Raytheon Company (RTN) Credit Suisse Global Industrials Conference December 3, 2013 9:00 AM ET
Executives
William H. Swanson – Chairman and CEO
David C. Wajsgras – Senior Vice President and Chief Financial Officer
Analysts
Operator
[Call Started Abruptly] performance. These forward-looking statements represent only the company’s current expectations regarding such matters. Our actual actions or results could differ materially from these statements, and you should consult our SEC filings for a description of the factors that could cause such differences. Bill and I may also use non-GAAP financial measures. As such please refer to our third quarter 2013 earnings release materials that can be found on our investor relations website for reconciliation of these measures and a discussion of why the company uses them.
Is that okay [Todd]?
Question-and-Answer Session
Unidentified Participant
Thank you very much. So now that we have done that let us just start at a high level. Bill it is a good month since we heard your last earnings report, and folks in Washington are down there continuing to debate the budget outlook and deals et cetera. What is the latest from your vantage point, where do we stand right now?
William H. Swanson
You are asking me to handicap what is going on in Washington?
Unidentified Participant
I sure am.
William H. Swanson
Having just been down there my opinion, I think the prospects of a grand bargain as people talk about it is difficult at best, mainly structurally things have to be done with entitlements on one end and taxes or revenue on the other side has to be looked at and to get both of those in sync to take on the deficit problem long-term I think right now is too hard to do.
Clearly from our standpoint, January 15 looms as a date and what individuals have told me that at least work in Raytheon that they would like to be able to go into the holidays knowing that something is at least done and a stick in the ground knowing where to go, and what they really ask is that people in charge make the system work, and the way I kind of describe it is all great nations need their government to function. And so the grand bargain doesn’t seem in the cards to me. There is some talk about a small bargain, and the small bargain is how do you minimize the dips in ’14 and a little bit in ’15?
And clearly to me what I hear in the small bargain is that ’14 and ’15 would look like ’13. So from a standpoint that there wouldn’t be a dip or the speed bump as I affectionately call it, and it would be fairly flat and then we all have to remember that the budgets do go up at a point in time because they are all off the fiscal year ’12 baseline. So that is kind of how I see it in -- right now I think people are working hard to see if they can come up with something in that regard.
Unidentified Participant
So, if we get the small bargain, given the fact that gets here through this administration, and while we don’t know the outcome of the next presidential election, do you think people might take that as meaning the worst is over?
William H. Swanson
Yes, I would think so. I mean, you have always heard me talk about this thing as how do you position your company that you go over a speed bump, once you go over that how do you take off as quick as you possibly can. And from that regards, I don’t see anything changing. You know, on the back of my mind we have been over in the Mideast for some time. We have got equipment that is tired and worn out. There is going to have to be some kind of recapitalization. Couple that with a strategic shift to be probably a little smaller, lighter and faster, and all of those things bode well for what I call a recapitalization kind of program. And I think that fits our portfolio well as we look at it because we can both forward fit and backward fit in the way we do things.
Unidentified Participant
So just to clarify I’m going to throw some numbers out that I’m doing up here right now. If we get the mini deal, then basically we have -- we get a second and third year of $37 billion, you know, we are kind of flattish having cut the old line by 37ish in three years. So, let us call that a 100 billion, 110 billion whatever the number is.
William H. Swanson
But remember the cuts are coming off of an increasing number in the out years. Washington is the only place where a cut is really [in that].
Unidentified Participant
Right.
William H. Swanson
So, I mean…
Unidentified Participant
So -- but the way I am thinking, but this is a ten-year plan?
William H. Swanson
Yes.
Unidentified Participant
To cut 550ish billion from that old growing top line, in the first three years we will cut 100, you are saying at that point you wouldn’t be worried about them stuffing another 400 billion in cuts, 450 billion in cuts in the last seven years. In other words, you think the climate at that point might be open to just moving forward in a more positive way?
William H. Swanson
Yes, I think one of the things that has to be done, I mean I think about this in the way I think about my own personal finances, we have to balance a check book, and we have got to get it right, while at the same time making sure we take care of national security, and I don’t think we should sacrifice national security in a way that hampers our way to be able to do things that we need to do as a nation and you know, all you have to do is look around the world and there is always something happening, whether it is North Korea, whether it is the islands off of Japan now, where people are calling a no-fly zone, or an area of notification, go back to the Mideast.
