Attached files
| file | filename |
|---|---|
| EXCEL - IDEA: XBRL DOCUMENT - Exelis Inc. | Financial_Report.xls |
| EX-12 - EXHIBIT 12 - Exelis Inc. | xls-2014930xexhibit12.htm |
| EX-32 - EXHIBIT 32.1 - Exelis Inc. | xls-2014930xexhibit321.htm |
| EX-31 - EXHIBIT 31.1 - Exelis Inc. | xls-2014930xexhibit311.htm |
| EX-32 - EXHIBIT 32.2 - Exelis Inc. | xls-2014930xexhibit322.htm |
| EX-31 - EXHIBIT 31.2 - Exelis Inc. | xls-2014930xexhibit312.htm |
| EX-3 - EXHIBIT 3.2 - Exelis Inc. | xls-2014930xexhibit32.htm |
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2014
or
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 001-35228
EXELIS INC.
(Exact name of registrant as specified in its charter)
State of Indiana | 45-2083813 | |
(State or Other Jurisdiction of Incorporation or Organization) | (I.R.S. Employer Identification Number) | |
(Address of Principal Executive Offices)
(703) 790-6300
(Registrant’s telephone number, including area code)
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 and (2) has been subject to such filing requirements for the past 90 days. Yes þ No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer þ | Accelerated filer ¨ | Non-accelerated filer ¨ | Smaller reporting company ¨ | |||
(Do not check if a smaller reporting company) | ||||||
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
As of October 28, 2014 there were 186,749,096 shares of common stock ($0.01 par value per share) outstanding.
TABLE OF CONTENTS
Page | 2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
EXELIS INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
Product revenue | $ | 503 | $ | 498 | $ | 1,506 | $ | 1,515 | |||||||
Service revenue | 565 | 643 | 1,724 | 2,062 | |||||||||||
Total revenue | 1,068 | 1,141 | 3,230 | 3,577 | |||||||||||
Cost of product revenue | 356 | 354 | 1,088 | 1,091 | |||||||||||
Cost of service revenue | 477 | 537 | 1,456 | 1,708 | |||||||||||
Selling, general and administrative expenses | 117 | 100 | 344 | 337 | |||||||||||
Research and development expenses | 18 | 11 | 43 | 39 | |||||||||||
Restructuring and asset impairment charges | 4 | 6 | 11 | 68 | |||||||||||
Operating income | 96 | 133 | 288 | 334 | |||||||||||
Interest expense, net | 9 | 10 | 27 | 28 | |||||||||||
Other (income) expense, net | (1 | ) | 3 | (5 | ) | 2 | |||||||||
Income from continuing operations before income tax expense | 88 | 120 | 266 | 304 | |||||||||||
Income tax expense | 36 | 40 | 101 | 102 | |||||||||||
Net income | $ | 52 | $ | 80 | $ | 165 | $ | 202 | |||||||
Earnings Per Share | |||||||||||||||
Basic | |||||||||||||||
Net income | $ | 0.28 | $ | 0.42 | $ | 0.87 | $ | 1.07 | |||||||
Diluted | |||||||||||||||
Net income | $ | 0.27 | $ | 0.41 | $ | 0.85 | $ | 1.06 | |||||||
Weighted average common shares outstanding – basic | 188.4 | 188.5 | 189.0 | 188.3 | |||||||||||
Weighted average common shares outstanding – diluted | 193.2 | 192.8 | 193.9 | 191.0 | |||||||||||
Cash dividends declared per common share | $ | 0.10 | $ | 0.10 | $ | 0.31 | $ | 0.31 | |||||||
The accompanying notes are an integral part of the condensed consolidated financial statements.
Page | 3
EXELIS INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)
(IN MILLIONS)
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
Net income | $ | 52 | $ | 80 | $ | 165 | $ | 202 | |||||||
Other comprehensive income (loss), net of tax | |||||||||||||||
Net foreign currency translation adjustments | (9 | ) | 9 | (5 | ) | (3 | ) | ||||||||
Defined benefit plans | |||||||||||||||
Net actuarial gain arising during the period | — | — | — | 116 | |||||||||||
Amortization of net actuarial loss included in net periodic benefit cost | 25 | 17 | 52 | 53 | |||||||||||
Amortization of prior service cost included in net periodic benefit cost | — | — | 1 | 1 | |||||||||||
Other comprehensive income (loss), net of tax | 16 | 26 | 48 | 167 | |||||||||||
Total comprehensive income | $ | 68 | $ | 106 | $ | 213 | $ | 369 | |||||||
The accompanying notes are an integral part of the condensed consolidated financial statements.
Page | 4
EXELIS INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(IN MILLIONS)
September 30, 2014 | December 31, 2013 | ||||||
Assets | |||||||
Current assets | |||||||
Cash and cash equivalents | $ | 524 | $ | 469 | |||
Receivables, net | 939 | 939 | |||||
Inventories, net | 258 | 246 | |||||
Deferred tax asset | 44 | 16 | |||||
Other current assets | 42 | 70 | |||||
Total current assets | 1,807 | 1,740 | |||||
Plant, property and equipment, net | 452 | 498 | |||||
Goodwill | 2,195 | 2,184 | |||||
Other intangible assets, net | 157 | 167 | |||||
Deferred tax asset | 186 | 216 | |||||
Other non-current assets | 120 | 79 | |||||
Total non-current assets | 3,110 | 3,144 | |||||
Total assets | $ | 4,917 | $ | 4,884 | |||
Liabilities and Shareholders’ Equity | |||||||
Current liabilities | |||||||
Accounts payable | $ | 311 | $ | 367 | |||
Advance payments and billings in excess of costs | 266 | 301 | |||||
Compensation and other employee benefits | 183 | 216 | |||||
Other accrued liabilities | 173 | 160 | |||||
Total current liabilities | 933 | 1,044 | |||||
Defined benefit plans | 1,259 | 1,407 | |||||
Long-term debt | 778 | 649 | |||||
Deferred tax liability | 3 | 2 | |||||
Other non-current liabilities | 155 | 130 | |||||
Total non-current liabilities | 2,195 | 2,188 | |||||
Total liabilities | 3,128 | 3,232 | |||||
Commitments and contingencies (Note 15) | |||||||
Shareholders’ equity | |||||||
Common stock | 2 | 2 | |||||
Additional paid-in capital | 2,660 | 2,623 | |||||
Treasury stock | (69 | ) | (16 | ) | |||
Retained earnings | 580 | 475 | |||||
Accumulated other comprehensive loss | (1,384 | ) | (1,432 | ) | |||
Total shareholders’ equity | 1,789 | 1,652 | |||||
Total liabilities and shareholders’ equity | $ | 4,917 | $ | 4,884 | |||
The accompanying notes are an integral part of the condensed consolidated financial statements.
Page | 5
EXELIS INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(IN MILLIONS)
Nine Months Ended September 30, | |||||||
2014 | 2013 | ||||||
Operating activities | |||||||
Net income | $ | 165 | $ | 202 | |||
Adjustments to reconcile net income to net cash provided by operating activities: | |||||||
Depreciation and amortization | 88 | 85 | |||||
Stock-based compensation | 21 | 25 | |||||
Restructuring and asset impairment charges | 11 | 68 | |||||
Payments for restructuring | (23 | ) | (42 | ) | |||
Defined benefit plans expense | 48 | 69 | |||||
Defined benefit plans payments | (134 | ) | (136 | ) | |||
Change in assets and liabilities | |||||||
Change in receivables | 1 | (22 | ) | ||||
Change in inventories | (10 | ) | (4 | ) | |||
Change in other assets | 9 | (5 | ) | ||||
Change in accounts payable | (56 | ) | (93 | ) | |||
Change in advance payments and billings in excess of costs | (35 | ) | 13 | ||||
Change in deferred taxes | (14 | ) | 31 | ||||
Change in other liabilities | 2 | (73 | ) | ||||
Other, net | (2 | ) | — | ||||
Net cash provided by operating activities | 71 | 118 | |||||
Investing activities | |||||||
Capital expenditures | (37 | ) | (57 | ) | |||
Proceeds from the sale of assets | 4 | 9 | |||||
Acquisitions, net of cash acquired | (22 | ) | (16 | ) | |||
Other, net | (1 | ) | — | ||||
Net cash used in investing activities | (56 | ) | (64 | ) | |||
Financing activities | |||||||
Proceeds from the issuance of debt | 140 | — | |||||
Payment of debt Issuance costs | (4 | ) | — | ||||
Dividends paid | (60 | ) | (39 | ) | |||
Common stock repurchased | (53 | ) | (5 | ) | |||
Proceeds from the exercise of stock options | 17 | 11 | |||||
Other, net | 2 | (2 | ) | ||||
Net cash provided by (used in) financing activities | 42 | (35 | ) | ||||
Exchange rate effects on cash and cash equivalents | (2 | ) | (2 | ) | |||
Net change in cash and cash equivalents | 55 | 17 | |||||
Cash and cash equivalents – beginning of year | 469 | 292 | |||||
Cash and cash equivalents – end of period | $ | 524 | $ | 309 | |||
The accompanying notes are an integral part of the condensed consolidated financial statements.
Page | 6
EXELIS INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(IN MILLIONS, EXCEPT PER SHARE AMOUNTS, UNLESS OTHERWISE STATED)
NOTE 1
BACKGROUND, BASIS OF PRESENTATION AND USE OF ESTIMATES
Background
Exelis Inc. (“Exelis” or the “Company”) is a diversified aerospace, defense, information and services company that leverages a greater than 50-year legacy of deep customer knowledge and technical expertise to deliver affordable mission-critical solutions in the areas of imaging and analysis, electronic warfare, air traffic solutions, positioning and navigation, communications and information systems, logistics, and technical services to military, government and commercial customers in the United States and globally. We are focused on strategic growth in the areas of: critical networks; intelligence, surveillance, reconnaissance (ISR) and analytics; electronic warfare; and composite aerostructures. The Company's customers include the U.S. Department of Defense (DoD) and its prime contractors, U.S. Government intelligence agencies, the National Aeronautics and Space Administration (NASA), the Federal Aviation Administration (FAA), allied foreign governments and domestic and foreign commercial customers. As a prime contractor, subcontractor, or preferred supplier, Exelis participates in many high priority defense and civil government programs in the United States and internationally. Exelis conducts most of its business with the U.S. Government, principally the DoD.
References in these notes to “Exelis”, “we,” “us,” “our,” “the Company” and “our Company” refer to Exelis Inc. and its subsidiaries, unless the context otherwise requires.
Basis of Presentation
The unaudited Condensed Consolidated Financial Statements included in this Form 10-Q have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) and, in the opinion of management, reflect all adjustments (which include normal recurring adjustments) necessary for a fair presentation of the Company's financial position, results of operations, and cash flows for the periods presented. Certain information and note disclosures normally included in financial statements prepared annually in accordance with accounting principles generally accepted in the United States of America (GAAP) have been condensed or omitted pursuant to such SEC rules. These financial statements should be read in conjunction with the audited Consolidated and Combined Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2013. We believe that the disclosures included in this Form 10-Q are adequate to make the information presented not misleading.
