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Raytheon Co. (NYSE:RTN)

Q3 2009 Earnings Call

October 22, 2009 09:00 AM ET

Executives

Marc Kaplan - Vice President, Investor Relations

William H. Swanson - Chairman and Chief Executive Officer

David C. Wajsgras - Senior Vice President and Chief Financial Officer

Analysts

Peter Arment - Broadpoint AmTech

Noah Poponak - Goldman Sachs

Ronald Epstein - Bank of America-Merrill Lynch

Troy Lahr - Stifel Nicolaus

Rob Stallard - Macquarie Group

Cai von Rumohr - SG Cowen Securities Inc.

Heidi Wood - Morgan Stanley

Robert Spingarn - Credit Suisse First Boston LLC

George Shapiro - Access 342

David Strauss - UBS

Myles Walton - Oppenheimer

Howard Rubel - Jefferies & Company, Inc.

Douglas Harned - Sanford C. Bernstein

Operator

Good day, ladies and gentlemen. And welcome to the Raytheon Third Quarter 2009 Earnings Conference Call. My name is Michael and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we'll conduct a question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today's call, Mr. Marc Kaplan, Vice President of Investor Relations. You may proceed.

Marc Kaplan

Thank you, Michael. Good morning, everyone. And thank you for joining us today on our third 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 the live call, an archive of both the audio replay and a principle version of the slide will be available in 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'll start with some brief remarks by Will and Dave and then we'll move on to questions. Please limit your question to one per caller and one follow-up to allow for broader participation.

Before I turn the call over to Bill, I'd liked 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 our 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, Marc. Good morning everyone. We delivered strong results during the quarter. Our sales were up 6%, EPS was up 24% and we continued to have good cash flow and solid bookings.

Our bookings for the quarter totaled 5.1 billion. 25% of that was international. If we look further at the 5.1 billion, about a dozen bookings or so were 50 million or more. The balance of our bookings, roughly 1500, averaged around 2.5 million each. This speaks to both the broad diversity and strength of our portfolio.

There is good demand for our solutions, technology, products, upgrades and support. Our program performance across the board remains strong, and so we feel good about our competitive position.

In the U.S. and internationally, our businesses are aligned with the evolving needs of our customers. We're able to both forward fit and backward fit our technology and our solutions to enhance our customers' capabilities. Our international business continues to be strong and it's an important driver to our growth.

We do business in over 80 countries around the world, in fact we have our highest sales from international this quarter and we expect double digit international growth over '08.

There's strong interest in air and missile defense systems. In missiles, air borne sensors, training solutions and classified programs, at the same time having personally worked international business development for over 40 years or close to 40 years, I know from experience that timing is always a factor. That's the nature of the business but as a result of our performance, our capabilities and our relationship building, we have a full pipeline of opportunities.

Another area of focus is our investment in growth and technology. During the quarter, we announced our agreement to acquire BBN Technologies, a privately held world leader in research and development and a provider of critical solutions for national defense and security missions.

We're excited about the capabilities that BBN will provide us and see immediate areas where there are technologies can be applied to enhance our products. We expect the transaction to close in the fourth quarter.

So overall, we continue to see a high demand for our solutions domestically and internationally, which makes us confident that we'll continue to execute and drive for future growth.

Shifting the guidance in our news release this morning, we announced that we're increasing our 2009 guidance for EPS and ROIC. And while we're still going through our 2010 planning process,

We provided preliminary guidance for 2010 that shows good growth and strong performance. We believe this positive forecast is a clear demonstration of the success of our strategic planning. Our proven technologies and innovative solutions are squarely aligned with U.S. and international customers' priorities on capabilities, performance and cost.

This provides us a solid foundation to continue to grow and to create shareholder value. With that let me turn it over to Dave.

David C. Wajsgras

Okay. Thanks Bill. I have a few opening remarks, starting with the third quarter highlights and then we'll move on to questions.

During my remarks, we'll be referring to the website that we issued earlier this morning. Okay, if everyone could please move to page three. As Bill noted we performed well in the third quarter, sales of 6.2 billion are up 6% from Q3 of last year. Income from continuing operations of 499 million was up 14% and EPS from continuing operations was $1.25 was up 24%.

Operating cash flow from continuing operations during the quarter, 749 million was above our prior guidance primarily due to timing. Our cash performance during the quarter included a $397 million improvement in working capital, which largely offset higher cash contributions to our pension plans. In the third quarter of 2009 we made $547 million in cash contributions to our pension plans compared to 137 million in the third quarter of 2008.

This substantially completed our planned pension cash contributions of approximately 1.1 billion in 2009 in line with our total contributions made in the full year of 2008. The company repurchased 6.4 million shares of common stock for $300 million in the third quarter bringing the year-to-date repurchases to 19.8 million shares for $900 million.

At the end of the quarter, we had approximately $1.2 billion remaining on the current share repurchase plan. And as Bill just mentioned, we expect the BBN acquisition to close in the fourth quarter. The purchase price is approximately $350 million and we expected to be accretive in 2010.

Again as Bill noted earlier, we increased our 2009 guidance for EPS and ROIC and narrowed the range for sales. I'll provide additional color on our guidance in just a minute.

If you move to page four, let me provide you with some more detail on our third quarter results. We had solid bookings of 5.1 billion in the quarter and $18 billion on a year-to-date basis inline with last year.

Our book-to-bill approximate 1 to 1 through the first three quarters of 2009. In the third quarter, IDS booked a $75 million option related to two volume search rate for the U.S. navy, one for the Zoomo program and one for the CVN 78 aircraft carrier, bringing the year-to-date bookings on the program to $217 million. IDS also booked 81 million for the production of airborne, low frequency sonar systems for the U.S. navy.

