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Raytheon Company (NYSE:RTN)

Q4 2008 Earnings Call

January 29, 2009 9:00 a.m. ET

Executives

Mark Kaplan – Vice President Investor Relations

William H. Swanson – Chairman and Chief Executive Officer

Dave Wajsgras – Sr. VP and CFO

Analysts

Robert Spingarn – Credit Suisse

Troy Lahr – Stifel, Nicolaus

Robert Stallard – Macquarie

Doug Harned – Sanford Bernstein

Joe Nadol – JPMorgan

Howard Rubel – Jefferies

Myles Walton – Oppenheimer & Company

Joe Campbell – Barclays Capital

Ron Epstein – Banc of America Securities

Operator

Good day ladies and gentlemen, and welcome to the Raytheon fourth quarter conference call. My name is Lauren and I will be your operator for today. At this time all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator instructions) As a reminder this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s call, Mr. Mark Kaplan, Vice President.

Mark Kaplan

Thank you, Lauren. Good morning, everyone. Thank you for joining us today on our fourth quarter conference call. The results that we announced this morning, the audio feed of this call and the slides that we will reference are available on our web site at raytheon.com. Following the live call, an archive of both the audio replay and a printable version of the slides will be available on the Investor Relations section of our website.

With me today are Bill Swanson, our Chairman and Chief Executive Officer; and Dave Wajsgras, our Chief Financial Officer. We will start with some brief remarks by Bill and Dave and then we’ll move on to questions. Please limit your questions to two per caller to allow for broader participation.

Before I turn the call over to Bill, I would like to caution you 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 that we discuss in detail in our SEC filings. Bill?

William H. Swanson

Thank you, Mark. Good morning, everyone. 2008 was another strong year for the company and we remain confident about our future. We continue to successfully execute our strategy and had strong operating results for the year. Reflected in our record backlog, 9% sales growth and 23% growth in our adjusted earning’s per share. We had excellent cash generation of $2 billion for the year and continued to improve ROIC.

Fourth quarter was also strong. We continue to have good sales, earning’s, and cash flow generation. All of our businesses performed well. Overall, we had another strong year, we met our commitments, and are reaffirming the outlook for 2009 that we initially announced last October.

It’s no secret that there has been in impact in the financial markets on the global economy. For Raytheon, this impact is reflected in our pension plans, which Dave will take you through in detail. Let me reiterate that the pension plan remains solid and we continue to meet our obligations going forward.

Looking back on the year we continue to operate very successfully around the world. One of the key drivers of our growth strategy is international sales, which contributed 28% of our total bookings for the year. These results are in line with our overall objective to achieve a 72/25 split in our domestic and international sales going forward. In other words, we’re on track.

The success of this strategy is reflected in the resurgence of our Patriot program highlighted by the $3.3 billion award for the UAE. We also received a competitive award for the Royal Moroccan Air Force to put a Raytheon EW Sweep on F16’s going forward. These awards highlight a variety of international programs we were awarded in 2008. The growth in our international bookings reflects very good progress in our international strategy.

Domestically, some of our key highlights during the year included winning the FAA’s Epcot contract to provide training support. This program is off to a great start. The Standard Missile-3’s intercept of a non-functioning satellite, winning JPEL’s contract to assist the navy with pinpoint landing accuracy, and also our continued investments to strengthen and expand our advanced capabilities in cyber security.

These examples reflect the strength of our team and our continued focus on the performance across our programs, our relationships, and solutions that drive customer success and shareholder value.

In summary, our businesses are performing well, our domestic and international growth is on target, and our company continues to be a disciplined, predictable performer with a strong and diverse portfolio of solid programs. This portfolio was built on the core capabilities that support and meet the global needs of our customers, capabilities that enable us to deliver strong results today and position us well for the future.

In closing, I’d like to recognize the Raytheon team, all 73,000 members around the world for their efforts in 2008 and thanking them for their ongoing commitment to our customers, our shareholders, and the communities in which we live and work. With that, I will turn the call over to Dave.

Dave Wajsgras

Thanks, Bill, and good morning everyone. I have a few opening remarks starting with fourth quarter and full year results. Then I’ll discuss our outlook for 2009, and after that, Bill and I will open up the call for questions. During my remarks, I will be referring to the web slides that we issued earlier this morning, which are posted on our web site.

Before I get into the fourth quarter results, I’d like to put them in perspective because when you compare fourth quarter 2008 to fourth quarter 2007, there is a unique event in both quarters, one favorable and one unfavorable.

First, you may recall that in the fourth quarter of 2007, we had a significant tax refund that favorably impacted income from continuing operations. And, secondly, in the fourth quarter of 2008, we had an unfavorable adjustment due to the impact of pension asset returns on our existing contracts and backlog, which we refer to as the KAZ (ph) pension adjustment.

In an effort to provide you with a clearer picture of our operational performance, these two events are in our reported results, but have been excluded from our adjusted results. I will be specifically addressing the latter in today’s discussion.

Okay, would everyone please move to page three? Operationally, we had a very good year and strong results. As Bill mentioned earlier, we ended the year with a record $38.9 billion backlog and we delivered 9% sales growth. Fourth quarter adjusted EPS from continuing operations of $1.13 was up 18%, and for the full year it was $4.06, up 23%.

We also generated excellent operating cash flow of $2 billion during the year after making $660 million dollars in discretionary contributions to our pension plan in the fourth quarter. Based on our performance in 2008 and our confidence we have in our outlook for 2009, we are reaffirming the guidance that we provided to you in October. We expect another year of strong performance with continued growth in sales, EPS and ROIC.

