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Whistleblower alerted L-3 to accounting misconduct

By Sagarika Jaisinghani, Sweta Singh and Alwyn Scott

(Reuters) - An employee complaint exposed accounting misconduct at L-3 Communications Holdings Inc, according to people familiar with the matter, prompting the aerospace and defense supplier to fire four people, revise two years of earnings statements and cut its earnings forecast.

L-3's shares plunged as much as 17 percent - their biggest intraday percentage drop ever - after the company said on Thursday it would take a pretax charge of $84 million for misconduct and accounting errors, including cost overruns and overstated sales figures from 2013 and 2014.

The surprise announcement prompted some analysts to cut ratings on the company, and raised concern about a broader problem at L-3, which also suffered an ethics scandal in 2010.

The sources said the latest misconduct stemmed from a single fixed-price contract for maintenance and logistics support with the U.S. military that began in December 2010 and runs through January 2015.

The Pentagon has not barred L-3 from bidding on other contacts as a result of the misconduct, the sources added.

The pretax charge includes adjustments for accounting errors L-3 found as it scrubbed its books during the review, said the sources, who spoke on condition that they not be named.

"The profit L-3 expected in the contract just wasn't there," said one of the sources.

The sources declined to say which branch of the military had the contract, or precisely which part of L-3 was involved, other than that it was in its aerospace unit. They also would not say how recently the employee lodged the complaint.

However, they said the New York-based company quickly fired four employees and hired law firm Simpson Thatcher to conduct the investigation and consulting firm AlixPartners to perform forensic accounting.

"We had some bad actors and they are no longer part of L-3," Chief Executive Michael Strianese said on a conference call with analysts.

Another employee resigned in connection with the review. The whistleblower is still with the company, and the review is continuing, but not expected to turn up significant additional charges, the sources said.

L-3, founded in 1997 and built through mergers and acquisitions of smaller companies, supplies a wide range of military and civil electronics equipment and services, including aircraft "black boxes," communications transponders and cockpit display panels.

The accounting errors surprised investors, but they stopped short of triggering a "restatement" of L-3's accounting. Instead, the financial statements are being "revised" to reflect what are considered non-material adjustments, and the statements can still be relied on by investors, the sources said.

L-3 also reported on Thursday preliminary sales of $3.02 billion for the second quarter ended June 27, but said the figure could be revised lower after the review is finished.

The company cut its full-year earnings forecast by 30 cents a share, to $7.90-$8.10 per share from $8.20-$8.40, reflecting expected charges in the second half related to the review.

Analysts peppered Strianese and CFO Ralph D'Ambrosio with questions on the conference call about whether other misconduct could appear elsewhere.

"We have no reason to believe that this issue occurred at any other segment of the company," Strianese said.

Accounting irregularities tend to unnerve investors and bring further scrutiny of company's operations, analyst said. The incident raised memories of a 2010 event in which an L-3 unit was suspended from doing contract work for the U.S. Air Force for allegedly using a government computer to gather business information for its own use.

Strianese said that case found no evidence that anyone at L-3 "did anything wrong" and "actually proved that we did not have any bad actors."

Still, "situations involving accounting misconduct with government contractors do not end quickly and generally are expanded in scope," said CRT Capital analyst Brian Ruttenbur, who cut his rating on L-3 stock to "sell" from "fair value."

D'Ambrosio said the contract involved in the review had average annual sales of about $150 million.

"It's a low-margin contract and with these adjustments, it is now in a loss position," he said.

L-3 said about $50 million of the $84 million charge related to periods prior to 2014 and about $30 million related to the second quarter of 2014.

The company's shares were down 16.3 percent at $103.33 in afternoon on the New York Stock Exchange.

(Editing by Ted Kerr, Saumyadeb Chakrabarty and Andrew Hay)

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