Our quarterly financial periods end on the Friday closest to the last day of the calendar quarter, except for the last quarterly period of the fiscal year, which ends on December 31st. For ease of presentation, the quarterly financial statements included herein are described as ending on the last day of the calendar quarter. The results reported in these financial statements are not necessarily indicative of results that may be expected for the entire year.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting periods. Estimates are revised as additional information becomes available. Estimates and assumptions are used for, but not limited to, revenue recognition, income taxes, contingency accruals and valuation allowances, fair value measurements, impairment of goodwill and other intangible assets, postretirement obligations and certain contingent liabilities. Actual results could differ from these estimates.
Page | 7
During the performance of long-term sales contracts, estimated final contract prices and costs are reviewed periodically and revisions are made as required and recorded in income in the period in which they are determined. Changes in estimated revenue, cost of revenue and the related effect to operating income are recognized using a cumulative catch-up adjustment which recognizes in the current period the cumulative effect of the changes on current and prior periods based on a contract’s percent complete. For the three and nine months ended September 30, 2014, net favorable cumulative catch-up adjustments related to prior periods increased operating income by approximately $6 and $6, respectively, and diluted earnings per share by approximately $0.02 and $0.02, respectively. For the three and nine months ended September 30, 2013, net favorable cumulative catch-up adjustments related to prior periods increased operating income by approximately $16 and $83, respectively, and diluted earnings per share by approximately $0.06 and $0.29, respectively.
NOTE 2
RECENT ACCOUNTING PRONOUNCEMENTS
Pronouncements Not Yet Adopted
In May 2014, the Financial Accounting Standards Board (FASB) issued final guidance on revenue recognition, which provides a single, comprehensive revenue recognition model for all contracts with customers, aimed at improving comparability within industries, across industries, and across capital markets. The new guidance contains principles, including a five step approach, that an entity will apply to determine the measurement and timing of revenue recognition that will require an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new guidance also requires additional disclosures intended to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and the related cash flows. Adoption of this guidance could affect the measurement and timing of revenue recognition on our contracts. The guidance is effective for the first interim period within annual reporting periods beginning after December 15, 2016, and can be applied retrospectively to each prior reporting period presented (full retrospective method) or retrospectively with the cumulative effect of initial application of the guidance recognized in retained earnings on the date of initial adoption (simplified transition method). Early adoption is not permitted. We are currently evaluating the methods of adoption and the potential impact of this guidance on our financial position, results of operations and cash flows.
The FASB recently issued final guidance aimed at reducing the frequency of disposals reported as discontinued operations by raising the threshold for a disposal to qualify as a discontinued operation, focusing on strategic shifts that have or will have a major effect on an entity's operations and financial results. The guidance expands the disclosures for discontinued operations, but does not change the presentation requirements for discontinued operations in the income statement. The guidance is effective prospectively for annual periods beginning on or after December 15, 2014, with early adoption permitted, and would only apply to disposals completed subsequent to adoption. We will adopt this guidance on January 1, 2015.
Other new pronouncements issued but not effective until after September 30, 2014 are not expected to have a material impact on our financial position, results of operations or cash flows.
NOTE 3
SPIN-OFF OF VECTRUS
On the first day of our fiscal fourth quarter, September 27, 2014, the Company completed the previously announced spin-off of part of its military and government services business ("Vectrus, Inc." or "Vectrus", formerly referred to as Mission Systems) through a pro rata distribution to the Company's shareholders of one share (in whole shares) of Vectrus common stock for every 18 shares (in whole shares) of the Company's common stock held by such shareholders on September 18, 2014 (the "Record Date"), or approximately 10.5 shares of Vectrus common stock. Immediately after the spin-off, the Company did not beneficially own any shares of Vectrus common stock. Additionally, on September 26, 2014, Vectrus incurred debt and made a net cash distribution of $136 to a subsidiary of Exelis in connection with the spin-off. This cash distribution is subject to a working capital adjustment. The spin-off has been structured to qualify as a tax-free transaction to Exelis and its shareholders for U.S. Federal income tax purposes,
Page | 8
except to the extent shareholders receive cash in lieu of fractional shares. Vectrus began trading as an independent, publicly traded company on the New York Stock Exchange on September 29, 2014.
The spin-off was completed pursuant to various agreements between the Company and Vectrus executed on September 25, 2014 that govern the ongoing relationships between the companies after the spin-off and provided mechanisms for an orderly transition, including the transfer of assets and assumption of liabilities at spin-off and the allocation of employee benefits, income taxes, and certain other liabilities and obligations attributable to periods prior to the spin-off. The executed agreements include the Distribution Agreement, Employee Matters Agreement, Tax Matters Agreement, Master Transition Services Agreement and certain agreements relating to intellectual property.
Vectrus is part of the Company’s Information and Technical Services segment and included the following major program areas: Infrastructure Asset Management; Logistics and Supply Chain Management; and Information Technology and Network Communication Services. As the spin-off was completed subsequent to the end of the Company's quarterly financial reporting period on the last Friday of the calendar quarter (September 26, 2014), this Form 10-Q includes Vectrus' financial results as part of our continuing operations. Vectrus' financial results prior to the spin-off will be reported as discontinued operations beginning in our Annual Report on Form 10-K for the year ended December 31, 2014.
NOTE 4
EARNINGS PER SHARE
The following table sets forth the reconciliation of basic and diluted weighted average shares outstanding for our earnings per share calculations:
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||
Weighted average common shares outstanding | 188.4 | 188.5 | 189.0 | 188.1 | |||||||
Add: Weighted average restricted stock awards outstanding(a) | — | — | — | 0.2 | |||||||
Basic weighted average common shares outstanding | 188.4 | 188.5 | 189.0 | 188.3 | |||||||
Add: Dilutive impact of stock options | 2.7 | 2.2 | 2.8 | 0.9 | |||||||
Add: Dilutive impact of restricted stock units | 2.1 | 2.1 | 2.1 | 1.8 | |||||||
Diluted weighted average common shares outstanding | 193.2 | 192.8 | 193.9 | 191.0 | |||||||
(a) | Restricted stock awards containing rights to non-forfeitable dividends which participate in undistributed earnings with common shareholders are considered participating securities for purposes of computing earnings per share. |
For the three and nine months ended September 30, 2014, we excluded from our diluted share calculation 0.6 and 0.4 shares, respectively, related to stock options and zero and less than 0.1 shares, respectively, related to restricted stock units, and for the three and nine months ended September 30, 2013, we excluded 0.1 and 2.6 shares, respectively, related to stock options and zero and less than 0.1 shares, respectively, related to restricted stock units, as their effect would have been antidilutive.
NOTE 5
SHAREHOLDERS’ EQUITY
Capital Stock
Authorized capital was comprised of 750 shares of common stock ($0.01 par value per share) and 50 shares of preferred stock (no par value per share) on September 30, 2014 and December 31, 2013. There were 192.5 and 190.4 shares of common stock issued at September 30, 2014 and December 31, 2013, respectively, and 188.5 and 189.4 shares of common stock outstanding at September 30, 2014 and December 31, 2013, respectively. No preferred stock was issued and outstanding at September 30, 2014 and December 31, 2013.
Page | 9
During the nine months ended September 30, 2014, we repurchased a total of 2.9 shares of our common stock under our share repurchase program for $53, and as of September 30, 2014 the Company had remaining authorization of $31 for future share repurchases through December 31, 2015.
Dividends
On August 12, 2014, our Board of Directors declared a cash dividend of $0.10 per share, payable on October 1, 2014 to shareholders of record on August 29, 2014. During the nine months ended September 30, 2014, we declared three quarterly cash dividends totaling $60 or $0.31 per share.
NOTE 6
ACCUMULATED OTHER COMPREHENSIVE LOSS
The following table presents changes in accumulated other comprehensive loss, net of tax, by component, for the nine months ended September 30, 2014:
Net Foreign Currency Translation Adjustments | Unamortized Defined Benefit Plan Costs | Accumulated Other Comprehensive Loss | ||||||||
Balance at January 1, 2014 | $ | 16 | $ | (1,448 | ) | $ | (1,432 | ) | ||
Other comprehensive income (loss) before reclassifications | (5 | ) | — | (5 | ) | |||||
Amounts reclassified from accumulated other comprehensive loss | — | 53 | (a) | 53 | ||||||
Other comprehensive income (loss), net of tax | (5 | ) | 53 | 48 | ||||||
Balance at September 30, 2014 | $ | 11 | $ | (1,395 | ) | $ | (1,384 | ) | ||
(a) This accumulated other comprehensive loss component primarily relates to the amortization of net actuarial loss. For the three and nine months ended September 30, 2014, the amortization of net actuarial loss was $25 (net of tax of $(2)) and $52 (net of tax of $15), respectively, which are included in the computation of net periodic benefit cost (Note 12).
Unamortized defined benefit plan costs consist primarily of net actuarial loss totaling $1,391 and $1,443, net of tax, as of September 30, 2014 and December 31, 2013, respectively. Net actuarial gains or losses principally arise from gains or losses on plan assets due to variations in the fair market value of the underlying assets and changes in the benefit obligation due to changes in actuarial assumptions.
Unamortized defined benefit plan costs included in accumulated other comprehensive loss in the unaudited Condensed Consolidated Balance Sheets were reduced by taxes of $919 and $934 as of September 30, 2014 and December 31, 2013, respectively. The changes in defined benefit plan costs included in other comprehensive income (loss) in the unaudited Condensed Consolidated Statements of Comprehensive Income were reduced by taxes of $(2) and $15 for the three and nine months ended September 30, 2014, respectively, and $11 and $111 for the three and nine months ended September 30, 2013, respectively.
NOTE 7
INCOME TAXES
Effective Tax Rate
Our quarterly income tax expense is measured using an estimated annual effective income tax rate, adjusted for discrete items within the period. The comparison of effective income tax rates between periods is significantly affected by discrete items recognized during the periods, the level and mix of earnings by tax jurisdiction and permanent differences.
Page | 10
For the three months ended September 30, 2014, the Company recorded an income tax provision of $36 or 40.9% of income from continuing operations before income tax expense as compared to $40 or 33.3% during the same prior year period. For the nine months ended September 30, 2014, the Company recorded an income tax provision of $101 or 38.0% of income from continuing operations before income tax expense as compared to $102 or 33.6% during the same prior year period. The effective income tax rate varies from the federal statutory rate of 35% primarily due to the unfavorable impact of state taxes offset by the favorable impact from the U.S. manufacturing deduction. The effective income tax rate for the three and nine months ended September 30, 2014 included the unfavorable impact of discrete items primarily related to tax credit adjustments. The effective income tax rate for the nine months ended September 30, 2013 also included the favorable impact of a discrete item related to the renewal of the 2012 federal research and development tax credit.
Uncertain Tax Positions
As of September 30, 2014 and December 31, 2013, unrecognized tax benefits were $40 and $0, respectively. Unrecognized tax benefits are primarily related to the timing of certain income and deductions and could partially impact income tax expense when settled. We anticipate that these unrecognized tax benefits will not significantly decrease within the next twelve months.
NOTE 8
RECEIVABLES, NET
Receivables, net were comprised of the following:
September 30, 2014 | December 31, 2013 | ||||||
Billed receivables | $ | 388 | $ | 395 | |||
Unbilled contract receivables | 545 | 537 | |||||
Other | 9 | 11 | |||||
Receivables, gross | 942 | 943 | |||||
Allowance for doubtful accounts | (3 | ) | (4 | ) | |||
Receivables, net | $ | 939 | $ | 939 | |||
Total billed receivables due from the U.S. Government, either directly or as a subcontractor with the U.S. Government, were $287 and $314 at September 30, 2014 and December 31, 2013, respectively. Because the Company’s billed receivables are primarily with the U.S. Government, the Company does not have a material credit risk exposure.
