,532,344 1,382,010
Corporate .......................................... 716,332 547,872
---------- ----------
Consolidated total ............................... $4,949,226 $3,339,249
========== ==========
17
L-3 COMMUNICATIONS HOLDINGS, INC. AND
L-3 COMMUNICATIONS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-- CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The following table presents the changes in goodwill allocated to the
reportable segments during the six months ended June 30, 2002.
AVIATION
SECURE TRAINING, PRODUCTS
COMMUNICATIONS SIMULATION & & AIRCRAFT SPECIALIZED CONSOLIDATED
& ISR SUPPORT SERVICES MODERNIZATION PRODUCTS TOTAL
---------------- ------------------ --------------- ------------- -------------
BALANCE JANUARY 1, 2002 ......... $181,215 $377,127 $371,222 $778,154 $1,707,718
Acquired ...................... 491,098 4,916 222,063 48,426 766,503
-------- -------- -------- -------- ----------
BALANCE JUNE 30, 2002 ........... $672,313 $382,043 $593,285 $826,580 $2,474,221
======== ======== ======== ======== ==========
The Company's sales by product and services are summarized in the table
below.
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
--------------------------- -----------------------------
2002 2001 2002 2001
----------- ----------- ------------- -------------
Avionics and ocean systems ........................ $ 138,123 $160,871 $ 250,466 $ 292,674
Aircraft modernization and maintenance ............ 143,241 -- 201,672 --
Intelligence, surveillance and
reconnaissance products .......................... 126,583 -- 165,027 --
Telemetry and instrumentation ..................... 81,788 82,897 162,759 156,045
Military and high data rate
communications ................................... 80,628 51,746 143,116 100,279
Detection systems and premium fuzing
products ......................................... 61,756 13,030 104,942 16,554
Information security systems ...................... 51,069 24,500 94,730 43,866
Training devices and motion simulators ............ 37,881 35,784 67,260 66,813
Microwave components .............................. 20,749 30,715 42,782 55,538
Space and commercial communications,
satellite control and tactical sensor
systems .......................................... 24,509 14,994 41,291 32,434
--------- -------- ---------- ----------
Subtotal products .............................. 766,327 414,537 1,274,045 764,203
Training, simulation and support services ......... 201,000 151,774 398,302 268,760
--------- -------- ---------- ----------
Subtotal ....................................... 967,327 566,311 1,672,347 1,032,963
Intercompany eliminations ......................... (12,138) (4,751) (20,318) (9,502)
--------- -------- ---------- ----------
Total .......................................... $ 955,189 $561,560 $1,652,029 $1,023,461
========= ======== ========== ==========
11. NEW ACCOUNTING PRONOUNCEMENTS
In August of 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations. SFAS No. 143 applies to legal obligations associated
with the retirement of tangible long-lived assets that result from the
acquisition, construction, development or normal operation of a long-lived
asset, except for certain obligations of lessees. This statement does not apply
to obligations that arise solely from a plan to dispose of a long-lived asset.
SFAS No. 143 requires that estimated asset retirement costs be measured at
their fair values and recognized as assets and depreciated over the useful life
of the related asset. Similarly, liabilities for the present value of asset
retirement obligations are to be recognized and accreted as interest expense
each year to their estimated future value until the asset is retired. These
provisions will
18
L-3 COMMUNICATIONS HOLDINGS, INC. AND
L-3 COMMUNICATIONS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-- CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
be applied to existing asset retirement obligations as of the adoption date as
a cumulative effect of a change in accounting principle. SFAS No. 143 is
effective for the Company's fiscal years beginning January 1, 2003. SFAS No.
143 is not expected to have a material effect on the Company's consolidated
results of operations and financial position.
In October of 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-lived Assets. SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
This statement supersedes SFAS No. 121, Accounting for the Impairment of
Long-lived Assets and for Long-lived Assets to Be Disposed Of, and the
accounting and reporting provisions of APB Opinion No. 30, Reporting the
Results of Operations -- Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions (APB No. 30), for the disposal of a segment of a business (as
previously defined in that Opinion). SFAS No. 144 expands the scope of
accounting for disposals to include all components of an entity, including
reportable segments and operating segments, reporting units, subsidiaries and
certain asset groups. It requires the gain or loss on disposal to be measured
as the difference between (1) the fair value less the costs to sell and (2) the
carrying value of the component, and such gain or loss cannot include the
estimated future operating losses of the component, which were included in the
gain or loss determination under APB No. 30. SFAS No. 144 also amends
Accounting Research Bulletin No. 51, Consolidated Financial Statements, to
eliminate the exception to consolidate a subsidiary for which control is likely
to be temporary. The provisions of SFAS No. 144 became effective on January 1,
2002. SFAS No. 144 did not have a material effect on the Company's consolidated
results of operation and financial position.
In May 2002, the FASB issued SFAS No. 145, Rescission of SFAS Nos. 4, 44
and 64, Amendment of SFAS No. 13, and Technical Corrections as of April 2002.
SFAS No. 145, rescinds SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and SFAS No. 64, Extinguishments of Debt made to
Satisfy Sinking-Fund Requirements. Under the provisions of SFAS No. 145, gains
and losses from extinguishment of debt can only be classified as extraordinary
items if they meet the criteria in APB Opinion No. 30. The provisions of this
Statement related to the rescission of SFAS No. 4 shall be applied in fiscal
years beginning after May 15, 2002. Earlier application is permitted. This
statement also amends SFAS No. 13, Accounting for Leases, to eliminate an
inconsistency between the accounting for sale-leaseback transactions and
certain lease modifications that have economic effects that are similar and is
effective for transactions occurring after May 15, 2002. This Statement also
amends other existing authoritative pronouncements to make various technical
corrections, clarify meanings, or describe their applicability under changed
conditions and are effective for financial statements issued on or after May
15, 2002. SFAS No. 145 is not expected to have a material effect on the
Company's consolidated results of operations, financial position or cash flows.
In July of 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS No. 146 replaces EITF No.
94-3 "Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." SFAS No. 146 requires companies to recognize costs associated
with exit or disposal activities when they are incurred rather than at the date
of a commitment to an exit or disposal plan as was required by EITF No. 94-3.
Examples of costs covered by SFAS No. 146 include lease termination costs and
certain employee severance costs that are associated with a restructuring,
discontinued operation, plant closing, or other exit or disposal activity. SFAS
No. 146 is to be applied to exit or disposal activities initiated after
December 31, 2002. SFAS No. 146 is not expected to have a material effect on
the Company's consolidated results of operations and financial position.
19
L-3 COMMUNICATIONS HOLDINGS, INC. AND
L-3 COMMUNICATIONS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-- CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
12. 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 its outstanding senior subordinated notes and
borrowings under amounts drawn against the senior credit facilities, are
guaranteed, on a joint and several, full and unconditional basis, by certain of
its wholly owned 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 present
the results of operations, financial position and cash flows of (i) L-3
Communications excluding its consolidated subsidiaries (the "Parent") (ii) the
Guarantor Subsidiaries, (iii) the Non-Guarantor Subsidiaries and (iv) the
eliminations to arrive at the information for L-3 Communications on a
consolidated basis.
L-3 CONSOLIDATED
COMMUNICATIONS GUARANTOR NON-GUARANTOR L-3
(PARENT) SUBSIDIARIES SUBSIDIARIES ELIMINATIONS COMMUNICATIONS
---------------- -------------- --------------- ---------------- ---------------
CONDENSED COMBINING BALANCE SHEETS:
- -----------------------------------
AS OF JUNE 30, 2002
- -------------------
Total current assets .................... $ 991,005 $ 643,545 $ 209,266 $ -- $1,843,816
Other long-term assets .................. 1,015,846 1,631,442 458,122 -- 3,105,410
Investment in and amounts due from
(to) consolidated subsidiaries ......... 2,425,949 290,091 (26,287) (2,689,753) --
---------- ---------- --------- ------------ ----------
Total assets ......................... $4,432,800 $2,565,078 $ 641,101 $ (2,689,753) $4,949,226
========== ========== ========= ============ ==========
Total current liabilities ............... $ 322,954 $ 206,832 $ 89,682 $ -- $ 619,468
Other long-term liabilities ............. 177,290 139,078 8,995 -- 325,363
Long-term debt .......................... 1,844,332 -- -- -- 1,844,332
Minority interest ....................... -- -- 71,839 -- 71,839
Shareholders' equity .................... 2,088,224 2,219,168 470,585 (2,689,753) 2,088,224
---------- ---------- --------- ------------ ----------
Total liabilities and shareholders
equity ............................. $4,432,800 $2,565,078 $ 641,101 $ (2,689,753) $4,949,226
========== ========== ========= ============ ==========
20
L-3 COMMUNICATIONS HOLDINGS, INC. AND
L-3 COMMUNICATIONS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-- CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
L-3 CONSOLIDATED
COMMUNICATIONS GUARANTOR NON-GUARANTOR L-3
(PARENT) SUBSIDIARIES SUBSIDIARIES ELIMINATIONS COMMUNICATIONS
---------------- -------------- --------------- ---------------- ---------------
AS OF DECEMBER 31, 2001
- -----------------------
Total current assets ..................... $ 786,498 $ 300,585 $155,318 $ -- $1,242,401
Other long-term assets ................... 965,566 701,887 429,395 -- 2,096,848
Investment in and amounts due from
consolidated subsidiaries ............... 1,229,572 150,580 43,236 (1,423,388) --
---------- ---------- -------- ------------ ----------
Total assets .......................... $2,981,636 $1,153,052 $627,949 $ (1,423,388) $3,339,249
========== ========== ======== ============ ==========
Total current liabilities ................ $ 278,598 $ 136,579 $109,394 $ -- $ 524,571
Other long-term liabilities .............. 173,894 31,080 10,663 -- 215,637
Long-term debt ........................... 1,315,252 -- -- -- 1,315,252
Minority interest ........................ -- -- 69,897 -- 69,897
Shareholders' equity ..................... 1,213,892 985,393 437,995 (1,423,388) 1,213,892
---------- ---------- -------- ------------ ----------
Total liabilities and shareholders'
equity ............................... $2,981,636 $1,153,052 $627,949 $ (1,423,388) $3,339,249
========== ========== ======== ============ ==========
CONDENSED COMBINING STATEMENTS OF
- ---------------------------------
OPERATIONS:
-----------
FOR THE SIX MONTHS ENDED
