Overview and Outlook

Spin-off of Engility

On July 17, 2012 L-3 Communications Holdings, Inc. (L-3 Holdings and, together with its subsidiaries, referred to herein as L-3 or the "Company") successfully completed the previously announced spin-off of its subsidiary, Engility Holdings, Inc. (Engility). L-3 shareholders of record as of July 16, 2012 (the "record date") received one share of Engility common stock for every six shares of L-3 common stock held on the record date. In connection with the spin-off, Engility made a net cash distribution of approximately $325 million to L-3. The Company used a portion of the proceeds to redeem $250 million of its 63/8% Senior Subordinated Notes due 2015 (2015 Notes) on July 26, 2012 and intends to use the remaining proceeds to repurchase approximately $75 million of its outstanding shares of common stock.

The spin-off has been structured to qualify as a tax-free distribution to L-3 shareholders for U.S. federal tax purposes, except for cash received in lieu of fractional shares. Engility began trading as an independent publicly traded company on the New York Stock Exchange on July 18, 2012.

Engility includes the systems engineering and technical assistance (SETA), training and operational support services that were part of L-3's Government Services segment. L-3 is retaining its cyber security, intelligence, enterprise information technology (IT) and security solutions businesses that are also part of L-3's Government Services segment, which has been renamed National Security Solutions (NSS). The NSS businesses develop unique solutions to address growing challenges for DoD, U.S. Government intelligence agencies, and global security customers.

As the spin-off was completed subsequent to the end of L-3's 2012 second quarter, Engility financial results will be reported as discontinued operations beginning with L-3's 2012 third quarter, along with all comparative prior periods. All amounts reported in this Management Discussion and Analysis include the Engility financial results, unless otherwise indicated.

L-3's Business

L-3 is a prime contractor in Command, Control, Communications, Intelligence, Surveillance and Reconnaissance (C3ISR) systems, aircraft modernization and maintenance, and government services. L-3 is also a leading provider of a broad range of electronic systems used on military and commercial platforms. Our customers include the United States (U.S.) Department of Defense (DoD) and its prime contractors, U.S. Government intelligence agencies, the U.S. Department of Homeland Security (DHS), U.S. Department of State (DoS), U.S. Department of Justice (DoJ), allied foreign governments, domestic and foreign commercial customers, and select other U.S. federal, state and local government agencies.

For the year ended December 31, 2011, we generated sales of $15.2 billion. Our primary customer was the DoD. The table below presents a summary of our 2011 sales by end customer and the percent contributed by each to our total 2011 sales. We currently expect sales to the DoD, as a percentage of total 2012 sales, to decline by a few percentage points as compared to sales to the DoD as a percentage of total 2011 sales.

                                                              % of
                                        2011 Sales         2011 Sales
                                       (in millions)
              DoD                     $        11,321               75 %
              Other U.S. Government             1,113                7

              Total U.S. Government            12,434               82 %
              Foreign governments               1,200                8
              Commercial - foreign                905                6
              Commercial - domestic               630                4

              Total sales             $        15,169              100 %

We have the following four reportable segments: (1) C3ISR, (2) Electronic Systems, (3) Aircraft Modernization and Maintenance (AM&M), and (4) Government Services. Financial information with respect to each of our reportable segments is included in Note 20 to our unaudited condensed consolidated financial statements. C3ISR provides products and services for the global ISR market, C3 systems, networked communications systems and secure communications products. We believe that these products and services are critical elements for a substantial number of major command, control and communication, intelligence gathering and space systems. These products and services are used to connect a variety of airborne, space, ground and sea-based communication systems and are used in the transmission, processing, recording, monitoring, and dissemination functions of these communication systems. Electronic Systems provides a broad range of products and services, including components, products, subsystems, systems, and related services to military and commercial customers in several niche markets across several business areas, including microwave, power & control systems, integrated sensor systems, aviation products, simulation & training, warrior systems, precision engagement, security & detection, space & propulsion, undersea warfare and marine services. AM&M provides modernization, upgrades and sustainment, maintenance and logistics support services for military and various government aircraft and other platforms. We sell these services primarily to the DoD, the Canadian Department of Defense and other allied foreign governments. Government Services provides a full range of SETA, training, operational support, cyber security, intelligence, enterprise IT and security solutions services to the DoD, DoS, DoJ, and U.S. Government intelligence agencies and allied foreign governments.