Unbilled contract receivables represent revenue recognized on long-term sales contracts in excess of amounts billed as of the balance sheet date. We expect to bill and collect substantially all of the September 30, 2014 unbilled contract receivables during the next twelve months as scheduled performance milestones are completed or units are delivered.
NOTE 9
INVENTORIES, NET
Inventories, net were comprised of the following:
September 30, 2014 | December 31, 2013 | ||||||
Production costs of contracts in process | $ | 222 | $ | 217 | |||
Less progress payments | (24 | ) | (27 | ) | |||
Production costs of contracts in process, net | 198 | 190 | |||||
Product inventory | 60 | 56 | |||||
Inventories, net | $ | 258 | $ | 246 | |||
Page | 11
NOTE 10
GOODWILL AND OTHER INTANGIBLE ASSETS, NET
Goodwill
As of September 30, 2014 and December 31, 2013, goodwill was $2,195 and $2,184, respectively. As of September 30, 2014 and December 31, 2013, goodwill for our C4ISR Electronics and Systems segment was $1,808 and $1,800, respectively, and goodwill for our Information and Technical Services segment was $387 and $384, respectively.
During the third quarter of 2014, the Company acquired Barco Orthogon GmbH for an aggregate purchase price of approximately $18, net of cash acquired, resulting in an increase in goodwill of $8 and other intangible assets of $6. The operating results of the business are reported in the Information and Technical Services segment from the date of acquisition. The assets, liabilities and results of operations for the acquired business were not material to the Company.
Other Intangible Assets, Net
Information regarding our other intangible assets was as follows:
September 30, 2014 | December 31, 2013 | ||||||||||||||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Intangibles | Gross Carrying Amount | Accumulated Amortization | Net Intangibles | ||||||||||||||||||
Customer and distributor relationships | $ | 526 | $ | (388 | ) | $ | 138 | $ | 525 | $ | (371 | ) | $ | 154 | |||||||||
Proprietary technology | 36 | (22 | ) | 14 | 30 | (22 | ) | 8 | |||||||||||||||
Trademarks, patents and other | 10 | (5 | ) | 5 | 9 | (4 | ) | 5 | |||||||||||||||
Total other intangible assets | $ | 572 | $ | (415 | ) | $ | 157 | $ | 564 | $ | (397 | ) | $ | 167 | |||||||||
Amortization expense related to other intangible assets for the three and nine months ended September 30, 2014 was $6 and $18, respectively, and $7 and $20 for the three and nine months ended September 30, 2013, respectively.
Estimated amortization expense for the remaining three months of 2014 and each of the five succeeding years and thereafter is as follows:
Remaining 2014 | $ | 6 | |
2015 | 22 | ||
2016 | 20 | ||
2017 | 18 | ||
2018 | 15 | ||
2019 and thereafter | 76 | ||
Total | $ | 157 | |
NOTE 11
DEBT
Debt consisted of the following:
September 30, 2014 | December 31, 2013 | ||||||
Current portion of Vectrus term loan | $ | 11 | $ | — | |||
Total short-term debt | 11 | — | |||||
Long-term debt | 779 | 650 | |||||
Unamortized debt discounts | (1 | ) | (1 | ) | |||
Total long-term debt | 778 | 649 | |||||
Total debt | $ | 789 | $ | 649 | |||
Page | 12
The following table provides a summary of interest rates, carrying values and estimated fair values of outstanding long-term debt:
September 30, 2014 | December 31, 2013 | |||||||||||||||||
Interest rate | Carrying Value | Fair Value | Carrying Value | Fair Value | ||||||||||||||
Long-term debt | ||||||||||||||||||
Senior notes due 2016 | 4.25 | % | $ | 250 | $ | 263 | $ | 250 | $ | 263 | ||||||||
Senior notes due 2021 | 5.55 | % | 400 | 425 | 400 | 404 | ||||||||||||
Vectrus term loan | 2.99 | % | 140 | 140 | — | — | ||||||||||||
Total | $ | 790 | $ | 828 | $ | 650 | $ | 667 | ||||||||||
The fair value of our notes was determined using prices in secondary markets for identical and similar securities (Level 2 inputs) obtained from external pricing sources. The fair value of the Vectrus term loan approximates the carrying value due to the Vectrus term loan's floating interest rate and due to the short duration between the execution of the Vectrus term loan agreement and the balance sheet date.
Commercial Paper
The Company's commercial paper program is fully supported by available borrowing capacity under our Credit Facility. As of September 30, 2014 and December 31, 2013, there was no commercial paper outstanding under our commercial paper program.
Credit Facility
The Company has a competitive advance and revolving credit facility agreement (“Credit Facility”) with a consortium of lenders, which is available for working capital, capital expenditures and other general corporate purposes. The Credit Facility provides for a four year maturity, expiring October 25, 2015, with a one year extension option upon satisfaction of certain conditions, and comprises an aggregate principal amount of up to $600 of revolving loans, competitive advances and letters of credit with a face amount up to $100. Borrowings under the Credit Facility bear interest at rates based, at our option, on a Eurodollar rate or an alternate base rate, as defined in the Credit Facility. As of September 30, 2014 and December 31, 2013, there were no borrowings or letters of credit outstanding under the Credit Facility.
The Credit Facility contains customary affirmative and negative covenants that, among other things, limit or restrict our ability to: incur additional debt or issue guarantees of indebtedness; create liens; enter into certain sale and lease-back transactions; merge or consolidate with another person; sell, transfer, lease or otherwise dispose of assets; liquidate or dissolve; and enter into restrictive covenants. Additionally, the Credit Facility requires us not to permit the ratio of combined total indebtedness to combined EBITDA (leverage ratio) to exceed 3.50 to 1.00 at any time.
Senior Notes
The Company has outstanding long-term debt consisting of $250 aggregate principal amount of 4.25% senior notes due October 1, 2016 and $400 aggregate principal amount of 5.55% senior notes due October 1, 2021 (together the “Notes”). As of September 30, 2014 and December 31, 2013, accrued interest payable on the Notes, included in other accrued liabilities, was $16 and $8, respectively, and is payable on April 1 and October 1 of each year.
The Notes have covenants that restrict our ability to, subject to exceptions, incur indebtedness secured by liens or engage in sale and leaseback transactions. The Notes also have customary events of default, including, but not limited to, non-payment of principal and interest, and certain events of bankruptcy, insolvency or reorganization of the Company. Under the terms of the Notes, we have the option to redeem the Notes prior to maturity, and we will be required to make an offer to purchase the Notes if a change of control triggering event (as defined in the Notes indenture) occurs.
Page | 13
Vectrus Debt
In connection with the spin-off of Vectrus, on September 17, 2014, Vectrus, a wholly-owned subsidiary of the Company, entered into a Credit Agreement with a consortium of lenders, including JP Morgan Chase Bank, N.A. as administrative agent. The Credit Agreement includes a five-year senior secured revolving credit facility ("Revolving Facility") and five-year senior secured term loan ("Term Loan"). The Revolving Facility is available for Vectrus' working capital, capital expenditures and other general corporate purposes. Vectrus used the net proceeds from the Term Loan to pay a net cash distribution to a subsidiary of Exelis on September 26, 2014. The Revolving Facility and Term Loan will remain with Vectrus subsequent to the spin-off.
The Revolving Facility is comprised of an aggregate principal amount of up to $75 of revolving loans, up to $35 of which can be used for the issuance of letters of credit, and expires on September 17, 2019. As of September 30, 2014, there were no borrowings or letters of credit outstanding under the Revolving Facility.
The Term Loan consists of an aggregate principal amount of $140 of debt borrowed on September 26, 2014 and is repayable in quarterly installments, with the first installment due December 31, 2014. The quarterly Term Loan repayments are 1.88% of the aggregate principal amount per quarter during year one, 2.50% during each of years two and three, 3.75% during year four, and 14.38% during year five, with the final quarterly installment due September 17, 2019. Voluntary prepayments of principal are allowed without penalty and annual mandatory prepayments are required if there is excess cash flow, as defined in the Credit Agreement.
Borrowings under the Revolving Facility and Term Loan bear interest at rates, at Vectrus' option, based on an alternate base rate or an adjusted LIBO rate, plus an applicable rate dependent on the total leverage ratio of Vectrus, as defined in the Credit Agreement. Interest is payable, at a minimum, quarterly. All borrowings under the Credit Agreement are secured by a first-priority lien on substantially all tangible and intangible assets of Vectrus.
The Credit Agreement contains affirmative and negative covenants that, among other things, restrict Vectrus' ability to, subject to exceptions, create liens and encumbrances; incur additional indebtedness; merge, dissolve, liquidate or consolidate; make acquisitions, investments, advances or loans; dispose of or transfer assets; pay dividends or make other payments in respect of capital stock; amend certain material governance or debt documents; redeem or repurchase capital stock or prepay, redeem or repurchase certain debt; engage in certain transactions with affiliates; enter into certain speculative hedging arrangements; and enter into certain restrictive agreements. The Credit Agreement also requires Vectrus to maintain a ratio of consolidated EBITDA to consolidated interest expense, net of cash interest income, of greater than or equal to 4.50 to 1.00 and a ratio of consolidated indebtedness to consolidated EBITDA (leverage ratio) of less than or equal to 3.50 to 1.00 from December 31, 2014 through June 30, 2015; 3.00 to 1.00 from July 1, 2015 through December 31, 2015; and 2.75 to 1.00 from January 1, 2016 and thereafter.
The Credit Agreement contains customary events of default, including, but not limited to, nonpayment of principal and interest; violation of covenants; failure to pay certain judgments; certain events of bankruptcy and insolvency; certain materially adverse ERISA events; and a change in control. If an event of default occurs, remedies include, but are not limited to, the right of lenders to request immediate payment of all or part of the outstanding principal and interest and termination of future commitments to extend credit under the Revolving Facility.
