RTX Corp (RTX) — Q2 2015 Earnings Call Transcript

Good morning, everyone. Thank you for joining us today on our second quarter conference call. The results that we announced this morning, the audio feed of this call and the slides that we’ll reference are available on our website at raytheon.com. Following this morning’s call, an archive of both the audio replay and a printable version of the slides will be available in the investor relations section of our website. With me today are Tom Kennedy, our Chairman and Chief Executive Officer; and Toby O’Brien, our Chief Financial Officer. We’ll start with some brief remarks by Tom and Toby and then we’ll move on to questions. Before I turn the call over to Tom, I’d like to caution regarding our forward-looking statements. Any matters discussed today that are not historical facts, particularly comments regarding the company’s future plans, objectives and expected performance, constitute forward-looking statements. These statements are based on a wide range of assumptions that the company believes are reasonable but are subject to a range of uncertainties and risks that are summarized at the end of our earnings release and are discussed in detail in our SEC filings.

Thank you, Todd. Good morning, everyone. This morning Raytheon reported solid second quarter operating results. Sales exceeded our guidance increasing by 3% over second quarter 2014. This was driven by IDS and missiles and was primarily organic. With this solid revenue performance, we now see an opportunity for top line growth in 2015. EPS and cash flow also exceeded our expectations in the quarter. This performance demonstrates that our focus on global growth is succeeding. As a result, we have updated our financial outlook to reflect our solid year to date performance and the acquisition of Websense in late May. Global demand for advanced technologies drove an 11.9% increase in bookings in the quarter compared to the second quarter 2014. International bookings were particularly strong representing 46% of total bookings, led by the $2 billion Saudi Patriot award as well as a number of missile awards. Domestic bookings were also solid with awards from across our portfolio including Standard Missile 3, Evolved Seasparrow Missile, next generation radars for P-8 maritime aircraft as well as $626 million in classified awards at both SAS and IIS. Given the strength of our overall bookings year to date, we now expect full-year 2015 bookings to be approximately $24.5 billion, plus or minus $500 million. The Raytheon team and I had the opportunity to meet with many of our global customers last month at the Paris Air Show. The feedback reinforced what we have been seeing over the last year. That is many of them are investing in strong defense to deter evolving threats. I would note that compared to the Farnborough Air Show last year, the demand to strengthen the deterrence has increased, particularly from our customers in Eastern Europe, the Middle East and North Africa and the Asia-Pacific region. We see this increased demand reflected in our results. For example, at the end of the second quarter of 2015 approximately 44% of our total backlog was international. A new high for the company. This compares to 38% at the end of the second quarter 2014. Total backlog increased $1.5 billion year-over-year to $34.5 billion. This is important because it sets the stage for growth and provides future margin expansion opportunity. I would like to take a moment to further highlight our missile business. As many of you know, Raytheon is a premier provider of missile and ship defense systems. Whether it's for new builds or upgrading existing ships, most of them will have one or more Raytheon missile systems solutions on them. Our core product within this domain is our Standard missile family of interceptors. Standard Missile-6, also known as SM-6, is designed to provide over the horizon defense against aircraft and anti-ship cruise missiles. In the second quarter, an SM-6 successfully intercepted a supersonic target in an over the horizon test, a key demonstration of the missile's capability. Further, SM-6 moved from low rate initial production to full rate production in the second quarter. We also received a $143 million booking in the quarter which drove year-to-date bookings for SM-6 to approximately $215 million. Another version of our Standard Missile is SM-3, which is used by the U.S. Navy to intercept short to intermediate range ballistic missile threats. This is one of the company’s largest programs. In the second quarter we received a $512 million award for the 1B version of this missile, supporting the ongoing ramp-up in production. The SM-3 1B will be deployed on the U.S. and allied navy ships. It will also be deployed at the end of the year on land in Europe as an integral part of the Phased Adaptive Approach missile defense system. The next generation of SM-3 has also taken flight. In the second quarter, SM-3 IIA which we are developing in partnership with Japan, had its first flight test which was successful and is expected to enter production later in the decade. Taken all together, Standard Missile programs have driven over $800 million of bookings year-to-date. Beyond Standard Missile, the missile business segment is also benefiting from significant demand for a wide range of other solutions, including global demand for Paveway and the Evolved Seasparrow missile, which saw strong bookings in the quarter. Our missile portfolio is well-aligned with the evolving priorities of our global customers and that provides a strong foundation for our future growth. Looking at our domestic market from a broader perspective, the defense budget environment remains fluid. While there have been positive signs coming from Washington, there are still differences between Congress and the administration in their approaches to fund fiscal year '16 defense spending. Additional time may be needed to resolve these differences which increases the probability of another continuing resolution this fall. We have had CRs for the past several years and we would not expect a significant impact on our results should we have another one this year. Now turning to our capital deployment strategy. As part of our balanced approach, we are increasing our expectation for the share repurchase program. We now expect the share repurchase for full year 2015 to be around $1 billion, which represents a $250 million increase both over 2014 and our original expectation for 2015. This follows a 10.7% increase in the dividend in the first quarter and the Websense transaction in May. As I mentioned, we closed on the Websense acquisition in the second quarter and the integration is on track. The combination of Raytheon and Websense is a great fit, allowing us to bring our advanced cyber-security capabilities to government and commercial customers around the world. We welcome Websense employees to the Raytheon team. Overall, I am pleased with our performance in the quarter. The members of our team are proud and passionate about what they do for our global customers, our investors and our company. The focus and enthusiasm contributed to our success and helped drive our results. I would like to thank the Raytheon team for its hard work and dedication.