Turning now to page four, I’ll go through some of the details of our fourth quarter full year results. Again, strong bookings, not only for the quarter, but also for the full year, resulted in a record backlog of $38.9 billion. Our book-to-bill ratio for the fourth quarter was 1.4 times and for the year it was 1.2 times.

Here are some of the highlights during the quarter. IDS booked $2.5 billion of the $3.3 billion award to provide advanced Patriot air missile defense capabilities for the UAE. IIS and SAS captured a number of classified contracts totaling approximately $1 billion.

Missiles booked at $423 million for the production of standard missile-2 for international customers, and the US Navy, and $161 million for standard missile-3 for the US Navy and the Missile Defense Agency. Missiles also booked $132 million for the production of (inaudible) missiles for international customers and the US Army.

NCS booked $218 million to provide support for the Fire Finder Weapon Locating Radar, $173 million to provide HTI forward-looking infrared kits, and $122 million for long-range advanced scout surveillance systems for the US Army.

SAS booked $127 million for the production of the advanced counter measures, electronic system, for the Royal Moroccan Air Force, and $106 million for the development of the F15-E radar program.

TS booked $130 million for the work on war fiber focus contract for the US Army, bringing the full year to 2,008 bookings on the program, and $957 million. In total, our full year bookings were $26.8 billion, a 5% increase over 2007.

Turning now to page five, we continue to deliver solid organic sales growth, even with three fewer, or approximately 5% less, work days in the quarter compared to the prior year. For the full year, sales grew 9% over last year, and each of our businesses contributed to this growth.

IBS had fourth quarter 2008 net sales of $1.4 billion, up 10% for both the quarter and the year primarily due to growth on US Army programs. IIS had fourth quarter 2008 net sales of $810 million. For the year, IIS net sales were up 14%, primarily the result of the International E-Boarder’s program.

In the fourth quarter, missile systems net sales were $1.4 billion. For the year, missiles net sales were up 8% driven by (inaudible). Network Centrics Systems had fourth quarter 2008 net sales of $1.1 billion. For the year, sales were up 8% primarily due to high volume on US Army programs.

Space and airborne systems had net sales of $1.2 billion in the quarter, and for the year net sales of $4.4 billion, or up 2%. Technical services had fourth quarter 2008 net sales of $744 million. Full year sales of $2.6 billion were up 20% from last year due to the strong growth in training programs, principally the War Fighter Focus contract. So overall, we delivered solid sales growth for the quarter and very strong growth for the year.

Turning to page six, fourth quarter adjusted EPS from continuing operations of $1.13 versus $0.96 in 2007. The 18% increase was due to operational improvements, lower FAS/CAS expense, and other items, primarily lower share account.

Next on page seven, full year 2008 adjusted EPS from continuing operations was $4.06 versus $3.31 in 2007. The key drivers of the 23% increase were essentially the same as those which drove the fourth quarter. Operational improvements, lower FAS/CAS pension expense, and other items, again, primarily lower share account.

Okay, would everyone please turn to page eight? Our adjusted operating margin for the quarter was up 80 basis points compared to the fourth quarter of 2007. Before I talk about the businesses, let me first highlight one additional item on the table to the right. The subtotal for the fourth quarter of 2008 includes the $69 million, or 100 basis point impact, for the CAS pension adjustment. If you add that back, our fourth quarter 2008 margin was 12.1%, which is 20 basis points higher than the fourth quarter of 2007. The point here is that we delivered strong operating performance.

Looking at the business margins, IBS had strong overall results during the quarter. The increase over the prior year was driven by the sales of licensed software. Margins for IIS, margins increased slightly at IIS. We continue to invest in cyber operations and information security capabilities. NCS margin was up 140 basis points during the quarter, primarily due to productivity improvements. Missiles, SAS, and technical services met or exceeded our expectations for the quarter, and on a full year basis were in line or improved compared with 2007.

Turning now to page nine, our full year adjusted operating margin was up 60 basis points compared to the prior year. And, again, if you were to look at the subtotal line and add back to CAS pension adjustment, our total full year 2008 margin of 12% was essentially in line with our results in 2007.

Shifting now to cash flow on page ten. It is important to point out that the company made a $660 million discretionary contribution to our pension plans in the fourth quarter of 2008, which is $160 million more than we contributed in the fourth quarter of 2007. It is also worth noting that the $660 million discretionary contribution was not contemplated on our prior guidance. And, as we’ve discussed, the company received a tax refund of $381 million in the fourth quarter of 2007.

On a full year basis, we generated over $2 billion in operating cash flow compared to $1.2 billion in 2007. Working capital improvements were one of the significant drivers of our cash generation during the year. In fact, we are fast approaching our goal of $750 million of working capital reductions that we first discussed in early 2007.

Before I move on to 2009, I would like to take a moment and sum up our financial performance for 2008. It was a very strong year for the company. Our book-to-bill of 1.2 times resulted in a record backlog, while organic sales grew 9% and we continued to deliver solid margins. In addition, we also reduced our working capital despite the strong sales growth, which helped us generate over $2 billion of operating cash flow, while contributing $660 million of discretionary contributions to our pension plans.

Our financial position is solid. At the end of the year we had approximately $2.3 billion in cash, the majority of which was in US Treasuries. In addition, we have no debt maturities until 2011 and no borrowings on our revolver. So we have the financial stability and flexibility to focus our efforts on continuing to grow our business.