- ------------------------
JUNE 30, 2002
-------------
Sales .................................... $ 748,768 $ 779,368 $131,964 $ (8,071) $1,652,029
---------- ---------- -------- ------------ ----------
Operating income ......................... 68,431 72,818 27,746 -- 168,995
Interest and other income (expense) ...... 3,646 (198) 181 (2,805) 824
Interest expense ......................... 56,127 1,396 2,945 (2,805) 57,663
Minority interest ........................ -- -- 2,764 -- 2,764
Provision for income taxes ............... 5,630 25,142 7,843 -- 38,615
Equity in net income of consolidated
subsidiaries ............................ 60,457 -- -- (60,457) --
Extraordinary item-loss on
extinguishment of debt, net of taxes..... (9,858) -- -- -- (9,858)
---------- ---------- -------- ------------ ----------
Net income ............................... $ 60,919 $ 46,082 $ 14,375 $ (60,457) $ 60,919
========== ========== ======== ============ ==========
FOR THE SIX MONTHS ENDED
- ------------------------
JUNE 30, 2001
-------------
Sales .................................... $ 597,558 $ 165,947 $262,195 $ (2,239) $1,023,461
---------- ---------- -------- ------------ ----------
Operating income (loss) .................. 88,913 (7,729) 26,152 -- 107,336
Interest and other income (expense) ...... 7,997 (306) (6,237) -- 1,454
Interest expense ......................... 46,415 17 4 -- 46,436
Minority interest ........................ -- -- 1,585 -- 1,585
Provision (benefit) for income taxes ..... 19,340 (3,084) 7,019 -- 23,275
Equity in net income (loss) of
consolidated subsidiaries ............... 6,339 -- -- (6,339) --
---------- ---------- -------- ------------ ----------
Net income (loss) ........................ $ 37,494 $ (4,968) $ 11,307 $ (6,339) $ 37,494
========== ========== ======== ============ ==========
FOR THE THREE MONTHS ENDED
- --------------------------
JUNE 30, 2002
-------------
Sales .................................... $ 408,065 $ 476,668 $ 75,330 $ (4,874) $ 955,189
---------- ---------- -------- ------------ ----------
Operating income ......................... 27,427 51,161 19,100 -- 97,688
Interest and other income (expense) ...... 2,824 (273) 51 (2,805) (203)
Interest expense ......................... 31,367 135 2,873 (2,805) 31,570
21
L-3 COMMUNICATIONS HOLDINGS, INC. AND
L-3 COMMUNICATIONS CORPORATION
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS-- CONTINUED
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
L-3 CONSOLIDATED
COMMUNICATIONS GUARANTOR NON-GUARANTOR L-3
(PARENT) SUBSIDIARIES SUBSIDIARIES ELIMINATIONS COMMUNICATIONS
---------------- -------------- --------------- -------------- ---------------
FOR THE THREE MONTHS ENDED
- --------------------------
JUNE 30, 2002 (CONTINUED)
-------------------------
Minority interest ......................... -- -- 1,776 -- 1,776
Provision (benefit) for income taxes ...... (394) 17,916 5,119 -- 22,641
Equity in net income of consolidated
subsidiaries ............................. 42,220 -- -- (42,220) --
Extraordinary item-loss on
extinguishment of debt, net of taxes...... (9,858) -- -- -- (9,858)
------ ------ ----- ------- ------
Net income ................................ $ 31,640 $ 32,837 $ 9,383 $ (42,220) $ 31,640
============ ============ ========== ============ ============
FOR THE THREE MONTHS ENDED
- --------------------------
JUNE 30, 2001
-------------
Sales ..................................... $ 316,673 $ 86,068 $ 159,951 $ (1,132) $ 561,560
------------ ------------ ---------- ------------ ------------
Operating income .......................... 44,318 (4,054) 20,203 -- 60,467
Interest and other income (expense) ....... 7,614 (306) (6,336) -- 972
Interest expense .......................... 22,283 (256) 4 -- 22,031
Minority interest ......................... -- -- 1,585 -- 1,585
Provision (benefit) for income taxes ...... 11,356 (1,572) 4,703 -- 14,487
Equity in net income (loss) of
consolidated subsidiaries ................ 5,043 -- -- (5,043) --
------------ ------------ ---------- ------------ ------------
Net income (loss) ......................... $ 23,336 $ (2,532) $ 7,575 $ (5,043) $ 23,336
============ ============ ========== ============ ============
CONDENSED COMBINING STATEMENTS OF
- ---------------------------------
CASH FLOWS:
-----------
FOR THE SIX MONTHS ENDED
- ------------------------
JUNE 30, 2002
-------------
Net cash from (used in) operating
activities ............................... $ (7,861) $ 119,705 $ 982 $ -- $ 112,826
------------ ------------ ---------- ------------ ------------
Net cash used in investing activities ..... (1,325,593) (1,168,458) (149,669) 1,304,937 (1,338,783)
------------ ------------ ---------- ------------ ------------
Net cash from financing activities ........ 1,476,293 1,034,273 125,424 (1,304,937) 1,331,053
------------ ------------ ---------- ------------ ------------
Net increase (decrease) in cash ........... 142,839 (14,480) (23,263) -- 105,096
Cash and cash equivalents, beginning
of period ................................ 320,210 (4,412) 45,224 -- 361,022
------------ ------------ ---------- ------------ ------------
Cash and cash equivalents, end of
period ................................... $ 463,049 $ (18,892) $ 21,961 $ -- $ 466,118
============ ============ ========== ============ ============
FOR THE SIX MONTHS ENDED
- ------------------------
JUNE 30, 2001
- --------------
Net cash from (used in) operating
activities ............................... $ 20,806 $ (23,583) $ 35,455 $ -- $ 32,678
------------ ------------ ---------- ------------ ------------
Net cash used in investing activities ..... (151,123) (5,232) (216,621) 208,746 (164,230)
------------ ------------ ---------- ------------ ------------
Net cash from financing activities ........ 160,929 26,974 188,048 (208,746) 167,205
------------ ------------ ---------- ------------ ------------
Net increase (decrease) in cash ........... 30,612 (1,841) 6,882 -- 35,653
Cash and cash equivalents, beginning
of period ................................ 18,708 4,911 9,061 -- 32,680
------------ ------------ ---------- ------------ ------------
Cash and cash equivalents, end of
period ................................... $ 49,320 $ 3,070 $ 15,943 $ -- $ 68,333
============ ============ ========== ============ ============
22
ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
RESULTS OF OPERATIONS AND FINANCIAL CONDITION
GENERAL
We are a leading merchant supplier of secure communications and
intelligence, surveillance and reconnaissance (ISR) systems, training,
simulation and support services, aviation products and aircraft modernization,
as well as specialized products. Our customers include the DoD, prime
contractors to the DoD, certain U.S. Government intelligence agencies, major
aerospace and defense contractors, foreign governments, commercial customers
and certain other U.S. federal, state and local government agencies. As a
result of our recently completed acquisitions, including our acquisitions of
Aircraft Integration Systems, a division of Raytheon Company, on March 8, 2002,
and Spar, Analytics, BT Fuze and SY Technologies in November and December of
2001 and their effect on our operations, effective January 1, 2002, we began to
present our businesses in the following four reportable segments: (1) Secure
Communications & ISR; (2) Training, Simulation & Support Services; (3) Aviation
Products & Aircraft Modernization; and (4) Specialized Products. Prior to
December 31, 2001, we had two reportable segments: Secure Communications
Systems and Specialized Products.
Our Secure Communications & ISR segment provides products and services for
the global ISR market as well as secure, high data rate communications systems
for military and other U.S. Government reconnaissance and surveillance
applications. We believe our systems and products are critical elements of
virtually all major communication, command and control, intelligence gathering
and space systems. Our systems and products are used to connect a variety of
airborne, space, ground and sea-based communication systems and are used in
transmission, processing, recording, monitoring and dissemination functions of
these communication systems. Our Training, Simulation & Support Services
segment produces training systems, programs and related support services, and
provides a wide range of engineering development and integration support, a
full range of teaching, training, logistic and communication software support
services and custom ballistic targets. Our Aviation Products & Aircraft
Modernization segment provides TCAS products, cockpit voice, flight data and
cruise ship hardened voyage recorders, displays and specialized aircraft
modernization, upgrade and maintenance services. Our Specialized Products
segment provides ocean products, telemetry, instrumentation, space and guidance
products, premium fuzing products, detection systems, training devices and
microwave components.
In recent years, domestic and worldwide political and economic
developments have significantly affected the markets for defense systems,
products and services. Two events in 2001 had a dramatic impact on the domestic
and international political and economic landscape. They impacted L-3 and the
defense industry generally. First, the events of September 11 created
uncertainty and exposed vulnerabilities in security and the overall defense of
our homeland. Second, in the conclusions of the U.S. Quadrennial Defense Review
(QDR) that was completed in 2001, there was a fundamental and philosophical
shift in focus from a "threat-based" model to one that emphasizes the
capabilities needed to defeat a full spectrum of adversaries. Transforming the
nation's defense posture to a capabilities-based approach involves creating the
ability for a more flexible response, with greater force mobility, stronger
space capabilities, missile defense, improved and network-centric
communications, intelligence and information systems security and an increased
emphasis on homeland defense.
The current U.S. defense budget and the proposed U.S. defense budgets for
fiscal years 2003 through 2006 have each been increased by approximately 20%
over their previous budgets for those same years with increased focus on
command, control, communications, intelligence, surveillance and reconnaissance
(C3ISR), precision-guided weapons, unmanned aerial vehicles (UAVs),
communications networks and missile defense. We believe we are well positioned
to benefit from increased spending in those areas. In addition, increased
emphasis on homeland defense may increase demand for our capabilities in areas
such as airport security systems, information security, crisis management,
preparedness and prevention services, and civilian security operations. While
there is no assurance that the proposed increased DoD budget levels will be
approved by Congress, after over a decade of downward trends, the current
outlook
23
is one of increased spending, which we believe should positively affect our
future sales and could potentially favorably affect our future operating
profits because of increased sale volumes.
All of our domestic government contracts and subcontracts are subject to
audit and various cost controls, and include standard provisions for
termination for the convenience of the U.S. Government. Multiyear U.S.
Government contracts and related orders are subject to cancellation if funds
for contract performance for any subsequent year become unavailable. Foreign
government contracts generally include comparable provisions relating to
termination for the convenience of the relevant foreign government.
ACQUISITIONS
The table below summarizes the material acquisitions that we have
completed during the year ended December 31, 2001 and the six-month period
ended June 30, 2002.