Industry Considerations

As described above, sales to the DoD represented approximately 75% of our total 2011 sales. The U.S. Government fiscal year ends on September 30th. From fiscal year (FY) 2000 to FY 2010, the DoD budget, including wartime funding for Overseas Contingency Operations (OCO) grew at a compound annual rate of approximately 9%. The total DoD budget (base and OCO) for FY 2011 was approximately flat compared to fiscal year 2010. During the year ended December 31, 2011, the U.S. Government completed its drawdown of U.S. military troops from Iraq, and began to drawdown troops from Afghanistan, in accordance with the Obama Administration's (the "Administration") plan to complete the drawdown from Afghanistan by the end of 2014. While the U.S. is expected to maintain a presence in the Middle East to deter aggression and prevent the emergence of new threats, we expect that there will be a rebalance toward other regions of the world such as the Asia-Pacific theatre. In addition, the U.S. Government has been under increasing pressure to reduce the U.S. fiscal budget deficit and national spending.

In August 2011, Congress enacted the Budget Control Act of 2011 (the BCA). The BCA immediately imposes spending caps that contain approximately $487 billion in reductions to the DoD base budgets over the next ten years (FY 2012 to FY 2021), compared to previously proposed DoD base budgets for the same fiscal years. An automatic sequestration process was also triggered and becomes effective on January 3, 2013, unless modified by the enactment of new law. The sequestration process imposes additional cuts of approximately $50 billion per year to the currently proposed DoD budgets for each fiscal year beginning with FY 2013 through FY 2021, for which FY 2013 to FY 2017 proposed DoD budgets are presented below.

On February 13, 2012, the Administration submitted its FY 2013 proposed budget (FY 2013 DoD Plan) to Congress, which complies with the first phase of the BCA imposed spending cuts. The FY 2013 DoD Plan reduces proposed DoD base budgets by $259 billion for FY 2013 to FY 2017, compared to the previously proposed DoD base budgets. The FY 2013 DoD Plan does not address or provision for the automatic sequestration process. The FY 2013 DoD Plan reflects a revised national security strategy that includes a more disciplined use of resources from: (1) various efficiency initiatives, (2) military force structure reductions, (3) equipment modernization savings, including program terminations, restructuring and deferrals, and (4) military personnel compensation changes. The table below presents the enacted DoD budget (base and OCO) for FY 2012 and the proposed DoD budgets for FY 2013 to FY 2017, as provided in the FY 2013 DoD Plan.

                                                                    Annual
                                                                     Total
                                                                    Budget
                  Fiscal Year    Base         OCO        Total      Change
                                               (in billions)
                  2012          $ 530.6     $ 115.1     $ 645.7          -6 %
                  2013          $ 525.4     $  88.5     $ 613.9          -5 %
                  2014          $ 533.6     $  44.2     $ 577.8          -6 %
                  2015          $ 545.9     $  44.2     $ 590.1           2 %
                  2016          $ 555.9     $  44.2     $ 600.1           2 %
                  2017          $ 567.3     $  44.2     $ 611.5           2 %

The FY 2013 DoD Plan is expected to continue to focus on advanced ISR (intelligence, surveillance and reconnaissance), communications, strike aircraft, precision-guided weapons, unmanned systems, networked information technologies, cyber security, special operations forces, missile defense and space programs, and generally, systems and capabilities that are critical to both conventional and irregular warfare, and the ability to project power in denied environments. We believe L-3 is well positioned to benefit from the DoD's focus in several of these areas. The declining DoD budgets, however, will reduce funding for some of our revenue arrangements and generally, will have a negative impact on our sales, results of operations and cash flows. Additionally, the planned withdrawal of U.S. military forces from Afghanistan by the end of 2014 is expected to negatively impact our sales related to supporting U.S. military operations in Afghanistan.