Other notable awards during the quarter included 357 million at Missile Systems for the production of Tow Missiles for the U.S. army and the U.S. marine corp. And that's also booked a 140 million for the production Sparrow Missiles for the U.S. navy and international customers.

Shortly after the quarter close, NTS booked 127 million for Tow replacement programs. NTS booked 511 million on multiple contracts, both domestic and international associated with the warfighter focus program for the U.S. army.

IIS and SAS booked 468 million in classified awards during the quarter. IIS booked 151 million on a U.S. airforce contract to provide operation and maintenance support in the weak following the quarter close.

Looking now at the graph on the right side of page four, backlog at the end of the third quarter was 36.2 billion compared to 37 billion at the end of the third quarter of 2008. As we discussed during last quarter's conference call, the impact to our backlog from the KDI program termination was about 2.4 billion in the second quarter.

We now move to page five. You can see that our overall sales increased by 6% in the third quarter of 2009 and 7% year-to-date inline with our previous guidance. IDS net sales 1.4 billion were up 9% compared to the same period last year. This was primarily due to growth on international patriot programs.

Intelligence and information systems had net sales of 805 million inline with the last year. Higher volume in the classified business was offset as expected by the lower subcontract activity on the e-Borders programs.

Missile Systems net sales 1.4 billion was higher than last year's third quarter primarily due to higher volume on the standard missile programs. Growth at missiles was partially offset by the impact of KDI.

Network Centric Systems' net sales 1.2 billion were up 6% largely due to higher volume across production programs primarily for the U.S. army. States and airborne systems had net sales of 1.1 billion, up 6% versus third quarter of 2008, driven by growth related to their ClassV business. And technical services had net sales of 797 million, up 16%.

The result on strong growth on training programs for the U.S. army and the FAA.

Moving to page six. Operating margins for the total company and in each of our individual businesses remained strong. Our operating margin before the FAS/CAS adjustment was 12.3%, up 10 basis points versus last year.

Our overall operating margin for the quarter including the FAS/CAS adjustment was also 12.3%, up 50 basis points versus last year. Both NCS and SAS delivered strong margins during the quarter, driven by improved program performance and higher volume on international programs.

Technical services margins benefited from the timing of an award fee, a contract modification impacting the scope on a training program as well as from indirect support cost efficiencies associated with the increased level of program activities.

As we discussed on our prior calls we expected IDS to have lower margins than last year due to a change in contract mix, principally the result of completing some international program in 2008.

Both the Missiles and IIS margins remained relatively consistent with the third quarter of 2008. So overall we had strong operational performance at each of our businesses resulting in margin expansion for the total company.

Turning now to page seven. Third quarter EPS from continuing operations was a $1.25 up 24% from a $1.01 in the prior year. Operational improvements, share accounts, the best cash adjustments and another items contributed to the increase.

Okay. If you please move to page eight. I would like to briefly comment on our updated outlook for the year. We've narrowed the range for full year 2009 net sales increasing the low end by $200 million. We now expect sales to be in the range of between 24.7 billion and $25 billion and we are comfortable with the higher end of the range.

As we've done in prior year during the third quarter, we updated our actuarial estimates related to our pension plans as a result of the update FAS/CAS pension income for the year decreased by $18 million from 47 million to $29 million.

We improved the range for diluted shares to between 397 and 400 million. In spite the reduction in FAS/CAS income, our performance has enabled us to increase the high-end of our full year EPS guidance by $0.05.

And we've also updated and tightened the range to between $4.70 and $4.80. You should also know that our 2009 guidance for FAS/CAS adjusted EPS is now between $4.65 and $4.75.

And finally, we've increased the high-end of our outlook for ROIC by 10 basis points between 11.5 and 11.8%. Our outlook for 2009 reflects our continued confidence in delivering another strong year.

Turning now to page nine, I'll discuss some detail on our full year guidance for 2009 by business. We increased the high-end our range for technical services full year sales by $100 million due to the strong growth in training program and we tightened the full year sales range for NCS, SAS and TS.

Next, we increased the range of our full year operating margin guidance for NCS and SAS businesses. The increase in profit margin at both businesses is driven by improved overall performance.

Finally, we lowered the range of our full year operating margin guidance for IIS, primarily due to the timing of both program improvements and new awards which are now expected in 2010.

Moving on to page ten, you can see our initial financial outlook for 2010. We expect next year sales to grow by approximately 46% ending the year between 25.9 and $26.4 billion. We expect net interest expense to be in a range of between 90 and a 105 million, our diluted share count to be in the range of between 377 and 382 million shares and our effective tax rate to be approximately 31.5%, which is primarily due to the full phase in of domestic manufacturing tax benefits.

We expect earnings per share on a GAAP basis to be between $4.75 and $4.90 and our FAS/CAS adjusted EPS to be between $5.16 and $5.31, which would represent a double digit increase of about 10 to 13% over 2009.

For forecasting our operating cash flow to be between 2 and $2.2 billion. When you compare our expected cash flow performance in 2010 to 2009, it's important to recognize that in 2009, we received about $400 million of cash tax refunds early in the year.

Turing now to page 11. Let me add a little bit of color on our pension plan. We've assumed that the net impact on our income statement for 2010 FAS/CAS pension adjustment will be in expense of 228 million as highlighted in the shaded box on this page.