PURCHASE
ACQUIRED COMPANY DATE ACQUIRED PRICE(1)
- ---------------- ------------------- ---------------------
KDI Precision Products May 4, 2001 $ 78.9
EER Systems May 31, 2001 $ 119.4(2)
Spar Aerospace Limited November 23, 2001 $ 146.8(3)
Emergent Government Services Group November 30, 2001 $ 39.7(4)
BT Fuze Products December 19, 2001 $ 49.5(5)
SY Technology December 31, 2001 $ 58.5(6)
Aircraft Integration Systems March 8, 2002 $1,148.7(5)(7)
Detection Systems June 14, 2002 $ 100.0(5)
- ----------
(1) Purchase price represents the contractual consideration for the acquired
business, excluding adjustments for net cash acquired and acquisition
costs.
(2) Excludes additional purchase price, not to exceed $5.0 million, which is
contingent upon the financial performance of EER for the year ending
December 31, 2002.
(3) Includes $43.6 million for the remaining 29.7% of the outstanding common
stock of Spar that we acquired and paid for in January 2002.
(4) Following the acquisition we changed Emergent Government Services Group's
name to L-3 Communications Analytics.
(5) Purchase price is subject to adjustment based on actual closing date net
assets or net working capital of the acquired business.
(6) Excludes additional purchase price, not to exceed $3.0 million, which is
contingent upon the financial performance of SY for the years ending
December 31, 2002 and 2003.
(7) Includes $18.7 million related to additional assets contributed by
Raytheon Company to AIS. Following the acquisition, we changed AIS's name
to L-3 Integrated Systems ("IS").
- ----------
Additionally, we purchased other businesses during 2002 and 2001, which
individually and in the aggregate were not material to our consolidated results
of operations, financial position or cash flows in the year acquired.
All of our acquisitions have been accounted for as purchase business
combinations and are included in our consolidated results of operations from
their respective effective dates.
We regularly evaluate potential acquisitions and joint venture
transactions, but we have not entered into any agreements with respect to any
material transactions at this time.
RESULTS OF OPERATIONS
The following information should be read in conjunction with our unaudited
condensed consolidated financial statements as of June 30, 2002. Our results of
operations for the periods presented are impacted significantly by our
acquisitions. See Note 3 to the unaudited condensed consolidated financial
statements
24
for a discussion of our acquisitions, including pro forma sales, net income and
diluted earnings per share data. The tables below provide our selected
statement of operations data for the three-month and six-month periods ended
June 30, 2002, which we refer to as the 2002 Second Quarter and 2002 First
Half, and for the three-month and six-month periods ended June 30, 2001, which
we refer to as the 2001 Second Quarter and 2001 First Half. Prior period
reportable segment information has been restated to conform to the current year
presentation of reportable segments.
THREE MONTHS ENDED JUNE 30, 2002 COMPARED WITH THREE MONTHS ENDED JUNE 30,
2001
THREE MONTHS ENDED JUNE 30,
---------------------------
2002 2001
----------- ------------
(in millions)
Sales(1):
Secure Communications & ISR ........................ $278.2 $ 88.9
Training, Simulation & Support Services ............ 197.2 151.7
Aviation Products & Aircraft Modernization ......... 203.5 70.8
Specialized Products ............................... 276.3 250.2
------ -------
Total ............................................ $955.2 $ 561.6
====== =======
Operating income:
Secure Communications & ISR ........................ $ 29.7 $ 4.8(2)
Training, Simulation & Support Services ............ 22.3 19.4(2)
Aviation Products & Aircraft Modernization ......... 32.2 24.9(2)
Specialized Products ............................... 13.5 11.4(2)
------ -------
Total ............................................ $ 97.7 $ 60.5(2)
====== =======
- ----------
(1) Sales are after intersegment eliminations. See Note 10 to the Unaudited
Condensed Consolidated Financial Statements.
(2) Operating income for the three months ended June 30, 2001, includes
goodwill amortization expense of $0.9 million for Secure Communications
and ISR, $1.7 million for Training, Simulation & Support Services, $2.0
million for Aviation Products & Aircraft Modernization, and $6.0 million
for Specialized Products, which aggregated $10.6 million for all of L-3.
In accordance with SFAS No. 142, after December 31, 2001, goodwill is not
amortized to expense.
- ------------
Consolidated sales increased $393.6 million to $955.2 million in the 2002
Second Quarter from sales of $561.6 million for the 2001 Second Quarter. Sales
to the U.S. Government, foreign governments and other customers that are made
pursuant to written contractual arrangements or "contracts" for products and/or
services according to the specifications of the customer are within the scope
of SOP 81-1, Accounting for Performance of Construction--type and certain
Production-type contracts, and are presented on the statement of operations
under the caption "Contracts, primarily long-term U.S. Government." Sales from
"Contracts, primarily long-term U.S. Government", increased $408.3 million to
$862.1 million in the 2002 Second Quarter from $453.8 million in the 2001
Second Quarter. The KDI, EER, Spar, Analytics, SY, BT Fuze, and IS acquisitions
contributed $343.7 million of the increase in sales. The remaining increase was
primarily attributable to volume increases of (1) $60.2 million for secure
telephone equipment (STE) and secure data links, (2) $15.7 million for
explosive detection systems, (3) $5.5 million for guidance products, and (4)
$3.9 million for displays. These increases were partially offset by declines of
(1) $4.8 million on naval power equipment, (2) $9.1 million for acoustic
undersea warfare products, and (3) $6.8 million principally for simulation and
support services. Sales arrangements that are not within the scope of SOP 81-1
are recognized in accordance with the SEC's SAB No. 101, Revenue Recognition in
Financial Statements, and are presented on the statement of operations under
the caption "Commercial, primarily products." Sales from "Commercial, primarily
products" decreased $14.7 million to $93.1 million in the 2002 Second Quarter
from $107.8 million in the 2001 Second Quarter. The decline was principally
caused by lower volume of $15.8 million on commercial aviation products and
$6.8 million on telemetry, space, microwave and other communications products.
These decreases were partially offset by sales from the Detection Systems
acquired business of $7.9 million.
25
Consolidated costs and expenses increased $356.4 million to $857.5 million
in the 2002 Second Quarter from $501.1 million in the 2001 Second Quarter
primarily as a result of the increase in sales. Costs and expenses for
"Contracts, primarily long-term U.S. Government" increased $351.4 million to
$759.7 million in the 2002 Second Quarter from $408.3 million in the 2001
Second Quarter primarily as a result of the increase in sales. Costs and
expenses for "Commercial, primarily products" increased $5.0 million to $97.8
million in the 2002 Second Quarter from $92.8 million in the 2001 Second
Quarter primarily due to higher expenses for the Prime Wave business.
Consolidated operating income increased by $37.2 million to $97.7 million
for the 2002 Second Quarter from $60.5 million for the 2001 Second Quarter
primarily because of higher sales, which were partially offset by lower
operating margins. Consolidated operating income as a percentage of sales
("operating margin") declined by 0.6 percentage points to 10.2% from 10.8% in
the 2001 Second Quarter. The impact of not amortizing goodwill to expense
beginning on January 1, 2002 in accordance with SFAS No. 142 increased
operating margin by 1.1 percentage points. The remaining decline in
consolidated operating margin of 1.7 percentage points was attributable to
lower margins for the Training, Simulation & Support Services, Aviation
Products & Aircraft Modernization and Specialized Products segments, which were
partially offset by higher margins for the Secure Communications & ISR segment.
The changes in the operating margins of the segments are discussed below.
Additionally, in the 2002 Second Quarter a loss of $3.0 million was recorded
for the settlement of certain litigations assumed as part of the acquisition of
Aydin Corporation in April 1999, because the settlement amounts exceeded the
original estimates of the acquired litigation liabilities. This loss was
partially offset by a foreign currency related net gain of $1.9 million in the
2002 Second Quarter. Operating income for "Contracts, primarily long-term U.S.
Government" increased $56.9 million to $102.4 million in the 2002 Second
Quarter from $45.5 million in the 2001 Second Quarter. Operating margin for
"Contracts, primarily long-term U.S. Government" increased 1.9 percentage
points to 11.9% in the 2002 Second Quarter from 10.0% in the 2001 Second
Quarter, and the increase was principally due to the impact of not amortizing
goodwill to expense in accordance with SFAS No. 142. Operating income for
"Commercial, primarily products" declined $19.7 million to a loss of $4.7
million in the 2002 Second Quarter from operating income of $15.0 million in
the 2001 Second Quarter. Operating margin for "Commercial, primarily products"
declined 18.9 percentage points to a negative 5.0% in the 2002 Second Quarter
from 13.9% in the 2001 Second Quarter. The decline was principally attributable
to lower margins on commercial aviation products, microwave, space and
broadband communication products because of volume declines in sales, as well
as continued marketing, selling and development expenses for the Prime Wave
business, which were partially offset by not amortizing goodwill to expense in
accordance with SFAS No. 142.
Interest expense increased $9.6 million to $31.6 million for the 2002
Second Quarter from $22.0 million for the 2001 Second Quarter, because of the
higher outstanding debt principally related to the borrowings incurred to
finance the IS acquisition, which was partially offset by savings of $3.7
million from the interest rate swap agreements we entered into in July 2001 and
November 2001, as well as lower interest rates on our variable rate borrowings.
Interest and other income (expense) decreased $1.2 million to a $0.2
million expense from the 2001 Second Quarter to the 2002 Second Quarter. The
2001 Second Quarter included a net gain of $0.6 million related to a gain on
the sale of a 30% interest in the ACSS business offset by the write-down of the
carrying value of an investment in the common stock of a telecommunications
company because the decline in value was determined to be other than temporary.
Additionally, losses on an equity method investment increased.
The income tax provision for the 2002 Second Quarter is based on the
estimated effective income tax rate for 2002 of 35.3%, compared with the
effective tax rate of 38.3% for the 2001 Second Quarter. The decrease in the
effective income tax rate is primarily attributable to the exclusion of
goodwill amortization expense that is non-deductible for income tax purposes
from the annual estimated effective income tax rate calculation as a result of
goodwill not being amortized beginning on January 1, 2002 in accordance with
SFAS No. 142.
Basic earnings per share ("EPS") before extraordinary items increased
$0.21 to $0.52 for the 2002 Second Quarter from $0.31 for the 2001 Second
Quarter, and diluted EPS before extraordinary items
26
increased $0.19 to $0.49 from $0.30 for the 2001 Second Quarter. The impact of
not amortizing goodwill to expense beginning on January 1, 2002 in accordance
with SFAS No. 142 increased both basic EPS before extraordinary items and
diluted EPS before extraordinary items each by $0.11. Excluding the impact of
not amortizing goodwill to expense, basic EPS before extraordinary items grew
23.8% and diluted EPS before extraordinary items grew 19.5%. Basic EPS was
$0.40 and diluted EPS was $0.38 after an extraordinary loss of $9.9 million,
net of income taxes, on the early extinquishment of debt arising from the
retirement of our $225.0 million of 10 3/8% senior subordinated notes. Diluted
weighted-average common shares outstanding increased 16.3% principally
reflecting the dilutive effect of the convertible notes.
