L-3 Communications Beats Estimates, Raises Guidance

| About: L3 Technologies (LLL)
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L-3 Communications Holdings Inc. (NYSE:LLL) reported fourth quarter earnings per share (NYSEARCA:EPS) of $2.37, up 23% year over year from $1.93 in the year-ago quarter. The quarterly figure comfortably surpassed the Zacks Consensus Estimate of $2.31. For the full year 2010, diluted EPS was up 8% year over year to $8.25 from $7.61 in the prior year. The annualized EPS figure also beat the Zacks Consensus Estimate of $8.03.

Operating Statistics
Net sales rose marginally by 1% or $47 million year over year to $4.3 billion compared with $4.2 billion for the fourth quarter of 2009. Net sales also beat the Zacks Consensus Estimate of $4.2 billion by $29 million. Sales growth primarily came from the Command, Control, Communications, Intelligence, Surveillance and Reconnaissance (C3ISR) and Electronic Systems segments. This was partially offset by lower sales from the Government Services segment and from the Aircraft Modernization and Maintenance (AM&M) segment. The downside was primarily due to a loss of a Special Operations Forces Support Activity (SOFSA) contract with the U.S. Special Operations Command (SOCOM) in June 2010. The SOFSA contract was the single largest revenue generator contract of 2009.

Operating income in the fourth quarter 2010 was $461 million, up 3% year over year from $446 million in fourth quarter 2009. Operating margin expanded 20 basis points to 10.8% reflecting improved contract performance across several businesses, lower pension expense and synergies from a sale of a technology license in the Electronic Systems segment. These increases were however partially offset by severance costs in the Electronic Systems segment and lower operating margin in the C3ISR and Government Services segments.

For full-year 2010, net sales of approximately $15.7 billion inched past $15.6 billion in full year 2009 by $65 million. Results however came short of the Zacks Consensus Estimate of $16 billion by $339 million. The company ended full-year 2010 with a funded backlog of $11.1 billion versus $10.9 billion at the end of the prior year.

Segmental Performance

The C3ISR segment recorded net sales of $987.4 million in the reported quarter, up 13% year over year led by demand for networked communication systems for manned and unmanned platforms and airborne ISR logistics support and fleet management services to the U.S. Department of Defense (DoD).

Segment operating income rose 10% year over year to $102.1 million in the fourth quarter 2010. Operating margin however slipped 50 basis points to 10.3% primarily due to a higher mix of lower-margin service sales and contract performance, partly countered by lower pension expense.

AM&M segment net sales for fourth quarter 2010 slumped 9% year over year to $661.2 million as a result of sales volume declines from the SOFSA contract loss. This decrease however was partially offset by higher aircraft modernization sales primarily for rotary wing cabin assemblies and the Canadian Maritime Helicopter Program (MHP).

Segment operating income in fourth quarter 2010 decreased 3% year over year to $57.4 million. Operating margin surprisingly rose by 60 basis points to 8.7% due to favorable contract close-outs, decrease of lower-margined sales, and lower pension expense.

Government Services
The Government Services unit generated net sales for fourth quarter 2010 of slightly more than a billion, down 3% year over year. The decrease was primarily due to reduced subcontractor pass-through sales volume related to task order renewals for U.S. Army systems and software engineering and sustainment (SSES) services that migrated to a contract where the company is not a prime contractor, and the loss of an Afghanistan Ministry of Defense support contract. These decreases were partially offset by information technology support services for the U.S. Special Operations Command (SOCOM) and other U.S. Government agencies.

Operating income in the Government Services segment was $91 million, down 11% year over year. Operating margin plummeted 70 basis points to 8.9% driven by lower sales volume and lower margins on select contract renewals and new contracts due to competitive price pressures. These decreases were partially offset by a decline in lower-margined subcontractor pass-through sales.

Electronic Systems Segment
Electronic Systems generated net sales of $1.6 billion in fourth quarter 2010 that rose by 2% year over year on the back of acquired businesses. Other drivers of sales growth include higher volumes of microwave products, security & detection systems, and from the sale of a technology license related to a general aviation product. These increases were, however, partially offset by lower sales volume for commercial ship building products as a result of reduced demand, combat propulsion systems due to a reduction in DoD funding for Bradley Fighting Vehicles, and precision engagement and marine services due to contracts nearing completion.

Electronic Systems recorded an operating income growth of 10% year over year to $210.7 million. Operating margin increased by 100 basis points to 13.4%. The results were driven by improved contract performance primarily for microwave products, simulation & training, the sale of a technology license and lower pension expense. These increases were partially offset by severance charges as well as lower sales volume primarily for commercial ship building and combat propulsion systems.

Financial Position
In full-year 2010, L-3 Communications generated net cash of $1.5 billion from operating activities, up $54 million compared with $1.4 billion of cash generated in full-year 2009. The company ended full-year 2010 with cash and cash equivalents of $607 million, while long-term debt stood at $3.4 billion. During the reported fiscal the company repurchased shares worth $834 million and distributed $184 million as dividends.

L-3 Communications reaffirmed its revenue guidance for full-year 2011 of $15.7 billion – $15.9 billion. The company however increased its EPS guidance range for full-year 2011 to $8.40 – $8.55 versus its previous guidance of $8.20 – $8.40.

Our Take
L-3 Communications is one of the best-positioned pure defense players based on its non-platform focus, its broad diversification of programs, strong order bookings and order backlog, strong cash flow generation and its focus on shareholder value. However, this is offset by the loss of key contracts, a backlog skewed toward fixed price contracts and apprehensions over defense spending in full-year 2012 budget under the Obama administration.

L-3 Communications currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. The sideline strategy is reflected across the board for its peers like Raytheon Company (NYSE:RTN) and the big one Lockheed Martin Corporation (NYSE:LMT). Both of whom have witnessed lower profits year over year in the reported quarter.