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NOTE 12
POSTRETIREMENT BENEFIT PLANS
The following tables provide the components of net periodic benefit cost for our defined benefit plans, including defined benefit pension plans and other postretirement defined benefit plans:
Three Months Ended September 30, | |||||||||||||||||||||||
2014 | 2013 | ||||||||||||||||||||||
Pension | Other Benefits | Total | Pension | Other Benefits | Total | ||||||||||||||||||
Net periodic benefit cost | |||||||||||||||||||||||
Service cost | $ | 15 | $ | — | $ | 15 | $ | 16 | $ | — | $ | 16 | |||||||||||
Interest cost | 62 | 5 | 67 | 60 | 5 | 65 | |||||||||||||||||
Expected return on plan assets | (86 | ) | (5 | ) | (91 | ) | (83 | ) | (5 | ) | (88 | ) | |||||||||||
Amortization of net actuarial loss | 22 | 1 | 23 | 25 | 3 | 28 | |||||||||||||||||
Amortization of prior service cost | — | — | — | — | — | — | |||||||||||||||||
Total net periodic benefit cost | $ | 13 | $ | 1 | $ | 14 | $ | 18 | $ | 3 | $ | 21 | |||||||||||
Nine Months Ended September 30, | |||||||||||||||||||||||
2014 | 2013 | ||||||||||||||||||||||
Pension | Other Benefits | Total | Pension | Other Benefits | Total | ||||||||||||||||||
Net periodic benefit cost | |||||||||||||||||||||||
Service cost | $ | 47 | $ | 1 | $ | 48 | $ | 54 | $ | 1 | $ | 55 | |||||||||||
Interest cost | 188 | 15 | 203 | 180 | 14 | 194 | |||||||||||||||||
Expected return on plan assets | (256 | ) | (16 | ) | (272 | ) | (254 | ) | (16 | ) | (270 | ) | |||||||||||
Amortization of net actuarial loss | 64 | 3 | 67 | 79 | 9 | 88 | |||||||||||||||||
Amortization of prior service cost | 1 | — | 1 | 2 | — | 2 | |||||||||||||||||
Net periodic benefit cost | 44 | 3 | 47 | 61 | 8 | 69 | |||||||||||||||||
Effect of curtailments | 1 | — | 1 | — | — | — | |||||||||||||||||
Total net periodic benefit cost | $ | 45 | $ | 3 | $ | 48 | $ | 61 | $ | 8 | $ | 69 | |||||||||||
We contributed $123 and $114 to our qualified defined benefit pension plans during the nine months ended September 30, 2014 and 2013, respectively. We currently anticipate making additional contributions to our qualified defined benefit pension plans in the range of $10 to $20 during the remainder of 2014.
NOTE 13
STOCK-BASED COMPENSATION
The Company maintains an equity incentive plan to govern awards granted to Exelis employees and directors, including awards of non-qualified stock options (NQOs), restricted stock units (RSUs), total shareholder return (TSR) awards, and other awards.
The following table provides the impact of stock-based compensation in our unaudited Condensed Consolidated Statements of Operations:
Three Months Ended September 30, | Nine Months Ended September 30, 2014 | ||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
Compensation cost for equity-based awards | $ | 5 | $ | 7 | $ | 18 | $ | 20 | |||||||
Compensation cost for liability-based awards | 2 | 2 | 3 | 5 | |||||||||||
Total compensation costs, pre-tax | $ | 7 | $ | 9 | $ | 21 | $ | 25 | |||||||
Future tax benefit | $ | 3 | $ | 3 | $ | 8 | $ | 8 | |||||||
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At September 30, 2014, total unrecognized compensation costs related to equity-based awards and liability-based awards were $15 and $3, respectively, which are expected to be recognized ratably over a weighted-average period of 2.0 years and 1.9 years, respectively.
The following table provides a summary of the activities for NQOs and RSUs for the nine months ended September 30, 2014:
Stock Options | Restricted Stock Units | ||||||||||||
Shares | Weighted- Average Exercise Price Per Share | Shares | Weighted- Average Grant Date Fair Value Per Share | ||||||||||
Outstanding at January 1, 2014 | 11.46 | $ | 11.13 | 3.48 | $ | 11.48 | |||||||
Granted | 0.57 | 20.82 | 0.72 | 20.52 | |||||||||
Exercised | (1.51 | ) | 10.85 | — | — | ||||||||
Vested | — | — | (0.81 | ) | 12.64 | ||||||||
Forfeited, canceled or expired | (0.08 | ) | 10.95 | (0.06 | ) | 12.16 | |||||||
Outstanding at September 30, 2014 | 10.44 | $ | 11.70 | 3.33 | $ | 13.15 | |||||||
During the nine months ended September 30, 2014, we granted long-term incentive awards to employees consisting of 0.6 NQOs and 0.7 RSUs with respective weighted average grant date fair values per share of $5.12 and $20.52. The NQOs vest annually in three equal installments and have a ten-year expiration period. The RSUs vest annually in three equal installments. We also granted TSR awards with an aggregate target value of $5 that are cash settled at the end of a three-year performance period. The fair value of the NQOs was estimated on the date of grant using the Black-Scholes model. The fair value of the RSUs was determined based on the closing price of Exelis common stock on the date of grant. The fair value of the TSR awards were measured based on the Company’s performance relative to the performance of the S&P 1500 Aerospace and Defense index. Depending on the Company’s performance during the three-year performance period, payment can range from 0% to 200% of the target value.
The following table details the weighted average assumptions utilized in determining the fair value of the NQOs granted during the first nine months of 2014.
Dividend yield | 1.98 | % | |
Expected volatility | 26.8 | % | |
Expected life (in years) | 7.0 | ||
Risk-free rates | 2.20 | % | |
Weighted-average grant date fair value per share | $ | 5.12 | |
NOTE 14
RELATED PARTY TRANSACTIONS
Separation Agreements
On October 31, 2011, ITT Corporation ("ITT") completed the spin-off (the “ITT Spin-off”) of Exelis and Exelis began operating as a stand-alone publicly traded corporation. Prior to the ITT Spin-off, Exelis operated as the Defense and Information Solutions Segment of ITT.
In order to govern certain ongoing relationships between Exelis and ITT following the ITT Spin-off and to provide mechanisms for an orderly transition, on October 25, 2011, Exelis, ITT, and Xylem Inc. executed the various agreements that govern the ongoing relationships between and among the three companies after the ITT Spin-off and provided for the allocation of employee benefits, income taxes, and certain other liabilities and obligations attributable to periods prior to the ITT Spin-off. The executed agreements include the Distribution Agreement, Benefits and Compensation Matters Agreement, Tax Matters Agreement, several real estate matters agreements, and Master Transition Services Agreement. Certain intercompany work orders and/or informal intercompany commercial arrangements were converted into third-party contracts based on ITT’s standard terms and conditions.
Page | 16
The Distribution Agreement provides for certain indemnifications and cross-indemnifications among Exelis, ITT and Xylem Inc. The indemnifications address a variety of subjects, including indemnification by ITT of Exelis in respect of certain asserted and unasserted asbestos or silica liability claims.
Services provided to and received from ITT and Xylem Inc. under the separation agreements were generally provided at cost and were substantially completed by the end of 2013. At September 30, 2014 and December 31, 2013, total payables due from Exelis to ITT and Xylem Inc. were $9 and $9, respectively, and total receivables due to Exelis from ITT and Xylem Inc. were $7 and $7, respectively.
NOTE 15
COMMITMENTS AND CONTINGENCIES
General
From time to time, we are involved in legal proceedings that are incidental to the operation of our businesses. Some of these proceedings seek remedies relating to environmental matters, personal injury claims, employment and pension matters, and commercial or contractual disputes, sometimes related to acquisitions or divestitures.
Although the ultimate outcome of any legal matter cannot be predicted with certainty, based on present information, including our assessment of the merits of the particular claim, we do not expect that any asserted or unasserted legal claims or proceedings, individually or in the aggregate, will have a material adverse effect on our cash flow, results of operations, or financial condition.
Environmental
In the ordinary course of business, we are subject to federal, state, local, and foreign environmental laws and regulations. We are responsible, or are alleged to be responsible, for ongoing environmental investigation and remediation of multiple sites. These sites are in various stages of investigation and/or remediation and in many of these proceedings our liability is considered de minimis. We have received notification from the U.S. Environmental Protection Agency (EPA), and from other governmental agencies, that a number of sites formerly or currently owned and/or operated by Exelis, and other properties or water supplies that may be or have been impacted from those operations, contain disposed or recycled materials or wastes and require environmental investigation and/or remediation. These sites include instances where we have been identified as a potentially responsible party under federal and state environmental laws and regulations.
Accruals for environmental matters are recorded on a site by site basis when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated, based on current law and existing technologies available to us. Our accrued liabilities for these environmental matters represent our best estimates related to the investigation and remediation of environmental media such as water, soil, soil vapor, air and structures, as well as related legal fees. These estimates, and related accruals, are reviewed quarterly and updated for progress of investigation and remediation efforts and changes in facts and legal circumstances. Liabilities for these environmental expenditures are recorded on an undiscounted basis.
It is difficult to estimate the final costs of investigation and remediation due to various factors, including incomplete information regarding particular sites and other potentially responsible parties, uncertainty regarding the extent of investigation or remediation and our share, if any, of liability for such conditions, the selection of alternative remedial approaches, and changes in environmental standards and regulatory requirements. We have estimated and accrued $26 and $26 as of September 30, 2014 and December 31, 2013, respectively, for environmental matters. We believe the total amount accrued is appropriate based on existing facts and circumstances.
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The following table illustrates the range of estimated loss and number of active sites for these environmental matters:
September 30, 2014 (a) | December 31, 2013 | ||||||
Low-end range | $ | 23 | $ | 23 | |||
High-end range | $ | 69 | $ | 44 | |||
Number of active environmental investigations and remediation sites | 46 | 24 | |||||
(a) | In June 2014, the Company received notice from the Department of Justice, Environment and Natural Resources Division, that it may be potentially responsible for contribution to the environmental investigation and remediation of multiple locations in Alaska. Pending further information, we have increased the number of active sites and the high-end range of estimated loss based on our historical costs for similar matters. |
On April 11, 2014, the EPA issued a proposed plan for remedial alternatives to address the cleanup of the lower eight mile stretch of the Passaic River. The EPA estimates the cost for the alternatives will range from $0.4 billion to $3.2 billion. The EPA’s preferred alternative would involve dredging the river bank to bank and installing an engineered cap at an estimated cost of $1.7 billion. The EPA is currently evaluating all the input from a public comment period that ended in August 2014 before it makes its final record of decision, which is expected in 2015. Therefore, the ultimate remedial approach and associated costs and the parties who will participate in funding the remediation and their respective allocations have not been determined. The Company has found no evidence that it contributed any of the primary contaminants of concern to the Passaic River. We will vigorously defend our self in this matter and we believe our ultimate costs will not be material.
U.S. Government Contracts, Investigations and Claims
The Company has U.S. Government contracts that are funded incrementally on a year-to-year basis. Changes in government policies, priorities or funding levels through agency or program budget reductions by the U.S. Congress or executive agencies could have a material adverse effect on the Company’s cash flow, financial condition or results of operations. Furthermore, contracts with the U.S. Government may be terminated or suspended by the U.S. Government at any time, with or without cause. Such contract suspensions or terminations could result in un-reimbursable expenses or charges or otherwise adversely affect the Company’s cash flow, financial condition or results of operations.
Departments and agencies of the U.S. Government have the authority to investigate various transactions and operations of the Company, and the results of such investigations may lead to administrative, civil or criminal proceedings, the ultimate outcome of which could be fines, penalties, repayments or compensatory or treble damages. U.S. Government regulations provide that certain findings against a contractor may lead to suspension or debarment from future U.S. Government contracts or the loss of export privileges for a company or an operating division or subdivision. Suspension or debarment could have a material adverse effect on the Company because of its reliance on U.S. Government contracts.
U.S. Government agencies, including the Defense Contract Audit Agency (DCAA) and others, routinely audit and review a contractor’s performance on government contracts, indirect rates and pricing practices, and compliance with applicable contracting and procurement laws, regulations and standards. Accordingly, costs billed or billable to the U.S. Government customers are subject to potential adjustment upon audit by such agencies. They also review the adequacy of the contractor’s compliance with government standards for its accounting and management internal control systems, including: control environment and accounting systems, general information technology systems, budget and planning systems, purchasing systems, material management systems, compensation systems, labor systems, indirect and other direct costs systems, billing systems and estimating systems. Audits currently underway include the Company’s control environment and accounting, billing, and indirect and other direct cost systems, as well as reviews of the Company’s compliance with certain U.S. Government Cost Accounting Standards.