The 2002 Second Quarter diluted EPS computation did not include the effect
of the 7.8 million shares of L-3 Holdings common stock that are issuable upon
conversion of the CODES (See Notes 5 and 7 to the unaudited condensed
consolidated financial statements) because the conditions for their conversion
were not satisfied. However, if the CODES had been convertible for the 2002
Second Quarter, reported diluted EPS would not have changed.
SECURE COMMUNICATIONS & ISR
Sales for the Secure Communications & ISR segment increased $189.3 million
or 212.9% to $278.2 million in the 2002 Second Quarter from $88.9 million for
the 2001 Second Quarter. The increase was principally attributed to $126.6
million from the IS-Tactical Reconnaissance Systems (TRS) and Airborne
Surveillance & Control (ASC) acquired businesses and $62.7 million of increased
volume principally on STE, secure data links and military communications
products, which was attributable to greater demand for secure communications
from the DoD and U.S. Government intelligence agencies. Additionally, the
increase in STE volume of $21.0 million was partially related to lower volume
in the 2001 Second Quarter arising from software development enhancements on
STE made in 2001 which caused production and delivery delays in 2001.
Operating income increased by $24.9 million to $29.7 million in the 2002
Second Quarter because of higher sales and operating margin. Operating margin
improved by 5.3 percentage points to 10.7% from 5.4%. The impact of not
amortizing goodwill to expense beginning on January 1, 2002 in accordance with
SFAS No. 142 increased operating margin by 0.4 percentage points. Increased
volume and cost improvements on STE accounted for 1.9 percentage points of the
increase. A provision to increase the allowance for doubtful accounts by $3.0
million for certain commercial receivables decreased operating margin by 1.1
percentage points. The remaining increase in operating margins was principally
attributable to margins from the IS-TRS and ASC acquired businesses, which were
higher then the Secure Communications & ISR segment operating margins for the
2001 Second Quarter. Additionally, the Prime Wave business continued to
generate losses in the 2002 Second Quarter because of lower sales volume as
well as continued marketing, selling and development expenses. We expect
margins for the segment to improve in the second half of 2002 because of
expected volume increases and additional cost improvements on DoD business, as
well as lower losses for the Prime Wave business arising from anticipated
increases in sales.
TRAINING, SIMULATION & SUPPORT SERVICES
Sales for the Training, Simulation & Support Services segment increased
$45.5 million or 30.0% to $197.2 million for the 2002 Second Quarter from
$151.7 million for the 2001 Second Quarter. The EER, SY and Analytics acquired
businesses contributed $50.7 million to sales. The remaining net decrease of
$5.2 million was principally attributable to lower sales on a ballistic missile
target services contract which is approaching its scheduled completion.
Operating income increased by $2.9 million to $22.3 million in the 2002
Second Quarter because of higher sales, which were partially offset by lower
operating margins. Operating margin declined by 1.5 percentage points to 11.3%
for the 2002 Second Quarter from 12.8% for the 2001 Second Quarter. The impact
of not amortizing goodwill to expense beginning on January 1, 2002 in
accordance with SFAS No. 142 increased operating margin by 0.9 percentage
points. This increase was offset by a decline in operating
27
margin of 2.4 percentage points, which was principally attributable to the
expected lower margins for the SY and Analytics acquired businesses, as well as
lower margins on training services in the current period compared to the prior
period as a result of profit improvements on certain contracts during 2001. We
do not expect margins for the segment to change significantly during the second
half of 2002.
AVIATION PRODUCTS & AIRCRAFT MODERNIZATION
Sales for the Aviation Products & Aircraft Modernization segment increased
$132.7 million or 187.4% to $203.5 million for the 2002 Second Quarter from
$70.8 million for the 2001 First Quarter. The IS-Aircraft Modification &
Maintenance (AMM) and Spar acquired businesses contributed $143.2 million to
sales. The remaining decline in sales of $10.5 million was principally
attributable to lower volume of $15.8 million on traffic collision and
avoidance systems (TCAS) and aviation recorders used primarily for commercial
applications, that were partially offset by an increase in volume for displays
used in military applications. The decline in sales of commercial aviation
products was caused by a decline in orders and customer-deferred delivery
schedules stemming from the continued downturn in the commercial aircraft
industry that began in 2001. We expect the sales volume for all of 2002 on
commercial aviation products to be lower than 2001 volumes; however, the amount
of the declines are expected to be smaller during the second half of 2002 than
they were in the 2002 First Half when compared to the same periods in the prior
year.
Operating income increased by $7.3 million to $32.2 million for the 2002
Second Quarter from $24.9 million for the 2001 Second Quarter because of higher
sales, which were partially offset by lower operating margins. Operating margin
declined by 19.3 percentage points to 15.9% for the 2002 Second Quarter from
35.2% for the 2001 Second Quarter. The impact of not amortizing goodwill to
expense beginning on January 1, 2002 in accordance with SFAS No. 142 increased
operating margin by 1.0 percentage points. Lower volumes on TCAS and aviation
recorders which generated lower gross margin contributions, as well as
increased development expenses for a terrain awareness warning system and a
commercial displays product-line which are planned to be introduced later this
year reduced operating margin by 5.7 percentage points. The remaining decrease
in operating margin of 14.6 percentage points was principally attributable to
margins from the IS-AMM and Spar acquired businesses, which were lower than the
Aviation Products & Aircraft Modernization segment operating margins for the
2001 Second Quarter. Operating margins benefited from a foreign currency gain
recorded from the Spar acquisition. We expect the operating margins on
commercial aviation products to increase during the second half of 2002 arising
from expected increases in volumes.
SPECIALIZED PRODUCTS
Sales for the Specialized Products segment increased $26.1 million or
10.4% to $276.3 million in the 2002 Second Quarter from $250.2 million for the
2001 Second Quarter. The increase was principally related to the acquisitions
of KDI, BT Fuze and Detection Systems, which accounted for $31.1 million in
sales, and higher volume of $5.5 million for guidance products and $15.7
million for explosive detection systems. The increase in volume for explosive
detection systems was substantially all from a contract with the Transportation
Security Administration (TSA) of the U.S. Department of Transportation that was
awarded to us in April 2002. The initial contract value for the TSA award is
$162 million and includes full-funding for 100 units of our examiner 3DXTM 6000
explosive detection systems and long-lead funding for an additional 200 systems
plus production ramp-up funding. The contract value for this TSA award is
expected to be about $250 million if all of these additional units are fully
funded. This increase was partially offset by a decrease in sales that was
principally attributable to lower volume of (1) $4.8 million on naval power
equipment arising from lower shipments caused by production capacity diverted
to fixing quality control problems and the related rework activities, (2) $9.1
million for acoustic undersea warfare products arising from the timing of
shipments, and (3) $12.3 million principally on telemetry and space products
and microwave components arising from continued softness and declining demand
in the space, broadband and wireless commercial communications markets. We
expect our sales of explosive detection
28
systems to increase substantially in the second half of 2002 as we increase our
production for the TSA contract. Additionally, we expect to return to normal
production levels for naval power equipment in the second half of 2002, and
anticipate an increase in volume for space, broadband and wireless
communications products.
Operating income increased by $2.1 million to $13.5 million for the 2002
Second Quarter from $11.4 million for the 2001 Second Quarter primarily because
of higher sales. Operating margin increased by 0.3 percentage points to 4.9%
for the 2002 Second Quarter from 4.6% for the 2001 Second Quarter. The impact
of not amortizing goodwill to expense beginning on January 1, 2002 in
accordance with SFAS No. 142 increased operating margin by 2.2 percentage
points. Higher margins from the KDI and BT Fuze acquired businesses related to
new contracts entering production caused an increase in operating margin of 1.5
percentage points. A loss of $3.0 million recorded in June 2002 for the
settlement of certain litigations assumed as part of the acquisition of Aydin
Corporation in April 1999 caused a decline in operating margin of 1.1
percentage points. The remaining decline was principally attributable to lower
margins resulting from lower shipments and rework efforts for naval power
equipment and lower volume on microwave components and acoustic undersea warfare
products. We expect the operating margin for Specialized Products to improve in
the second half of 2002 arising from expected volume increases for explosive
detection systems, naval power equipment, telemetry and space products and
microwave components.
SIX MONTHS ENDED JUNE 30, 2002 COMPARED WITH SIX MONTHS ENDED JUNE 30, 2001
SIX MONTHS ENDED JUNE 30,
---------------------------
2002 2001
------------ ------------
(in millions)
Sales(1):
Secure Communications & ISR ........................ $ 435.6 $ 171.6
Training, Simulation & Support Services ............ 392.0 268.7
Aviation Products & Aircraft Modernization ......... 310.8 131.4
Specialized Products ............................... 513.6 451.8
-------- --------
Total ............................................ $1,652.0 $1,023.5
======== ========
Operating income:
Secure Communications & ISR ........................ $ 46.1 $ 11.1(2)
Training, Simulation & Support Services ............ 43.8 28.6(2)
Aviation Products & Aircraft Modernization ......... 49.7 47.6(2)
Specialized Products ............................... 29.4 20.1(2)
-------- --------
Total ............................................ $ 169.0 $ 107.4(2)
======== ========
- ----------
(1) Sales are after intersegment eliminations. See Note 10 to the Unaudited
Condensed Consolidated Financial Statements.
(2) Operating income for the six months ended June 30, 2001, includes
goodwill amortization expense $1.9 million for Secure Communications and
ISR, $3.0 million for Training, Simulation & Support Services, $3.9
million for Aviation Products & Aircraft Modernization, and $11.7 million
for Specialized Products, which aggregated $20.5 million for all of L-3.
In accordance with SFAS No. 142, after December 31, 2001, goodwill is not
amortized to expense.
