Through much of last year, and all of this year to date, defense contractor L-3 Communications (NYSE: LLL) has astounded the cynics, reporting earnings in excess of expectations. On Thursday, L-3 aims to close out this year's winning streak with a bang, as it reports its fiscal Q4 and full-year 2007 results.

What analysts say:

  • Buy, sell, or waffle? Fourteen analysts follow L-3. Six of them think the stock's a buy, seven more say "hold," and one's a seller.
  • Revenue. On average, they expect to see 7% quarterly sales growth, to $3.63 billion.
  • Earnings. Profits are predicted to rise 18% to $1.61 per share.

What management says:
L-3 is swimming in cash these days. Last quarter, CEO Michael Strianese boasted of "robust cash flow," which grew roughly 30% year over year for the first nine months of 2007. Nice, but not quite what you'd expect, given the results L-3 has reported under GAAP. Year to date, L-3's 12% sales growth has translated into a 56% improvement in net income.

What management does:
Why the disconnect between earnings and free cash flow growth? Perhaps because L-3 already generates free cash flow that's half again as rich as its net profit. So far this year, the firm has generated $836 million in free cash flow, far above its $549 million in accounting profits.

The GAAP number is catching up fast, though, powered both by continued strong sales growth and additional profits earned on those sales. Every quarter for the past year, L-3 has improved its take on both an operating and a net profits basis. While still lagging defense-industry peers like General Dynamics (NYSE: GD), Lockheed Martin (NYSE: LMT), and Textron (NYSE: TXT), L-3 is now neck-and-neck with Raytheon (NYSE: RTN) for operating margins, surpassing both Boeing (NYSE: BA) and Northrop Grumman (NYSE: NOC).

Margins

6/06

9/06

12/06

3/07

6/07

9/07

Operating

10%

10.1%

9.9%

9.9%

10.3%

10.3%

Net

4.2%

4.2%

4.2%

4.3%

5.2%

5.3%

All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
This earnings season, I'm running down the "backlog" numbers at all of the major defense contractors, in hopes of finding clues to what their futures might hold. L-3's a bit of a queer beast in this regard. While some of its peers report only their "total backlog" numbers, and others break the numbers down into more reliable "funded backlog" and "unfunded backlog," L-3 just gives you the most reliable number: funded backlog. Here's how the numbers have been trending relative to sales over the last couple of years:

Q3 2005

Q3 2006

Q3 2007

Funded backlog

$7.1 billion

$8.2 billion

$9.5 billion

YTD revenues

$6.5 billion

$9.1 billion

$10.2 billion

So here's my concern regarding L-3, in a nutshell. The firm's a fantastic cash generator, no doubt. It's growing like a weed, and the 34% growth in contracts for "future sales" is nothing to catch hay fever over. However, that backlog number doesn't compare well to the 57% sales growth that L-3 has posted over the past two years. To me, this seems to suggest that the pace of L-3's sales growth could be starting to slow.

Let's see what Strianese has to say on that score tomorrow.

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