Key Performance Measures

The primary financial performance measures that L-3 uses to manage its businesses and monitor results of operations are sales and operating income trends. The two main determinants of our operating income are sales and operating margin. We define operating margin as operating income as a percentage of sales. Management believes that sales growth and operating margin improvements are financial performance measures of the primary growth drivers for L-3's earnings per common share and net cash from operating activities. Generally, in evaluating our businesses and contract performance, we focus on net sales, operating income and operating margin, and not by type or amount of operating costs. As a result of this approach and the general nature of our operations, the discussion of results of operations focuses on changes in net sales and operating margin.

One of L-3's primary business objectives is to increase sales from organic growth and select business acquisitions. We define organic sales growth as the increase or decrease in sales for the current period compared to the prior period, excluding sales in the: (1) current period from business acquisitions that are included in L-3's actual results of operations for less than twelve months, and (2) prior period from business divestitures that are included in L-3's actual results of operations for the twelve-month period prior to the divestiture date. We expect to supplement our organic sales growth by selectively acquiring businesses that: (1) add important new technologies and products, (2) provide access to select customers, programs and contracts, and
(3) provide attractive returns on investment.

Sales Trend. For the year ended December 31, 2011, consolidated net sales of $15,169 million declined by 3.3%, due to a decline in organic sales of 4.3%, partially offset by net sales from business acquisitions of 1.0%. For the quarter ended June 29, 2012 (2012 Second Quarter), consolidated net sales of $3,558 million declined by

$208 million, or 5.5%, due to a decline in organic sales of $250 million, or 6.6%, partially offset by net sales from acquisitions of $42 million, or 1.1%, compared to the quarter ended July 1, 2011 (2011 Second Quarter). For the first half ended June 29, 2012 (2012 First Half), consolidated net sales of $7,146 million declined by $221 million, or 3.0%, due to a decline in organic sales of $287 million, or 3.9%, partially offset by net sales from acquisitions of $66 million, or 0.9%, compared to the first half ended July 1, 2011 (2011 First Half).

For the year ended December 31, 2011, our largest contract (revenue arrangement) in terms of annual sales was the Fort Rucker Maintenance Support contract with the U.S. Army Aviation and Missile Life Cycle Management Command (AMCOM), which is included in our AM&M segment. Under this contract, which generated approximately 3% of our 2011 sales, we provide maintenance, logistics and other related sustainment support services for rotary-wing aircraft assigned to Fort Rucker and satellite units in Alabama. On July 24, 2012, we won the AMCOM contract re-competition, which includes a one-year base period through September 30, 2013, and four one-year options, with an estimated total contract value of $1.98 billion.

Operating Income Trend. Operating income for the 2012 Second Quarter was $367 million, a decrease of 9% from $404 million for the 2011 Second Quarter. Our operating margin was 10.3% for the 2012 Second Quarter, a decrease of 40 basis points from 10.7% for the 2011 Second Quarter. Operating income for the 2012 Second Quarter included $7 million of transaction expenses for the Engility spin-off. Excluding the spin-off transaction expenses, our segment operating income was $374 million for the 2012 Second Quarter, a decrease of 7% from $404 million for the 2011 Second Quarter, and our segment operating margin was 10.5% for the 2012 Second Quarter, a decrease of 20 basis points from 10.7% for the 2011 Second Quarter.