This is based on our current estimate of actual returns on our pension assets for 2009 and an assumed 6.25% discount rate at 12:31 '09. We provided a matrix of sensitivity analysis to help you better understand the impact of the market environment could have on our FAS/CAS pension adjustment for 2010. And just to be clear these will be known in term until we close out 2009. We will provide the details on our fourth quarter conference call in January. You should note that through the end of the third quarter, our pension investment performance approximated a positive 14% return.

Turning to page 12, and here we've provided you with a little more color on our assumed FAS expense, has contract cost and cash funding requirements for 2009-10. We expect our gross cash funding requirements in 2010 to increase by less than $100 million over 2009.

Finally, on page 13, we've provided you with a summary of our earnings per share results and outlook both including and excluding the impact of the FAS/CAS pension adjustments.

Let me conclude by saying that the company had a strong third quarter. We delivered good growth in sales, double digit growth in earnings per share. Dollar cash flow generation and healthy bookings and we've provided initial guidance in 2010 that reflects our confidence in continued profitable growth we're in an excellent financial position. We're strategically aligned with our customers and we are confident about our future.

So with that we can open up the call to questions, Michael.

Question-and-Answer Session

Operator

Ladies and gentlemen. (Operator Instructions). And your first question comes from the line of Peter Arment of Broadpoint. You may proceed.

Peter Arment - Broadpoint AmTech

Yeah, good morning Bill and Dave, congrats on another nice quarter.

Unidentified Company Representative

Thank you.

Peter Arment - Broadpoint AmTech

Will, could you -- it's always nice to get your perspective on the -- sort of, not so much the timing but I guess the overall flavor on the international contracts that you may be seeing out there and I know you, last quarter you gave a very good update on UAE, Saudi Arabia and some of the players out there. And maybe you could just give us where you think things stand at this point heading into 2010?

William Swanson

Yeah, let's all back track to what we said last quarter. I don't think I've seen any changes internationally, quarter-over-quarter. I think for us we see some things getting closer to the goal line now. As I mentioned in my remarks I still believe our pipeline is really strong, we are off to a good start as you heard what the percentage is, I was talking about, we expect bookings to be in the 25 to 30% range this year.

In fact it could be higher if things happen at the end of the year. The timing was right, but if not it would be right in the first quarter there. We still see opportunities in various countries, I'll run through those here in a second. And, we also see classified opportunities starting to pop-up in other countries. If I run through some of the big ones, so we are wrapping up final negotiations and everything on UAE.

Saudi Arabia, we are going through the process with them so maybe sometime early next year. Taiwan has put in a down payment for their systems into the U.S. systems. So probably late fourth quarter, early fourth quarter maybe for them.

Followed by Israel, who'll end up buying and then a little bit longer term after that would be Turkey, Kuwait and Qatar. So we feel good about all the activity and we've got people deployed in countries making sure that we answer all our customers' questions.

And of course, surface launching MRM has started with the first booking there in Finland and we expect other countries to follow there. Australia, we expect an announcement sometime late this year on another system for them. And then we've got a cost fight effort that we're hoping to bring in here in the fourth quarter. So a lot going on internationally and we feel pretty good about our efforts there, as you can see from the pipeline.

Peter Arment - Broadpoint AmTech

Right and just one follow up, just on the -- relating to that, you are growing double digits internationally, 2009 over 2008. I mean is it fair to assume that this pace can continue into 2010, just based on what you are seeing?

William Swanson

Yeah based on the order enter I would say yes. It just feels right.

Peter Arment - Broadpoint AmTech

Okay. Thanks for everything. Thanks again.

William Swanson

Okay.

Unidentified Company Representative

Michael if you can go to the next caller please.

Operator

Your next question comes from the line of Noah Poponak of Goldman Sachs. You may proceed.

Noah Poponak - Goldman Sachs

Hi, good morning.

William Swanson

Good morning. Yeah, technical services has been very strong recently. Can you just discuss how level to the operating tempo that business is and how sustainable that growth is going forward. What are you thinking for that business in 2010?

Unidentified Company Representative

Yeah, I would say that we feel certainly good about our training business and what we're doing for virtual, live and constructive training, not only domestically but we see the international market taking note of what's happening here.

From our standpoint, we believe we've got some innovative approaches to training, especially on the ground training with the Army. We think that has applicability to other services and we think it really has applicability internationally. As O&M budgets get a little bit tighter, everybody is looking to figure out how they do compression of training. Compression by that I mean, how do you do it quicker and we've got a great international -- excuse me, commercial background that we've learned from and we're able to apply that into our defense and government business so I'd classify that one as a strong one with plenty of opportunities.

Noah Poponak - Goldman Sachs

I mean just, if nothing else you have very difficult comparison just because it's been so strong in 2009. What kind of growth rate is embedded for that business in your 2010 revenue number?

Unidentified Company Representative

No, we'll get into the specific guidance by business in January but let me just give you a little bit of color, we won a couple of significant programs, the air traffic controller training program with the FAA. And the training -- the Warfighter FOCUS program for the U.S. Army. We're expanding that program both domestically and internationally. Now we have very strong on a comparable basis, third quarter and we will this year.

Next year we are still seeing continued strong growth but it'll moderate to sort of the mid to high single digits.

Noah Poponak - Goldman Sachs

Okay, very helpful thanks.

Unidentified Company Representative

Okay.

Operator

And you next....

Unidentified Company Representative

I'm sorry, Michael go ahead.

Operator

Your next question comes from the line of Ron Epstien of Bank of America-Merrill Lynch. You may proceed.

Ronald Epstein - Bank of America-Merrill Lynch

Yeah, good morning guys.

