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L-3 Communications Holdings Inc. (LLL - Analyst Report) reported its second quarter 2012 adjusted earnings per share of $2.13, surpassing the Zacks Consensus Estimate of $1.93. However, on a year-over-year basis it was down 0.9% from $2.15. Strong orders could not offset the challenging U.S. defense budget environment.
Including Engility Holdings, Inc.’s (EGL - Snapshot Report) spin-off transaction expenses of 5 cents per share, the company’s GAAP EPS was $2.08 compared with $2.26 in the year-ago quarter. The year-ago quarter includes tax benefit of 11 cents per share.
Quarterly net sales were down by 5.5% year over year to $3.56 billion. However, it was above the Zacks Consensus Estimate by $189 million. Sales were only up in the Command, Control, Communications and Intelligence, Surveillance, and Reconnaissance (“C3ISR”) segments, with all the other segments experiencing decline in sales mainly due to the overseas U.S. troop draw downs and budget pressures.
In the reported quarter, funded orders increased to $3.9 billion compared with $3.8 billion in the prior-year period mainly due to the Australian contract for 10 new C-27J aircrafts. Funded backlog was $11.7 billion versus $10.9 billion in the year-ago period.
Total operating income for the reported quarter decreased by 9.2% year over year to $367 million. Operating margin contracted 40 basis points to 10.3%.
C3ISR: The segment recorded net sales of $862.1 million, up 4.4% year over year, driven by increased demand for logistics support and fleet management services and higher volume for airborne ISR systems. However, these were partially offset by lower sales for networked communication systems as the contracts for Rover handheld communication devices is almost complete. Segment operating income was down 7.6% to $87.3 million.
Government Services: The Government Services unit generated net sales of $752.6 million, down 19.8% year over year. The results reflect less demand for linguist, law enforcement and intelligence support services for the U.S. and coalition forces due to the withdrawal of the U.S. military forces from Iraq, contract losses in 2011, and lower volumes due to completion of contracts for safety and security systems.
Also, conversion of single-award contracts to several multiple-award contracts increased the number of competitors. This reduced the company’s work share, ultimately leading to a decline in sales. However, these headwinds were to some extent offset by an U.S. Army training contract, competitively won in 2011. Segment operating income was down 11.9% to $62 million.
AM&M: Net sales at the AM&M segment were down 3% year over year to $591.6 million. The downside reflects less logistics support services mainly due to reduced tasking orders for contract field team support services in Southwest Asia for the U.S. Army and lower platform sales due to lower Joint Cargo Aircraft (“JCA”) volume for the United States Air Force (“USAF”).
However, these were partially offset by increased demand for field maintenance and sustainment services on a U.S. Army rotary wing aircraft contract that was competitively won in September 2011 and for U.S. Army C-12 aircraft alongwith increased volume for international head-of-state aircraft modification contracts. The segment generated operating income of $52.1 million, down 7% year over year.
Electronic Systems: Electronic Systems generated net sales of $1.4 billion in the reported quarter, down 2.8% year over year. The decline reflects lower sales for Precision Engagement, Marine and Power Systems, Warrior Systems and Aviation products.
These declines were partially offset by increase in sales for Microwave Products and Sensor Systems due to the acquisition of Kollmorgen Electro-Optical (“KEO”) in February 2012. Segment operating income was $172.5 million, down 6% year over year.
The company ended the quarter with cash and cash equivalents of $481million versus $548 million at the end of the second quarter of 2011. Long-term debt was $4.1 billion, flat year over year.
Following the trend of deploying capital and free cash flow, the company repurchased $177 million of common stock and continued to pay dividends.
The company has maintained its financial guidance for fiscal 2012, which it had provided on the approval of the Engility spin-off in June 2012. L-3 Communications expects its revenue to be in the range of $12,950 million–$13,150 million. It expects earnings in the range of $7.70 to $7.85. Operating margin is expected to be 10.3%.
On July 17, 2012, L-3 Communications Holdings completed the 100% spin-off of a new, independent, publicly traded government services company – Engility Holdings to L-3 shareholders. The company has retained its cyber, intelligence and security solutions businesses.
Going forward, the segment will be known as National Security Solutions that develops unique solutions to deal with the challenges faced by the U.S. Department of Defense, intelligence and global security customers. From the third quarter of 2012, L-3 will report Engility’s financial results as discontinued operations. Comparable periods will also be retrospectively adjusted.
The company’s top line and bottom line surpassed the Zacks Consensus Estimates with ease. Going forward, we expect the company to continue to post strong earnings based on its opportunities in growth areas, including Intelligence, Surveillance, and Reconnaissance, Electro-Optical/Infrared systems and cyber security.
Moreover, the company’s balanced business mix, improving operational efficiencies and focus on research and development allows it to pursue strategic opportunities in the commercial arena and overseas.
Also, with the completion of spin-off, the company will be able to focus more on core areas by providing market-leading, value-added products and solutions to its customers. In the long run, we expect the company to be one of the best-positioned pure defense players based on its broad diversification of programs and its focus on shareholders’ value. However, we remain concerned about the loss of key contracts, defense spending cuts and the lack of near-term catalysts.
The company presently retains a short-term Zacks #3 Rank (Hold) that corresponds with our long-term Neutral recommendation on the stock.
L-3 Communications Holdings operates through its wholly owned subsidiary, L-3 Communications Corporation. L-3 Communications is a leading supplier of a wide range of products and services used in a number of aerospace and defense platforms. The company supplies subsystems on many platforms that are used for secure communication networks; mobile satellite communications; information security systems; shipboard communications; telemetry and instrumentation; and airport security systems.