With wars raging in two nations, plus a "General War on Terror," you might imagine it's a good time to invest in U.S. defense companies.

To a certain extent, you'd be right, too. Last week, every defense contractor I've ever heard of, and several I haven't, reported better earnings numbers than Wall Street was expecting: Raytheon (NYSE: RTN), Rockwell Collins (NYSE: COL), Boeing (NYSE: BA), and General Dynamics (NYSE: GD) -- they all beat estimates.

As, for that matter, did the subject of today's story, L-3 Communications (NYSE: LLL). And what's more, L-3 raised its guidance for the rest of the year. So why's the stock flat after earnings were announced? That's what we're here to find out.

Buy the numbers
L-3 earned $1.54 per share last quarter, or 19% better than in Q1 2007. Not bad for a company that grew its revenue a bare 6%. These outsize gains came from several sources: Operating margins improved by 60 basis points against the year-ago quarter (to 10.5%). Meanwhile, L-3 continued buying back stock, and as we know, the fewer shares among which your profits get divided, the more profit per share. L-3 spent more than a quarter-billion dollars buying back stock in Q1, helping to push the weighted average number of diluted shares outstanding down 1.2% compared with its level at the end of Q1 2007. Finally, Uncle Sam lent a hand, charging L-3 10 basis points less tax this year than last, primarily on revenue earned abroad.

L-3 experienced its greatest revenue growth in its second-biggest unit by revenue, government services. Revenue here grew 7.5%, while operating margin was flat at 9%. In contrast, the biggest improvement in profitability came at L-3's smallest business: command, control, communications, intelligence, surveillance and reconnaissance, or C3ISR, where a bare 2% rise in sales was magnified by a 220-basis-point jump in operating profitability. At 11.2%, C3ISR is now L-3's second-most profitable business, by margins.

Looking forward, L-3 expects continued outsize growth in its two largest businesses -- government services and specialized products -- to push its revenue up to about $14.6 billion this year. Unfortunately, operating margins will likely contract, depriving L-3 of the full benefit of this growth. Also disappointing -- free cash flow for the year will likely lag GAAP profit. Management predicts only $1.2 billion in its free cash flow this year -- just 8% better than last year, and weaker than the 11% earnings growth we're told to expect.

In this Fool's view, last week's plunge in free cash flow, combined with slower growth in this metric going forward, makes L-3's stock look less like a bargain than I at first thought. Judging from Wall Street's anemic applause for the earnings report, others may be thinking similarly.

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Fool contributor Rich Smith does not own shares of any company named above. The Motley Fool has a disclosure policy.