Page | 18
From time to time, U.S. Government customers advise the Company of claims and penalties concerning certain potential disallowed costs. When such findings are presented, Exelis and the U.S. Government representatives engage in discussions to enable Exelis to evaluate the merits of these claims as well as to assess the amounts being claimed. Where appropriate, provisions are made to reflect the expected exposure to the matters raised by the U.S. Government representatives and such provisions are reviewed on a quarterly basis for sufficiency based on the most recent information available.
Indemnifications
As part of the ITT Spin-off, Exelis, ITT and Xylem Inc. indemnify one another with respect to such parties’ assumed or retained liabilities under the Distribution Agreement and breaches of the Distribution Agreement or related ITT Spin-off agreements. Exelis expects ITT and Xylem Inc. to fully perform under the terms of the Distribution Agreement and therefore we have not recorded a liability for matters for which we are indemnified. In addition, we are not aware of any claims or other circumstances that would give rise to material payments to ITT or Xylem Inc. under the indemnity that we provide to them.
Letters of Credit
In the ordinary course of business, we use standby letters of credit, guarantees issued by commercial banks and surety bonds issued by insurance companies, as well as self-guarantees, principally to guarantee our performance on certain contracts and to support our self-insured workers’ compensation plans. At September 30, 2014, there was an aggregate of approximately $91 in surety bonds, guarantees and stand-by letters of credit outstanding.
Rabbi Trust
The Company maintains a grantor trust (“Rabbi Trust”) for the purpose of assisting the Company with the payment of certain nonqualified deferred compensation obligations in the event of a change in control of the Company. The Company is obligated to contribute an amount equal to 110 percent of the Company’s obligations under eight nonqualified deferred compensation plans at the time of an “Acceleration Event,” as defined in such plans and the Rabbi Trust.
NOTE 16
SEGMENT INFORMATION
The Company’s segments are reported on the same basis used internally for evaluating performance and for allocating resources. We operate in two segments: Command, Control, Communications, Computers, Intelligence, Surveillance and Reconnaissance (C4ISR) Electronics and Systems, and Information and Technical Services. Assets of the business segments exclude general corporate assets, which principally consist of cash, deferred tax assets, certain plant, property, and equipment, and certain other assets.
C4ISR Electronics and Systems
This segment provides engineered systems and solutions, including: ISR systems; integrated electronic warfare systems; radar and sonar systems; electronic attack and release systems; communications solutions; space systems; and composite aerostructures, for government and commercial customers around the world.
Information and Technical Services
This segment provides a broad range of service solutions, including: systems integration; network design and development; air traffic management; cyber; intelligence; operations; sustainment; advanced engineering; logistics; and space launch and range-support, for a wide variety of U.S. military and U.S. Government customers.
Page | 19
Segment financial results were as follows:
Three Months Ended September 30, | |||||||||||||||||||||||
2014 | 2013 | ||||||||||||||||||||||
Product Revenue | Service Revenue | Total Revenue | Product Revenue | Service Revenue | Total Revenue | ||||||||||||||||||
C4ISR Electronics and Systems | $ | 503 | $ | — | $ | 503 | $ | 498 | $ | — | $ | 498 | |||||||||||
Information and Technical Services | — | 565 | 565 | — | 643 | 643 | |||||||||||||||||
Total | $ | 503 | $ | 565 | $ | 1,068 | $ | 498 | $ | 643 | $ | 1,141 | |||||||||||
Nine Months Ended September 30, | |||||||||||||||||||||||
2014 | 2013 | ||||||||||||||||||||||
Product Revenue | Service Revenue | Total Revenue | Product Revenue | Service Revenue | Total Revenue | ||||||||||||||||||
C4ISR Electronics and Systems | $ | 1,506 | $ | — | $ | 1,506 | $ | 1,515 | $ | — | $ | 1,515 | |||||||||||
Information and Technical Services | — | 1,724 | 1,724 | — | 2,062 | 2,062 | |||||||||||||||||
Total | $ | 1,506 | $ | 1,724 | $ | 3,230 | $ | 1,515 | $ | 2,062 | $ | 3,577 | |||||||||||
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
Operating Income | |||||||||||||||
C4ISR Electronics and Systems | $ | 59 | $ | 69 | $ | 162 | $ | 128 | |||||||
Information and Technical Services | 37 | 64 | 126 | 206 | |||||||||||
Total Operating Income | $ | 96 | $ | 133 | $ | 288 | $ | 334 | |||||||
Operating Margin | |||||||||||||||
C4ISR Electronics and Systems | 11.7 | % | 13.9 | % | 10.8 | % | 8.4 | % | |||||||
Information and Technical Services | 6.5 | % | 10.0 | % | 7.3 | % | 10.0 | % | |||||||
Total Operating Margin | 9.0 | % | 11.7 | % | 8.9 | % | 9.3 | % | |||||||
September 30, 2014 | December 31, 2013 | ||||||
Assets | |||||||
C4ISR Electronics and Systems | $ | 3,027 | $ | 3,031 | |||
Information and Technical Services | 1,115 | 1,097 | |||||
Segments total | 4,142 | 4,128 | |||||
Corporate and Other | 775 | 756 | |||||
Total Assets | $ | 4,917 | $ | 4,884 | |||
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(In millions, except per share amounts, unless otherwise stated)
The following discussion of our financial condition and results of operations should be read in conjunction with the unaudited Condensed Consolidated Financial Statements and notes thereto included in this quarterly report on Form 10-Q as well as the audited Consolidated and Combined Financial Statements and the notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2013, which provides additional information regarding the Company, our products and services, industry outlook and forward-looking statements that involve risks and uncertainties. The forward-looking statements are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about our industry, business and future financial results. Our actual results could differ materially from the results contemplated by these forward looking statements.
OVERVIEW
Exelis is a diversified aerospace, defense, information and services company that leverages a greater than 50-year legacy of deep customer knowledge and technical expertise to deliver affordable mission-critical solutions in the areas of imaging and analysis, electronic warfare, air traffic solutions, positioning and navigation, communications and information systems, logistics, and technical services to military, government and commercial customers in the United States and globally. We are focused on strategic growth in the areas of: critical networks; intelligence, surveillance, reconnaissance (ISR) and analytics; electronic warfare; and composite aerostructures. The Company's customers include the U.S. Department of Defense (DoD) and its prime contractors, U.S. Government intelligence agencies, the National Aeronautics and Space Administration (NASA), the Federal Aviation Administration (FAA), allied foreign governments and domestic and foreign commercial customers. As a prime contractor, subcontractor, or preferred supplier, Exelis participates in many high priority defense and civil government programs in the United States and internationally. Exelis conducts most of its business with the U.S. Government, principally the DoD.
We operate in two segments: Command, Control, Communications, Computers, Intelligence, Surveillance and Reconnaissance (C4ISR) Electronics and Systems, and Information and Technical Services. Our C4ISR Electronics and Systems segment provides engineered systems and solutions, including: ISR systems; integrated electronic warfare systems; radar and sonar systems; electronic attack and release systems; communications solutions; space systems; and composite aerostructures, for government and commercial customers around the world. Our Information and Technical Services segment provides a broad range of service solutions, including: systems integration; network design and development; air traffic management; cyber; intelligence; operations; sustainment; advanced engineering; logistics; and space launch and range-support, for a wide variety of U.S. military and U.S. Government customers.
Spin-off of Vectrus
On September 27, 2014, the Company completed the previously announced spin-off of part of its military and government services business ("Vectrus, Inc." or "Vectrus", formerly referred to as Mission Systems) through a pro rata distribution of Vectrus common stock to the Company's shareholders that has been structured to qualify as a tax-free transaction to Exelis and its shareholders. Vectrus began trading as an independent, publicly traded company on the New York Stock Exchange on September 29, 2014. Vectrus is part of the Company’s Information and Technical Services segment and included the following major program areas: Infrastructure Asset Management; Logistics and Supply Chain Management; and Information Technology and Network Communication Services. As the spin-off was completed subsequent to the end of the Company's quarterly financial reporting period, this Form 10-Q includes Vectrus' financial results as part of our continuing operations.
Economic Opportunities, Challenges, and Risks
U.S. defense and other discretionary budgets have been under pressure as the United States continues to face economic challenges and as concerns over persistent U.S. fiscal deficits and the level of U.S. national debt continue to drive political debate. The Consolidated Appropriations Act of 2014, which was signed into law on January 17, 2014, provides $1.012 trillion in discretionary spending and adheres to the Bipartisan Budget Act of 2013. Within the $1.012 trillion in discretionary spending, the amount for national security and defense related spending for fiscal year 2014 was $520 billion, about $2 billion more than in fiscal year 2013. Within the $1.014 trillion in discretionary
Page | 21
spending for fiscal year 2015, the amount for national security and defense related spending increased slightly to $521 billion.
The Budget Control Act of 2011 (Budget Control Act) provided for a reduction in planned defense budgets and mandated substantial additional spending reductions through a process known as "sequestration." The sequestration spending reductions required for defense were approximately $43 billion for fiscal year 2013, increasing to approximately $55 billion for fiscal year 2014 and beyond. The combined effect of the Bipartisan Budget Act of 2013 and the Consolidated Appropriations Act of 2014 is a substantial alteration of sequestration in the near term. The Congressional Budget Office (CBO) reported that there would be no additional cuts, across the board cuts or sequestration in fiscal year 2014. This is the expectation, because Congress has enacted a fiscal year 2014 appropriations bill complying with the new defense and non-defense caps. The same could occur in fiscal year 2015 if Congress appropriates no more than the $1.014 trillion in discretionary spending and adheres to the revised defense and non-defense caps. By incorporating these alterations to the original Budget Control Act, the CBO still anticipates achievement of $539 billion in discretionary spending reductions from fiscal year 2016 to 2021.
Companies which derive substantial revenues from federal contracting will benefit from comprehensive legislation which implements fundamental multi-year changes that would prevent sequestration from continuing. The debate over how and when a solution may be reached over the as-yet unresolved sequestration matter remains a significant issue for the defense industry. Uncertainty by our customers related to potential changes in their appropriations and strategic priorities and continued spending reductions from sequestration could materially impact our business.
Programs related to the support of ongoing operations in Afghanistan are subject to changes in the level of U.S. commitment in the region. In May 2014, the Administration announced its plan to steadily reduce the U.S. military presence in Afghanistan over the next three years, to force levels of approximately 9,800 troops beginning in 2015, 5,000 troops beginning in 2016 and 500 troops beginning in 2017, down from over 60,000 U.S. troops in Afghanistan at the beginning of 2013. The U.S. military plans to maintain a limited presence at only two major operating bases after 2015.
The information provided above does not represent a complete list of known trends and uncertainties that could impact our business in either the near or long-term. It should, however, be considered along with the risk factors identified in Part 1, Item 1A under the caption “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2013 and our disclosure under the caption “Forward-Looking and Cautionary Statements” at the end of this section.
