Best Defense

By Annetta Miller

How's this for a product lineup: sensors for cutting-edge military drone aircraft, minivan-size airport baggage scanners, lifelike human dummies that breathe and bleed? If it sounds like a grab bag, that just goes to show how rapidly the defense business is changing. And the best model for a post-9/11, homeland-security-era defense firm may be L-3 Communications, which makes each of these unique high-tech devices.

Founded just six years ago in New York City, L-3 last week announced $4 billion in 2002 sales, ranking it among the nation's top 10 defense contractors, just below such industry giants as Lockheed Martin and Boeing. L-3's fast start is widely credited to CEO Frank Lanza, 71, who was head of Loral Corp., maker of electronic warfare systems, when it was sold to Lockheed in 1996. With partner Robert La Penta, then a Loral executive, and financing from Lehman Bros., Lanza bought 10 Loral electronic-manufacturing divisions, glued them together, bulked up their research-and-development units and named them L-3 (for Lanza, La Penta and Lehman Bros.). Lanza took the company public in 1998. Now L-3 thrives in two fast-growing markets: high-tech military gear and civilian security.

The firm, best known for its military-communications and reconnaissance systems, solidified its reputation in the 2001 war in Afghanistan, when its technology enabled commanders at a base in, say, Tampa, Fla., to see real-time images of Afghan battlefields. Contracts soon multiplied. "The U.S. has plenty of firepower," says Kevin Landis, chief investment officer of Firsthand Funds, a tech-focused mutual-fund group in Silicon Valley. "But Frank Lanza tells them where to point it." L-3's military customers also include Canada and other NATO countries.

On the morning of Sept. 11, 2001, Lanza's professional world view changed. From the windows of his 34th-floor Manhattan office, he saw the attacks on the World Trade Center, and in those minutes the national-security business was redefined. "Nobody gave a damn about homeland security before that morning," he says. "Suddenly the whole world was interested."

In response, L-3 has been scrambling to devise civilian applications for its technology. Over the past year or so, the company has been on an acquisition binge, buying smaller companies in electronic-communications niches. A recent purchase was Wescam, a Canadian maker of stable cameras used by the movie industry to film action scenes--cameras well suited for aerial duty. And L-3 is one of the few suppliers of those hulking new airport luggage scanners mandated by Congress to screen checked bags. L-3's version uses technology originally developed to process military surveillance and reconnaissance photos. The company produces other scanning devices, designed to reveal concealed weapons (including any secreted inside human-body cavities), that are based on technology it supplied to help soldiers and intelligence operatives detect Taliban fighters hiding in Afghan caves.

Up next: sensors used to secure naval-base perimeters are being adapted to protect nuclear power plants and major landmarks. As for those dummies--technically, "medical simulator mannequins"--they have been deployed by the military to train MASH units and are being adapted for civilian emergency medical teams and teaching hospitals. The more sophisticated civilian models, costing $50,000 to $150,000 each, have variable pulses, respiration rates, oxygen saturation counts, pupil dilation and other programmable manifestations of sickness and injury.

The luggage scanner, at $800,000-plus, is L-3's hottest item. It uses C.T.-scan technology, similar to that used in medicine, to compare the density of luggage contents with those of various kinds of explosives. L-3 has installed the scanner at more than 100 U.S. airports and in Austria, Ireland, Italy and Sweden. The company has contracts to supply at least 450 of the estimated 2,000 machines needed to equip U.S. commercial airports.

Since 9/11, annual revenues from L-3's airport-security business have soared from $20 million to $400 million. The ride hasn't been all smooth. Early on, federal inspectors complained that some of the machines gave too many false alarms (even mistaking certain dense materials for the much feared C-4 explosive). Improvements have since increased the machines' error-free operating intervals from an average of 200 hours to 700 hours, Lanza says.

InVision Technologies is so far the only company other than L-3 to win government contracts for airport scanners. InVision, based in Newark, Calif., will build about 625 C.T.-based machines. HiEnergy Technologies of Irvine, Calif., meanwhile, is at work on a new explosive-detection technology that some analysts believe could one day give L-3 a run for its money. "It's possible that new technology could render L-3's obsolete," says Christopher Tavares, an analyst for MetroTrading, a brokerage in Deerfield Beach, Fla. "To stay competitive, L-3 will have to continue to develop new product lines."

For now, L-3 has the edge; 25% of its revenues come from domestic-security business. "It's well positioned to get a big piece of the homeland-security pie," says Tavares. And the pie will be big. Congress has pledged about $38 billion in 2003 for homeland security. Some of it will go to the likes of General Dynamics, Raytheon and Northrup, all of which sell security systems. But they tend to hire smaller shops like L-3 to make components, so, as Lanza puts it, "we won't be competing with the gorillas." Last year L-3 was a subcontractor for Boeing on several airport-security systems, and it is now working with Lockheed to supply communications gear and systems engineering for the U.S. Coast Guard. Also, last year roughly two-thirds of L-3's 35% earnings growth came from acquisitions. But Lanza predicts that internal growth will account for a steadily increasing share of growth and is aiming for $6 billion in sales within five years. Given this increasingly unsafe world, that doesn't seem farfetched.