Turning now to page 11, we are reaffirming our outlook for sales, EPS, and operating cash flow, and providing other important information. In 2009, we expect continued growth in sales in the range of between $24.3 and $24.8 billion. As for pension, we now expect a positive FAS/CAS pension adjustment of $47 million versus the $77 million that we projected in October. There are three factors that drove this change. First, as a result of the significant declines in bond yields in December, our end-of-year discount rate was 6.5% versus the 7.5% that we had assumed in October.

Second, our actual pension plan return in 2008 was a negative 25%. On the October call, we had assumed a negative 15% return. And lastly, during the fourth quarter we made the discretionary pension contribution.

Next we expect net interest expense to be between $105 and $115 million. The increase over 2008 is driven by lower interest income, and we expect our average diluted shares outstanding to be between $402 million and $405 million on a full-year basis.

As for EPS, we expect to be in the range of $4.45 to $4.60 per share. This represents a growth of 10% to 13% compared to the $4.06 in adjusted EPS for 2008. It’s important to note that our guidance includes approximately $0.05 per share for the unfavorable impact of higher CAS expense on our existing contracts and backlogs. Just to be clear, it’s roughly $35 million of impact to operating income, or about 15 basis points on margin. Our operating cash flow guidance is unchanged from our prior guidance at $2.2 to $2.4 billion. A key driver of the $200 to $400 million expected increase in cash flow over 2008 is lower cash contributions to our pension plan, the net of the CAS recovery. I’ll talk more about this in just a moment. And, finally, we expect our return on invested capital to be between 10.9% and 11.4%.

Continuing on to page 12, I’ll briefly comment on our outlook by business. First, we expect all of our businesses to deliver solid performance in 2009 each with increasing sales and higher operating income. As we discussed in our last call, we expect total margins to be down slightly from 2008, again, one of the contributing factors is the approximately $35 million in higher CAS pension expense on our existing contracts, which I described just a minute ago. This additional expense is spread across multiple programs within each business. In addition, our margin in ’09, primarily at IBS will be impacted by the timing and start-up of new international programs. Overall, we expect to deliver solid margins in 2009 driven by our continued focus on sales growth and operational execution across the company.

If you will now turn to page 13, we have provided you with a summary of the financial impact of pensions in 2008, as well as our current and prior assumptions for 2009. In 2009, we expect a net cash impact to be roughly $457 million. That is the $1,115,000,000 in total cash funding, less approximately $659 million of CAS recovery. So on a year-over-year basis, in 2009 we expect to have approximately $300 million in lower net cash payments.

In summary, the company’s pension plan assets remain solid. The plan is well diversified and it’s highly liquid with significant cash and treasuries on hand to meet all obligations for the foreseeable future. Let me conclude by saying that Raytheon is in a strong financial position. As a diverse portfolio of innovative products and technologies, we delivered solid results in 2008 and were confident in our continued profitable growth for 2009.

With that, we will open up the call to questions.

Question and Answer Session

Operator

(Operator instructions) And your first question comes from the line of Robert Spingarn with Credit Suisse.

Robert Spingarn – Credit Suisse

Good morning. Bill, we had been thinking that cost constraints could possibly prohibit any changes to the electronic systems on DDG51, but now it looks like that radar may be opened for bidding. Could you talk about the opportunity there and, while we’re on the topic of destroyers, could you give us a comparison of a three ship versus a two ship scenario on DDG1000 for Raytheon and flow timing and that sort of thing?

William H. Swanson

Yes, I’ll look at Mark and see how much time he gives me to answer this question. We could have a dissertation on (inaudible) radars here, then I don't think anybody wants to hear. But let me put in perspective because there will always be some swirl on this thing until it gets settled, and talk a little bit about DDG1000 first. IT gives me a chance to thank the team, they are absolutely performing well on DDG1000, both in terms and schedule and cost. That is on the portion we are responsible for, which I call the mission systems integration portion, all the electronics, ten technologies there. Those technologies are world class, they have been looked at and tested and broadened and probed, and we feel really good about those because any surface combatant going forward in the future is going to have to measure itself against some very proven technology at a very high TRL level.

So when we look at it, you know for example our spy three radar that Expian Radar is already slated to go on carriers and is designated for CVN78, so we know the technologies that we are developing that our customer wants. The third Zimwald ship was authorized and appropriated in the FY09 budget, so there is funding for that. For us, people always worry like something is going to happen tomorrow. We don't see any change in revenue, at least over the next couple of years on that program, and who knows in year three, but it is not falling off a cliff.

And then, you know, I need to always remind everybody we don't do the hull, we do the electronics, those electronics are portable, both forward and backward in designs, and the program continues to meet all its cost milestones, which is important. Secretary Gates talked about the fact that, in my words, programs that swim funny, the sharks are going to come out and get him. So we really work hard here to really make sure all our programs are on track.

The other thing I want to point out if nobody knows the cost of the next restart of a DDG51, and I think I just owe it to everybody because I spent many years as a plant manager. One of the things you always worry about and you know you can't control is restarting a line. And that happens because you have obsolescence and people forget that on the DDG51, we do a lot of the innards and guts of the radar that's on there now. We build the final power amplifiers, the driver pre-drivers, I could go on and on and tell us. And nobody started any bids on those, so we have got to start up those lines and there is going to be some pretty big costs associated with them.