Executive Summary
Exelis reported revenue of $1.1 billion for the quarter ended September 30, 2014, a decrease of 6% compared to the corresponding period in 2013. The decrease in revenue was driven by a revenue decline of 12% within our Information and Technical Services segment primarily due to lower activity on our Afghanistan based contracts within our Infrastructure Asset Management program area. The decrease in revenue was partially offset by a 1% increase in revenue in our C4ISR Electronics and Systems segment.
Operating income for the three months ended September 30, 2014 was $96, reflecting a decrease of $37 or 28% compared to the corresponding prior year period primarily due to higher selling, general and administrative expenses and lower revenue. Operating margin decreased quarter-over-quarter to 9.0% from 11.7% primarily due to higher selling, general and administrative expenses resulting from the spin-off of Vectrus.
Further details related to the quarter are contained in the Discussion of Financial Results section.
Key Performance Indicators and Non-GAAP Measures
Management reviews key performance indicators including revenue, segment operating income and margins, orders growth, and backlog, among others metrics on a regular basis. In addition, we consider certain additional measures to be useful to management and investors evaluating our operating performance for the periods presented, and provide a tool for evaluating our ongoing operations, liquidity and management of assets. This information can assist investors in assessing our financial performance and measures our ability to generate capital for deployment among
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competing strategic alternatives and initiatives, including, but not limited to, acquisitions and debt repayment. These metrics, however, are not measures of financial performance under accounting principles generally accepted in the United States of America (GAAP) and should not be considered a substitute for revenue, operating income, income from continuing operations, or net cash from continuing operations as determined in accordance with GAAP. We consider the following non-GAAP measure, which may not be comparable to similarly titled measures reported by other companies, to be a key performance indicator:
• | “Adjusted net income” defined as net income, adjusted to exclude items that include, but are not limited to, significant charges or credits that impact current results, but are not related to our ongoing operations, unusual and infrequent non-operating items and non-operating tax settlements or adjustments. A reconciliation of adjusted net income is provided below. |
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
2014 | 2013 | 2014 | 2013 | ||||||||||||
Net income | $ | 52 | $ | 80 | $ | 165 | $ | 202 | |||||||
Separation costs related to the Vectrus spin-off, net of tax | 9 | — | 19 | — | |||||||||||
Adjusted net income | $ | 61 | $ | 80 | $ | 184 | $ | 202 | |||||||
DISCUSSION OF FINANCIAL RESULTS
THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2014 COMPARED TO THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2013
Selected financial highlights are presented in the table below:
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||
2014 | 2013 | Change | 2014 | 2013 | Change | ||||||||||||||||
Product and service revenue | $ | 1,068 | $ | 1,141 | (6.4 | )% | $ | 3,230 | $ | 3,577 | (9.7 | )% | |||||||||
Cost of product and service revenue | 833 | 891 | (6.5 | )% | 2,544 | 2,799 | (9.1 | )% | |||||||||||||
Operating expense | 139 | 117 | 18.8 | % | 398 | 444 | (10.4 | )% | |||||||||||||
Operating income | 96 | 133 | (27.8 | )% | 288 | 334 | (13.8 | )% | |||||||||||||
Operating margin | 9.0 | % | 11.7 | % | 8.9 | % | 9.3 | % | |||||||||||||
Interest expense, net | 9 | 10 | (10.0 | )% | 27 | 28 | (3.6 | )% | |||||||||||||
Other (income) expense, net | (1 | ) | 3 | (133 | )% | (5 | ) | 2 | (350 | )% | |||||||||||
Income tax expense | 36 | 40 | (10.0 | )% | 101 | 102 | (1.0 | )% | |||||||||||||
Effective income tax rate | 40.9 | % | 33.3 | % | 38.0 | % | 33.6 | % | |||||||||||||
Net income | $ | 52 | $ | 80 | (35.0 | )% | $ | 165 | $ | 202 | (18.3 | )% | |||||||||
Revenue
Revenue for the three and nine months ended September 30, 2014 decreased $73 or 6.4% and $347 or 9.7%, respectively, as compared to the same prior year periods. The following table illustrates revenue for our segments:
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||
2014 | 2013 | Change | 2014 | 2013 | Change | ||||||||||||||||
C4ISR Electronics and Systems | $ | 503 | $ | 498 | 1.0 | % | $ | 1,506 | $ | 1,515 | (0.6 | )% | |||||||||
Information and Technical Services | 565 | 643 | (12.1 | )% | 1,724 | 2,062 | (16.4 | )% | |||||||||||||
Total Revenue | $ | 1,068 | $ | 1,141 | (6.4 | )% | $ | 3,230 | $ | 3,577 | (9.7 | )% | |||||||||
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Revenue from our C4ISR Electronics and Systems segment increased $5 for the three months ended September 30, 2014 as compared with the same period in 2013. The increase in revenue was primarily due to higher revenue on our Integrated Defensive Electronic Countermeasures (IDECM) products for military aircraft and our Electronic Support Measures (ESM) systems for the Royal Australian Navy of approximately $13 and $12, respectively, partially offset by lower revenue on our communication solutions products of approximately $20.
Revenue from our C4ISR Electronics and Systems segment decreased $9 for the nine months ended September 30, 2014 as compared with the same period in 2013. The decrease in revenue was primarily due to volume declines in Night Vision products of approximately $37. Additionally, revenue decreased on our Worldview-3 satellite imaging program by approximately $18, as this program was substantially completed in 2013. The decrease in revenue was partially offset by higher revenue on our IDECM products of approximately $44.
Revenue from our Information and Technical Services segment decreased $78 and $338 for the three and nine months ended September 30, 2014, respectively, as compared with the same periods in 2013. The decrease in revenue for the three and nine months ended September 30, 2014 was primarily due to lower net activity on our Infrastructure Asset Management program area contracts, primarily the Afghan National Security Forces (ANSF) Facilities Support and Logistics Civilian Augmentation Program (LOGCAP) programs, of approximately $34 and $168, respectively, and our Information Technology and Network Communication Services program area contracts, primarily the Operations Maintenance and Defense of Army Communications in Southwest Asia and Central Asia (OMDAC-SWACA) contract, of approximately $17 and $62, respectively. Revenue on Afghanistan based contracts declined due to site reductions and reduced service levels associated with U.S. military troop reductions. The decrease in revenue for the nine months ended September 30, 2014 was partially offset by higher revenue on our Automated Dependent Surveillance-Broadcast (ADS-B) contract of approximately $13.
Cost of Revenue and Operating Expenses
Cost of product and service revenue and other operating expenses are comprised of the following:
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||
2014 | 2013 | Change | 2014 | 2013 | Change | ||||||||||||||||
Cost of product revenue | $ | 356 | $ | 354 | 0.6 | % | $ | 1,088 | $ | 1,091 | (0.3 | )% | |||||||||
% of product revenue | 70.8 | % | 71.1 | % | 72.2 | % | 72.0 | % | |||||||||||||
Cost of service revenue | $ | 477 | $ | 537 | (11.2 | )% | $ | 1,456 | $ | 1,708 | (14.8 | )% | |||||||||
% of service revenue | 84.4 | % | 83.5 | % | 84.5 | % | 82.8 | % | |||||||||||||
Selling, general and administrative expenses | $ | 117 | $ | 100 | 17.0 | % | $ | 344 | $ | 337 | 2.1 | % | |||||||||
% of total revenue | 11.0 | % | 8.8 | % | 10.7 | % | 9.4 | % | |||||||||||||
Research and development expenses | $ | 18 | $ | 11 | 63.6 | % | $ | 43 | $ | 39 | 10.3 | % | |||||||||
% of total revenue | 1.7 | % | 1.0 | % | 1.3 | % | 1.1 | % | |||||||||||||
Restructuring and asset impairment charges | $ | 4 | $ | 6 | (33.3 | )% | $ | 11 | $ | 68 | (83.8 | )% | |||||||||
% of total revenue | 0.4 | % | 0.5 | % | 0.3 | % | 1.9 | % | |||||||||||||
Cost of Product and Service Revenue
The increase in cost of product revenue of $2 or 0.6% for the three months ended September 30, 2014 as compared to the same period in 2013 was primarily due to higher revenue. The cost of product revenue as a percentage of product revenue decreased for the three months ended September 30, 2014 as compared to the corresponding period in 2013 primarily due to a net revenue mix of higher margin products.
The decrease in cost of product revenue of $3 or 0.3% for the nine months ended September 30, 2014 as compared to the same period in 2013 was primarily due to lower revenue. The cost of product revenue as a percentage of product revenue increased for the nine months ended September 30, 2014 as compared to the corresponding period in 2013 primarily due to a net revenue mix of lower margin products.
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The decrease in cost of service revenue of $60 or 11.2% and $252 or 14.8% for the three and nine months ended September 30, 2014, respectively, as compared to the same periods in 2013 was primarily due to lower activity within our Information and Technical Services segment. The cost of service revenue as a percentage of service revenue increased for the three and nine months ended September 30, 2014 as compared to the corresponding periods in 2013 primarily due to a net revenue mix of lower margin services, including lower activity on certain higher margin Afghanistan based contracts.
Selling, General & Administrative (SG&A) Expenses
SG&A expenses as a percentage of total revenue were 11.0% and 10.7% for the three and nine months ended September 30, 2014, respectively, as compared to 8.8% and 9.4%, respectively, during the same periods in 2013. The increase in SG&A expenses as a percentage of total revenue for the three and nine months ended September 30, 2014 was primarily due to higher SG&A expenses and lower revenue. For the three and nine months ended September 30, 2014, SG&A expenses increased as compared to the same periods in 2013 primarily due to separation costs resulting from the spin-off of Vectrus.
Research and Development (R&D) Expenses
The increase in R&D expenses of $7 or 63.6% and $4 or 10.3% for the three and nine months ended September 30, 2014, respectively, as compared to the same periods in 2013 was primarily due to the timing of new R&D projects.
Restructuring and Asset Impairment Charges
The decrease in restructuring and asset impairment charges of $2 and $57 for the three and nine months ended September 30, 2014, respectively, as compared to the same periods in 2013 was primarily due to a restructuring action started in the first quarter of 2013 to reduce the size of our workforce and consolidate our facilities footprint to align our cost structure more closely to customer and market conditions, which was substantially completed by the end of 2013. During the three and nine months ended September 30, 2014, restructuring and asset impairment charges primarily related to employee severance, and to a lesser extent, lease cancellation and other costs associated with the consolidation of certain facilities.
Operating Income
The following table illustrates the operating income results of our business segments, including operating margin results.
Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||||||||
2014 | 2013 | Change | 2014 | 2013 | Change | ||||||||||||||||
C4ISR Electronics and Systems | $ | 59 | $ | 69 | (14.5 | )% | $ | 162 | $ | 128 | 26.6 | % | |||||||||
Operating margin | 11.7 | % | 13.9 | % | 10.8 | % | 8.4 | % | |||||||||||||
Information and Technical Services | 37 | 64 | (42.2 | )% | 126 | 206 | (38.8 | )% | |||||||||||||
Operating margin | 6.5 | % | 10.0 | % | 7.3 | % | 10.0 | % | |||||||||||||
Total operating income | $ | 96 | $ | 133 | (27.8 | )% | $ | 288 | $ | 334 | (13.8 | )% | |||||||||
Total operating margin | 9.0 | % | 11.7 | % | 8.9 | % | 9.3 | % | |||||||||||||
Operating income at our C4ISR Electronics and Systems segment for the three months ended September 30, 2014 decreased $10 or 14.5% as compared to the same period in 2013. Operating income as a percentage of revenue for the three months ended September 30, 2014 was 11.7% as compared to 13.9% for the same period in 2013. The decrease in operating margin was primarily due to higher SG&A expenses for the three months ended September 30, 2014 as compared to the same period in 2013.