So, things are going to happen and so we need to be prepared for that and that is where the strategy really has to be linked to the budget process, and right now, you know, operating under the kind of environment, how [Indiscernible] DOD with no budgets. I mean, they are literally operating on a day-to-day basis without plans and we need some stability in that, and so from my standpoint I caution a little bit that we have got to look at it in a way that national security still needs to be protected.
Unidentified Participant
It is interesting because when John McCain was nominated, and you still had a race between President Obama and Hillary Clinton. I personally felt the best outcome for defense was Clinton, and -- so once it was narrowed down to Obama versus McCain I figured we get cuts. On the Obama side, you know, rotating interests internally coming out of Southwest Asia, you know, winding down the wars. But on the McCain side more efficient procurement and buying more with fewer dollars. So when you look at the budget, this is more of an industry question not a Raytheon question, how much fluff is in there, so you talk about taking enough of the dollars down, we impair national security, is that really true if we do it right?
William H. Swanson
It is hard when you say you do it right. I think what is really necessary is you start with strategy, what are you trying to do as a nation? Do you have to prepare to fight one war some place, do you have to be able to stop an incursion at some place else, once you get the strategy right of what you want to do as a nation then the budget process ought to flow from there. Right now what we seem to do is take the budget and then we fill it up.
And so from my standpoint, I think the department is trying to do the right things, but you eventually get to a point where it forces a different course of action. You have to change something. And so for us when we look at our company, we realize what our revenue is, what our expenses are, what our margins are, and we size and we run our company to be able to deliver what our investors expect out of us.
It is no different in the building that they are going to have to find out what their number is once and for all, and once they can do that I think then plan to what they have to go do and develop the strategy of how they are going to go fight. It is -- you know, I hear all the numbers that people are saying, what can you take out? The point of it is that you really got to look at it in a different light. And you know, I’m not in the building and I am not running it. So from my standpoint what we always do in Raytheon is we tell everyone, you work on the things you can control.
And so what can we control? We can deliver our products on time, we can make sure we underrun wherever we can, on follow-on jobs, how do we make the programs more affordable, and so those are the things and how do we do things technology wise. I mean, one of the things that is going to eventually happen here is that we are going to only worry about manning the equipment. And so when you look at our large ships with 450 sailors on them, you really want ships that can operate with 150 sailors on them.
So it takes a long-term planning to get that in, but that is one of the things that is going to have to be looked at because people cost you money, whether you are in industry or whether you are in the service.
Unidentified Participant
So with that backdrop how important is this QDR?
William H. Swanson
It is important. But I think what is more important is for us to get our fiscal house in order as a nation. Basically the way I look at it is you tell people if you give industry a number, and tell them what is there, then we are all paid to get the job done. And right now, you know, we operate under a sequester, you operate under a [CR], and so you go through these things and people keep their powder dry. And once they sort this out, and you know, I believe there is a mood now that this has got to get sorted out. I mean if you look at approval ratings, aren’t they good? And so if people care about them then they got to go do something about it.
And at least the people I talk to on the Hill, I think people are getting to the point where they have had enough and they have got to go do something. Whether you can do the whole grand thing? I think that is too hard, but I think we can take some small steps to get there.
Unidentified Participant
So…
William H. Swanson
And I am encouraged about while I am here, and of course, you know, the Senate goes and does something that the nuclear option. Now we need to have that settled down, and people to get on and get with it. But in the meantime, we are running the company and we are doing the things that we have to do that we can control and deliver our results.
Unidentified Participant
Well, so here is one that I think -- I’m hopeful you will like to answer, as we talked about the industry now, this is a Raytheon question, given your positioning, talk about Raytheon’s ability to outperform industry? Do you feel that you will trend with whatever budget, and international demand paradigm we end up with, or will you outperform industry growth and why?
William H. Swanson
I feel good about Raytheon’s position. Jim, [Indiscernible] we could all put up a slide up there that we all feel good about our portfolios and everything, but if you look at Raytheon I feel good about where we are at because of our mixture of not only domestic, but our international programs. I just came back from a trip to the Mideast, spent a week out there. Trips are always great for me because I feel good about our performance and our execution and the way our customers talk about our products.