Okay. Thanks, Tom. I have a few opening remarks, starting with the second quarter highlights and then we will move on to questions. During my remarks I will be referring to the web slides that we issued earlier this morning. We are pleased with the solid performance the team delivered in the second quarter with sales, EPS and operating cash flow all better than our expectations. We had strong bookings in the second quarter at $7.6 billion, resulting in a book to bill ratio of 1.3. Sales were $5.8 billion in the quarter, up 3%, led by our IDS business. You should note that with the acquisition of Websense, we have moved away from presenting adjusted numbers but have provided additional information that should help you with your understanding of the financial performance of the company. Our EPS from continuing operations was $1.65, which I will give a little more color on in a few minutes. Operating cash flow of $376 million was better than our prior guidance, driven by the timing of collections. Second quarter 2015 operating cash flow was higher than last year's second quarter primarily due to the timing of required pension contributions and the expected collection of the eBorders settlement with the U.K. Home Office which we resolved in the first quarter 2015, partially offset by higher cash taxes. During the quarter, the company repurchased 1.9 million shares of common stock for $200 million, bringing the year-to-date share repurchase to 4.6 million shares for $500 million. As Tom mentioned, we closed on the Websense transaction on May 29 and formed Raytheon Websense, a new joint venture company that was created through the combination of Websense and Raytheon Cyber Products. The Raytheon Websense segment results have been presented to reflect Raytheon Cyber Product results for all periods and Websense results after the acquisition date. Our full year 2015 guidance, which I will discuss in a few minutes, has been updated to include Websense, as well as improved operating performance for the first half of the year. Company bookings for the quarter were $7.6 billion an increase over $800 million compared to the second quarter 2014. And on a year-to-date basis were $12.1 billion, an increase of approximately $1 billion over the same period last year. It's worth noting that on a trailing four quarter basis, our book to bill ratio was 1.1 times. For the quarter, international was 46% of total company bookings and on a year-to-date basis was 41%. For the year, we expect international to be in the range of 32% to 35% of total bookings. As Tom just mentioned, we booked several significant awards in the second quarter, including a $2 billion contract for Patriot for the Kingdom of Saudi Arabia, $538 million on the Warfighter FOCUS program, $529 million for Standard, $511 million on Evolved Seasparrow Missile and $363 million Paveway. Backlog at the end of the second quarter was $34.5 billion, an increase of approximately $1.5 billion compared to the second quarter of last year. And on a funded basis, backlog was $25.3 billion, an increase of almost $1.8 billion compared to last year's comparable quarter. If you now move to Page 5, as I mentioned earlier, for the second quarter 2015 sales exceeded the high end of the guidance range we set in April, primarily due to better than expected performance at IDS and missiles. For the second quarter, our international sales were approximately 30% of total sales and all of our businesses were at or above our expectations. Looking now at sales by business. IDS had second quarter 2015 net sales of $1.7 billion, an increase of approximately 10% compared to the second quarter of 2014. The increase was primarily due to two recent international Patriot awards. It is important to note that the second quarter 2015 included the recognition of additional sales for pre-contract work that had previously been deferred. We now expect full year growth to be closer to 4%. In the second quarter 2015, IIS and missiles had net sales of $1.5 billion and $1.6 billion respectively. In line to slightly up when compared with the same quarter last year. SAS had net sales of $1.4 billion. The change versus last year was driven by volume on international tactical radar systems programs. And for Raytheon Websense, keep in mind that the results for the second quarter of 2015 include Raytheon Cyber Products for the full quarter and Websense results for the month of June. Overall, the company continues to perform well. Our operating margin was 11.1%, both on a total company and business segment basis. On a year-to-date basis, our operating margin was 13.4% and on a business segment basis was 13.2%. As we discussed on the last few earnings calls, compared to 2014, our margins for 2015 have been impacted by a change in program mix as well as higher IR&D and program investments. We continue to invest in ourselves with the objective of positioning the company for future growth. So looking now at the business margins. The change in margins at IDS was primarily driven by a change in program mix on international Patriot programs nearing completion. Included in IDS operating income in the second quarter of 2015 was an adjustment of $33 million to eliminate all remaining estimated incentive fees related to the air warfare destroyer program due to the shipbuilder extending the planned schedule and related increase in cost to