Operating income at our C4ISR Electronics and Systems segment for the nine months ended September 30, 2014 increased $34 or 26.6% as compared to the same period in 2013. Operating income as a percentage of revenue for the nine months ended September 30, 2014 was 10.8% as compared to 8.4% for the same period in 2013. The increase in operating margin was primarily due to lower restructuring charges for the nine months ended September 30, 2014 as compared to the same period in 2013.
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Operating income at our Information and Technical Services segment for the three and nine months ended September 30, 2014 decreased $27 or 42.2% and $80 or 38.8%, respectively, as compared to the same periods in 2013. Operating income as a percentage of revenue for the three and nine months ended September 30, 2014 was 6.5% and 7.3%, respectively, as compared to 10.0% for the same periods in 2013. The decrease in operating margin was primarily due to higher SG&A expenses and higher cost of service revenue as a percentage of service revenue for the three and nine months ended September 30, 2014 as compared to the same periods in 2013.
During the performance of long-term sales contracts, estimated final contract prices and costs are reviewed periodically and revisions are made as required and recorded in income in the period in which they are determined. Changes in estimated revenue, cost of revenue and the related effect to operating income are recognized using a cumulative catch-up adjustment which recognizes in the current period the cumulative effect of the changes on current and prior periods based on a contract’s percent complete. Net favorable cumulative catch-up adjustments related to prior periods increased operating income by approximately $6 and $6, for the three and nine months ended September 30, 2014, respectively, and by approximately $16 and $83 for the three and nine months ended September 30, 2013, respectively. Productivity improvements and contract pricing adjustments primarily contributed to the net favorable cumulative catch-up adjustments in the current three and nine month periods.
Impact to Operating Income from Defined Benefit Plan Expense
We recorded net periodic benefit cost of $14 and $48 for the three and nine months ended September 30, 2014, respectively, as compared to $21 and $69, respectively, during the same periods in 2013. The decrease in net periodic benefit cost was primarily attributable to better than expected return on plan assets in 2013, which resulted in lower amortization of net actuarial loss for the three and nine months ended September 30, 2014 as compared to the same periods in 2013.
Interest Expense, Net
We recorded interest expense, net, of $9 and $27 for the three and nine months ended September 30, 2014, respectively, as compared to $10 and $28, respectively, during the same periods in 2013. Interest expense, net, is primarily related to our senior notes.
Other (Income) Expense, Net
We recorded other income, net, of $1 and $5 for the three and nine months ended September 30, 2014, respectively, as compared to other expense, net, of $3 and $2, respectively, during the same periods in 2013. The period-over-period changes were not significant.
Income Tax Expense
We recorded income tax expense of $36 and $101 for the three and nine months ended September 30, 2014, respectively, which represented effective income tax rates of 40.9% and 38.0%, respectively, as compared to $40 or 33.3% and $102 or 33.6%, respectively, during the same periods in 2013. The increase in the 2014 quarterly and year-to-date effective income tax rates as compared to the same periods in 2013 was primarily due to the unfavorable impact of discrete items related to tax credit adjustments recorded in the third quarter of 2014 and the expiration of the federal research and development tax credit at the end of 2013. The 2013 year-to-date effective income tax rate also included the favorable impact of a discrete item related to the renewal of the 2012 federal research and development tax credit.
Backlog
Total backlog includes both funded backlog (firm orders for which funding is contractually obligated by the customer) and unfunded backlog (firm orders for which funding is not currently contractually obligated by the customer). Unfunded backlog represents firm orders, potential options on multi-year contracts and multi-year commercial contracts when demand is supported by customer backlog, and excludes potential orders under indefinite delivery / indefinite quantity (IDIQ) contracts. Backlog is converted into revenue as work is performed or deliveries are made. The level of order activity related to defense programs can be affected by the timing of government funding
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authorizations and project evaluation cycles. Year-over-year comparisons could, at times, be impacted by these factors, among others.
Funded orders received decreased $0.7 billion, to $3.7 billion, during the nine months ended September 30, 2014 as compared to the same period in 2013, primarily due to the absence of several large multi-year funded awards received in the first nine months of 2013 on our Middle East and Afghanistan based programs within our Information and Technical Services segment and a lower volume of funded awards for communication solutions products within our C4ISR Electronics and Systems segment. The decrease in funded orders was partially offset by higher funded orders for GPS satellite payloads within our C4ISR Electronics and Systems segment. At September 30, 2014, total backlog was $8.9 billion compared to $9.4 billion at December 31, 2013. The decrease in total backlog relates primarily to Middle East and Afghanistan based programs within our Information and Technical Services segment, partially offset by GPS and environmental satellite payloads awards within our C4ISR Electronics and Systems segment.
Backlog consisted of the following:
(In billions) | September 30, 2014 | December 31, 2013 | |||||
Funded backlog | $ | 3.9 | $ | 3.4 | |||
Unfunded backlog | 5.0 | 6.0 | |||||
Total backlog | $ | 8.9 | $ | 9.4 | |||
LIQUIDITY AND CAPITAL RESOURCES
Liquidity
We expect to fund our ongoing working capital, capital expenditures, strategic investments, and financing requirements through cash flows from operations, cash on hand and access to capital markets. If our cash flows from operations are less than we expect, we may need to access the short or long-term capital markets. We believe our $600 credit facility and commercial paper program will permit us to finance our operations on acceptable terms and conditions.
Our access to, and the availability of, financing on acceptable terms and conditions in the future will be impacted by many factors, including: (i) our credit ratings or absence of a credit rating, (ii) the liquidity of the overall capital markets, and (iii) the current state of the economy. We cannot assure that such financing will be available to us on acceptable terms or that such financing will be available at all.
A portion of our cash is held by our foreign subsidiaries. We manage our cash requirements considering available funds among our subsidiaries and the cost effectiveness with which those funds can be accessed. We continue to look for opportunities to access cash balances in excess of local operating requirements to meet liquidity needs in a cost-efficient manner.
Funding of Pension Plans
Funding requirements under applicable laws and regulations are a major consideration in making contributions to our U.S. pension plans. While the Company has significant discretion in making voluntary contributions, the Employee Retirement Income Security Act of 1974, as amended by the Pension Protection Act of 2006 and further amended by the Worker, Retiree, and Employer Recovery Act of 2008, the Moving Ahead for Progress in the 21st Century Act and applicable Internal Revenue Code regulations, mandate minimum funding thresholds. Failure to satisfy the minimum funding thresholds could result in restrictions on our ability to amend the plan or make benefit payments. With respect to U.S. qualified pension plans, we intend to contribute annually not less than the required minimum funding thresholds.
The Highway and Transportation Funding Act of 2014 (HATFA), which was signed into law on August 8, 2014, modified the interest rate stabilization provision of Moving Ahead for Progress in the 21st Century Act. We expect that this provision will reduce our minimum funding thresholds for the remainder of 2014 and for the next several years.
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At December 31, 2013, our defined benefit pension plans were underfunded by $1.2 billion. During the nine months ended September 30, 2014, we made total contributions of $123 to our qualified pension plans. We currently anticipate making additional contributions to our qualified pension plans in the range of $10 to $20 during the remainder of 2014.
Future required contributions will depend primarily on the actual annual return on assets and the discount rate used to measure the benefit obligation at the end of each year. Depending on these factors, and the resulting funded status of our pension plans, the level of future statutory minimum contributions could be material.
Dividends
Our Board of Directors will review and approve the declaration and distribution of any future dividends based on an analysis of many factors, including our operating performance and outlook, financial condition, available liquidity and expected future requirements for cash and capital resources. Moreover, if we determine to pay any dividend in the future, there can be no assurance that we will continue to pay such dividends.
On August 12, 2014, our Board of Directors declared a cash dividend of $0.10 per share, payable on October 1, 2014 to shareholders of record on August 29, 2014. During the nine months ended September 30, 2014, we declared three quarterly cash dividends totaling $60 or $0.31 per share.
Sources and Uses of Liquidity
The following table provides the net cash provided by or used in operating activities, investing activities and financing activities.
Nine Months Ended September 30, | |||||||
2014 | 2013 | ||||||
Operating activities | $ | 71 | $ | 118 | |||
Investing activities | (56 | ) | (64 | ) | |||
Financing activities | 42 | (35 | ) | ||||
Foreign exchange | (2 | ) | (2 | ) | |||
Net change in cash and cash equivalents | $ | 55 | $ | 17 | |||
Net cash provided by operating activities decreased $47 for the nine months ended September 30, 2014 as compared to the same period in 2013, primarily due to changes in advance payments and billings in excess of costs of $48, changes in deferred taxes of $45, and a decrease in restructuring and asset impairment charges net of payments for restructuring of $38, partially offset by changes in other liabilities of $75.
Net cash used in investing activities decreased $8 for the nine months ended September 30, 2014 as compared to the same period in 2013, primarily due to lower capital expenditures of $20, partially offset by higher net cash paid for acquisitions of $6.
Net cash provided by financing activities increased $77 for the nine months ended September 30, 2014 as compared to the same period in 2013, primarily due to proceeds from the Vectrus term loan of $140, partially offset by an increase in cash paid for common stock repurchases of $48 and dividend payments to our shareholders of $21.
Capital Resources
At September 30, 2014, the Company held cash and cash equivalents of $524, which included $129 held by foreign subsidiaries, and had a $600 revolving credit facility which expires in October 2015. There were no borrowings outstanding under the credit facility and there was no commercial paper outstanding under our commercial paper program as of September 30, 2014.
Borrowings under the credit facility would be unsecured and bear interest at rates based, at our option, on the Eurodollar rate or a bank defined alternative base rate. Each bank’s obligation to make loans under the credit facility is subject to, among other things, our compliance with various representations, warranties and covenants.
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The Company's commercial paper program is fully supported by available borrowing capacity under our credit facility. As with all other financing programs, our access to the commercial paper market will be impacted by many factors, including our credit ratings, liquidity of the capital markets, and state of the economy. As such, we cannot assure that we will have continued access to the commercial paper market or that the terms of the commercial paper will be acceptable to us.
We have outstanding long-term debt consisting of $250 of 4.25% senior notes due in 2016 and $400 of 5.55% senior notes due in 2021. Interest on the senior notes is payable on April 1 and October 1 of each year. The senior notes are senior unsecured obligations and rank equally with all of our existing and future senior unsecured indebtedness. The senior notes have covenants that restrict our ability to, subject to exceptions, incur indebtedness secured by liens or engage in sale and leaseback transactions, and the senior notes are subject to customary events of default.
In connection with the spin-off of Vectrus, Vectrus, a wholly-owned subsidiary of the Company, entered into a credit agreement that includes a $75 five-year senior secured revolving credit facility and $140 five-year senior secured term loan. The revolving credit facility is available for Vectrus' working capital, capital expenditures and other general corporate purposes and there were no borrowings outstanding under this facility at September 30, 2014. Vectrus used the net proceeds from the term loan to pay a net cash distribution to a subsidiary of Exelis. The revolving credit facility and term loan will remain with Vectrus subsequent to the spin-off.