- ------------
Consolidated sales increased $628.5 million to $1,652.0 million for the
2002 First Half from $1,023.5 million for the 2001 First Half. Sales from
"Contracts, primarily long-term U.S. Government" increased $653.4 million to
$1,478.5 million for the 2002 First Half from $825.1 million for the 2001 First
Half. The KDI, EER, Spar, Analytics, SY, BT Fuze, and IS acquired businesses
contributed $544.9 million of the increase in sales. The remaining increase was
primarily attributable to volume increases of (1) $96.6 million on STE, secure
data links and military communications products, (2) $15.5 million for
explosive detection systems, (3) $14.8 million on guidance products, and (4)
$5.2 million for displays. These sales increases were partially offset by
declines of (1) $18.4 million on naval power equipment and (2) $5.2 million
principally for acoustic undersea warfare products. Sales from "Commercial,
primarily
29
products" decreased $24.9 million to $173.5 million in the 2002 First Half from
$198.4 million in the 2001 First Half. The decline was principally caused by
lower volume of $28.7 million on commercial aviation products and $4.1 million
on telemetry, space, microwave and other communications products. These
decreases were partially offset by sales from the Detection Systems acquired
business of $7.9 million.
Consolidated costs and expenses increased $566.9 million to $1,483.0
million in the 2002 First Half from $916.1 million in the 2001 First Half,
primarily as a result of the increase in sales. Costs and expenses for
"Contracts, primarily long-term U.S. Government" increased $558.6 million to
$1,304.7 million in the 2002 First Half from $746.1 million in the 2001 First
Half primarily as a result of the increase in sales. Costs and expenses for
"Commercial, primarily products" increased $8.3 million to $178.3 million in
the 2002 First Half from $170.0 million in the 2001 First Half primarily due to
higher expenses for the Prime Wave business.
Consolidated operating income increased by $61.6 million to $169.0 million
in the 2002 First Half from $107.4 for the 2001 First Half primarily because of
higher sales. Consolidated operating margin declined by 0.3 percentage points
to 10.2% from 10.5% in the 2001 First Half. The impact of not amortizing
goodwill to expense beginning on January 1, 2002 in accordance with SFAS No.
142 increased operating margin by 1.2 percentage points. The remaining decline
in operating margin of 1.5 percentage points was due to declines in the
Training, Simulation & Support Services, Aviation Products & Aircraft
Modernization and the Specialized Products segments, which were partially
offset by increases in the Secure Communications & ISR segment. The changes in
the operating margins of the segments are discussed below. Additionally, a loss
of $3.0 million was recorded in June 2002 for the settlement of certain
litigations assumed as part of a prior acquisition. This loss was partially
offset by a foreign currency related net gain of $1.9 million. Operating income
for "Contracts, primarily long-term U.S Government increased $94.8 million to
$173.8 million in the 2002 First Half from $79.0 million in the 2001 First
Half. Operating margin for "Contracts, primarily long-term U.S. Government
increased 2.2 percentage points to 11.8% in the 2002 First Half from 9.6% in
the 2001 First Half, and the increase was principally due to the impact of not
amortizing goodwill to expense in accordance with SFAS No. 142. Operating
income for "Commercial, primarily products" declined $33.2 million to a loss of
$4.8 million in the 2002 First Half from operating income of $28.4 million in
the 2001 First Half. Operating margin for "Commercial, primarily products"
declined 17.1 percentage points to a negative 2.8% in the 2002 First Half from
14.3% in the 2001 First Half. The decline was principally attributable to lower
margins on commercial aviation products, microwave, space and broadband
communication products because of volume declines in sales, as well as
continued marketing, selling and development expenses for the Prime Wave
business, which were partially offset by not amortizing goodwill to expense in
accordance with SFAS No. 142.
Interest expense increased $11.3 million to $57.7 million in the 2002
First Half from $46.4 for the 2001 First Half, because of the higher
outstanding debt, partially offset by savings of $6.6 million from the interest
rate swap agreements we entered into in 2001 and lower interest rates on our
variable rate borrowings.
Interest and other income decreased $0.7 million to $0.8 million for the
2002 First Half from $1.5 million for the 2001 First Half, principally because
the 2001 First Half included a net gain of $0.6 million. The net gain relates
to a gain on the sale of a 30% interest in the ACSS business offset by the
write-down of the carrying value of an investment in the common stock of a
telecommunications company because the decline in value was determined to be
other than temporary.
The income tax provision for the 2002 First Half is based on our estimated
effective income tax rate for 2002 of 35.3%, compared with the effective tax
rate of 38.3% for the 2001 First Half, as discussed above in the 2002 Second
Quarter discussion.
Basic EPS before extraordinary items increased $0.37 to $0.89 in the 2002
First Half from $0.52 in the 2001 First Half, and diluted EPS increased $0.34
to $0.84 in the 2002 First Half from $0.50 in the 2001 First Half. The impact
of not amortizing goodwill to expense beginning on January 1, 2002 in
accordance with SFAS No. 142 increased basic EPS before extraordinary items by
$0.23 and diluted EPS before extraordinary items by $0.21. Excluding the impact
of not amortizing goodwill to expense, basic EPS before extraordinary items
grew 18.7% and diluted EPS before extraordinary items grew 18.3%. Basic
30
EPS was $0.77 and diluted EPS was $0.73 after an extraordinary loss of $9.9
million, net of taxes, on the early extinquishment of debt arising from the
retirement of our $225.0 million of 10 3/8% senior subordinated notes. Diluted
weighted-average common shares outstanding increased 20.5% principally
reflecting the dilutive effect of the convertible notes and the sale of 9.2
million shares of our common stock in May 2001.
The 2002 First Half diluted EPS computation did not include the effect of
the 7.8 million shares of L-3 Holdings common stock that are issuable upon
conversion of the CODES (See Notes 5 and 7 to the unaudited condensed
consolidated financial statements) because the conditions for their conversion
were not satisfied. However, if the CODES had been convertible for the 2002
First Half, reported diluted EPS would have not changed.
SECURE COMMUNICATIONS & ISR
Sales for the Secure Communications & ISR segment increased $264.0 million
or 153.8% to $435.6 million for the 2002 First Half from $171.6 million for the
2001 First Half. The increase was principally attributed to $165.0 million from
the IS-TRS and ASC acquired businesses and $99.0 million of increased volume
principally on STE, secure data links and military communications products,
which was attributable to greater demand for secure communications from the DoD
and U.S. Government intelligence agencies. Additionally, the increase in STE
volume of $41.6 million was partially related to lower volume in the 2001 First
Half arising from software development enhancements on STE made in 2001 which
caused production and delivery delays in 2001.
Operating income increased by $35.0 million to $46.1 million in the 2002
First Half from $11.1 million for the 2001 First Half, because of higher sales
and operating margin. Operating margin improved by 4.1 percentage points to
10.6% in the 2002 First Half compared to 6.5% in the 2001 First Half. The
impact of not amortizing goodwill to expense beginning on January 1, 2002 in
accordance with SFAS No. 142 increased operating margin by 0.4 percentage
points. Increased volume and cost improvements on STE accounted for 3.1
percentage points of the increase. A provision to increase the allowance for
doubtful accounts by $3.0 million for certain commercial customers decreased
operating margin by 0.7 percentage points. The remaining increase in operating
margins was principally attributable to margins from the IS- TRS and ASC
acquired businesses, which were higher than the Secure Communications & ISR
segment operating margins for the 2001 First Half. Additionally, the Prime Wave
business continued to generate losses in the 2002 Second Half because of low
sales volume as well as higher marketing, selling and development expenses.
TRAINING, SIMULATION & SUPPORT SERVICES
Sales for the Training, Simulation & Support Services segment increased
$123.3 million or 45.9% to $392.0 million for the 2002 First Half from $268.7
million for the 2001 First Half. The EER, SY and Analytics acquired businesses
contributed $115.8 million of the increase in sales. The remaining net increase
of $7.5 million was principally attributable to volume increases at our
training and simulation business attributable to new contracts competitively
awarded during 2001, that were partially offset by lower sales on a ballistic
missiles target services contract which is approaching its scheduled
completion.
Operating income increased by $15.2 million to $43.8 million in the 2002
First Half from $28.6 million for the 2001 First Half, principally because of
higher sales and operating margin. Operating margin increased by 0.6 percentage
points to 11.2% in the 2002 First Half compared to 10.6% in the 2001 First
Half. The impact of not amortizing goodwill to expense beginning on January 1,
2002 in accordance with SFAS No. 142 increased operating margin by 0.8
percentage points. The remaining decrease in operating margin of 0.2 percentage
points was principally attributable to slightly lower margins from the acquired
businesses, as well as lower margins on training services in the current period
compared to the prior period as a result of profit improvements on certain
contracts during 2001.
AVIATION PRODUCTS & AIRCRAFT MODERNIZATION
Sales for the Aviation Products & Aircraft Modernization segment increased
$179.4 million or 136.5% to $310.8 million for the 2002 First Half from $131.4
million for the 2001 First Half. The IS-AMM
31
and Spar acquired businesses contributed $201.7 million to sales. The remaining
decline in sales of $22.3 million was principally attributable to lower volume
of $28.7 million on TCAS and aviation recorders used primarily for commercial
applications, that were partially offset by an increase in volume for displays
used in military applications. The decline in sales of commercial aviation
products was due to reduced demand and customer-deferred delivery schedules
stemming from the continued downturn in the commercial aircraft industry that
began in 2001.
Operating income increased by $2.1 million to $49.7 million for the 2002
First Half from $47.6 million for the 2001 First Half, because of higher sales,
which were largely offset by lower operating margins. Operating margin declined
by 20.2 percentage points to 16.0% for the 2002 First Half from 36.2% for the
2001 First Half. The impact of not amortizing goodwill to expense beginning on
January 1, 2002 in accordance with SFAS No. 142 increased operating margin by
1.3 percentage points. Lower volumes on TCAS and aviation recorders which
generated lower gross margin contributions, as well as increased development
expenses for a terrain awareness warning system and a commercial displays
product-line which are planned to be introduced later this year reduced
operating margin by 7.6 percentage points. The remaining decrease in operating
margins of 13.9 percentage points was principally attributable to margins from
the IS-AMM and Spar acquired businesses, which were lower than the Aviation
Products & Aircraft Modernization segment operating margins for the 2001 First
Half.
SPECIALIZED PRODUCTS
Sales for the Specialized Products segment increased $61.8 million or
13.7% to $513.6 million for the 2002 First Half from $451.8 million for the
2001 First Half. The increase was principally related to the acquisitions of
KDI, BT Fuze and Detection Systems, which accounted for $70.3 million in sales
and higher volume of $14.8 million for guidance products and $15.5 million for
explosive detection systems. This increase was partially offset by a decrease
in sales that was principally attributable to lower volume of (1) $18.4 million
on naval power equipment arising from lower shipments caused by production
capacity diverted to fixing quality control problems, (2) $4.4 million for
acoustic undersea warfare products arising from the timing of shipments, and
(3) $16.0 million on telemetry and space products and microwave components
arising from continued softness and declining demand in the space, broadband
and wireless commercial communications markets.
