Basis of Presentation

These unaudited condensed consolidated financial statements for the quarterly period ended March 29, 2019 should be read in conjunction with the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.

Principles of Consolidation and Reporting

The accompanying financial statements comprise the consolidated financial statements of L3. The consolidated financial statements of the Company include all wholly-owned and majority-owned subsidiaries and variable interest entities (VIEs) if the Company is the primary beneficiary. The Company also holds interests in certain VIEs for which it was determined the Company is not the primary beneficiary. All significant intercompany transactions are eliminated in consolidation. Investments in equity securities, joint ventures and limited liability corporations over which the Company has significant influence but does not have voting control are accounted for using the equity method. Investments over which the Company does not have significant influence are accounted for using the cost method. For the classification of certain current assets and liabilities, the Company uses the duration of the related contract or program as its operating cycle, which may be longer than one year.

Certain reclassifications have been made to conform prior-year amounts to the current-year presentation.

The unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Commission (SEC). Accordingly, they do not include all of the disclosures required by U.S. GAAP for a complete set of annual audited financial statements. The December 31, 2018 condensed consolidated balance sheet data was derived from audited financial statements but does not include all disclosures required by U.S. GAAP. In the opinion of management, all adjustments (consisting of normal and recurring adjustments) considered necessary for a fair statement of the results for the interim periods presented have been included. The results of operations for the interim periods are not necessarily indicative of results for the full year.

It is generally the Company’s established practice to close its books for the quarters ending March, June and September on the Friday preceding the end of the calendar quarter. The interim unaudited condensed consolidated financial statements included herein have been prepared and are labeled based on that convention. The Company closes its books for annual periods on December 31 regardless of what day it falls on.

Accounting Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of sales and cost of sales during the reporting period. The most significant of these estimates and assumptions relate to sales, profit and loss recognition for performance obligations satisfied over time, fair values of assets acquired and liabilities assumed in business combinations and investments, market values for inventories reported at lower of cost or realizable value, pension and post-retirement benefit obligations, stock-based employee compensation expense, income taxes, including the valuations of deferred tax assets, litigation reserves, useful lives and valuation of recorded amounts of long-lived assets, identifiable intangible assets and goodwill. Changes in estimates are reflected in the periods during which they become known. Actual amounts may differ from these estimates and could differ materially.

Revenue Recognition

A substantial majority of the Company’s consolidated net sales are generated from long-term contracts with customers that require it to design, develop, manufacture, modify, upgrade, test and integrate complex aerospace and electronic equipment and to provide engineering and technical services according to the customers’ specifications. These contracts are primarily with agencies of, and prime system contractors to, the U.S. Government and foreign governments and are generally priced on a fixed-price, cost-plus or time-and-material type basis. The majority of the Company's sales are from performance obligations satisfied over time and are primarily with agencies of, and prime system contractors to, the U.S. Government and foreign governments. The Company also records sales from performance obligations satisfied at a point in time, which are typically for standard goods. See Note 22 for additional information regarding the composition of the Company’s net sales.

Revisions or adjustments to estimates of the transaction price, estimated costs at completion and estimated profit or loss of a performance obligation may be required as work progresses under a contract, as experience is gained, as facts and circumstances change and as new information is obtained, even though the scope of work required under the contract may not change. Revisions or adjustments may also be required if contract modifications occur. The impact of revisions in profit or loss estimates are recognized on a cumulative catch-up basis in the period in which the revisions are made. The revisions in contract estimates, if significant, can materially affect the Company’s results of operations and cash flows, as well as reduce the valuations of contract assets, and in some cases result in liabilities to complete contracts in a loss position. Net sales recognized from the Company's performance obligations partially satisfied in prior periods were $83 million for the quarterly period ended March 29, 2019 and relate to revisions in contract estimates. The aggregate impact of net changes in contract estimates is presented in the table below.



	First Quarter Ended
	March 29, 2019		March 30, 2018
	(in millions, except per share data)
Operating income	$	66	$	50
Diluted earnings per share	$	0.63	$	0.48

The following table presents a summary of the Company’s net sales by revenue recognition method as a percentage of total net sales for the quarterly periods ended March 29, 2019 and March 30, 2018.



