L-3 Communications Holdings Inc. (LLL) reported fourth quarter and fiscal 2011 earnings results before the bell. During the fourth quarter of 2011, the company clocked pro forma earnings per share of $2.44, easily surpassing the Zacks Consensus Estimate of $2.41 and the year-ago figure of $2.37. Including a net gain of 28 cents, GAAP EPS was $2.72 versus $2.37 in the fourth quarter of 2010. The gain of 28 cents includes a tax benefit of 77 cents partially offset by a non-cash impairment charge of 49 cents per share.

Earnings in the final quarter were impacted by a debt retirement charge of $17 million related to the redemption of $500 million of the company’s outstanding $1 billion aggregate principal amount of 6.375% senior subordinated notes due 2015.

In fiscal year 2011, excluding a one-time gain of 26 cents, the company reported pro forma EPS of $8.77, above the Zacks Consensus Estimate of $8.45 and the year-ago figure of $8.25. GAAP EPS was $9.03 as compared to $8.25 in the previous year period.

Operating Statistics

Quarterly net sales fell by 5.6% year over year to $4.0 billion, and also missed the Zacks Consensus Estimate by $168 million. The top-line reflects the company’s areas of competitive strength overshadowed by a challenging defense budget environment felt particularly in the Aircraft Modernization and Maintenance (“AM&M”), Government Services and Electronic Systems segments.

During the fiscal year 2011, total net sales were $15.2 billion, missing the Zacks Consensus Estimate by $351 million. It was also below the year-ago figure of $15.7 billion.

In the reported quarter, funded orders decreased to $3.2 billion compared with $4.4 billion in the prior-year period. Funded backlog was $10.7 billion versus $11.1 billion in the previous-year period. The major contracts received by the company during the quarter include the U.S. Air Force’s F-16 Training System program, as well as continued strong orders for Electro-Optic/Infrared (“EO/IR”) products, Rover 6, and satellite communications products and services.

Consolidated operating income for the reported quarter decreased by 13.7% year over year to $398 million due to a goodwill impairment charge. Consolidated operating income for the fiscal year was $1.6 billion, down 8.7% year over year.

Segment Performance

C3ISR: The segment recorded net sales of $1.0 billion, up 8.2% year over year driven by increased volume for airborne Intelligence, Surveillance and Reconnaissance (“ISR”) logistics support and fleet management services and new business for international airborne ISR platforms.

Government Services: The Government Services unit generated net sales of $832.2 million, down 18.8% year over year.

The results reflect lower sales from linguist, intelligence support and logistics services, loss related to an Afghanistan Ministry of Defense (“MoD”) support contract and a Federal Aviation Administration Information Technology (IT) support services contract, loss in IT support services for the U.S. Special Operations Command and lower pass-through subcontractor sales.

AM&M: Net sales at the AM&M segment declined 7.1% year over year to $614.1 million due to the SOFSA contract loss, lower Joint Cargo Aircraft (“JCA”) volume, partially offset by increased CLS services primarily for U.S. Army C-12 aircraft.

Electronic Systems: Electronic Systems generated net sales of $1.5 billion in the reported quarter, down 5% year over year. The results reflect lower sales due to declining DoD demand for night vision products, undersea warfare products and simulation & training devices, and lower manufacturing yields for power devices for satellite communications and airborne radar systems. However, these decreases were partially offset by sales from acquired businesses and sales volume increases for EO/IR products to the U.S. Army and U.S. Air Force.

Financial Position

During fiscal 2011, L-3 Communications generated net cash of $1.5 billion from operating activities, up $23 million from cash generated in the year-ago period. Capital expenditure made by the company during the year was $186 million compared with $171 million in the year-ago period.

As of December 31, 2011, cash and cash equivalents were $764 million versus $607 million at the end of December 31, 2010. Long-term debt increased by $1 million to $4.1 billion.

The company repurchased $158 million of its common stock in the quarter under review consistent with its shareholder-friendly moves.

Guidance

The company at the earnings call once again affirmed its focus on improving operational efficiencies and investing in research and development to provide affordable solutions. Moreover, it believes that the spin-off of Engility businesses, expected to be complete by June 30, 2012, will add to margin expansion.

With the pending acquisition of Kollmorgen Electro-Optical (KEO), L-3 is confident that it will continue to focus on adding new capabilities that expand product lines and customer base.

L-3 Communications expects full-year 2012 revenue to be in the range of $14.4-$14.6 billion. It expects operating margin of 10.1% for fiscal 2012. The company expects EPS for full-year 2012 to be between $8.35 and $8.55.

The guidance does not include the results and expected expenses from the Engility spin-off. It also does not take into account the Kollmorgen Electro-Optical (“KEO”) business which the company agreed to acquire in December 2011.

Also, the guidance does not reflect the U.S. Federal research and experimentation credit which expired on December 31, 2011, due to which 2012 diluted EPS would decrease by 10 cents.

At the Peer

Recently, one of its competitors, Lockheed Martin Corporation (LMT) posted fourth-quarter 2011 operating earnings of $2.14 per share, beating the Zacks Consensus Estimate of $1.94. However, this was lower than the year-ago quarterly earnings of $2.28 per share by a margin of 14 cents.

Our Take

We believe that L-3 Communications stands out among pure defense players by virtue of its non-platform focus, its prominent position as a sub-contractor/supplier to other defense primes, and its broad diversification of programs. The company has opportunities for growth and profit expansion from the impending acquisitions and spin-offs. However, these positives are offset by the loss of key contracts, defense spending cuts and lack of near-term catalysts. Order growth and volume increases also remain dubious in this challenging environment. The company presently retains a short-term Zacks #4 Rank (Sell). We have a 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 broad range of products and services used in a number of aerospace and defense platforms.

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