And the report in the paper about a competition on those radars, that is new news to us, there is no ROP’s, there is no discussion with the navy on that. And people discussing radars in the press, the last time I looked they hadn’t designed any of them, so from our standpoint there will be a huge debate going on of what you do, and people have to remember that the current DDG51 is queued. And by that I mean it points that ship in the right direction by our X-Band large radars that have to locate the target, and thus the handoff. So for us, we look at it, we are going to work with the navy here and everybody else, and you know in the end there is not unlimited money to go start up lines, and people are going to have to make some very hard choices, and I like some of Secretary Gates’ comments in his testimony when he is saying I am encouraging military leaders to seek more cost effective solutions for operational requirements. That is right in Raytheon’s wheel house. That is a long answer, I’m sorry, but you got right in the wheel house.

Robert Spingarn – Credit Suisse

Right, but on the DDG1000, you are good for 2009, 2010 regardless of what happens with that third ship?

William H. Swanson

Yes, exactly, and they have to, you know part of it is the third ship is already being funded. Congress has got it in there, somebody would have to go start terminating something, and we all know when you terminate, you get nothing happens with that third ship.

Bill Swanson

Yes, exactly. Part of it is the third ship is already being funded. Congress has got it in there, somebody would have to go start terminating something, and we all know when you terminate, you get nothing for your money.

And so, I basically see a three-ships scenario here. But for us, this was never all about Zumwalt. This was about the technologies that the navy needed for their surface combatants for the future.

I for one, will fight as hard as I can to make sure men and women in uniform have the best technology they can on the battlefield. We want them to have an unfair advantage, and we think they get that with Raytheon's gear.

Robert Spingarn – Credit Suisse

Okay. And then my second question is on missile defense. Could you talk a little bit about the missile defense area, your exposure, how you think about it with the new administration coming in. That was talked Obama may target that area or parts of it. We hear that we could see an increase actually on theater missile defense, but maybe a pullback in the Europe. How do you think about that?

Bill Swanson

The way I look at it is, Europe is not a big swinger. I mean that it gets lost in the round off there. I guess the way I'd say, I don't mean they are diminish anything. I'm just saying it from a financial point of view.

For us, our missile defense efforts are probably in a mid single-digit range when you look at revenue. We are not in any of the advanced stuff, except a little bit of MKV which is a small effort. What I kind of happening, or at least some of the discussion is that the stuff that is at risk, that's unproven technology that's going for the 99% exquisite system solution is going to get under review.

And so part of that, we'll feel pressure. For us the stuff that's put metal on target, whether it's Standard Missile-3, or whether it's the EKV. That technology is proven. It's hit a bullet with a bullet, and our view is that what we've heard on the hill is that people want to produce things that they know will do the job, and so we kind of feel confident with that.

Robert Spingarn – Credit Suisse

Thank you very much.

Bill Swanson

If that helps.

Robert Spingarn – Credit Suisse

It does. Thank you.

Bill Swanson

Yes, okay.

Operator

Your next question comes from the line of Troy Lahr with Stifel, Nicolaus.

Troy Lahr – Stifel, Nicolaus

Thanks. Are you guys still expecting about $21 billion, $22 billion of bookings for the year, or did some of the work get pulled into 2008 with the strong bookings that we saw?

Bill Swanson

Actually as you point out, we saw a $26.8 billion. I should point out about 28% of that was international, which was good. And this year, we were looking about 24.5, plus or minus $500 million here there, but for us that's our initial look. International has a tendency to drive that higher. We might be a little conservative on the international side.

Troy Lahr – Stifel, Nicolaus

Okay, so bookings 24.5 for '09?

Bill Swanson

Yes, plus or minus, they have been a little bit conservative on international, so where I got here.

Troy Lahr – Stifel, Nicolaus

Okay. And then in the fourth quarter it looks like IIS came in a little below what you were guiding towards for the full year. Anything going on there, just still investing in cyber security stuff, or what's moving the numbers around there?

Bill Swanson

Yes. That's what moves their margin around. And then for us, we are going to be cranking up here. We are going to do, to use the correct word, we do a drop in the April timeframe. That's where we will have some initial capability on the e-Borders, so little close start, moving it up and probably in the December timeframe, we spend some time making sure that's all lined up, so I expect them to keep on cranking here.

Troy Lahr – Stifel, Nicolaus

Okay, thanks.

Operator

And your next question comes from the line of Robert Stallard with Macquarie.

Robert Stallard – Macquarie

Good morning.

Bill Swanson

Good Morning.

Robert Stallard – Macquarie

Dave, on the pension fronts. I was wondering if I could ask you what your initial thoughts are on 2010, and where you think the FAS/CAS lines could you assuming you meet your expectation return and the discount rate doesn't move?

David Wajsgras

Yes, it's a good question. And you know there is a number of variable that impact the FAS/CAS adjustment with the FAS/CAS delta. And they include the discount rate, the return on assets, the funding and I guess importantly the potential CAS harmonization. And with all that said, given that these variables, all have different ways of impacting the outcome. It's very difficult to predict the 2010 or beyond impact on the P&L.

Robert Stallard – Macquarie

You have given your funding estimate. We have discount rate, assuming you stayed here. We have an assumption for returns. Do you have any wildcard there? I think that's a CAS harmonization, assume that doesn't happen, what do you think 2010 will be?

David Wajsgras

Yes, I'm glad you asked that. I pointed out a couple of minutes ago that on a net basis, we had just under $460 million in cash contributions to the pension estimated for 2009. And looking beyond, again, it's subject to a lot of different assumptions, but if everything plays out under current assumptions, the net cash contribution. And it's sort of '010 and beyond. It's basically inline or a little bit inside of the '09 estimates.

Robert Stallard – Macquarie

You are saying that the 2010 FAS/CAS line will be similar to the income in '09?