William Swanson

Good morning, Ron.

Ronald Epstein - Bank of America-Merrill Lynch

As we look in the 2010 Will, do you mind and maybe give a little color on where you see some strengths and weaknesses in the Raytheon portfolio.

William Swanson

Can I talk about the strengths?

Ronald Epstein - Bank of America-Merrill Lynch

Sure.

William Swanson

I think that the real strengths for us are on our broad based programs. The fact that we just cover it from I'll say DC to light. They are not the way I describe it and we are positioned well.

If I look at it, maybe a little more than two-thirds of our business is in DoD. Although DoD spending may flatten out in the future. We see good strength in our areas, especially if you look at ISR, missile defense and the areas that they are going to and proven technologies is right in our wheel house.

We also see that from our sensor point of view, everybody wants to see everything, in all conditions. And we think we're aligned up well there. Clearly in the classified area, we really had good growth this year, if we look at it, we expect our growth '09 over '08 to be around 10%. And then, we've got homeland security and cyber security, which is picking up for us.

So, really what we're trying to do is make sure we leverage all our programs, so depending on which way our customers want to go, we're positioned well for that, going in the future. And of course for us, a major driver in growth is international. And, we expect that to represent about 20 to 22% of our sales as we finish up the year.

So, I think, we're aware of downward pressure on defense spending, particularly in the U.S., but we've been aggressively expanding our participation in growth areas. And to sustain our above industry, average growth rates.

And, I always remind everybody keep in mind, as we look ahead that defense spending is really driven by the threat environment. And if I had a threat meter, I would not say it's gone down.

And so, that's what we're mindful of, but at the same time, we need speed and agility to react. And so, from a concerned point of view, to be broad-based and it -- everything would have to go down, given our type of portfolio. And I really don't see that scenario. I just see plenty of opportunities for us and my responsibility is to make sure we go after them with vigor and rigor.

Ronald Epstein - Bank of America-Merrill Lynch

Great and maybe just a follow on. Are there any specific areas that you think could be more challenging, next year?

William Swanson

I think the challenge I always worry about is timing, that when you have indecision and you have tough budgets and stuff. I really never see people not doing anything, the point is, is they postpone it. And so what we need to do is help them think through that, we need to be an honest broker that presents different alternatives and work with our customers that way. And if there's not something right now how do we make sure we're positioned for the future by helping them walk through these difficult times if they are going through. So, I'd say timing is the issue from my standpoint.

Ronald Epstein - Bank of America-Merrill Lynch

Okay great, thank you.

William Swanson

Okay.

Operator

And your next question comes from the line of Troy Lahr with Stifel Nicolaus. You may proceed.

Troy Lahr - Stifel Nicolaus

Thanks. It appears that your 2010 guidance essentially calls for flat segment margins I don't know if I am backing into that correctly or not but can you maybe just talk just directionally. I mean are you seeing some kind of margin pressures so you're just going to fight more margins next year?

David Wajsgras

I am not sure I would frame the question the way you just did but I appreciate where you are coming from. We've seen continued strengths in our business margins year-over-year and we... at this stage of the process to give out specific margins by business is not something that we are ready to commit to, we will do that in January.

But overall I think if you stand back and look at the numbers that we spoke about, the top line at 4 to 6% growth and the, what we call the economic or operational earnings the FAS CAS adjusted EPS growing by 10 to 13%. We're pretty positive on the way 2010 is expected to look from a financial perspective.

Troy Lahr - Stifel Nicolaus

Okay but you're getting a benefit from taxes there, you kind of have some lower interest expense. I mean just on the segment income line, I mean not even segment by segment but just directionally I mean should we think about that as kind of flattish or up a little bit?

David Wajsgras

Let me answer it like this. I mean it's I would say if we're looking at margins today you would be looking in line to maybe slightly up year-over-year but it's early. And we will get into again more definition as we get on to January call. Looking at margin at the margin profile in the very sort of high 11% range or low 12% range is very healthy from our perspective.

Troy Lahr - Stifel Nicolaus

Okay that's helpful. Thanks guys.

David Wajsgras

Okay.

Operator

And your next question comes from the line of Robert Stallard of Macquarie. You may proceed.

Rob Stallard - Macquarie Group

Good morning.

William Swanson

Good morning Rob.

Rob Stallard - Macquarie Group

Dave, just a question on the 2010 outlook. Your operating cash flow at the top end is down 2 billion year-on-year. You mentioned the issue about cash taxes, but what other cash items are you anticipating in 2010 that are different from '09?

David Wajsgras

Well, the primary driver is the cash taxes and the timing of some deductions and refunds. I think the important takeaway there is that operationally, we're making up more than half essentially of the cash tax refund that we received early in '09 through performance.

So, our working capital focus are focused on continuing to covert earnings into cash, is obviously a positive. We do see some slight improvement in the CAS reimbursement next year. So taken as a whole, we feel good about the operational performance in driving cash flow.

If you're just looking it for the number per se, I think the way to think about it is we did receive a refund of $420 million in the first half of refunds and credits in the first half of 2009, and that's not expected to repeat itself in '10.

Rob Stallard - Macquarie Group

So you strip out the tax situation here, would you say that the underlying operating cash flow performance in terms of conversion is pretty similar in 2010 versus '09?

David Wajsgras

Similar to improved is the way I would characterize it.

Rob Stallard - Macquarie Group

Yeah.

Operator

And your next question comes from the line of Cai von Rumohr of Cowen & Company. You may proceed.

Cai von Rumohr - SG Cowen Securities Inc.