Our programs are on track. I have had -- met with the highest levels in every country and was pleased to hear people talk about our programs and the sense the reason they buy them is it makes their enemies think twice before they do anything. And you know, to be called one of the best providers in at least two of the countries that made the comment makes me feel good when I come back and address the team. So I feel good about Raytheon’s international business getting close to almost 30% now. That helps to offset what happens to us domestically, and the things that we build here in missile defense, the things that we build in ISR, our cyber capabilities are all being recognized and in demand.
So I feel good about the international aspect. On the domestic side, we are a company that likes to compete. We put on our helmets and pads and we get on the field everyday. Competition is just something we thrive on, and Raytheon’s has had two very good, more than two, but at least two very good, Next Generation Jammer and AMDR, both under protest, which seems to be the new norm. But you go win them twice now, and from that standpoint those are game changing wins that having technology that we invested in 10 years ago.
So when we looked at [technology], we knew that we would need lower power energy would be a requirement that would creep into systems that the military couldn’t use the kind of power consumption that they had in the past. So, [Indiscernible] was there along with the bandwidth, along with efficiencies, and that technology plays into both of those wins. And so when you look at it, we feel good about our ability to compete. Best value is something that we thrive on. Of course, lowest cost, technically acceptable, means you are into almost a commodity, and you have to compete on those kind of in a different manner.
But from the way I look at it Raytheon has displayed its ability to compete domestically, and compete internationally. And so that is how I look at it.
Unidentified Participant
You mentioned a couple of programs here specifically, and I had some questions written down on both Next Gen Jammer and AMDR, those are real, and you touched on this, those are real scientific wins, can you talk about three things, first, maybe the third question will be how you think this plays out, you just said, you won them twice, so I think I know how you think it will play out at a high level…
William H. Swanson
That is a good guess.
Unidentified Participant
Yes. But maybe throw some timing around that, but the first questions are, how are you winning relative to the other guy, what did you do here that was different, why did you win, and the second question is how did the customer evaluate this, maybe something we don’t understand, and sometimes we [Indiscernible] down to price, or spec price and schedule, and overly simplified, so can you talk about how you won, and is the customer evaluating these things correctly, what is their focus point and then timing of the outcome?
William H. Swanson
Yes, I will have to stay away from why we won because we are still in the midst of sorting both of them out, and I have been asked not to comment on that aspect of it, but I think what people may not realize that both of these were best value competitions. There is the set of requirements that you have to meet. There are points awarded if you do better than spec, but what not everyone appreciates is that in at least one or both the customers lived with all three competitors for two or three years.
So you have a proof of concept kind of an award, and the Navy does a very good job at this, and they award three competitors or two, and they live with you for a period of two or three years as you go do the things you said you were going to go do in that proposal. So they have a good idea of how you met your spec, how your costs were done, how you managed the program, how your suppliers acted on your team, and that is all part of the evaluation.
It is not like you rip open a proposal, read it, and that is it. There is a sense of the past performance and how you have done. So from my standpoint, you are better off started on day one during the initial development phase, and done everything outstandingly because that is all going to be taken into account when you deliver your proposal. So for us we felt very comfortable with the wins because we knew what we had done for the Navy in this case over that period of time, and you build up that trust, you build up that expectation and for us is we always want to make sure that our performance exceeds the expectation of our customers.
And clearly in these, what I will call, lifetime programs, because when you win them they should become a heritage program where they are with you the rest of your life, and so, you know, in some cases they were 40 year incumbents that were knocked out in competition. And that doesn’t happen lightly.
Unidentified Participant
Okay.
William H. Swanson
And ultimately in a [test] what you have to remember is the customer did select the winner. And so when the [GAL] goes in, what they are looking at is if the customer followed the process. They lead the technical evaluation, and that part of the selection, that is the right of the customer and that is what people have to remember [Indiscernible].
Unidentified Participant
Okay. Switching -- sticking with…
William H. Swanson
Can we get to a lighter topic, I’m just joking.