David Wajsgras

No. I'm saying from a net cash impact standpoint. If all the assumptions were to maintain as we look 12 months out, and that's a really important point. The approximate net cash contribution to the pension would be pretty much inline from an '09, '010 standpoint. And then maybe a little bit less going forward, it could swing $100 million, $200 million depending on how the CAS harmonization plays out and the timing.

Again, I just want to reemphasize that there is a lot of assumptions behind what I'm saying, and things could change from what I just said.

Robert Stallard – Macquarie

If you are looking at the income statement, can you give us any sort of feel that how that could pan out in 2010?

David Wajsgras

I'm sorry. I think I was answering that with your initial question, and there are just too many moving variables as you look to 2000, really beyond 2009 it's just too difficult to estimate.

Robert Stallard – Macquarie

Okay, have a crack at that. The other second question is, I was wondering if you could give us an update on the Saudi border contract.

Bill Swanson

Yes. First of all, let me stress, we've received no formal notification from the customer. There is a lot of swirl going on. The swirl is that that customer may select a lower tax solution that really contains the berms, fences and cortyna wire. That's not our strength. And if they went that way that would put something about at least 50% below what we would put in given our solution.

And so from that standpoint, that's the swirl. I want to point out that that program is not in any of our forecast whatsoever, so that doesn't have any baring on the reaffirmed guidance that we just put out, and whatever the MOI does there in any capacity will help them, and we continue to support them with a number of internal programs and country and we've been there for 45 years and our company play some major role in their national security.

Robert Stallard – Macquarie

No firm conclusion at this stage, Bill?

Bill Swanson

No, but I suspect that the way I'd look at it. I'd suspect a lower tax solution if I had to guess, but we are not notified, but guess, my opinion, I'm giving it to you.

Robert Stallard – Macquarie

Okay, thanks very much.

Bill Swanson

Okay.

Operator

And your next question comes from the line of Doug Harned with Sanford Bernstein.

Doug Harned – Sanford Bernstein

Good morning.

Bill Swanson

Good morning, Doug.

Doug Harned – Sanford Bernstein

When I look at the NCS and Missile Systems, and your guidance for '09, you are looking at a lower growth rate than we have seen in the past, and I was interested in are you seeing any shift there in terms of growth possibly related to supplemental spend, or is this more conservative view on the outlook?

Bill Swanson

Well, we haven't seen any real shift there. I think from our standpoint, when we look at our plan going forward, the supplemental impact. We are not a company that's rotated around them. My guess would be the way I had to say it, and it's kind of our view of where they are given the orders that came in the later part of last year. So there are no surprises there, and we expect those businesses to deliver good result for us this year.

Doug Harned – Sanford Bernstein

So no real change in the way you are looking at that?

Bill Swanson

No, no. Not at all, no surprise there and no supplemental pressure either.

Doug Harned – Sanford Bernstein

Okay. And then, second on IDS, the lower margins that you expect in '09. Could you talk a little bit more about that in terms of the timing of awards? And what your expectations would be longer-term? In other words, is '09 a year where you are looking at some changes in contract and this is more unusual year for the lower margins, or have the past couple been the unusual years with the high margins?

Bill Swanson

Well, let me see if I can generally give you an answer and then I will have Dave chime in if it's added color needed. The way I look at it, it depends on the timing and mix of your programs that are in your portfolio. We were finishing up some programs last couple of years in IDS and they were really able to manage risk and retire that risk, so when we finished up that was able to flow to the bottom-line. IDS was starting up a number of programs, and one other things we want to make sure of this that we have right risk profiles in that program and as we retire risk then we hope to have that flow to the bottom-line. But the one thing that we have gotten very good at in this company is been predictable and knowing our milestones and laying that out.

And so Dan's challenge and IDS's challenge to start up, to get those programs moving with some speed agility and compress the schedules and get them delivered and retire the risk and give us some good returns.

Doug Harned – Sanford Bernstein

But presumably these contracts are of the similar nature to past ones, and it's a matter of timing and the rate of risk retirement rather than any fundamental difference in the potential possibility of the contracts.

Bill Swanson

Yes, I'd kind of say it that way. For us with all of our programs, we manage risk and it's a part of the DNA here, and we want to make sure that we do it in a very pragmatic way. But as you said that there is no fundamental difference taking place there, it's we are starting off some big programs that have some long-gestation period here and we want to make sure we've got the flexibility to do what we need to do for our customers.

Doug Harned – Sanford Bernstein

Okay, good. Thank you.

David Wajsgras

Let me just add one thing just briefly. The guidance.

Bill Swanson

You're not going to tell them to ignore everything I said?

David Wajsgras

No, no, no. The margin guidance that we are looking at next year for IDS specifically is industry-leading, and I think that's an important point to keep in mind. And to reiterate what Bill just went through, it is a bit of a transition year for IDS.

Now with that said, the company manages over 8,000 programs. And if you look at the overall company margins they are continuing to be very strong notwithstanding of the fact that we are absorbing about 15 basis point from the cash pension expense that I spoke to a few minutes ago.

And this sort of top line transition year for IDS. As Bill mentioned that we continue to invest in important areas in the company and particular, in the cyber security area. You'll notice that IIS's margins are improved substantially year-over-year, and that’s the case for a number of other business as well.

Doug Harned – Sanford Bernstein

Okay, thank you.

Bill Swanson

Okay.

Operator

Your next question comes from the line of Joe Nadol with JPMorgan.

Joe Nadol – JPMorgan

Thanks, good morning.

Bill Swanson

Good morning, Joe.

Joe Nadol – JPMorgan

Question on sales outlook. I believe we had established a $500 million wedge for international air and missile defense in October for the '09 guidance.