Yes thank a lot. A couple of pension questions. First, could you tell us for every 25 dip swing in the discount rate, what it does to your pension benefit obligation at year end? And secondly, one of your competitors gave some general color on pension trends in 2011, given that we do use moving and you should have some general visibility as to where things are going. Could you share any of those with us at this point?

David Wajsgras

Cai, I think those are excellent questions. So let me start with the first one. If you are looking at a basis point, what happens to that 25 basis point change in the discount rate. It's about $400 million effect at relative to the 12/31 2008 PBO on the unfunded positions. So that's -- I believe that's your first question.

Cai von Rumohr - SG Cowen Securities Inc.

Yes.

David Wajsgras

From a 2011 standpoint and beyond I have thought that we might get this question. And as you know there are many variables that impact the FAS/CAS adjustment and pension funding requirements, including the discount rate, the return on the assets, there's other actuarial assumption and obviously, and I think importantly, the CAS harmonization rules which are still evolving and they've not yet been published. And since no one knows what the final harmonization rules will be, I'm not in a position to provide any meaningful guidance beyond 2010, at least at this point.

However, we do expect the CAS rules to be published prior to the Q4 earnings call and will provide more information on 2011 expectations at that time when we also have the final 2009 asset returns and discount rates. Now with that being said, if you hold all assumptions constant and the harmonization rules were to favorably impact the adjustment in '011, we could see as much as $100 million favorable versus 2010, but who knows? Again these rules are moving.

And if nothing were to occur or if the rules don't change the profile meaningfully, we could see a $100 million increase in the 2011 adjustment compared to '010. I think more importantly or at least equally as important, if you're looking beyond 2011, we expect to see a notable improvements in the FAS/CAS adjustment in 2012 and then turning to income by 2013, again under, these are all under current assumptions.

And if you are looking at the funding, we expect to fund about $1.2 billion gross and about $500 million net in 2010. We are looking beyond 2010, we expect our gross funding requirements to remain at about a $1 billion while the net funding requirements will gradually decrease even before taking into account any impact from CAS harmonization.

Let me close this out by saying we don't know the way the harmonization rules play out ultimately at this point but we do expect to have more insight obviously before our fourth quarter call and will provide, maybe even a little more detail on that call.

Cai von Rumohr - SG Cowen Securities Inc.

Great answer. Just one quick follow up, it looks like -- with all you've said and based on your return to year-to-date that your under funding will decline from 5.5 billion going into this year to maybe 4 to 4.5 and if you hit all of your objectives no change in the discount, your fund that you indicate it goes down some more in 2011 so that unless the world changes a lot your contributions on a gross basis are going to be flat to down for a couple of years because you've been into that normally high level since 2007, we are going back, we were at much lower levels with comparable funding.

David Wajsgras

Cai, the way you articulated the question, I am not disagreeing with anything you said. I think it's probably the short answer we do see continued improvement in our funded position. Let me just reiterate for '10 and '11, the gross contributions will be basically in line to a little bit down. The net contributions will be meaningfully down. But you are right from a funded position, the pension plans continue to improve.

Cai von Rumohr - SG Cowen Securities Inc.

Terrific thanks a lot, good work.

David Wajsgras

Thanks Cai.

Operator

And your next question comes from the line of Heidi Wood of Morgan Stanley. You may proceed.

Heidi Wood - Morgan Stanley

Good morning, again nice quarter guys.

William Swanson

Thanks Heidi.

Heidi Wood - Morgan Stanley

Bill, a question for you. Last decade when the weapons account was declining, it translated into a Hale (ph) consolidation and Raytheon, as you recall was a chief player in that.

Now the sectors consolidated, can you talk a little bit about how you expect the industry to respond to more challenging budget this time overall? I mean, I'm seeing you get more active on the M&A front. Should we expect accelerated activity in buying smaller companies like BBN to get classified clear personnel?

William Swanson

We didn't buy it for classified clear personnel, we bought -- I'll give you, three things that excel out. They have disruptive tolerant networking to kind of translate what that means is most of us are in cell phone conversations now and then we drop a connection. We don't know what we've said to the -- what the other person heard, what we've said, the conversation finishes about half way through.

Basically, their technology preserves those packets of information, so nothing is lost. And that technology can be applied directly to a number of things.

They also have wireless network after next is an example where you have the next generation of software defined radios and that's one of their strengths and finally, they are working on a Military Network Protocol, MNP, think of that as a makeover of the Internet for the Military.

So those are just three things that I could say I'm a little bit excited about as I look at and so for us its technology that get supplied to our products, both domestically and internationally as we go forward.

But to answer your question specifically, I do not believe there is going to be another last supper. I do not believe the government wants to go to single source applications.

They still want competition, that's something we have no problem with as we go forward here. And so I don't see some of that, I see people probably fine tuning their portfolios to make sure that they got them set up the right way and -- as they go forward.

And for us, our thoughts on acquisition haven't changed. We continue to do our GAAP analysis, we look at where we think the market's going and if we need that technology or capability, we first look if we can invest in ourselves because that's the right way to do it, the second is it can be a partner and then do you need to acquire it.

So I haven't seen much of a change other than we confirm the fact that they're not going to go from to five to four or three to two. They're definitely not going to one.

Heidi Wood - Morgan Stanley

That's terrific, very helpful. And can I ask the follow-up?

William Swanson

Sure absolutely.

Heidi Wood - Morgan Stanley

We get opposing views as we probe into the realm of cyber and understand its a delicate topic to approach but you can run into some that say there are big new potentials out there, some that view that cyber is just going to be threaded throughout platforms and existing programs, and so the real budget dollars for pure play cyber opportunities is actually relatively small.

