Fitch Affirms L-3 Communications at 'BBB-'; Outlook Stable

  Fitch Affirms L-3 Communications at 'BBB-'; Outlook Stable

Business Wire

NEW YORK -- September 26, 2013

Fitch Ratings has affirmed the 'BBB-' Issuer Default Rating (IDR) and debt
ratings for L-3 Communications Holdings, Inc. (L-3) and L-3 Communications
Corporation. Fitch also affirms the 'BB+' rating for L-3's convertible
contingent debt securities, which are rated one notch below the IDR and senior
unsecured debt due to the subordination of the security's guarantees. The
Rating Outlook is Stable. Approximately $3.6 billion of outstanding debt is
covered by these ratings. A full rating list follows at the end of this
release.

Key Rating Drivers

Key factors that support the ratings include L-3's adequate credit metrics;
strong liquidity position; and Fitch's expectation of solid margins and
substantial free cash flow (FCF; cash from operations less capital
expenditures and dividends). Other positive factors include L-3's diverse
portfolio of products and services, and increasing international and
commercial sales which accounted for 24% (11% international) of sales in 2012,
up from 18% (8% international) in 2011. L-3 expects international and
commercial sales to grow to 27% in 2013, a level which L-3 achieved in the
second quarter. The higher percentage of in international and commercial sales
is driven by organic sales growth and by the spin-off of Engility Holdings,
Inc. (Engility), which reduced L-3's exposure to the U.S. government spending.

Fitch's rating concerns include:

--L-3's declining revenues and lower margins, which are expected to remain
under pressure due to the impact of sequestration and the continued withdrawal
of the U.S. troops from Afghanistan;

--The company's cash deployment strategy, which includes a focus on dividends
and share repurchases, though this is mitigated by L-3's commitment to
retaining investment grade ratings and the $500 million of debt reduction
completed in 2012; and

--L-3's exposure to declines in core U.S. defense spending, and uncertainty
surrounding the fiscal 2014 Department of Defense (DoD) budget, although Fitch
believes that modest defense spending declines (which are incorporated into
Fitch's projections) will not have a material impact on the company's credit
metrics.

Fitch's is also concerned with L-3's underfunded pension plans, with a deficit
totaling $1.2 billion (63% funded status) as of Dec. 31, 2012. This concern is
mitigated the company's strong cash generation as the required minimum
contribution represents less than 10% of L-3's FCF. Additionally, the pension
deficit is expected to decline in 2013 due to increasing interest rates.

On July 17, 2012, L-3 completed the spin-off of Engility, receiving a one-time
$335 million dividend. On July 26, 2012, L-3 used some of the dividend
proceeds to redeemed $250 million of 6.375% senior subordinated notes due 2015
to decrease its leverage heightened by the spin-off of Engility which
accounted for approximately 8%-10% of L-3's combined EBITDA and FCF in 2012.
On Oct. 15, 2012, L-3 redeemed the remaining $250 million of the 6.375% senior
subordinated notes. The repayment of the notes completed the company's shift
away from senior subordinated debt in its capital structure.

L-3's credit metrics have remained relatively stable over the past five years
with leverage in the range of 2.0x-2.2x and FFO interest coverage typically
above 6.5x, and recently above 7.0x. The company's leverage was 2.2x as of
Dec. 31, 2012. Fitch expects L-3's leverage to deteriorate by the end of 2013
driven by declining sales and lower operating margins. Leverage may increase
further in 2014 and 2015 driven by deterioration of sales and operating
results due to significant unexpected U.S. defense budget cuts; however Fitch
believes L-3 will limit the leverage deterioration to maintain financial
metrics adequate for investment grade ratings.

The company's liquidity as of June 28, 2013 was $1.3 billion, consisting of
availability of substantially all of its $1 billion credit facility (expiring
in February 2017) and $328 million in cash and short-term investments. Fitch
expects L-3 to maintain cash balances of approximately $600-$700 million and
liquidity in the $1.6-1.7 billion range over the next several years.
Additionally, L-3 has no debt maturities through 2015 with the next material
debt maturity in 2016 when $500 million of 3.95% senior unsecured notes are
due.

The company generated $185 million of FCF in the first half of 2013, compared
to $175 million for the same period in 2012 (excluding Engility results). In
the last 12 months (LTM) ending June 28, 2013, the company generated
approximately $852 million of FCF. L-3 reported approximately $850 million FCF
in 2012 and $900 million in both 2011 and 2010. L-3's FCF benefits from low
capital expenditures as a percentage of sales; it has averaged 1.3% of sales
between 2009 and 2012. L-3's cash generation is seasonal as the company
collects the majority of its cash during the second half of the year. Despite
seasonality of the cash flows, L-3 generates positive FCF every quarter. Fitch
estimates that L-3 will generate approximately $800 million of annual FCF
(after dividends).

Fitch's ratings and Outlook for L-3 incorporate expectations of meaningful
cash deployment toward shareholders. In the first six months of 2013, L-3
deployed $248 million towards share repurchases and $101 million towards
dividend payments. L-3 has increased dividends per share by double digits
annually over the past three years (10%, 11% and 12.5% in 2013, 2012 and 2011,
respectively). Fitch expects L-3 to maintain its shareholder friendly cash
deployment strategies and to continue increasing its dividend yield. Fitch
expects L-3 to deploy approximately $900 million to $1 billion toward
shareholders annually, but the cash deployment may be limited to the $600
million to $700 million range in 2013.