Bill Swanson

Yes.

Joe Nadol – JPMorgan

And you got the big order in the fourth quarter. And I guess, could you layout why, or if that $500 million is full or overbooked, given that big order? And then maybe just how things sit with the other potential orders, given where oil is?

Bill Swanson

Yes. The way I would say this is it's not overbooked, but we have done a good job of filling up part of that let's say good majority of it is, it's getting close. We still have some other international orders to do. That was prudent for us to do that, because wouldn't knew we were close on the UAE ordering that wouldn't been proper not to have that in there. I think more people were concerned about us overreaching, but I just growth back to our five years performance and predictability, so we wanted to take that into account.

Going forward, the way I talk about oil is UAE bought up with price oil, so I always say in our business it is driven by the economy whenever it's more driven by the threat. What is each country have to do, what are they worried about and it's an individual decisions, so they made that decision in the phase of oil where it is.

We just recently booked some spares of order for them little over 200 million, so we see that probably grown a little bit more. We have got another program in that region that we are looking at air and missile defense. We have got work for kingdom Saudi Arabia potential there for patriot upgrades in expanding their capability.

You saw an initial part of the Taiwan order. There is more there that we'll doing for Taiwan with patriot. Israel is going to be upgrading some of their fire units and of course Kuwait is there. Those are some of ones on the horizon there that will help us to fill that bucket as you call them. Our goal is still overbooking.

Joe Nadol – JPMorgan

And it's fair to say that all these that you mentioned, Bill, these are all still not really slipped oil you haven't seen any impact from changing economic conditions in terms of the way things are moving along?

Bill Swanson

No, I have it at the gas pump. I have seen that one. But in talking with countries what we have to all remember is these aren't instant things that get done in 24 hours. This is a long-term commitment, you are look at UAE that $3.3 billion over five years. So, it's a long-term commitment when they look at it. I don't think they are planning on oil staying where it is for those five years. So, the point that's how they look at it. I guess the best way to describe it is nobody has told us to go home.

Joe Nadol – JPMorgan

Okay.

Bill Swanson

That's the way I describe it.

Joe Nadol – JPMorgan

Just to be clear on the $500 million at this point with the UAE order in the backlog, we are completely de-risked on that $500 million and everything from here will be upside?

Bill Swanson

We got a little bit left, but that don't completely de-risk it. It would have helped to get narrow order a little quicker, but we are going to through and move as quick as we can and get those lines going, but we have done a good job at filling part of that, that is the way I describe it.

Joe Nadol – JPMorgan

Okay, thank you.

David Wajsgras

You know there has been great, great questions. I think we're running close to out of time. So, maybe, if we can revise the instructions, I think we would be able to take one question per caller in the time remaining. So, then next caller, Lorraine the next caller, please?

Operator

Yes. Your next question comes from the line of Howard Rubel with Jefferies.

Howard Rubel – Jefferies

Thank you very much. I actually want to talk a little bit about your outlook. It looks pretty impressive, Bill and what you have constructed. If you go back, you know there is always puts and takes that happen.

How would you say today looks versus when you first sort of showed us October, part of it looks like a little bit lower margins is because FAS/CAS item. But other than that and maybe a little bit better because of share repurchase being a little aggressive, but is there anything else that sort of happened in the remaining three months either give you some confidence or raise some risks?

Bill Swanson

Yes, Howard it's a good question. Dave could talk to the financial aspect of it, but I think you are asking more a programmatic how I feel about the market in the programs you said?

Howard Rubel – Jefferies

Yes. That's correct.

Bill Swanson

Okay. Good then I’ll take on my side rather than Dave. He still probably want to talk, but if I look at it I feel pretty good. In October, when we look took a look at this thing you wonder what budgets are going to look like, world defense and so forth and how you build up your programs and so forth.

And we just finished our ops reviews for January and looking what's out there in front of us. And what's the administration is doing. I am encourage the way Secretary Gates and DoD is talking about things. And for us, I guess what I feel good about is he opposes across the board program adjustments.

He said it right that what you do is inefficiently extend all programs. So you drive the cost of it, it's a false sense of security, so now they are going to look at things in the right way, and they are not going to single out targets for contract efforts, but what he is really saying is if you are not performing, you are going to pay the price. And you all know we’ve been hell on wheels here to make sure we perform on our contracts, we want execution to be flawless.

Now you are not always able to do that everywhere, but I feel pretty good about our 8,000 programs in that regard. And he is encouraging military leaders to seek out more cost-effective solutions for operational requirements. That's what we've been training for, for the last five years. And we’ve been trying to train for it was some speed agility. So the way, I guess the bottom line I would say, I am confident.

Howard Rubel – Jefferies

Okay. And I figured Dave is going to say something.

David Wajsgras

Howard, can you see through this microphone.

Bill Swanson

Yes, Howard brought some technology for me so he is virtually here.

Dave Wajsgras

I know I have more technology from Bill I know what to do with it. Let me, I will be brief Howard, but I just a couple of points. The first one is bookings as Bill had mentioned, came in very, very strong in the fourth quarter and we are expecting that trend to continue to as we look at '09.

Now when we gave the initial guidance in '08, clearly we didn’t have as much visibility into the year as we do today. But there have been some important changes and moving pieces. I think firstly, we've talked about this before is the overall cash pension impact has flowed through the financials more significantly than we originally anticipated. And all in between the fourth quarter of 2008 and the full year 2009 that's impacting the company about $0.16 in earnings per share.