Unidentified Participant
Well, I don’t know if this one is lighter, but it is right in your wheelhouse, so I was going to ask you about increasing US and NATO support, or really pressure, I guess, on the Turkish missile defense selection, and for those of you who haven’t followed this, this was to go with the Chinese missile defense competitor over the Patriot systems. So how do you handicap the probability that this could switch back to or switch to Patriot. And well let us start with that?
William H. Swanson
Yes, I think we all have to realize Turkey made a decision. They made a decision on price. I have learned you get what you pay for in this business, and I won’t get into the technical specs of what they waived or didn’t waive when they selected the Chinese system, but they picked it on price, not on capability. Those of that that have been in the business know that it is very hard for some countries to develop and understand life cycle costs.
And life cycle costs become spares, manning, obsolescence and so forth. And you know that is one of the things that US Systems in my opinion win hands down every time when you look at the manning and reliability and spares requirements that over the life of the program the US does an unbelievable job of making sure that those costs are the lowest, and if you have watched or climbed over foreign systems, you know what the reliability is, you know what it takes to man them, and clearly the more sophisticated you are as a buyer, the more you can put life cycle costs in.
But they made their decision. They also made it based on the fact that they promised that 100% of the system is going to be built there. They are going to have to do them on the timelines that they promised. Now those are simple sounding problems, probably fixable, but the toughest one is going to be NATO operability. And when you now hook a Chinese system up to NATO that is not going to go so easy, in fact, I don’t know that it is going to be done.
And then ultimately it is going to create a problem when a Chinese or some foreign system [Indiscernible] one of our aircraft with a radar that has been identified as a threat. And so now you have got an interoperability issue that you got to go deal with. So there is a lot of problems that got to be worked out. But they are a sovereign nation. They made a decision. They will live with it one way or the other.
If they decide to change, then we are available and we can provide them a bid to do what they want to go do. And so, from that standpoint there is still more work to be done. They haven’t finished their negotiations, and we will see where it goes.
Unidentified Participant
So, you are not calling it over, but you are not relying on it. At this point this is…
William H. Swanson
No, and you know, the thing of it is I am not belittling somebody, but you know, I have been in two parts of the world recently, and I have seen two Chinese Systems sitting there rusting, not being used. So, you know, you got to really be careful what you buy, and we will see what it is like and you know it just says, you know, take notice that the Chinese are going to try and add their influence in different parts of the world, but I know if it was myself sitting in an area, or my son and daughter if I had one was there, I had sure want it manned by a US system to protect our life, but I am biased.
Unidentified Participant
Dave, while we are on the topic, and I’m going to see if anybody has a question please show a hand, and we will get a mike in your direction, but these various programs that we have been talking about, so Jammer, AMDR, you know, Turkey patriot and maybe we should throw in some of the other Middle Eastern opportunities on the missile defense side, can we talk about, reframe the magnitude of these types of programs?
David C. Wajsgras
Sure. So, we talked a little bit about this on the last earnings call. What we are seeing is this year playing out, we will have in excess of 30% of our bookings from international customers and sales in the high 20% range. That translates into a backlog as we go into ’14, close to 40% of international business.
There is a -- I wouldn’t say the majority, but there is a meaningful portion of that that is in the air and missile defense area, and that is primarily out of our IDS business. So, you know, I think the portfolio is strong from a domestic standpoint. We have talked about this as well in the past, but it is worth noting that we continue to align well with the priorities of our domestic customers.
And as Bill was saying earlier, if you look out over, you know, two or three year horizon, and you just, you kind of map out the expectations of the DOD, and we kind of see that coming out or flattening out as we get into the back half of ’14, in the first half of ’15 and then starting to improve a little bit. If you put that against where we fit internationally, I think longer term from a growth profile, we are positioned well.
Unidentified Participant
Let us dig into that a little bit, if we can, I think we are talking really about a mini deal potentially, knowing that it is not necessarily the outcome. But if we have a flattish environment from ’13 forward with a modest upward inflection after that, returning to that inflationary type growth it the ’16 time frame, we layer on your international opportunities, okay. Let us -- and we talk about some kind of a longer term revenue trajectory, and then what kind of a margin move you can have under that trajectory?