Can you kind of give us an understanding or try and flush out why we're getting such a difference of opinion in sizing cyber and how we on the outside can best think about it?

William Swanson

Yeah, I think, first thing, your perspective depends on where you sit. So given your capabilities, you might talk about it one way or another. For us, just to refresh everybody, we think of it in three ways. First of all, how do we protect ourselves? Internally, there is always constant threat if somebody is trying to steal your IP.

So we want to make sure we've got defenses in that regard. The second aspect of what we do, we want to make sure our products and services are protected. So we embed in our products the capability so that there's not an issue.

And third is the one where you provide capabilities to your customers, both commercially and on the government side.

Commercially, given the economy that's a little bit tough right now because people are looking at where they spend their money. So, I don't see a lot of commercial activity in that regard.

But on the government side, the government now is looking at how they go about tackling this problem. So, for me I see it in small programs maybe for the next 12 to 18 months. But after that period, my belief is the government will bundle some activity and we'll start to see some bigger programs that take care of the whole enterprise, because you have to kind of think of the government as a company in a way of how do you protect your assets and how do you do that in an integrated way.

And the integrated way is the hard part and -- but that's why were making sure we do that first internally here and then we can offer our customers whoever they maybe any one of the three things that I talked about.

Heidi Wood - Morgan Stanley

That's excellent Bill. Very, very helpful. Thank you.

William Swanson

Okay. Thanks, Heidi.

Operator

And your next question comes from the line of Robert Spingarn of Credit Suisse. You may proceed.

Robert Spingarn - Credit Suisse First Boston LLC

Good morning.

William Swanson

Good morning.

Robert Spingarn - Credit Suisse First Boston LLC

Dave going back to your slide number five. If we could for a moment -- when I look at the performance in the quarter, it was really strong across the segments. We talked a little about services and I think IBS was -- we expected that to be strong. But clearly NCS and Space were quite strong as well.

To what extent -- and I think we're expecting that in the fourth quarter too, so to what extent could these be leaders the in growth next year? I know this gets into a little bit of the segment color for next year. But it would be quite helpful to know what your focus segments will be.

David Wajsgras

Yeah, it's a fair question. Let me start out by saying, if you look at all of our businesses, they performed well in the quarter and on a year-to-date basis.

As we're looking to 2010, we overall just to mention what I said earlier 4 to 6% for the company is very solid.

If we're looking at sort of some the specific areas and again I appreciate the way you frame the question, we'll get into the details in the fourth quarter.

But I would say to mid the high single digit growth in those two businesses is probably the way to start thinking about it. Both businesses and now let me talk about and just very briefly individually.

SAS, if you look back a few years was -- had some challenges. The new team there that had been put in place led by John Jones have done just a tremendous job from an overall performance standpoint. We've seen healthy growth not withstanding some of the challenges that we've seen in their -- the Space business which Bill had spoke about on previous calls, relative to growth.

But again if you taking their entire portfolio, the airborne sensors, their strength in the classified area and you look at what's happening '09 versus '08, we expect that trend to continue.

From NCS standpoint, they've also performed exceedingly well continuing to post very high margins, very strong growth rate and we don't see a reason for that to change at this point.

The growth from '09 to '08 for NCS was healthy, but again, I think we would expect to see if you're kind of looking for book adds I think sort of the mid -- maybe, mid to high single digit range is sort of the way to start thinking about it.

Robert Spingarn - Credit Suisse First Boston LLC

Thanks for the color and just a last clarification. This was discussed earlier. Did you say, you've embedded the R&D tax credit next year?

David Wajsgras

Yeah, the R&D tax credit is in next year for us, its worth about $0.07 and that's embedded. But the major driver in our improved effective tax rate year-over-year is the full phasing of the Section 199 Domestic Manufacturing Deduction. That's really what the driver in the lower effective tax rate is.

Robert Spingarn - Credit Suisse First Boston LLC

Okay, thank you.

David Wajsgras

Okay, sure.

Operator

And your next question comes from the line of George Shapiro of Access 342. You may proceed.

George Shapiro - Access 342

Good morning.

William Swanson

Good morning, George.

George Shapiro - Access 342

David, quick one for you. The NCS margin you raised by 80 basis points. I mean you rarely jump to margins by that much I mean, so what's happening there that's continuing to keep your margins higher than what you might have thought three or six months ago.

David Wajsgras

Yeah that's a good question George. They continue to improve operations from all basically product areas within that group. It's really the timing of the efficiencies that we've been able to recognize in the first three quarters of the year and that we're now comfortable -- have been institutionalized and will continue for the balance of that of 2009 and that's really -- there's the general statement operational efficiencies is way to think about that business.

George Shapiro - Access 342

And you think that continues into '10?

David Wajsgras

Well I'm getting a lot of question on specifics in '10. We see that that business performing well in '10. Yes.

George Shapiro - Access 342

Okay. Then if I -- just one for you Bill. If you can summarize roughly what cyber sales and homeland security sales were this year and what kind of growth rates you've been seeing?

William Swanson

If we look at homeland security, we expect bookings this year to be about a little over 1 billion, 1 billion say between a billion and 1.2 billion, our sales will be about a billion roughly. And so that will give you the size of it. Cyber, it's really impossible to break out, if when you think about the way I talk about the BN3 parts for us and but we see that, let me just say a double-digit growth in the low teens for us as we go forward here. And the real problem I've got George is there is information option, formation assurance in there and the information ops, I can never talk to you about.

George Shapiro - Access 342

Okay, thank you.

