L-3 Communications [LLL] on Thursday reported lower earnings and sales in its second quarter as continued difficulties with head-of-state aircraft modification projects dented the bottom line and the company also said it is exploring a potential divestiture of its $1.2 billion National Security Solutions (NSS) segment to focus on its core defense electronics, communications systems, and ISR businesses.
The announcement that L-3 is exploring strategic alternatives for the NSS segment follows Lockheed Martin’s [LMT] decision last week to do the same with its government information technology and technical services businesses, which generate about $6 billion in annual sales. Lockheed Martin said it is looking to shed the businesses because the government contracting environment they operate in has become price sensitive and increasingly competitive, essentially out of line with its business model (Defense Daily, July 20).
The potential divestiture of the NSS segment follows the sale in the quarter of two businesses, the $500 million Marine Systems International to Finland’s Wartsila Corp. and Broadcast Sports, Inc. (BSI) to Slate Capital Group. The sale of these units frees “up capital to be invested in higher growth, higher margin opportunities,” Michael Strianese, L-3’s chairman, president and CEO, said on the company’s earnings call.
“At its core our strategy is very straight forward, we’re focused on performance and capturing new opportunities,” Strianese said. “We are transforming the business portfolio to sharpen our focus on the markets where we do best and have leading positions. Lastly we are focused on leveraging our strong cash flow generation to invest in areas critical to the future of our business. Most important, we’ll continue to return capital to shareholders.”
Areas of critical interest to L-3 for strategic investment include defense electronics, simulators and training, and “solutions to counter the ever increasing anti-access, area denial threats from near pier adversaries,” Strianese said.
Strianese also said L-3 is “actively” pursuing “additional acquisitions and portfolio shaping opportunities” with the goal being to “complement L-3’s existing businesses…that expand our market share, broaden our offering and bring us new customers.”
During the quarter L-3 acquired United Kingdom-based CTC Aviation, an airline pilot training company, extending its commercial aviation business.
L-3’s net income in the quarter fell 12 percent to $120 million, $1.44 earnings per share (EPS), from $137 million ($1.53 EPS) a year ago. Excluding a $3 million (3 cents EPS) gain from the sale of MSI and BSI, adjusted per share earnings were $1.41, 30 cents below consensus estimates.
The charges on the aircraft modification programs included $52 million (63 cents EPS) after-tax on international head-of-state contracts with two unidentified customers due to the need for additional engineering, production and support labor, and material costs, $12 million (14 cents EPS) after-tax on three other aircraft modification contracts. For the head-of-state aircraft, one plane was supposed to delivered in June and another this December but deliveries have slipped into 2016 and 2017, said Ralph D’Ambrosio, L-3’s chief financial officer.
In the first quarter the head-of-state aircraft programs trimmed $17 million from operating profits and D’Ambrosio warned then that risks remained until the aircraft are delivered (Defense Daily, April 30).
During the second quarter L-3 replaced the president and senior leadership of its Platform Integration division within the Aerospace segment and changed the program management and functional leads, Strianese said.
At the operating level, only the Communications Systems segment turned in a profit on improved performance.
Overall sales in the quarter were $2.8 billion, down 7 percent from $3 billion a year ago. L-3 tallied $2.8 billion in orders and the company said it expects to see growth in the second half of the year.
The NSS segment posted 47 percent decline in operating income to $10 million on a $22 million decline in sales to $261 million. The segment is still projected to have sales between $1.1 billion and $1.2 billion this year.
NSS includes a range of businesses in big data solutions, geospatial intelligence support, cyber security solutions, maritime and coastal surveillance systems, perimeter surveillance, intelligent video, command and control systems, and enterprise and mission IT.
Free cash flow for the quarter was $183 million.
L-3 still expects sales between $11.5 billion and $11.7 billion this year but lowered its earnings forecast by 62 cents to between $6.55 and $6.85 to account for the aircraft modification charges and related outlook for reduce profitability for the rest of 2015, a small charge related to a holographic weapons sight program, and another small charge for debt retirement action planned in the fourth quarter. The impact of the charges is being moderated somewhat by a lower than expected tax rate.
Strianese said the company is “confident we are nearing the end of the shrinking DoD budget environment and expect an inflection point starting next year. This will obviously support the growth of our business.”
L-3’s funded backlog at the end of the quarter stood at $9.8 billion, down 4 percent since the beginning of the year due to the MSI sale.