Operating income increased by $9.3 million to $29.4 million in the 2002
First Half from $20.1 million for the 2001 First Half, because of higher sales
and operating margin. Operating margin improved by 1.2 percentage points to
5.7% in the 2002 First Half compared to 4.5% in the 2001 First Half. The impact
of not amortizing goodwill to expense beginning on January 1, 2002 in
accordance with SFAS No. 142 increased operating margin by 2.3 percentage
points. Higher margins from the KDI and BT Fuze acquired businesses related to
new contracts entering production caused an increase in operating margin of 1.6
percentage points. A loss of $3.0 million recorded in June 2002 for the
settlement of certain litigations assumed as part of the acquisition of Aydin
caused a decline in operating margin of 0.6 percentage points. The remaining
decline was principally attributable to lower shipments and rework efforts for
naval power equipment.
LIQUIDITY AND CAPITAL RESOURCES
BALANCE SHEET
Contracts in process increased $502.4 million from December 31, 2001 to
June 30, 2002. The increase included $398.4 million related to acquired
businesses and $104.0 million principally from:
o increases of $54.9 million in billed receivables due to higher sales
from aircraft modifications, secure data links, displays, explosive
detection systems and ocean products;
o increases of $24.9 million in inventoried contract costs, primarily
for explosive detection systems for the TSA contract, secure data
links, ocean products, and telemetry products;
o increases of $22.9 million in unbilled contract receivables, net of
unliquidated progress payments,
32
due to increases on training devices and motion simulators, fuzing
products and secure communications products partially offset by higher
billings for aircraft modifications, display systems and training,
simulation and support services; and
o increases of $1.3 million in inventories at lower of cost or market
primarily for aviation products.
Included in contracts in process at June 30, 2002, are net billed
receivables of $12.8 million and net inventories of $28.1 million related to
our Prime Wave business. At December 31, 2001, we had $15.8 million of net
billed receivables and $30.2 million of net inventories related to our Prime
Wave business.
The increase in property, plant and equipment (PP&E) during the 2002 First
Half was principally related to the acquisition of IS. The percentage of
depreciation expense to average gross PP&E declined to 6.5% for the 2002 First
Half from 7.8% for the 2001 First Half. The decline was attributable to (1) the
impact from current acquisitions, for which the balance sheet reflects all of
the PP&E of the acquired businesses, but the statement of operations only
includes depreciation expense from the date of acquisition rather than for the
entire period, and (2) fully depreciated PP&E in certain of our operations
which are still being used despite having carrying values of zero (after
accumulated depreciation) and which are not derecognized from the balance sheet
until they are retired or otherwise disposed.
Goodwill increased $766.5 million to $2,474.2 million at June 30, 2002
from $1,707.7 million at December 31, 2001. The increase was principally due to
the IS and Detection Systems acquisitions as well as net purchase price
increases based on the closing date balance sheets for acquisitions completed
prior to January 1, 2002.
The increases in accounts payable, accrued employment costs, accrued
expenses and pension and postretirement liabilities were primarily due to the
timing of payments as well as the acquisitions of IS and Detection Systems. The
decrease in other current liabilities is primarily attributable to the payment
in January 2002 of $43.6 million for the remaining outstanding common stock of
Spar that was not tendered to L-3 as of December 31, 2001.
STATEMENT OF CASH FLOWS
SIX MONTHS ENDED JUNE 30, 2002 COMPARED WITH SIX MONTHS ENDED JUNE 30, 2002
The following table provides cash flow data:
SIX MONTHS ENDED JUNE 30,
---------------------------
2002 2001
------------ ------------
(in millions)
Net cash from operating activities ............ $ 112.8 $ 32.7
Net cash used in investing activities ......... (1,338.8) (164.2)
Net cash from financing activities ............ 1,331.1 167.2
--------- -------
Net increase in cash .......................... $ 105.1 $ 35.7
========= =======
OPERATING ACTIVITIES
During the 2002 First Half, we generated $112.8 million of cash from our
operating activities, an increase of $80.1 million over the $32.7 million
generated during the 2001 First Half. Earnings adjusted for non-cash items and
deferred income taxes increased $40.0 million to $150.1 million in the 2002
First Half from $110.1 million in the 2001 First Half. Deferred income taxes
for the 2002 First Half compared with the 2001 First Half increased primarily
because of larger estimated tax deductions arising from our recently completed
acquisitions, including our acquisition of IS. We expect our deferred income
taxes to be higher in 2002 than they were in 2001. During the 2002 First Half,
our working capital and operating assets and liabilities increased $37.3
million compared with an increase of $77.4 million in the 2001 First Half. Our
cash flows from operating activities during the 2002 First Half reflect
increases in inventories, billed receivables and unbilled contract receivables
as described above.
The use of cash arising from the decrease in customer advances was a
result of deliveries on contracts for acoustic undersea warfare products.
Customer advances are generally used to finance contracts with
33
foreign customers, and the timing of their receipts and liquidations, which are
based on the timing of contract awards specific contract terms, has no effect
on reported revenues and profits.
The change in other current liabilities was due to uses of cash relating
to performance on certain contracts in process, for which estimated costs
exceed the estimated billings. The uses of cash declined in the 2002 First Half
compared to the 2001 First Half.
The timing of payments to vendors, as well as the timing of payments to
employees for salaries and wages, was a source of cash reflected in the change
in accounts payable and accrued expenses.
The source of cash from the change in pension and postretirement benefits
was due to pension and postretirement expenses for the 2002 First Half
exceeding related cash contributions and funding. We expect to contribute $8.0
million to our pension plan for the remainder of 2002.
The source of cash generated from the change in other liabilities was
primarily attributable to the long-term portion of the deferred gain recorded
in connection with unwinding the interest rate swap agreements on $200.0
million of 8% Senior Subordinated Notes due 2008. See Financing Activities
below.
INVESTING ACTIVITIES
During the 2002 First Half, we invested $1,316.1 million to acquire
businesses, including (1) our acquisitions of IS and Detection Systems, (2) the
payment of $43.6 million for the remaining outstanding common stock of Spar
which were not tendered to L-3 at December 31, 2001 and (3) acquisition costs
and net purchase price increases based on the closing date balance sheets for
certain acquisitions completed prior to January 1, 2002. During the 2001 First
Half we invested $211.0 million to acquire businesses. The IS acquisition was
financed using approximately $229.0 million of cash on hand, borrowings under
our senior credit facilities of $420.0 million and a $500.0 million senior
subordinated bridge loan. We used a portion of the proceeds from the sale in
June 2002 of $750.0 million of senior subordinated notes and 14.0 million
shares of common stock to repay borrowings under the senior credit facilities
and the senior subordinated bridge loan as discussed below in Financing
Activities.
We make capital expenditures for the improvement of manufacturing
facilities and equipment. We expect that capital expenditures for the full year
of 2002 will be between $75.0 million and $80.0 million.
FINANCING ACTIVITIES
In June 2002, L-3 Communications sold $750.0 million of 7 5/8% Senior
Subordinated Notes due June 15, 2012 (the "June 2002 Notes") with interest
payable semi-annually on June 15 and December 15 of each year commencing
December 15, 2002. The net proceeds from that offering amounted to $732.8
million.
On June 28, 2002, L-3 Holdings sold 14.0 million shares of its common
stock in a public offering for $56.60 per share. Upon closing, L-3 Holdings
received net proceeds of $768.4 million after deducting discounts, commissions
and estimated expenses.
The net proceeds from both of these offerings were used to (1) repay
$500.0 million borrowed on March 8, 2002, under our senior subordinated bridge
loan facility, (2) repay the indebtedness outstanding under our senior credit
facilities, (3) repurchase and redeem the 10 3/8% Senior Subordinated Notes due
2007 and (4) increase cash and cash equivalents.
On June 6, 2002 we commenced a tender offer to purchase any and all of our
$225.0 million aggregate principal amount of 10 3/8% Senior Subordinated Notes
due 2007. The tender offer expired on July 3, 2002. On June 25, 2002 we sent a
notice of redemption for all of our $225.0 million aggregate principal amount
of 10 3/8% Senior Subordinated Notes due 2007 that remained outstanding after
the expiration of the tender offer. Upon sending the notice, the remaining
notes became due and payable at the redemption price as of July 25, 2002. At
June 30, 2002, we had purchased for cash $176.9 million of these notes plus
premiums, fees and other transaction costs of $9.5 million and accrued
interest. The remaining principal amount of these notes of $48.1 million was
purchased and redeemed in July 2002 plus premiums, fees and other transaction
costs of $3.0 million and accrued interest. In connection with the extinguish-
34
ment of these notes, we recorded a pre-tax extraordinary loss of $16.2 million
($9.9 million after-tax), including premiums, fees and other transaction costs
of $12.5 million and $3.7 million to write-off the remaining balance of debt
issue costs relating to these notes.
In June 2002, we unwound the interest rate swap agreements on $200.0
million of our 8% Senior Subordinated Notes due 2008 and received cash of $8.7
million. We recorded a reduction in interest expense for the six months ended
June 30, 2002 of $3.4 million, which represented the value of the interest
savings that was earned prior to the unwinding of these swap agreements. The
remaining $5.2 million was recorded as a deferred gain and will be amortized as
a reduction of interest expense over the remaining life of the $200.0 million
of 8% Senior Subordinated Notes due 2008 at an amount of $0.2 million per
quarter, or $0.9 million annually.
In June 2002, we entered into interest rate swap agreements on $200.0
million of our 7 5/8% Senior Subordinated Notes due 2012. These swap agreements
exchange the fixed interest rate for a variable interest rate on $200.0 million
of the $750.0 million principal amount outstanding. Under these swap
agreements, we will pay or receive the difference between the fixed interest
rate of 7 5/8% on the senior subordinated notes and a variable interest rate
determined two business days prior to the beginning of the interest period
equal to (1) the six month LIBOR rate, plus (2) an average of 215.25 basis
points. The difference to be paid or received on these swap agreements as
interest rates change is recorded as an adjustment to interest expense. The
swap agreements are accounted for as fair value hedges.
For every basis point (0.01%) that the six month LIBOR interest rate is
greater than 5.47%, we will incur an additional $20,000 of interest expense
above the fixed coupon rate on $200.0 million of our 7 5/8% Senior Subordinated
Notes due 2012 calculated on a per annum basis until maturity. Conversely, for
every basis point that the six month LIBOR interest rate is less than 5.47%, we
will recognize $20,000 of interest income on $200.0 million of our 7 5/8% Senior
Subordinated Notes due 2012 calculated on a per annum basis until maturity.