William Swanson

Not because I don't trust you since they won't let me talk about it.

George Shapiro - Access 342

Okay, thanks.

William Swanson

Okay

Operator

Your next question comes from the line of David Strauss of UBS. You may proceed.

David Strauss - UBS

Good morning. Bill, did you put a number around what percent of the total you expect international look to be in 2010?

William Swanson

No, we haven't done that yet. As I mentioned in my remarks, we are going through our AOP process or annual planning now that actually that I enjoy our businesses probably don't enjoy it but we are going through the detail right now. And when we do that then we can rack and stack and slice and dice it the way you guys all like to do it.

But we wanted to make sure that we could give you some color on how we felt about next year and why we thought we were positioned well and why our strategy is on track and that we don't have to change it, because we see where we're going. And the one thing I didn't get to talk about is we have some unbelievable technology wins this quarter that were just so many of them. I've never seen it be this high -- this high from activity and if somebody wanted to do, I could run through it quick but I don't want to take up everybody's time here with that.

But I was really encouraged from materials, the devices the capabilities to classify. It just ran the game at across everything we do in the company and convinced me that our technologists and our engineers are really aligned with our customers.

David Strauss - UBS

Kind of segue from that, just looking at the '10 budget, I know it's still going through the process. But anything meaningful happened from your perspective in committee or anything like that, anything on the program side that kind of moved around positively or negatively for you?

William Swanson

We feel pretty good about where it's at. Of course it's not finished and can't put a stake in the ground, but no surprises. I think our wheelhouse of ISR, we saw the attention there. We saw the attention in the classified programs that we always worry about as you go through it. And then what's really encouraging most people were worried about missile defense, clearly where they're going with that now is right in our wheelhouse with our radars and our interceptors.

And there is new activity and what we call push on (ph) phase, how we intercept there and we really think that plays into what we are trying to do. And now people are even talking about land based SM3 which bodes well for us because that's something we can do once the priorities and the funding are in place to match the programs that people are taking about in that.

I didn't touch base on that earlier when KDI was cancelled, the ship was over the standard missile and other sensors and things. Those programs haven't been put in place yet. So we expect to see some activity there to fill in the gap of what was cancelled and so we haven't seen that. And then the other thing that I wanted people to realize in case you missed it in the details, our funded backlog is up almost $2 billion when you look year-over-year. So that's a healthy part that are funded, backlog is increasing that for people's benefit.

David Strauss - UBS

Thanks for the color.

William Swanson

Okay.

Operator

Your next question comes from the line of Myles Walton of Oppenheimer. You may proceed.

Myles Walton - Oppenheimer

Thanks, good morning.

William Swanson

Good morning.

Myles Walton - Oppenheimer

Wondering Bill if I could ask you about the budget backdrop your seeing into next year that kind of gives you some color on what you expect for book-to-bill in 2010 and if you can hold in at a one times or greater book-to-bill even in 2010?

William Swanson

We haven't stated that yet for 2010, I got to give guys all credit for that.

Myles Walton - Oppenheimer

You opened the door.

William Swanson

We switched there -- you guys have moved the whole year on.

David Wajsgras

By the time you try, actually we will be in a fourth quarter conference call.

William Swanson

Dave and I -- these are numbers we want to -- that we could talk to you guys in January. I will just tell you what, it's still early. We believe what we hear on the QDR and there's a lot of stuff on the press. So, you all try and triangulate us and so we try and triangulate them. And so from a budget point of view I'm not expecting any big shifts there. What I am expecting the administration and DoD to do is to line up with the priorities. And it should match what we think is going to happen on the QDR. And I always remind everybody in the company that DoD's budget is two-thirds of a trillion dollars. That's a lot of money, I just want to make sure we are doing everything we can to be in the right growth areas and I think our portfolio allows us to shift to be able to do that.

And as I mentioned the speed and agility to adapt and take advantage of the portfolio is really important to us and that's where our drive is, that's what we've been trained in for a while here.

Myles Walton - Oppenheimer

I guess to ask it another way, would even higher international bookings be dependent on you getting to book-to-bill above one in 2010?

William Swanson

From my standpoint, I don't look at it at a book-to-bill that way. Our jobs are big and when you get these binary events on Patriot and so forth, they swing the needle. And so for us, our real thing is how do we take on each job as it's the most critical thing we can go do. That's our mentality. So, I don't try and get the arbitrary numbers, I guess I don't think of it that way. I don't think that answers your question, but at least it's the way we look at it. I mean every job is important here. And how do we make sure we're doing everything we can, I have a saying, I don't like would, could or should. And so if you do want everything you are supposed to be doing and you don't have to answer that question.

But we feel good about the bookings for next year. I mean, I'm not telegraphing something that says we don't feel good, it's just that I got to go through all the AOPs with everybody, and then when we give you our bookings number, it will be transparent and it will make sense and well track.

Myles Walton - Oppenheimer

Okay. And one follow-up if I could on the cash flow. You obviously have a funding required for next year, given any thoughts of pre-refunding that and is there any pushback from the tax deductibility limit or is it just you haven't made a decision yet?

David Wajsgras

Yes, there are no issues relative to tax deductibility. And we'll obviously meet all requirements relative to pension funding. And we consider various funding levels in connection with our entire cash deployment plan as we go forward and I think you can expect to see a balanced approach with respect to cash deployment as we go into 2010.

Myles Walton - Oppenheimer

All right, thanks.

Operator

Your next question comes from the line of Howard Rubel of Jefferies. You may proceed.

Howard Rubel - Jefferies & Company, Inc.