Operating income for the 2012 First Half was $724 million, a decrease of 9% from $794 million for the 2011 First Half. Our operating margin was 10.1% for the 2012 First Half, a decrease of 70 basis points from 10.8% for the 2011 First Half. Operating income for the 2012 First Half included $13 million of spin-off transaction expenses. Excluding the spin-off transaction expenses, our segment operating income was $737 million for the 2012 First Half, a decrease of 7% from $794 million for the 2011 First Half, and our segment operating margin was 10.3% for the 2012 First Half, a decrease of 50 basis points from 10.8% for the 2011 First Half. See Results of Operations, including segment results below for a discussion of operating margin.

We are focused on increasing operating margin, to the extent possible, by reducing our indirect costs and improving our overall contract performance. Our 2012 First Half operating margin was lower than our prior year comparative period operating margin and we expect our 2012 annual operating margin to decline as compared to 2011. While we are taking actions to increase operating margin, these actions may not be successful. Furthermore, in the future, select business acquisitions and select new business, including contract renewals and new contracts, could have lower operating margins than L-3's operating margin on existing business and contracts. Changes in the competitive environment and DoD procurement practices and reductions in our consolidated sales levels could also result in lower operating margin.

Other Events

2012 Amended and Restated Revolving Credit Facility. On February 3, 2012, we amended and restated our $1 billion Revolving Credit Facility, which extended the expiration date to February 3, 2017. The terms of the Amended and Restated Revolving Credit Facility are substantially consistent with the terms of this facility prior to its amendment and restatement except that: (1) provisions that previously limited the ability of L-3 Communications to pay dividends, repurchase L-3 Holdings' common stock and make other distributions with respect to any capital stock were eliminated, (2) a provision that previously limited the ability of L-3 Communications to make investments in L-3 Holdings was made less restrictive and (3) the cost of borrowings, loan commitment fees and letter of credit fees were reduced. In addition, the Amended and Restated Revolving Credit Facility provides for uncommitted incremental revolving facilities and additional term loan facilities in an aggregate principal amount of up to $500 million. See Note 9 of our unaudited condensed consolidated financial statements contained in this quarterly report for additional information regarding the amendment of our $1 billion Amended and Restated Revolving Credit Facility.

Debt Redemption. On July 26, 2012 (the redemption date), L-3 Communications utilized a portion of the proceeds from the spin-off of Engility to redeem $250 million in aggregate principal of the 2015 Notes at a redemption price of 102.125% of the principal amount redeemed, plus accrued and unpaid interest, up to but not including the redemption date. In connection with the redemption of the 2015 Notes, the Company will record a debt retirement charge of approximately $8 million in the quarter ending September 28, 2012.

Business Acquisitions and Dispositions

Our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 summarizes the business acquisitions and business dispositions that we completed during the three years ended December 31, 2011. During the 2012 First Half, we used $215 million of cash for the Kollmorgen Electro-Optical (KEO) and MAVCO, Inc. (MAVCO) business acquisitions. All of our business acquisitions are included in our consolidated results of operations from their dates of acquisition. Also, see Note 4 to our unaudited condensed consolidated financial statements contained in this quarterly report for further discussion of the business acquisitions completed during the 2012 First Half.

On April 7, 2012, we entered into an agreement to acquire all the assets of Thales Training & Simulation Ltd's (TTS) civil aircraft simulation and training business for approximately $132 million, which we expect to fund with cash on hand. TTS is a leading manufacturer of flight simulation systems for the civil aviation market. We anticipate completing this acquisition during the third quarter of 2012, subject to customary closing conditions and regulatory approvals. We regularly evaluate potential business acquisitions and may also dispose of certain businesses or product lines if we determine that they no longer fit into L-3's overall business strategy and we are able to receive an attractive price.

Results of Operations

The following information should be read in conjunction with our unaudited condensed consolidated financial statements contained in this quarterly report. Our results of operations for the periods presented are affected by our business acquisitions. See Note 4 to our unaudited condensed consolidated financial statements contained in this quarterly report for a discussion of our 2012 business acquisitions and Note 4 to our audited consolidated financial statements for the year ended December 31, 2011, included in our Annual Report on Form 10-K, for a discussion of our 2011 business acquisitions.