	First Quarter Ended
	March 29, 2019		March 30, 2018

Over time (cost-to-cost method)	76	%	76	%
Point in time	19	%	18	%
Output method	3	%	3	%
Billing method	2	%	3	%
Total	100	%	100	%

Remaining Performance Obligations

As of March 29, 2019, the Company had $12.0 billion of remaining performance obligations, which represents the transaction price of firm orders less inception to date sales recognized. Remaining performance obligations exclude unexercised contract options and potential orders under basic ordering agreements or master-type contracts (i.e., indefinite-delivery, indefinite-quantity). The Company expects to recognize sales relating to existing performance obligations of approximately $6.5 billion during the remainder of 2019, $3.4 billion in 2020, $1.1 billion in 2021 and $1.0 billion in the periods thereafter.

Leases

Effective January 1, 2019, the Company adopted ASU 2016-02 Leases, (ASC 842), using the optional transition method. In accordance with the optional transition method, the Company initially applied the new standard for existing leases as of January 1, 2019. In addition, in accordance with the optional transition method prior period amounts and disclosures are presented under ASC 840. The cumulative effect of applying ASC 842 was an increase of $640 million to the Company's assets and liabilities.

In accordance with ASC 842, the Company recognizes lease assets and liabilities on the balance sheet for operating and finance leases under which the Company is a lessee, except for equipment leases and, as permitted by a practical expedient under the standard, leases with a term of 12 months or less. Equipment leases were not material at January 1, 2019 or March 29, 2019 and therefore not recognized on the balance sheet for these periods. The Company recognizes a lease expense on a straight-line basis over the lease term for equipment leases and leases with a term of 12 months or less. The Company classifies operating lease assets as operating lease right-of-use (ROU) assets and operating lease liabilities in other current liabilities for obligations due within 12 months, or operating lease liabilities for obligations due longer than 12 months. Finance lease assets are classified in property, plant and equipment. Finance lease liabilities are classified in other current liabilities or other liabilities depending on when the obligation is due.

Lease assets and liabilities are recognized based on the present value of future lease payments. Lease payments primarily include rent and insurance costs (lease components). The Company's leases also include non-lease components such as real estate taxes and common-area maintenance costs. The Company elected the practical expedient to account for lease and non-lease components as a single component. In certain of the Company's leases, the non-lease components are variable and in accordance with the standard are therefore excluded from lease payments to determine the lease asset. The present value of future lease payments is determined using the Company's incremental borrowing rate at lease commencement over the expected lease term. The Company uses its incremental borrowing rate because the Company's leases do not provide an implicit lease rate. The expected lease term represents the number of years the Company expects to lease the property, including options to extend or terminate the lease when it is reasonably certain that the Company will exercise such option.

For operating leases, the lease expense is recognized on a straight-line basis over the expected lease term on the statement of operations as an operating cost. For finance leases, the asset is amortized on a straight-line basis over the lease term, and interest on the lease liability is recognized in interest expense. The amortization of lease assets for the Company's finance leases and interest expense were not material for the three months ended March 29, 2019.

Lessor

The Company is a lessor for certain arrangements for flight simulators. These leases meet the criteria for operating lease classification. Lease income associated with these leases is not material.

General and Administrative Expenses

The Company accounts for the portion of their G&A, independent research and development (IRAD) and bids and proposal (B&P) costs that are allowable and reimbursable under U.S. Government procurement regulations on their U.S. Government contracts as contract costs which are charged to costs of sales when sales on the related contracts are recognized. The Company’s U.S. Government contractor businesses record the unallowable portion of their G&A, IRAD and B&P costs to expense as incurred. G&A expenses for the Company's commercial businesses are expensed as incurred. The total research and development expenses incurred were $71 million and $75 million for the quarterly periods ended March 29, 2019 and March 30, 2018, respectively.

The Company capitalizes the incremental costs of obtaining a contract with foreign governments and foreign and domestic commercial customers (third-party sales commissions) if the Company expects to recover the costs under the contract. The Company expenses the costs to obtain a contract as incurred when the expected amortization period is one year or less. The Company classifies the portion of capitalized costs of obtaining a contract to be amortized over the next 12 months within prepaid expense and other current assets and classifies the remaining amount within other assets in its consolidated balance sheets.