In addition, from net interest expense advantage point, interest rates have come down about a 100 to 150 basis points, and that obviously impacts are interest income. So from a net interest standpoint, we are being impacted by an additional $0.03 to $0.04 net interest impact in 2009.

That’s all been offset by operational improvements and that's the point that I really want to drive home. We performed very well in the fourth quarter. You can see from the outlook or the guidance for '09, we expect continued improved performance in '09.

So when you stand back from all these from a purely financial perspective, the most significant change has been about $0.20 in earnings per share impact, positive impact from operational improvements.

Howard Rubel – Jefferies

Thank you, Dave.

David Wajsgras

Okay, Howard.

Operator

Your next question comes from the line of Myles Walton with Oppenheimer & Company.

Myles Walton – Oppenheimer & Company

Thanks. Good morning.

Bill Swanson

Good morning.

Myles Walton – Oppenheimer & Company

Maybe back to the pension, when you look back to kind of '05, 06 when we were kind of going through a similar pension trying to find ourselves when FAS/CAS was coming down, you were able to look out a year and 10 point pretty well with the next year coming was going to be looking like.

Any reason why, we can't do that today, is there anything that's changed within the actuarial drivers to either the FAS or the CAS? And it would seem like the answer to Rob's question, you do know with at least what the CAS is if you know what the cash contributions are going to look like for the next several years. So maybe you can give us those if you don't have the FAS.

David Wajsgras

Sure. Well, as you know we have about 13 or 14 different plans that are managed in a couple of large trust. The biggest one being the US qualified defined benefit plan. The reason this is increasingly difficult is there different rules based on funded position that drive the CAS allocation as well as the FAS expense.

So when we were in a different environment a couple years ago and had more stability in the equity markets and the bond market, it was easier to predict the outlook. So we are comfortable with what we've talked about with '09. But beyond that, it would be inappropriate to guestimate '010 and beyond.

Myles Walton – Oppenheimer & Company

And then maybe squeeze, on the CAS side it looks like into 2009, your cash guidance is absorbed about $400 million of increased contributions into the plan, is that about right given the contribution whereas about $500 million your cash reimbursement rose about $100 million, and what was the offset to that in the outlook?

David Wajsgras

Yes, you are right. That's the quick math, and we've had improvements on a number of different fronts from our original cash conversion estimates to our ability to manage our cash impact from a tax standpoint. And again, we are continuing to drive working capital.

Myles Walton – Oppenheimer & Company

Thank you.

Operator

Your next question comes from the line of Carter Copeland with Barclays Capital.

Joe Campbell – Barclays Capital

Hi good morning, it's Joe Campbell.

Bill Swanson

Good morning Joe.

Joe Campbell – Barclays Capital

Can you help us to understand a little more about cyber security and what it means for Raytheon? I am struggling with whether the cyber security means additional embedded features that you have to add across all your systems to make them safer?

Or is this a kind of overarching separate software effort, like I might buy McAfee or some software for my PC. IT'S sort of over layered on all kinds of other peoples' systems, and is this something that's pervasive through as many groups, or is there one focus to cyber security inside Raytheon.

And you talked about some of them, but are there some big competitors, or is this something, how should we think about this, both in the aggregate and specifically for Raytheon in terms of people in dollars and revenue in potential and so on.

Bill Swanson

Yes, I guess that the easy answer I was going to give you early on was yes, but then only you would give me a complicated one, Joe. The way I look at it, there is two aspects of it.

One, we want to make sure that our offerings to our customers have information assurance built into our products. Nothing is worse than having a network that you questioned the data you are getting from it.

Our all of us, our BlackBerrys were corrupted, we are not sure about where the list went or what data or what information we have in when you lose faith in it, you don't use it. So we have an obligation to make sure we build that into our offerings, and we differentiate ourselves in doing it in way that no one else can do it.

The other part is, is that we want to do more than our products and for us we look at given full service capability. Do we have the ability to understand it from, both bookings from forensic point of view to a weakness point of view and to a solution point of view that our customers could rest assure that you've got Raytheon inside and that there are protected.

We see cyber security gaining more and more attention, the administration, previous administration wedged in about 17 billion in order to protect the pipes across the government, we see that flowing into other areas. We see good double-digit growth for us in the IO/IA area, we've added three additions, we'll look for future additions. If they are not huge additions when you make them, so there bolt-on, but they give us the capability to be able to do the forensic part of it, the attacking part of it and then the systems architecture solution part of it.

So we want people the think about the fact at least governments, our customers that they can come here and we can give a full solution. We are not a piecemeal solution to the problem. So kind of in summary, it's yes in the products, yes in other markets, yes to expanding and growing. And for us, it's double-digit from what we have seen.

Joe Campbell – Barclays Capital

And Bill, if we were to look at the standalone sort of the forensic and weakness and simulate attacks and so on, how bigger business is that. And when you go to market, who do you compete with?

Bill Swanson

Right now, it's a fractionated market. I mean there is no one person you could point to that says that owns the whole thing even though some companies say that they don't have end-to-end capabilities. Right now, in our space non-invaded I-d probably say $150 million, $200 million range in sales, and we expect that to have good growth.

Joe Campbell – Barclays Capital

But I've talked about, but it's not really a lot of money yet?

Bill Swanson

No, not yet. And the problem is, not a lot of people -- I'm not impugning anybody but on the commercial side nobody wants to spend a dime for anything right now. Everybody is trying to stay afloat and doing layoffs. You know, we have the opposite problem we are hiring, but when you look at that market, that’s one when people don’t want to spend until you have been attacked. And the day you are attacked, all heck breaks loose. And so this is something when we talk about a year and half ago, it was our vision that this was going to be market and we wanted to be there in front of everybody else I think we are, I think we branded ourselves.

