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Defense operator L-3 Communications Holdings Inc.'s (LLL - Analyst Report) first quarter 2014 earnings of $2.01 per share beat the Zacks Consensus Estimate of $1.96 by 2.6%. The bottom line increased 1.5% from the year-ago adjusted profit of $1.98 per share.  

The company ended the quarter on a strong note in spite of budget uncertainties. The strong performance was attributable to its program execution capability, cost cutting initiatives and contribution from its international and commercial businesses.

Total Revenue

Total revenues of $2,971 million in the reported quarter exceeded the Zacks Consensus Estimate of $2,966 million. However, the top line was down 7% year over year due to declines across the board.

Operational Highlights

Funded orders for the reported quarter were $3 billion, up 4.5% year over year. Funded backlog declined 0.4% to $10.4 billion as of Mar 31, 2014, from $10.3 billion as of Dec 31, 2013.

The company’s operating income was down 2% year over year to $307 million, comprising 10.3% of total revenues during the quarter. Its operating margin expanded 80 basis points year over year due to lower pension expense.

Net income at the end of the quarter was $180 million, down 7% year over year.

Segment Performance

Aerospace Systems: The segment recorded net sales of $1,082 million, down 8.8% year over year. The decline reflects lower sales for Platform Systems and ISR Systems. However, these were partially offset by higher sales for C-27J aircraft to Australia due to the timing of contract deliverables.

Electronic Systems: The segment generated net sales of $1.48 billion in the reported quarter, down 8.2% year over year. The decline in sales was due to lower DoD demand.

Communication Systems: Net sales at the segment decreased 9.9% year over year to $503 million. The decrease was primarily due to lower volume for Tactical Satellite Communications products and for Broadband Communication Systems.    

National Security Solutions: The segment generated net sales of $304 million, a decrease of 7.9% from the year-ago level. The decrease in sales was mainly due to lower demand for a technical support contract for a U.S. government agency and for U.S. Special Operations Command information technology support services.

Financial Position

As of Mar 31, 2014, L-3 Communications had $227.0 million in cash and cash equivalents versus $500 million as of Dec 31, 2013.

Long-term debt as of Dec 31, 2013, was almost flat year over year at $3,631 million from the end 2013 level.

Net cash used in operating activities was $62 million, down significantly from the year-ago figure of $146 million.

Capital expenditure was $29 million in the quarter versus $48 million in the year-ago period. The company’s free cash flow stood at $91 million, down by $7 million year over year.

During the first quarter 2014, L-3 Communications increased the quarterly cash dividend by 9% from 55 cents to 60 cents per share.

Guidance

L-3 Communications listed its 2014 top-line expectation in the range of $11,950 million to $12,150 million (prior $11,900–$12,100 million). The company has also revised its earnings expectation for the year to $8.20–$$8.40 per share from its prior expectation of $8.35–$8.35 per share.

Interest expenses for 2014 are expected to be $177 million while operating margin is pegged at 10.5%. Capital expenditure is expected to be $195 million. Additionally, management expects to make $1 billion of free cash flow and buy back $0.5 billion of shares in 2014.

Peer Comparison

Raytheon Company (RTN - Analyst Report) reported first quarter 2014 adjusted earnings of $1.62 per share, missing the Zacks Consensus Estimate of $1.76 by 8.0%. The lower-than-expected results were due to soft sales.

Pentagon’s prime contractor, Lockheed Martin Corp. (LMT - Analyst Report), posted impressive first quarter 2014 earnings before the opening bell amid an uncertain budget environment. The company reported quarterly earnings of $2.87 per share, comfortably surpassing the Zacks Consensus Estimate of $2.52 by 13.9%. Earnings in the reported quarter also surged 27.6% from $2.25 in the year-ago quarter.

Another defense prime, Northrop Grumman Corp. (NOC - Analyst Report) reported first quarter 2014 adjusted earnings of $2.40 per share, surpassing the Zacks Consensus Estimate of $2.15 by 11.6%.

Our Take

L-3 Communications reported better-than-expected first quarter 2014 numbers. International and commercial businesses drove the uptrend, partially offset by a weak U.S. national security business.

L-3 Communications’ efforts to harness technology will strengthen its Electronic Systems and Platform & Logistics Solutions business segments. The company’s recent acquisition of Data Tactics Corporation will help it to benefit from the Big Data Analytic revolution.

The Department of Defense (DoD) is increasingly focusing on network-centric warfare which involves the collection of data from various sources as well as the seamless to and fro movement of confidential information.  Data Tactics is a provider of Big Data analytics and cloud computing solution services, primarily to the U.S. DoD.

That being said, the sequestration will to some extent dry up orders for all defense biggies. Budget austerities still remain an overhang on the military sector putting pressure on the top line. The companies that have little diversification outside the U.S. are highly susceptible to spending cuts from sequestration. On the other hand, those with an international order book would find it less difficult to outwit sequestration.

L-3 Communications currently has a Zacks Rank #3 (Hold).

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