Aerospace & Defense

L-3 Simply Not Normal for Accounting Problems

L-3 Communications Holdings Inc. (NYSE: LLL) is far from your typical company that faces accounting problems. The company is one of the key defense stocks for encrypted communications and a host of other issues around surveillance, reconnaissance, command and control and more. Now news of accounting problems pertaining to an aerospace logistics contract had shares down more than 15% on Thursday in midday trading. This is something that deserves a closer look.

The company gave no guidance Thursday morning, but the accounting issues took charge. L-3 said that its earnings per share (EPS) of $1.75 include a charge of $0.21 related to an internal review, and net revenue was $3.0 billion. Even if you add the two earnings numbers up, you only get EPS of $1.96 — and that is shy of the $2.02 EPS estimate from Thomson Reuters. That $3 billion in net revenue is right in line with the $2.99 billion expected by analysts.

Again, the real rub here is an accounting problem. The company signaled that its net cash from operating activities was $277 million. It further represented a book-to-bill ratio of 1.08, with funded orders of $3.3 billion and a total funded backlog of $10.7 billion.

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L-3 confirmed that it was in the Aerospace Systems segment where accounting problems arose. L-3 even said that this review is being conducted with the assistance of outside accounting and legal advisors. The adjustments primarily relate to contract cost overruns that were inappropriately deferred and overstatements of net sales, in each case with respect to a fixed-price maintenance and logistics support contract.

L-3 said:

The Company currently expects to incur an aggregate pre-tax charge of $84 million against operating income and a related reduction in net sales of approximately $43 million. Of these charges, approximately $50 million relates to periods prior to 2014, and approximately $34 million relates to the first half of 2014, of which $30 million relates to the second quarter of 2014. Additionally, as a result of the review, the Company has lowered its estimated operating income for the Aerospace Systems segment by approximately $35 million for the second half of 2014.

This is just not something that was expected from L-3. The company has generally had great corporate governance. ISS’s QuickScore for corporate governance was a 2, with 1 indicating lower governance risks and 10 indicating higher governance risks.

Sadly, investors always shoot first and ask questions later. That is evident with close to a 16% drop. You just do not see this sort of news that often about a company like L-3.

L-3 shares were down about 15.7% at $100.80 right before 1 p.m. Eastern Time on Thursday, with a 52-week range of $90.07 to $127.27. Shares had closed at $119.64 prior to this news, and the consensus price target from analysts had been almost $128.50.

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