complete its portion of the program. Although Raytheon's performance continues on plan for both a cost and schedule standpoint, the shipbuilder is now estimating an increase in its cost to complete the program which drove the decrease in estimated incentive fees. The change in margin at IIS was primarily driven by a change in program mix. Missiles and SAS margins were down in the quarter compared with the same period last year, primarily driven by higher net program efficiencies in the second quarter of 2014. When you normalize for these two items, Raytheon Websense margin would be in the high teens range. Before turning to the next page, I wanted to spend a minute discussing the purchase accounting adjustments and corporate items related to the Websense acquisition. In the second quarter of 2015, we had a deferred revenue adjustment of approximately $10 million and about $8 million for the amortization of acquired intangible assets. In addition, I want to point out that on the corporate line there is approximately $23 million of Websense acquisition related costs. Second quarter 2015 EPS was $1.65, better than expected driven by higher sales. Of note, second quarter 2015 included a favorable $0.29 non-cash tax settlement as reflected in our prior guidance, and an unfavorable $0.09 associated with the Websense acquisition. On Page 9, we are updating the company's financial outlook for 2015 to include Websense as well as our improved operating margin to date compared to our prior guidance. We are increasing full year 2015 net sales by $400 million, of which approximately $300 million is driven by IDS and missiles and approximately $100 million is driven by the Websense acquisition. We now expect our full year 2015 net sales to be between $22.7 billion and $23.2 billion, which is flat to up 2% over 2014. We now expect the EPS impact from the Websense acquisition to be $0.25 dilutive for 2015 compared with the original estimate of $0.48 we provided you back on April 20. This change is driven by the completion of our fair value analysis and as a result, we have updated our acquisition accounting adjustments. We have now incorporated this EPS impact into our updated 2015 guidance. Our full year 2015 EPS is now expected to be in the range of $6.47 to $6.62, which we normalized for the acquisition, is an improvement of about $0.05 over our previous guidance. And as a reminder, we have not included in our 2015 guidance the potential extension of the R&D tax credit. As I mentioned earlier, we repurchased 1.9 million shares of common stock for $200 million in the quarter. We are increasing our expected share repurchases for the year and now expect to repurchase approximately $1 billion, an increase of about $250 million from our initial outlook. We have tightened the range on share count and now see our diluted share count to be between 305 million and 306 million shares for 2015. Also we have raised the low end of the range for our 2015 operating cash flow guidance and now see it between $2.5 billion and $2.7 billion. And as you can see on Page 9, we have updated this sales guidance range for three of our businesses and for the addition of Raytheon Websense. We have increased sales at both IDS and missiles to reflect stronger bookings and higher than expected volume to date. At IIS, we adjusted sales to reflect the realignment of Raytheon Cyber Products to the new Raytheon Websense segment. Turning to margin. We have updated the margin guidance range for the company to reflect the Websense acquisition and now see operating margin to be between 13.1% and 13.3% for the full year. At the business segment level, we see business segment operating margin in a range of 13.2% to 13.4% for the full year. It's worth noting that we expect operating margins at Raytheon Websense to be between 9% and 10% for the full year. And excluding acquisition-related costs, their margins would be about 17% to 18%. On Page 10, we have provided some directional guidance on how we currently see the quarterly cadence for sales, earnings per share, and operating cash flow from continuing operations for the balance of 2015. Before concluding, with regard to our capital deployment strategy, we expect to continue to generate strong free cash flow and maintain a strong balance sheet going forward. We remain focused on deploying capital to create value for our shareholders and customers. This includes internal investments to support our growth plans as well as returning capital to shareholders through share buybacks and dividends. And as we sit here today, possibly smaller, targeted acquisitions that fit our technology and global growth needs. In summary, if you stand back and look at the quarter, we have solid performance. Bookings were strong with a book to bill ratio of 1.3. Our sales, EPS and operating cash flow from operations were all higher than expected. Based on this performance and our near-term expectations, we increased our guidance for 2015 sales and if you exclude the impact of the Websense transaction, we raised EPS guidance by $0.05. We had strong cash flow generation and have increased our planned share repurchases from approximately $750 million to approximately $1 billion for the year.

Okay. We are going to have to leave it there this morning. Thank you for joining us. We look forward to speaking with you again on our third quarter call in October.