Fitch Affirms Exelis' Ratings after Spin-off Announcement; Outlook Negative

Fitch Ratings has affirmed Exelis Inc.'s (XLS) 'BBB+' Issuer Default Rating (IDR) following the announcement of a planned spin-off of its Mission Systems business. Fitch believes a spin-off of Mission Systems would be credit neutral for the company, with the lower pro forma revenues and profitability still sufficient to support the ratings. Fitch continues to consider the company's pension to be the main credit concern and a key driver of the outlook.

The Rating Outlook is Negative. The ratings cover $650 million of long-term debt and the $600 million commercial paper program. A full list of rating actions follows at the end of this release.

ANNOUNCED SPIN-OFF

On Dec. 12, 2013, XLS announced plans to spin-off Mission Systems, a part of its Information & Technical Services (I&TS) segment. Fitch believes the spin-off will be neutral to XLS's ratings despite a modest deterioration in the pro forma credit metrics. The spin-off, which will be renamed and rebranded as a new independent company, represents approximately $1.5 billion or approximately 31% of estimated revenues in 2013. The transaction should be completed in the summer of 2014 and Fitch expects XLS could receive a cash dividend as part of the transaction, although this and other elements of the transaction have not been finalized. The spin-off will decrease XLS's exposure to declining DoD budgets, with approximately 50% of pro forma revenues derived from non-DOD customers, compared to approximately 31% currently.

Fitch estimates Mission Systems' businesses account for less than 20% of XLS's EBITDA and fund from operations, despite comprising approximately 31% of the company's estimated revenues in 2013. Although Fitch expects a slight deterioration of XLS's credit metrics after the spin-off, the company's credit profile will still be adequate for the existing 'BBB+' rating, with leverage (gross debt to EBITDA) estimated to be in the range of 1.2x - 1.3x compared to leverage of approximately 0.9x as of Sept. 30, 2013.

Leverage metrics based on FFO instead of EBITDA are not as strong because of the company's significant cash pension contributions. Fitch expects FFO Adjusted Leverage to deteriorate notably and be in the range of 3.8x to 4.3x, which is high for the ratings. FFO adjusted leverage was 2.8x as of Sept. 30, 2013. Fitch expects the weaker FFO based metrics, which are mitigated by solid liquidity, will improve meaningfully with the anticipated reduction of pension contributions by 2016. XLS's cash deployment strategy is expected to remain conservative with approximately $76 million of cash dividends and moderate share repurchases in 2014.

KEY RATING DRIVERS

XLS' large underfunded pension obligations; the uncertainty surrounding the U.S. Department of Defense (DoD) budget; the impact of scheduled sequestration cuts in fiscal 2014; and deteriorating revenues accompanied with slight margin pressures are Fitch's main rating concerns. Fitch's forecasts assume the impact of the full sequester, so the possible budget agreement announced on December 10th could provide modest relief for the next two years.

The company's pension obligation reached approximately $2 billion (68% funded) as of Dec. 31, 2012. Even though large underfunded pension liabilities are not expected to have an immediate impact on company's liquidity, the significant long term cash outflows is a concern for the ratings. Fitch believes that the funded status of XLS's pension liabilities will improve by the end of 2013 driven by favorable interest rate movements, strong performance of the global equity markets and some of the company's actions, including offering lump sum buyouts to some employees and freezing the plan as of 2016.

XLS' ratings are supported by the company's highly diversified portfolio of defense-related products and services provided to U.S. military and government customers. XLS has more than 1,000 prime and sub contracts which mitigate the exposure to a major program cancelation. The company's core businesses focus on the DoD's high priority programs in information, surveillance and reconnaissance (ISR), electronic warfare, cyber, and information and technical services. Additionally, the company benefits from strong cash flow generation, a good backlog and adequate credit metrics for the ratings.

RATING SENSITIVITIES

Fitch may consider a negative rating action if there is a large increase in required pension contributions or if the pension deficit does not decline as expected at the end of 2013. A negative rating action could also be considered if the company's cash generation declines significantly either due to poor operating performance or unexpected negative changes in U.S. defense spending policies. Fitch is not likely to consider a positive rating action given XLS' large pension liability, declining revenues, margin pressures and uncertainty surrounding the U.S. DoD budget.

Fitch affirms XLS' ratings as follows:

--IDR at 'BBB+';

--Senior unsecured notes at 'BBB+';

--Senior unsecured revolving credit facility at 'BBB+';

--Short-term IDR at 'F2';

--Commercial paper at 'F2'.

The Rating Outlook is Negative.

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

Applicable Criteria and Related Research:

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

Applicable Criteria and Related Research:

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

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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=811796

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