(The following statement was released by the rating agency)
NEW YORK, September 26 (Fitch) Fitch Ratings has affirmed the
Default Rating (IDR) and debt ratings for L-3 Communications
(L-3) and L-3 Communications Corporation. Fitch also affirms the
for L-3's convertible contingent debt securities, which are
rated one notch
below the IDR and senior unsecured debt due to the subordination
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
strong liquidity position; and Fitch's expectation of solid
substantial free cash flow (FCF; cash from operations less
and dividends). Other positive factors include L-3's diverse
products and services, and increasing international and
commercial sales which
accounted for 24% (11% international) of sales in 2012, up from
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.
percentage of in international and commercial sales is driven by
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
and share repurchases, though this is mitigated by L-3's
commitment to retaining
investment grade ratings and the $500 million of debt reduction
--L-3's exposure to declines in core U.S. defense spending, and
surrounding the fiscal 2014 Department of Defense (DoD) budget,
believes that modest defense spending declines (which are
Fitch's projections) will not have a material impact on the
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
contribution represents less than 10% of L-3's FCF.
Additionally, the pension
deficit is expected to decline in 2013 due to increasing
On July 17, 2012, L-3 completed the spin-off of Engility,
receiving a one-time
$335 million dividend. On July26, 2012, L-3 used some of the
to redeemed $250 million of 6.375% senior subordinated notes due
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
The repayment of the notes completed the company's shift away
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
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
investment grade ratings.
The company's liquidity as of June 28, 2013 was $1.3 billion,
availability of substantially all of its $1 billion credit
facility (expiring in
February 2017) and $328 million in cash and short-term
expects L-3 to maintain cash balances of approximately $600-$700
liquidity in the $1.6-1.7 billion range over the next several
Additionally, L-3 has no debt maturities through 2015 with the
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
$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
expenditures as a percentage of sales; it has averaged 1.3% of
2009 and 2012. L-3's cash generation is seasonal as the company
majority of its cash during the second half of the year. Despite
the cash flows, L-3 generates positive FCF every quarter. Fitch
L-3 will generate approximately $800 million of annual FCF
Fitch's ratings and Outlook for L-3 incorporate expectations of
deployment toward shareholders. In the first six months of 2013,
$248 million towards share repurchases and $101 million towards
payments. L-3 has increased dividends per share by double digits
the past three years (10%, 11% and 12.5% in 2013, 2012 and 2011,
Fitch expects L-3 to maintain its shareholder friendly cash
strategies and to continue increasing its dividend yield. Fitch
expects L-3 to
deploy approximately $900 million to $1 billion toward
but the cash deployment may be limited to the $600 million to
$700 million range
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
from the U.S. government which treats a part of pension costs of
contracts as allowable and reimbursable costs. Additionally, the
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
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
primarily the DoD. As a result, defense spending is a key driver
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 fiscal 2014 budget request submitted by President Obama in
attempted to avert sequestration cuts for the DoD and stabilize
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
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
will likely decline, albeit modestly, over 10 years. As an
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
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
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
the budget cut risks.
Fitch may consider a positive rating action should L-3 improve
profile by decreasing leverage and moderating its shareholder
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
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.
David Petu, CFA
Fitch Ratings, Inc.
One State Street Plaza, New York, NY 10004
Media Relations: Brian Bertsch, New York, Tel: +1 212-908-0549,
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
Dec. 13, 2012.
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and
Treatment and Notching of Hybrids in Nonfinancial Corporate and
ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND
PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS
here. IN ADDITION,
ON THE AGENCY'S
PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS,
METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S
CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE
AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE
FROM THE 'CODE OF
CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER
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
ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER
ON THE FITCH