People come to us, either in company in our industry, come to us because we are well respected and we are understand it. We see it coming. It's like snowball going down the mountain. It's going to gather momentum and it's going to get bigger in size as it goes and we want to get more than our fair share of that, if that helps.

Joe Campbell – Barclays Capital

Thanks very much, Bill.

Bill Swanson

Okay.

Operator

And your next question comes from the line Ron Epstein with Banc of America Securities.

Ron Epstein – Banc of America Securities

Yes. Good morning, guys.

Bill Swanson

Good morning.

Ron Epstein – Banc of America Securities

Bill, could you walk through as we look into 2009 and maybe 2010, and maybe a little a laundry list of programs that we should keep an keep an eye on had a potential opportunities for you guys?

Bill Swanson

Yes, I think foreign wise, I mentioned Saudi, Taiwan, we'll have more on UAE, maybe great if we go look at that and parts of Asia. Clearly, for us we've got some competitions. We've got GPS, OCX, we have got GOZAR, we have got small diameter bomb. Those will be ones that we are looking at and as you know, we factor those heavily and if we win, they are upside to the plan? So that’s kind of how we look at those. Those are probably the big deal items.

For us I am always amazed when we kind of look back over the year and look at all our programs, we just have a lot of programs that $5 million or less. And that's a real strength of this company, because as people start thinking about how do I get larger quantities a systems that represent 75% or 85% solution, those are our programs. So, we are excited. We are looking to this as an opportunity for us to really do it and other thing that’s happen, you know the classified I didn’t talk about it.

Our booking were up 35% last year represents about 13% of our bookings. So the classified world is growing for us. It should point no one asked. We probably don’t see space getting back on the straight narrow till about all ten time frame. I had predicted late '09, 010 I think it's more 010. That’s going to take a while for the new administration and people in charge to go look at it. So, we didn’t see any change there but classified it's done pretty good.

Ron Epstein – Banc of America Securities

Okay and then if I can just a --

Bill Swanson

I am sorry. I hate to interrupt. But I think we have time for just one more caller. We’ll follow-up after the call. I am sorry, Ron.

Operator

And your last question comes from the line of Heidi Wood with Morgan Stanley.

Heidi Wood – Morgan Stanley

Good morning. Nice quarter.

Bill Swanson

Thank you, Heidi.

Heidi Wood – Morgan Stanley

Question for you, do you could brief us on your international sales and today, you talked about bookings but what percentage were they in sales in '08, what are they go in '09? And expresses if you could by division just that we can so think about trajectory in '08 and '09?

Bill Swanson

Nice try, Heidi. You must have thought I was being really good today. By division, I will give it to you in total 20% of our sales in '08 were international. That’s almost double-digit growth over 2007. We expect 2009 international sales to be in 22% to 24% range. That could be a little bit conservative, mainly because it's shows the international but we are feeling pretty good about international around here what we’re seeing. But we don’t break it out by business.

Heidi Wood – Morgan Stanley

And Bill, can you talk about how you are thinking about -- when we look at this Obama administration, and we can anticipate an emphasis on diplomacy with them and we fold in sort of the appointments like Michele Flornay and others where we think there is going to probably emphasis on small power. Can you talk to us about how you are positioning or how you see Raytheon positioned to take advantage of possible budget focus there? And how do we think about how that translates into programs?

Bill Swanson

Yes, first of all, all good picks. I think, you know, the administrations going through it in the systematic way. The other thing I want to point out is, we have people in place. There is always a concern for somebody that’s been around as long as I have is that when you go through at administration change there is usually avoid that’s created. The last time you know, Secretary Rumsfeld was there by himself for a while in the beginning to all the replacements came in, but we’re in the time of war and they have done good job. People are there and we’re moving forward on programs which is good thing but your point of diplomacy.

One other things that we saw shift a couple of years ago is that big powerful solutions or hit with a baseball bat kind of thing wasn’t where we thought things were going to go. It's more urban warfare. It's more what I will call surgical in nature and frat Traside is not what anyone wants and literally those are the kinds of programs we have on our portfolios. How do you go in and do that with pinpoint accuracy and no collateral damage. How do you get the ISR Intel information you need make decisions. In times at diplomacy you want to know more about what's going on not less. And so kind of how we see the world is we’re ready for it. That’s what we have been training for. That’s the way we’re organized. That’s we’re incentivized. And as I was saying when I learned how to play ball, send me in coach. Okay, if that helps.

Heidi Wood – Morgan Stanley

Yes, when we have also seen you, Bill, you get much more active on the M&A front. Would you expect to pickup the pace towards those in 2009 as well?

Bill Swanson

Well, we continually look at it and that’s one other things were when you are running your programs well you get a chance to sit back and look, and we continue to work our capability GAAP analysis. And for us, you can fill that GAAP through investing internally which is where our whole engineering workforce gets tested and where I have a lot of enjoyment doing that part of it. Then we have teaming and partnering that we can go do, and then as you point out, acquisitions. No price change in acquisitions yet. So we want to make sure that the cash we have is used properly. So, those three areas are getting the lot of attention for us as we go forward.

Heidi Wood – Morgan Stanley

Great. Thanks very much.

Bill Swanson

Okay.

Marc Kaplan

I would like to close by thanking everyone for joining us this morning. I appreciate your interest in learning more about our company, our recent performance and outlook. We look forward to speaking with you in our first quarter conference call in April. Lorraine?

Operator

We thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

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