L-3 Communications [LLL] on Thursday reported a hefty loss in its third quarter due mainly to a charge related to a reduction in the estimated value of a business segment that it is trying to sell and the company also said it has also begun a strategic review for its other service and hardware businesses that have low returns.
The $491 million charge, $5.79 cents earnings per share (EPS), was due to a decline in expected future cash flows at L-3’s National Security Solutions (NSS) segment, which L-3 announced in July is being shopped around. Michael Strianese, L-3’s chairman and CEO, said on an analyst call that announcement on NSS is expected by the end of this year.
L-3 also said that it has begun an analysis of strategic alternatives for other hardware and services business that are delivering low returns with hopes to complete that over the next year. Strianese said the company did a “top to bottom review of the portfolio” this fall and the businesses it wants to keep are “where we have significant competitive discriminators, which are typically across the electronics space and have good profiles for future growth and margin expansion.”
Businesses outside of that “profile are being looked at more carefully with an eye toward potentially divesting,” he said.
The potential divestitures come in the wake of other recent disposals this year, including the sales of its former Marine Systems International (MSI) and Broadcast Sports Inc. units during the second quarter and its Tinsley Product Line in the third quarter.
The net loss in the quarter was $299 million ($3.74 EPS) versus $154 million ($1.78) in net income a year ago. Excluding the NSS-related charge, a $9 million (8 cents EPS) pre-tax loss, and an $8 million (8 cents EPS) hit from the Tinsley sale, adjusted income in the quarter was up 10 percent to $170 million ($2.09 EPS), beating consensus estimates of $1.82 EPS.
L-3’s sales in the quarter fell 4 percent to $2.8 billion from $2.9 billion a year ago driven by declines at NSS and the Electronic Systems segment.
At the operating level, segment profits were up 11 percent on the back of 61 percent gain at the Aerospace Systems segment and an 8 percent rise at Communications Systems on performance improvements and sales mix changes favoring higher margin products. Operating profit at Electronic Systems was relatively level.
The NSS segment posted a 14 percent decline in sales in the quarter to $264 million and a 63 percent drop in operating income to $7 million. The company said sales were off on lower revenue with the Defense Department and federal government and from the completion of some contracts. Segment profit dropped on a write down of excess inventory, lower margins on new business, lower sales and higher overhead rates on delayed awards for commercial contracts, and higher pension expense.
Overall segment operating margins were up 250 basis points to 10.2 percent.
Several head-of-state aircraft programs that have trimmed L-3’s profits in the first two quarters are on track, Strianese said.
For 2015, L-3 lowered its sales guidance to between $11.4 billion and $11.5 billion from prior expectations of between $11.5 billion and $11.7 billion. The outlook for segment operating margin was reduced 10 basis points to 8.3 percent and the tax rate was lowered as well. The outlook for adjusted earnings was lowered by a dime on the low and high end of the previous range to between $6.80 and $6.90 EPS.
L-3 also provided a preliminary outlook for 2016 with sales down nearly 3 percent on lower international business while per share earnings will rise 6 percent on higher margins.
Strianese said that uncertainty around the defense budget is ending, but the company is still “experiencing a delay in the anticipated DoD budget uptick.” He said if a bipartisan budget agreement covering FY ’16 and FY ’17 is approved, it will help the company with its long-term planning and enable contract awards.
Free cash flow in the quarter was $263 million and orders were $2.4 billion. Funded backlog at the end of the quarter stood at $9.4 billion, down from $10.2 billion at the end of 2014 mainly due to the sale of MSI.