The credit facility, commercial paper, senior notes and Vectrus debt are discussed further in Note 11, “Debt,” in the notes to the unaudited Condensed Consolidated Financial Statements.
Contractual Obligations
There have been no material changes to our contractual obligations from those discussed in our Annual Report on Form 10-K for the year ended December 31, 2013, except for the Vectrus term loan, which will remain with Vectrus subsequent to the spin-off. The following table represents the contractual obligations related to the Vectrus term loan as at September 30, 2014:
Payments due by period | ||||||||||||
Total | Less than 1 year | 1-3 Years | 3-5 Years | |||||||||
Debt (1) | $ | 140 | $ | 11 | $ | 28 | $ | 101 | ||||
Interest payments (2) | 17 | 4 | 8 | 5 | ||||||||
Total contractual obligations | $ | 157 | $ | 15 | $ | 36 | $ | 106 | ||||
(1) | See Note 11, “Debt,” in the notes to the unaudited Condensed Consolidated Financial Statements for additional information related to the Vectrus term loan. |
(2) | Amounts represent estimate of future interest payments on the Vectrus term loan as of September 30, 2014. |
Off-Balance Sheet Arrangements
At September 30, 2014, we had no significant off-balance sheet arrangements other than operating leases and certain indemnifications. There have been no material changes to our operating leases from those discussed in our Annual Report on Form 10-K for the year ended December 31, 2013. We do not have a liability recorded for our historic indemnifications and are not aware of any claims or other information that we believe would give rise to material payments under such indemnities. We are not aware of any claims or other circumstances that would give rise to material payments to ITT or Xylem Inc. under the indemnities that we provide to them pursuant to various separation arrangements entered into in connection with the ITT Spin-off.
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CRITICAL ACCOUNTING POLICIES, ESTIMATES AND JUDGMENTS
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting periods. Estimates are revised as additional information becomes available. Management believes that the accounting estimates employed and the resulting balances are reasonable; however, actual results in these areas could differ from management’s estimates under different assumptions or conditions.
There have been no significant changes in our critical accounting policies, estimates and judgments as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013.
Recent Accounting Pronouncements and Accounting Standards Updates
See Note 2, “Recent Accounting Pronouncements,” to the unaudited Condensed Consolidated Financial Statements for information related to recent accounting pronouncements and accounting standards updates.
FORWARD-LOOKING AND CAUTIONARY STATEMENTS
Some of the information included herein includes forward-looking statements intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995 (the “Act”). Whenever used, words such as “anticipate,” “estimate,” “expect,” “project,” “intend,” “plan,” “believe,” “target,” "may," "could," "outlook" and other terms of similar meaning are intended to identify such forward-looking statements. Forward-looking statements are uncertain and to some extent unpredictable, and involve known and unknown risks, uncertainties and other important factors that could cause actual results to differ materially from those expressed in, or implied from, such forward-looking statements. The Company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. In addition, forward-looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from the Company’s historical experience and our present expectations or projections. These risks and uncertainties include, but are not limited to, those described in Item 1A, “Risk Factors,” and elsewhere in our Annual Report on Form 10-K for the year ended December 31, 2013, and those described from time to time in our future reports filed with the Securities and Exchange Commission.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no significant changes in our market risk as discussed in our Annual Report on Form 10-K for the year ended December 31, 2013.
ITEM 4. CONTROLS AND PROCEDURES
The Company’s management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) as of September 30, 2014. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that, as of September 30, 2014, the Company’s disclosure controls and procedures were effective to accomplish their objectives.
We have evaluated the changes in our internal control over financial reporting that occurred during the three months ended September 30, 2014 and concluded that no change occurred in our internal control over financial reporting that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
From time to time, we are involved in legal proceedings that are incidental to the operation of our businesses. Some of these proceedings seek remedies relating to environmental matters, personal injury claims, employment and pension matters, and commercial or contractual disputes, sometimes related to acquisitions or divestitures.
Although the ultimate outcome of any legal matter cannot be predicted with certainty, based on present information, including our assessment of the merits of the particular claim, we do not expect that any asserted or unasserted legal claims or proceedings, individually or in the aggregate, will have a material adverse effect on our cash flow, results of operations, or financial condition.
See Note 15, “Commitments and Contingencies,” to the unaudited Condensed Consolidated Financial Statements for further information.
ITEM 1A. RISK FACTORS
The “Risk Factors” section, under Part I, Item 1A, of our Annual Report on Form 10-K for the year ended December 31, 2013 describes risks and uncertainties associated with our business. These risks and uncertainties have the potential to materially affect our business, financial condition, results of operations, cash flows, projected results, and future prospects. We do not believe that there have been any material changes to the risk factors previously disclosed.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(In millions, except per share amounts, unless otherwise stated)
There were no sales of unregistered equity securities during the quarter ended September 30, 2014. There were also no repurchases of our common stock that is registered pursuant to Section 12 of the Securities Exchange Act of 1934 during the quarter ended September 30, 2014.
We have a share repurchase program, which was approved by the Board of Directors and announced by the Company on December 11, 2012, for the repurchase of our outstanding common stock, from time-to-time, up to an authorized amount of $100. Under the program, management has discretion to determine the dollar amount of shares to be repurchased and the timing of any repurchases in compliance with applicable law and regulation. The share repurchase program expires on December 31, 2015. As of September 30, 2014, we had repurchased a total of 3.9 shares of our common stock under the program for $69 and had remaining authorization of $31 for future share repurchases. There were no repurchases of our common stock other than in connection with this share repurchase program.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS
See the Exhibit Index for a list of exhibits filed herewith.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
EXELIS INC. | ||
(Registrant) | ||
October 31, 2014 | /s/ GREGORY P. KUDLA | |
(Date) | Gregory P. Kudla | |
Chief Accounting Officer | ||
(Principal Accounting Officer) | ||
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EXHIBIT INDEX
EXHIBIT NUMBER | DESCRIPTION | LOCATION | ||
(2.1) | Distribution Agreement between Vectrus, Inc. and Exelis Inc. dated as of September 25, 2014 | Incorporated by reference to Exhibit 2.1 of Exelis Inc.’s Form 8-K Current Report filed on September 29, 2014 (CIK No. 1524471, File No. 1-35228). | ||
(3.1) | Amended and Restated Articles of Incorporation of Exelis Inc. | Incorporated by reference to Exhibit 3.1 of Exelis Inc.’s Form 8-K Current Report filed on May 9, 2014 (CIK No. 1524471, File No. 1-35228). | ||
(3.2) | Amended and Restated By-laws of Exelis Inc. | Filed herewith. | ||
(4.1) | Indenture, dated as of September 20, 2011, between Exelis Inc., ITT Corporation, as initial guarantor, and Union Bank, N.A., as trustee | Incorporated by reference to Exhibit 4.1 of ITT Corporation’s Form 8-K Current Report filed on September 21, 2011 (CIK No. 216228, File No. 1-5672). | ||
(4.2) | Form of Exelis Inc. 4.250% Senior Notes due 2016 | Incorporated by reference to Exhibit 4.5 of Exelis Inc.’s Form S-4 Registration Statement filed on May 25, 2012 (CIK No. 1524471, File No. 333-181682). | ||
(4.3) | Form of Exelis Inc. 5.550% Senior Notes due 2021 | Incorporated by reference to Exhibit 4.6 of Exelis Inc.’s Form S-4 Registration Statement filed on May 25, 2012 (CIK No. 1524471, File No. 333-181682). | ||
(10.1) | Employee Matters Agreement between Vectrus, Inc. and Exelis Inc. dated as of September 25, 2014 | Incorporated by reference to Exhibit 10.1 of Exelis Inc.’s Form 8-K Current Report filed on September 29, 2014 (CIK No. 1524471, File No. 1-35228). | ||
(10.2) | Tax Matters Agreement between Vectrus, Inc. and Exelis Inc. dated as of September 25, 2014 | Incorporated by reference to Exhibit 10.2 of Exelis Inc.’s Form 8-K Current Report filed on September 29, 2014 (CIK No. 1524471, File No. 1-35228). | ||
(10.3) | Transition Services Agreement between Vectrus, Inc. and Exelis Inc. dated as of September 25, 2014 | Incorporated by reference to Exhibit 10.3 of Exelis Inc.’s Form 8-K Current Report filed on September 29, 2014 (CIK No. 1524471, File No. 1-35228). | ||
(10.4) | Transitional Trademark License Agreement between Vectrus, Inc. and Exelis Inc. dated as of September 25, 2014 | Incorporated by reference to Exhibit 10.4 of Exelis Inc.’s Form 8-K Current Report filed on September 29, 2014 (CIK No. 1524471, File No. 1-35228). | ||
(10.5) | Technology License Agreement between Vectrus, Inc. and Exelis Inc. dated as of September 25, 2014 | Incorporated by reference to Exhibit 10.5 of Exelis Inc.’s Form 8-K Current Report filed on September 29, 2014 (CIK No. 1524471, File No. 1-35228). | ||
(10.6) | Credit Agreement by and among Vectrus, Inc., Exelis Systems Corporation, as the Borrower, the Lenders and Issuing Banks party thereto, and JPMorgan Chase Bank, N.A., as Administrative Agent, dated as of September 17, 2014 | Incorporated by reference to Exhibit 10.1 of Vectrus, Inc.’s Form 8-K Current Report filed on September 19, 2014 (CIK No. 1601548, File No. 1-36341). | ||
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EXHIBIT NUMBER | DESCRIPTION | LOCATION | ||
(11) | Statement re computation of per share earnings | Information required to be presented in Exhibit 11 is provided under “Earnings Per Share” in Note 4 to the Condensed Consolidated Financial Statements in Part I, Item 1 “Financial Statements” of Exelis Inc.’s Quarterly Report on Form 10-Q for the period ended September 30, 2014 in accordance with the provisions of Financial Accounting Standards Board Accounting Standards Codification 260, Earnings Per Share. | ||
(12) | Statement re computation of ratios | Filed herewith. | ||
(31.1) | Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | Filed herewith. | ||
(31.2) | Certification pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | Filed herewith. | ||
(32.1) | Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | This Exhibit is intended to be furnished in accordance with Regulation S-K Item 601(b) (32) (ii) and shall not be deemed to be filed for purposes of Section 18 of the Securities Exchange Act of 1934 or incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except as shall be expressly set forth by specific reference. | ||
(32.2) | Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | This Exhibit is intended to be furnished in accordance with Regulation S-K Item 601(b) (32) (ii) and shall not be deemed to be filed for purposes of Section 18 of the Securities Exchange Act of 1934 or incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except as shall be expressly set forth by specific reference. | ||
(101) | The following materials from Exelis Inc.’s Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2014, formatted in XBRL (Extensible Business Reporting Language): (i) Condensed Consolidated Statements of Operations, (ii) Condensed Consolidated Statements of Comprehensive Income, (iii) Condensed Consolidated Balance Sheets, (iv) Condensed Consolidated Statements of Cash Flows and (v) Notes to Condensed Consolidated Financial Statements. | Submitted electronically with this Report. | ||
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