William H. Swanson
So, let me answer the second question first. So we talked about the health of the portfolio from a mix standpoint, international and domestic. About 10 years ago we made the strategic decision to invest in enterprisewide systems, MRP, HR, Finance, engineering. We have invested over $1 billion, and now the company has a platform, a foundation that makes us very flexible, and I would suggest very efficient both from an absolute and relative standpoint.
Number three is, I talked about HR, we have stayed well out in front from a headcount standpoint of what is happening and what was happening from a revenue standpoint over the last three or four years. And that is because we have a -- as a result of the enterprisewide HR system, we have put in place a manpower planning system that allows us to be proactive in managing the employee base. So all of that taken together, I would see our what we call, our adjusted margins, before you take pension into account, again being strong over the next three to five years I would say in excess of 12%, if you are thinking about from an overall margin standpoint, and there is a little bit of upward pressure given everything that I just went through.
Unidentified Participant
And how -- how much operating leverage is in there, in other words, as business comes back, how permanent is this cost structure, how much do you have to scale up to accommodate the new business, and really ultimately I’m talking about what the new earnings power would be post this period of weakness?
William H. Swanson
Well, again, we will scale the company to the book of business. And I think we do that frankly better than anyone in this space. So that is part one. Part two is, and I didn’t touch on this, from a supply chain standpoint, we continue to work very closely with our major subcontractors, and we are continuing to see both cost efficiency improvements and continued quality and delivery improvements, and we also think that is a competitive differentiator as we look ahead over the next 3 to 5 year period.
Unidentified Participant
Because I’m thinking you still have very good margins, they are outstanding, especially given the circumstances, so you have obviously been doing, you are chopping a lot of wood somewhere, and so…
David C. Wajsgras
That is a good visual.
William H. Swanson
Me with an axe.
Unidentified Participant
Maybe too much of an visual, but you -- you know, roll forward two or three years, the revenue environment potentially it goes the direction we are talking about here, which in and of itself is a different tone than we have had before. So, you know, maybe there is a little -- maybe [Indiscernible] maybe not, I don’t know. We don’t know, but better revenue environment, you have done a lot in the operation, so it seems to me that margin potential should exceed anything you have done before?
William H. Swanson
Well, I think you got to be a little bit careful with the mix that is coming in. If you look at say the fourth quarter, I mean the reason I was over in the Mideast is to make sure that four or five jobs that are scheduled to come in, and you know, we used to talk about months and now they are weeks that we can touch them and see them, and there is probably 4 billion or 5 billion worth of business out there that I was able to touch real quick.
When you look at that, those jobs start out in a lower margin range because you are doing stuff in some countries that are brand-new to the corporation and so what you do is have the risk built-in and as you retire the risk, then the margin tends to grow. So it is more of a timing issue. And the other thing that is there is that clearly from a company point of view, we continually look at what more we can do. There is a big push on now to make sure we really have got all our space utilization in our factories utilized at the right points, and if you look at the four or five jobs out there that are coming in, they are all things that we have done before.
So they are not something new that we have to recapitalize and so forth. The other thing that we do is we have a great model in the sense that we know everything we bid, especially the reviews that up to corporate, and David and his financial team have a good view of what that looks like in the future, and the mix and everything that is in there. So from my standpoint I would just caution a little bit that the sense is that the mix has something to do with it in the way we plan that as we go out. But the good news is that being able to touch Kuwait and Oman and Qatar and other countries as Saudi, it was a good trip. I came back pleased with what all the teams are doing and how they are executing things.
Unidentified Participant
Anybody out there with a question? This points me in the direction of the segments. If you could talk about each of the businesses a little bit with some, whatever level of granularity you can offer in terms of where the strength is, you know, where do you see some of the headwinds both on a revenue -- I’m looking at the next year or so in this environment, and when you talk about ideas…
William H. Swanson
I think the first thing to talk about is to set the stage and Dave and I will double team this is that in April we announced our consolidation going from six businesses down to four. What a lot of people don’t realize is by the end of Q2 to touch base and tie up, news around something Dave mentioned is at the end of the second quarter all four businesses that we had reported out in the new financial structure. So we closed the second quarter out in just the way we are organized, and not many companies and I doubt any in our sector, could make an announcement and just a month or two later report their financials rolled up.