On April 23, 2002, we announced that our Board of Directors had authorized
a two-for-one stock split on all shares of our common stock. The stock split
entitled all shareholders of record at the close of business on May 6, 2002 to
receive one additional share of our common stock for every share held on that
date. The additional shares were distributed to shareholders in the form of a
stock dividend on May 20, 2002. Upon completion of the stock spilt, we had
approximately 80 million shares of common stock outstanding. Additionally, all
of our historical as reported EPS data has been restated to give effect to the
stock split.
On February 26, 2002, our lenders approved a $150.0 million increase in
the amount of our senior credit facilities. The five-year revolving credit
facility increased by $100.0 million to $500.0 million and the 364-day
revolving credit facility increased by $50.0 million to $250.0 million.
Additionally, the maturity date of the $250.0 million 364-day revolving credit
facility was extended to February 25, 2003.
At June 30, 2002, available borrowings under our senior credit facilities
were $577.7 million after reductions for outstanding letters of credit of
$172.3 million.
The senior credit facilities, senior subordinated notes, Convertible Notes
and CODES agreements contain financial covenants and other restrictive
covenants which remain in effect so long as we owe any amount or any commitment
to lend exists thereunder. We are in compliance with those covenants in all
material respects. The borrowings under the senior credit facilities are
guaranteed by L-3 Holdings and by substantially all of the material domestic
subsidiaries of L-3 Communications on a senior basis. The payments of principal
and premium, if any, and interest on the senior subordinated notes are
unconditionally guaranteed, on an unsecured senior subordinated basis, jointly
and severally, by all of L-3 Communications' restricted subsidiaries other than
its foreign subsidiaries. The guarantees of the senior subordinated notes are
junior to the guarantees of the senior credit facilities and rank pari passu
with each other and the guarantees of the Convertible Notes and the CODES. The
Convertible Notes and CODES are unconditionally guaranteed, on an unsecured
senior subordinated basis, jointly and severally, by L-3 Communications and
substantially all of its direct and indirect domestic subsidiaries. These
guarantees rank junior to the guarantees of the senior credit facilities and
rank pari passu with each other and the
35
guarantees of the senior subordinated notes. See Note 7 to our consolidated
financial statements for the fiscal year ended December 31, 2001, included in
our Annual Report on Form 10-K for the fiscal year ended December 31, 2001, for
a description of our debt and related financial covenants at December 31, 2001.
Based upon our current level of operations, we believe that our cash from
operating activities, together with available borrowings under the senior
credit facilities, will be adequate to meet our anticipated requirements for
working capital, capital expenditures, commitments, research and development
expenditures, contingent purchase prices, program and other discretionary
investments, and interest payments for the foreseeable future. There can be no
assurance, however, that our business will continue to generate cash flow at
current levels, or that currently anticipated improvements will be achieved. If
we are unable to generate sufficient cash flow from operations to service our
debt, we may be required to sell assets, reduce capital expenditures, refinance
all or a portion of our existing debt or obtain additional financing. Our
ability to make scheduled principal payments or to pay interest on or to
refinance our indebtedness depends on our future performance and financial
results, which, to a certain extent, are subject to general conditions in or
affecting the defense industry and to general economic, political, financial,
competitive, legislative and regulatory factors beyond our control. There can
be no assurance that sufficient funds will be available to enable us to service
our indebtedness, or make necessary capital expenditures and to make
discretionary investments.
EARNINGS BEFORE INTEREST, TAXES, DEPRECIATION AND AMORTIZATION (EBITDA)
Our EBITDA was $116.9 million for the 2002 Second Quarter compared with
$82.8 million for the 2001 Second Quarter. Our EBITDA was $203.4 million for
the 2002 First Half compared with $150.0 million for the 2001 First Half. We
define EBITDA as operating income plus depreciation expense and amortization
expense. Other than our amount of debt and interest expense, EBITDA is the
major component in the calculation of the debt ratio and interest coverage
ratio which are part of the financial covenants for our debt. The debt ratio is
defined as the ratio of consolidated total debt to consolidated EBITDA. The
interest coverage ratio is equal to the ratio of consolidated EBITDA to
consolidated cash interest expense. Higher EBITDA on a relative basis to
outstanding debt, results in a lower debt ratio, which indicates a higher
borrowing capacity. Similarly, an increase in our EBITDA on a relative basis to
consolidated cash interest expense, results in a higher interest coverage
ratio, which indicates a greater capacity to service debt.
EBITDA is presented as additional information because we believe it to be
a useful indicator of an entity's debt capacity and its ability to service its
debt. EBITDA is not a substitute for operating income, net income or cash flows
from operating activities as determined in accordance with generally accepted
accounting principles in the United States of America. EBITDA is not a complete
net cash flow measure because EBITDA is a financial performance measurement
that does not include reductions for cash payments for an entity's obligation
to service its debt, fund its working capital and capital expenditures and pay
its income taxes. Rather, EBITDA is one potential indicator of an entity's
ability to fund these cash requirements. EBITDA as we define it may differ from
similarly named measures used by other entities and, consequently could be
misleading unless all entities calculate and define EBITDA in the same manner.
EBITDA is also not a complete measure of an entity's profitability because it
does not include costs and expenses for depreciation and amortization, interest
and income taxes.
CONTINGENCIES
See Note 9 to the Unaudited Condensed Consolidated Financial Statements.
RECENTLY ISSUED AND PROPOSED ACCOUNTING STANDARDS
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 142, Goodwill and
Other Intangible Assets, which supersedes Accounting Principles Board ("APB")
Opinion No. 17, Intangible Assets. SFAS No. 142 revised the standards for
accounting for goodwill and other intangible assets. SFAS No. 142 requires that
goodwill and indefinite lived identifiable intangible assets no longer be
amortized, but be tested for impairment at
36
least annually based on their estimated fair values. The provisions of SFAS No.
142 became effective on January 1, 2002, and require full implementation of the
impairment measurement provisions by December 31, 2002. Effective January 1,
2002, we are not recording goodwill amortization expense. Based on the
estimated fair values of our reporting units using a discounted cash flows
valuation, the goodwill for certain space and broadband commercial
communications businesses included in the Specialized Products segment may be
impaired. The aggregate amount of goodwill recorded for these businesses is
approximately $21.0 million, net of related income taxes. We expect to complete
the valuation of the assets and liabilities for these businesses and to
determine the amount of the goodwill impairment in the second half of 2002. Any
resulting impairment would be a non-cash charge, recorded effective January 1,
2002, as a cumulative effect of a change in accounting principle in accordance
with the adoption provisions of SFAS No. 142.
In August of 2001, the FASB issued SFAS No. 143, Accounting for Asset
Retirement Obligations. SFAS No. 143 applies to legal obligations associated
with the retirement of tangible long-lived assets that result from the
acquisition, construction, development or normal operation of a long-lived
asset, except for certain obligations of lessees. This statement does not apply
to obligations that arise solely from a plan to dispose of a long-lived asset.
SFAS No. 143 requires that estimated asset retirement costs be measured at
their fair values and recognized as assets and depreciated over the useful life
of the related asset. Similarly, liabilities for the present value of asset
retirement obligations are to be recognized and accreted as interest expense
each year to their estimated future value until the asset is retired. These
provisions will be applied to existing asset retirement obligations as of the
adoption date as a cumulative effect of a change in accounting principle. SFAS
No. 143 is effective for our fiscal years beginning January 1, 2003. SFAS No.
143 is not expected to have a material effect on our consolidated results of
operations and financial position.
In October of 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS No. 144 addresses financial
accounting and reporting for the impairment or disposal of long-lived assets.
This statement supersedes SFAS No. 121, Accounting for the Impairment of
Long-lived Assets and for Long-lived Assets to Be Disposed Of, and the
accounting and reporting provisions of APB Opinion No. 30, Reporting the
Results of Operations--Reporting the Effects of Disposal of a Segment of a
Business, and Extraordinary, Unusual and Infrequently Occurring Events and
Transactions (APB No. 30), for the disposal of a segment of a business (as
previously defined in that Opinion). SFAS No. 144 expands the scope of
accounting for disposals to include all components of an entity, including
reportable segments and operating segments, reporting units, subsidiaries and
certain asset groups. It requires the gain or loss on disposal to be measured
as the difference between (1) the fair value less the costs to sell and (2) the
carrying value of the component, and such gain or loss cannot include the
estimated future operating losses of the component, which were included in the
gain or loss determination under APB No. 30. SFAS No. 144 also amends
Accounting Research Bulletin No. 51, Consolidated Financial Statements, to
eliminate the exception to consolidate a subsidiary for which control is likely
to be temporary. The provisions of SFAS No. 144 became effective on January 1,
2002, SFAS No. 144 did not have a material effect on our consolidated results
of operations and financial position.
In May 2002, the FASB issued SFAS No. 145, Rescission of SFAS Nos. 4, 44
and 64, Amendment of SFAS No. 13, and Technical Corrections as of April 2002.
SFAS No. 145 rescinds SFAS No. 4, Reporting Gains and Losses from
Extinguishment of Debt, and SFAS No. 64, Extinguishments of Debt Made to
Satisfy Sinking-Fund Requirements. Under the provisions of SFAS No. 145, gains
and losses from extinguishment of debt can only be classified as extraordinary
items if they meet the criteria in APB Opinion No. 30. The provisions of this
Statement related to the rescission of SFAS No. 4 shall be applied in fiscal
years beginning after May 15, 2002. Earlier application is permitted. This
statement also amends SFAS No. 13, Accounting for Leases, to eliminate an
inconsistency between the accounting for sale-leaseback transactions and
certain lease modifications that have economic effects that are similar and is
effective for transactions occurring after May 15, 2002. This Statement also
amends other existing authoritative pronouncements to make various technical
corrections, clarify meanings, or describe their applicability under changed
conditions and are effective for financial statements issued on or after May
15, 2002. SFAS No. 145 is not expected to have a material effect on our
consolidated results of operations, financial position or cash flows.
37
In July of 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS No. 146 replaces EITF No.
94-3 "Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)." SFAS No. 146 requires companies to recognize costs associated
with exit or disposal activities when they are incurred rather than at the date
of a commitment to an exit or disposal plan as was required by EITF No. 94-3.