Thanks. Two very brief ones, one Dave, the 6.25 you use for the discount rate, how does that compare with the current market rate?

David Wajsgras

Howard that's also a very good question and we checked it as of yesterday and it happens to be 6.25%. Now with that being said, it -- who knows because we actually measure it based on a hypothetical bond portfolio on 12/31 '09 but as of what day is today, today --

Howard Rubel - Jefferies & Company, Inc.

22nd.

David Wajsgras

Yeah actually as of Monday night -- as of the Monday night close is when we checked it was 6.25.

Howard Rubel - Jefferies & Company, Inc.

So this portfolio has differed from the AA bond yield by quite a bit over the last -- I mean it's gone up and the AA has tightened.

David Wajsgras

We use a bond portfolio that is put together by our actuaries and reviewed by our outside auditors, that mirrors the liability profile of our pension plan.

Howard Rubel - Jefferies & Company, Inc.

And then just to go to Bill for half a second, so your agenda sort of for next year for you're marching orders for everybody as they put together the 2010 plan is to be prudent and opportunities to look a little bit outside of what you've been doing in the past and work the international market in a bigger way than -- bring what you got domestically to the international market?

William Swanson

I'd say it one -- there's one word, it's growth. We want to perform better in our market and we think we're doing that. The opportunities are still clearly international.

With the international, I believe we can extend it by bringing more capabilities to that. The other part is from an engineering point of view, technical point of view, how do we take the company's unbelievable technology, get it into products and forward sit and backward sit that capability because I believe, domestic and internationally people are going to want to keep things running longer. If you do, you got to improve them or otherwise it's mediocrity.

And when you're fighting battles, you don't want mediocrity, you want an unfair advantage on the battlefield. And then I want to make sure our team is giving our customers and our partners that unfair advantage by having everything we can give them.

And so, we're not going to swim lanes over. So, don't worry about that risk, that's not where our growth is coming from. But our growth comes from just; Dave announced a toll road that's getting expanded over a 100 million there. We're working -- look at alternative energy, wind farms have problems with creating black holes for air traffic control. Our engineers have come up with a path they've approached to be able to solve that problem.

That's what I want us to be able to do. What are the problems that people have today and how do they dial 1-800- Raytheon for that solution.

Howard Rubel - Jefferies & Company, Inc.

Sounds good. Thank you Bill.

William Swanson

Okay.

David Wajsgras

I think we have time for one more question please.

Operator

Your next question comes from the line of Doug Harned of Sanford Bernstein. You may proceed.

Douglas Harned - Sanford C. Bernstein

Good morning.

David Wajsgras

Hi Doug.

William Swanson

Hi Doug.

Douglas Harned - Sanford C. Bernstein

I was interested in as you look at the situation in Afghanistan right now and there's clearly a lot of uncertainty around U.S. strategy both in terms of scale and exactly how we'll go forward there. When you look at Raytheon's capabilities, how do you think about your operating sample there, potential change in strategy and what that would mean for what some of your units can provide in the future?

William Swanson

Now that's right on point and something near and dear to my heart. There is one where these young kids have got a tough situation, its an unbelievable environment, there in vehicles, the enemy there tries to get them dismount, if they dismount, they're into an area they don't know, the area is probably boogie trapped, there is IEDs and that's probably the biggest concern the Military has and the concern I have now and so one of the things we've been able to do is to take our training and with virtual capabilities, we can actually create the same battlefield within about 24 hours and make sure the troops that are going over there experience in almost real life capability where they wear vest that will simulate being shot out, there is a goggle that they can wear. So they literally will re-enact what their buddies went through the day or two days before so that we can prepare these young kids so that they won't make a mistake and that's something where we can apply our compression learning and our technology together to give that young soldier a virtual experience before they realize it in real time.

The other thing is if you look at IEDs, there's no better company suited with our technology that could be able to help in that regard. So that's something else. The third one would be to come and control how do you get high fidelity information and how do you have it instantaneously. I talked a little about BBN and their network. The one thing you don't want to be is on the battlefield to get a map and the map stops half ay in between the download, you want to preserve those packets. So those are things that we can do, commanders need it now and that's where a company like us has got to be able to turn on a dime quickly to give them a solution into that battlefield to see if we can turn it around and that's what we're focused on.

Douglas Harned - Sanford C. Bernstein

So, I would assume that, also in more traditional areas that in NCS, in more -- and also in missile systems, those are areas where the need for more precision guided weapons depending on what the strategy is. I would think that this would be an important piece as well.

William Swanson

Yeah, it's -- you look at it, but I think long term the way we try and look at it is, what's happened in Iraq and what's happened in Iran, the Secretary Gates is really trying to line up the QDR to be able to handle those kinds of efforts. And if you look at it, the ISR they need, the command and control that they need, that the precision guided weapons that they need, the training that they need, those are all areas that I think, we as a company for some time have been focusing on and we will see what happens out at the QDR and the budget process that we think we are going to be lined up in those areas. And you know the good part is we don't rotate around supplemental funding and so forth. So we're not dependent on it, what we want to do is we make -- we want to bring capabilities to help them come home sooner to their loves ones.

Douglas Harned - Sanford C. Bernstein

Okay, well thank you.

William Swanson

Okay.

Marc Kaplan

Okay. I like to close by thanking everyone for joining us this morning. We appreciate your interest in learning more about our company, our recently performance and our outlook. And we'll look forward to speaking with you again in our fourth quarter conference call in January. Michael?

Operator

Ladies and gentlemen that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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Source: Raytheon Q3 2009 Earnings Transcript
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