L-3 has a pension deficit of $1.2 billion up from $1 billion at the end of
2011 (63% funded). L-3's pension benefit obligation (PBO) was $3.2 billion at
the end of 2012. The large pension deficit is mitigated by the expected
reimbursements from the U.S. government which treats a part of pension costs
of defense contracts as allowable and reimbursable costs. Additionally, the
underfunded status of the plans is mitigated by the company's strong cash
generation as the required minimum contribution represents less than 10% of
FCF.

L-3 contributed the $173 million and $176 million minimum required amount to
its pension plans in 2012 and 2011, respectively. The company expects to
contribute approximately $165 million ($95 million discretionary) to its
pension plans in 2013 and has already contributed $43 million during the first
half ended June 28, 2013. Fitch expects L-3 to make above $100 million annual
contributions over the next several years. Additionally, the pension plan
deficit is expected to decline significantly in 2013 due to increasing
interest rates.

L-3 generated approximately 71% of its 2012 revenues from the U.S. government,
primarily the DoD. As a result, defense spending is a key driver of L-3's
financial performance and credit quality. The DoD budget environment is highly
uncertain during fiscal 2014 because of the large, automatic spending cuts
which went into effect on March 1, 2013. The full implementation of
sequestration-driven defense spending reductions beginning with fiscal 2014
will increase pressure on revenues for most U.S. contractors. However, Fitch
believes it will not necessarily have a significant effect on credit ratings
in the U.S. aerospace and defense sector if companies take actions to offset
the impact of the sequester.

The fiscal 2014 budget request submitted by President Obama in April 2013
attempted to avert sequestration cuts for the DoD and stabilize defense
spending at the fiscal 2013 budget request level. The fiscal 2014 DoD budget
will be significantly reduced from fiscal 2013 levels if the proposal does not
pass or if another compromise is not reached by October 2013. Fitch believes
that there is a high likelihood that the budget proposal will not be approved
by the start of FY2014, and Congress will either enact a continuing resolution
at fiscal 2013 DoD spending levels or will let sequestration play out as the
law is written currently. Either scenario will result in lower military
spending in fiscal 2014. Such uncertainty creates a significant challenge for
defense contractors because it impairs their ability to plan appropriate cost
cutting measures to counter the potential DoD spending cuts.

Most of the expected spending cuts are from projected budget growth and come
off the existing high spending levels. Fitch expects inflation adjusted
spending will likely decline, albeit modestly, over 10 years. As an example,
Fitch estimates the implemented budget cuts would only reduce base budgets
back to the levels seen in fiscal years 2007 or 2008.

Sequestration is incorporated into Fitch's ratings for L-3, and Fitch believes
that the implementation of sequestration cuts in fiscal 2014 would not lead to
negative rating actions given L-3's diversified portfolio, long lead times for
program execution and solid backlog. Sequestration is expected to impact new
awards and Fitch believes L-3 will be able to adjust its cost structure to
maintain profitability. L-3's sales are not tied to any major program as the
company does not have a contract which represents more than 3% of its
revenues. A higher percentage of sales to foreign and commercial customers
also mitigates the budget cut risks.

Rating Sensitivities:

Fitch may consider a positive rating action should L-3 improve its credit
profile by decreasing leverage and moderating its shareholder friendly cash
deployment strategies. A negative rating action may be considered if L-3
completes a large debt-funded acquisition which weakens L-3's credit profile
or if there are dramatic changes in U.S. defense spending policies, but an
action would depend on L-3's efforts to reduce costs in line with lower
revenues.

Fitch affirms L-3's ratings as follows:

L-3 Communications Holdings, Inc.

--IDR at 'BBB-';

--Convertible contingent debt securities at 'BB+'.

L-3 Communications Corporation

--IDR at 'BBB-';

--Senior unsecured notes at 'BBB-';

--Senior unsecured revolving credit facility at 'BBB-'.

The Rating Outlook is Stable.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology: Including Short-Term Ratings and Parent and
Subsidiary Linkage', Aug. 5, 2013;

--'Treatment and Notching of Hybrids in Corporates and REIT Credit Analysis',
Dec. 13, 2012.

Applicable Criteria and Related Research:

Corporate Rating Methodology: Including Short-Term Ratings and Parent and
Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139

Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit
Analysis

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=696670

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=803368

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS.
PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK:
HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING
DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S
PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND
METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF
CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL,
COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM
THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER
PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS
OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN
EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER
ON THE FITCH WEBSITE.

Contact:

Fitch Ratings
Primary Analyst
David Petu, CFA, +1-212-908-0280
Director
Fitch Ratings, Inc.
One State Street Plaza, New York, NY 10004
or
Secondary Analyst
Craig Fraser, +1-212-908-0310
Managing Director
or
Committee Chairperson
Jason Paraschac, +1-212-908-0746
Senior Director
or
Media Relations
Brian Bertsch, +1-212-908-0549 (New York)
brian.bertsch@fitchratings.com
 
Press spacebar to pause and continue. Press esc to stop.