L-3 Restructures in the Face of Budget Realities and Policy Changes

As part of their earnings announcement of the second quarter L-3 Communications Holdings (L3) announced that it would separate most of its government service unit into a stand alone company called Engility. L-3 is a diverse provider of services and hardware to the U.S. Defense Department. Management stated concerns with new rules on Organizational Conflicts of Interest (OCI) led them to this decision.

Interestingly the company has decided to keep the intelligence and cyber support parts of this business with L-3 while letting the more traditional Scientific, Engineering, Technical and Analytical (SETA) support go with the new company. The first two are potential high growth areas as illustrated by the moves of the larger defense contractors such as Boeing (BA) and General Dynamics (GD) buying up of smaller companies in that field. The use of SETA contractors who often work directly supporting new system development and acquisition is under pressure first through insourcing and now just through cuts to the size of the work force as the Pentagon moves to reduce its overhead and budget.

Overall the company reported a drop in sales due to the loss of one major contract but overall a rise in profits of about 32 cents a share. Revenue compared to the similar quarter last year fell to $3.77 billion or about fiver percent. The company followed other defense contractors reporting this week by increasing their guidance for the year raising it 15 cents a share from last quarter’s prediction.

The future defense budget remains in flux but different companies are positioning themselves for what is expected to be declines in business, more strict regulations and policies and pressure on pricing. This has been reflected in moves like ITT Corporation (ITT) which is spinning off its entire defense business into a separate company, to be called ITT Exelis or Lockheed Martin’s (LMT) plans to eliminate thousands of jobs to cut overhead and prices. L-3 is holding onto its business lines with the most potential while putting its services unit in a place where they will either sink, swim or end up being part of another company.

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