Examples of costs covered by SFAS No. 146 include lease termination costs and
certain employee severance costs that are associated with a restructuring,
discontinued operation, plant closing, or other exit or disposal activity. SFAS
No. 146 is to be applied to exit or disposal activities initiated after
December 31, 2002. SFAS No. 146 is not expected to have a material effect on
our consolidated results of operations and financial position.
FORWARD-LOOKING STATEMENTS
Certain of the matters discussed concerning our operations, cash flows,
financial position, economic performance, and financial condition, including in
particular, the likelihood of our success in developing and expanding our
business and the realization of sales from backlog, include forward-looking
statements within the meaning of section 27A of the Securities Act and Section
21E of the Exchange Act.
Statements that are predictive in nature, that depend upon or refer to
events or conditions or that include words such as "expects," "anticipates,"
"intends," "plans," "believes," "estimates" and similar expressions are
forward-looking statements. Although we believe that these statements are based
upon reasonable assumptions, including projections of orders, sales, operating
margins, earnings, cash flows, research and development costs, working capital,
capital expenditures and other projections, they are subject to several risks
and uncertainties, and therefore, we can give no assurance that these
statements will be achieved.
Our forward-looking statements will also be influenced by factors such as:
o our dependence on the defense industry and the business risks peculiar
to that industry including changing priorities or reductions in the
U.S. Government defense budget;
o our reliance on contracts with a limited number of agencies of, or
contractors to, the U.S. Government and the possibility of termination
of government contracts by unilateral government action or for failure
to perform;
o our ability to obtain future government contracts on a timely basis;
o the availability of government funding and changes in customer
requirements for our products and services;
o our significant amount of debt and the restrictions contained in our
debt agreements;
o collective bargaining agreements and labor disputes;
o economic conditions, competitive environment, international business
and political conditions, timing of international awards and
contracts;
o our extensive use of fixed-price contracts as compared to
cost-reimbursable contracts;
o our ability to identify future acquisition candidates or to integrate
acquired operations;
o the rapid change of technology and high level of competition in the
communication equipment industry;
o our introduction of new products into commercial markets or our
investments in commercial products or companies;
o pension, environmental or legal matters or proceedings and various
other market, competition and industry factors, many of which are
beyond our control; and
o the fair values of the assets, including goodwill and other
intangibles, of our business which can be impaired or reduced by the
other factors discussed above.
38
Readers of this document are cautioned that our forward-looking statements
are not guarantees of future performance and the actual results or developments
may differ materially from the expectations expressed in the forward-looking
statements.
As for the forward-looking statements that relate to future financial
results and other projections, actual results will be different due to the
inherent uncertainties of estimates, forecasts and projections and may be
better or worse than projected. Given these uncertainties, you should not place
any reliance on these forward-looking statements. These forward-looking
statements also represent our estimates and assumptions only as of the date
that they were made. We expressly disclaim a duty to provide updates to these
forward-looking statements, and the estimates and assumptions associated with
them, after the date of this filing to reflect events or changes or
circumstances or changes in expectations or the occurrence of anticipated
events.
39
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See Part II, Item 7, "Management's Discussion and Analysis of Results of
Operations and Financial Condition--Liquidity and Capital Resources--Market
Risks", of the Company's Annual Report on Form 10-K for the fiscal year ended
December 31, 2001 for a discussion of the Company's exposure to market risks.
The only substantial change in those risks during the six months ended June 30,
2002 is discussed below.
DERIVATIVE FINANCIAL INSTRUMENTS
INTEREST RATE RISK. Our financial instruments that are sensitive to
changes in interest rates include borrowings under the senior credit facilities
and interest rate swap agreements, all of which are denominated in U.S.
dollars. The interest rates on the senior subordinated notes, Convertible Notes
and CODES are fixed-rate and are not affected by changes in interest rates.
In 2001 we entered into interest rate swap agreements on $380.0 million of
our senior subordinated notes to convert their fixed interest rates to variable
rates and to take advantage of the current low interest rate environment. These
swap agreements are described in Part II, Item 7, "Management's Discussion and
Analysis of Results of Operations and Financial Condition--Liquidity and
Capital Resources--Market Risks", of the Company's Annual Report on Form 10-K
for the fiscal year ended December 31, 2001. In 2002, we unwound $200.0 million
of these interest rate swap agreements and entered into new swap agreements on
$200.0 million of our senior subordinated notes. The new swap agreements
discussed above are described in "Management's Discussion and Analysis of
Results of Operations and Financial Condition -- Statement of Cash Flows --
Financing Activities," of this Report. For every basis point (0.01%) that the
six month LIBOR interest rate is greater than 4.99%, we will incur an additional
$18,000 of interest expense above the fixed interest rate on $180.0 million of
senior subordinated notes calculated on a per annum basis until maturity. For
every basis point that the six month LIBOR interest rate is greater than 5.47%,
we will incur an additional $20,000 of interest expense above the fixed interest
rate on $200.0 million of senior subordinated notes calculated on a per annum
basis until maturity. Conversely, for every basis point that the six month LIBOR
interest rate is less than 4.99%, we will recognize $18,000 of interest income
on $180.0 million of senior subordinated notes calculated on a per annum basis
until maturity. For every basis point that the six month LIBOR interest rate is
less than 5.47%, we will recognize $20,000 of interest income on $200.0 million
of senior subordinated notes calculated on a per annum basis until maturity. The
six month LIBOR rate at June 30, 2002 was 1.96%.
We attempt to manage exposure to counterparty credit risk by entering into
interest rate agreements only with major financial institutions that are
expected to perform fully under the terms of such agreements. Cash payments
between us and the counterparties are made on the interest payment dates of the
senior subordinated notes for the interest rate swap agreements. Such payments
are recorded as adjustments to interest expense. Additional data on our debt
obligations, our applicable borrowing spreads included in the interest rates we
pay on borrowings under the senior credit facilities and interest rate
agreements are provided in our Annual Report on Form 10-K for the fiscal year
ended December 31, 2001 and in Note 5 to our unaudited condensed consolidated
financial statements for the six months ended June 30, 2002.
40
The table below presents significant contract terms and fair values at
June 30, 2002 for our interest rate agreements.
INTEREST RATE SWAP AGREEMENTS
-------------------------------------
(in millions)
Notional amount ............. $200.0 $180.0
Interest rate ............... 7 5/8% 8.5%
Reference rate .............. 6 month LIBOR 6 month LIBOR
Designated maturity ......... Semi-Annual Semi-Annual
Expiration date ............. June 15, 2012 May 15, 2008
Fair value .................. $-- $(3.3)
41
PART II - OTHER INFORMATION
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On April 23, 2002, at the Company's annual meeting of Stockholders, the
following proposals were acted on:
(1) Three nominees for the Board of Directors were elected to three-year
terms expiring in 2003. The votes were as follows:
FOR WITHHELD
--- --------
Frank C. Lanza 29,814,575 1,897,322
Robert V. LaPenta 29,816,652 1,895,245
John M. Shalikashvili 31,492,990 218,907
(2) The approval of an amendment to the Company's Amended and Restated
Certificate of Incorporation to (1) increase the number of authorized
shares of common stock, par value $.01 per share from 100,000,000 to
300,000,000 and (2) increase the number of authorized shares of preferred
stock, par value $.01 per share from 25,000,000 to 50,000,000. The votes
were as follows:
For 25,318,135
Against 6,319,775
Withheld 73,983
(3) The selection of Pricewaterhouse Coopers LLP to serve as independent
auditors for 2002 was ratified. The votes were as follows:
For 30,529,684
Against 1,168,302
Withheld 13,911
42
ITEM 6.
EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
**3.1 Certificate of Incorporation of L-3 Communications Holdings,
Inc.
3.2 Bylaws of L-3 Communications Holdings, Inc. (incorporated
herein by reference to Exhibit 3.2 of L-3 Communications
Holdings, Inc.'s Registration Statement on Form S-1, No.
333-46975)
3.3 Certificate of Incorporation of L-3 Communications Corporation
(incorporated herein by reference to Exhibit 3.1 to L-3
Communication Corporation's Registration Statement on Form
S-4, No. 333-31649)
3.4 Bylaws of L-3 Communications Corporation (incorporated herein
by reference to Exhibit 3.2 to L-3 Communication Corporation's
Registration Statement on Form S-4, No. 333-31649)
*11 L-3 Communications Holdings, Inc. Computation of Basic
Earnings Per Share and Diluted Earnings Per Share
**12.1 Ratio of Earnings to Fixed Charges
**99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
**99.2 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* The information required on this exhibit is presented in Note 7 to the
Unaudited Condensed Consolidated Financial Statements as of June 30,
2002 in accordance with the provisions of FASB SFAS No. 128, Earnings
Per Share.
** Filed herewith
(b) Reports on Form 8-K
Report filed on April 24, 2002 announcing the authorization by the Board
of Directors of L-3 Communications Holdings, Inc. of a two for one stock split
on all the shares of L-3 Communications Holdings, Inc.
Report filed on June 10, 2002 announcing that (1) L-3 Communications
Corporation intends to raise $750.0 million of gross proceeds through a private
placement of senior subordinated notes, (2) L-3 Communications Holdings, Inc.
intends to publicly offer 14.0 million shares of its common stock and (3) L-3
Communications Corporation commenced a tender offer to purchase all of its
outstanding 10 3/8% Senior Subordinated Notes due 2007.
Report filed on June 20, 2002 regarding the Company's reportable segment
presentation. Also, reported net income, basic earnings per share and diluted
earnings per share for the years ended December 31, 2001, 2000, and 1999 were
restated to exclude goodwill amortization expense, net of related income tax
effects, in accordance with SFAS No.142 and to give effect to the L-3 Holdings,
Inc. authorized stock split and increased number of authorized shares.
Report filed on June 28, 2002 announcing that (1) on June 24, 2002, L-3
Communications Holdings, Inc. priced its public offering of 14.0 million shares
of its Common Stock at $56.60 per share, (2) on June 25, 2002, L-3
Communications Corporation priced at par an offering of $750.0 million
principal amount of 7 5/8% Senior Subordinated Notes due 2012, and (3) on June
25, 2002, L-3 Communications Corporation initiated a full redemption of all of
its remaining 10 3/8% Senior Subordinated Notes due 2007.
43
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrants have duly caused this report to be signed on their behalf by the
undersigned thereunto duly authorized.
L-3 Communications Holdings, Inc. and
L-3 Communications Corporation
----------------------------------------
Registrants
Date: August 5, 2002
/s/ Robert V. LaPenta
----------------------------------------
Name: Robert V. LaPenta
Title: President and Chief Financial Officer
(Principal Financial Officer)