And that is because everybody uses the same financial systems in the company and we could report our earnings in a way that matches the way we now run the company. I am happy to say that Tom Kennedy, who led up the consolidation efforts, has got all four businesses. Now all of that is done. We put a stake in it as we call it in our business and those four are up and running. If you think about them, IDS has got a great portfolio, and air and missile defense, also on the naval side, and future and naval radars with the AMDR win that they just had. So they have got a bright future, and missile defense is something that is in demand every place that I traveled to.
If you look at our IIS business, it is basically a service business, one that from a point of view that its structure is set up now to be able to provide the services -- the needs either on the hardware side or the side that really is growing for us is on the cyber side, including wins internationally in cyber. So we’re really comfortable with how they are doing it.
And missiles had probably the least change. They now have combat systems as part of that and one of the benefits we are now seeing is that we are actually working with our customers to where they used to buy things as components and now we’re talking to them about how to maximize the system from the viewers, the ground to ground missiles. And there is still a demand as I travel around for our missile systems around the world, and last but not least, is our space and airborne systems business, now located in Texas.
And clearly for them, their airborne radar business is going good. Space is still kind of in a malaise, eventually will pick up, and so from their standpoint and their combo business has been doing well. So from the point of view we think we have [organized right]. We are seeing more synergy than we anticipated by bringing together and probably the biggest benefit that we saw is that we had two organizations within a service that didn’t talk to each other, and by putting the businesses together, we are now able to get those two customers together, and do things for them to help them save money. So there has been a real synergistic benefit out of all of that. So that is kind of organizationally how it came together.
I think financially there has been no change. Dave…
David C. Wajsgras
Bill, I think you nailed it.
Unidentified Participant
Did you want to add anything to what…
David C. Wajsgras
No, no. I think he nailed it.
Unidentified Participant
Okay. So I’m going to close with -- I don’t see any hands. So I’m assuming we’re good in the audience. I’m going to close with a -- a cash return question, or a capital deployment question, if you will. Can you talk a little bit about M&A, what the latest environment is, how the pricing is, your thoughts on how central this should be, and then in the context of that, the question I am asking everybody is your stocks have all roughly doubled over the last couple of years, some more than others, you guys, you know, everybody, I’m sure you don’t finally look back to $40 a share?
William H. Swanson
No, you are right.
Unidentified Participant
There was -- but as I said to L-3 earlier, and I will continue to say throughout the day, it was easier to talk about buybacks to some extent at those prices. So is the commitment level to the buyback more difficult now, and so those two things, M&A and buyback.
David C. Wajsgras
Sure. So, most people who follow the company know that we do a very good job with respect to cash performance, cash conversion. And we see that being the case going forward. Looking in the rearview mirror, we have articulated a balanced capital deployment policy, and that is pretty much what we have followed. I know folks in the space say that, I think you need to go through the numbers and see who actually follows that and who doesn’t.
But I’m comfortable with what we have done in the past relative to share repurchase, the dividend increase, which I believe the last increase was the 9th year in a row that we have increased the dividend. We see that an increasing dividend every year as important from a shareholder return standpoint.
We have made discretionary contributions, I believe at the right times and has helped with the overall pension profile, and we put a strategy in place a few years back around acquisitions. Now most of the acquisitions we have done have been in the cyber area. We see that being the case going forward. The acquisitions have performed quite well. That business is part of our IIS business under Lynn Dugle. We are continuing to see strength in that area.
I would still articulate the cyberspace as fairly nascent, but it is really starting to get some tailwind now. So as we go forward we are going to continue to look for opportunities in that area. You know, as we look ahead, I wouldn’t suggest any wholesale changes in our overall capital deployment thinking or execution. As long as we are continuing to see value in our own equity, you know, we look at the trades, we would continue a share repurchase program at some level. You know, other than that I wouldn’t say there is going to be, you know, any real changes going forward.
Unidentified Participant
Would you say though that you are governed more by a consistent dollar amount that tracks your cash flow or a consistent accretion amount?
David C. Wajsgras
Well, I would say that when we stand back we take a multi-year approach to looking at capital deployment, and the starting point is what is the best model to drive the shareholder value over time? So although it looks like these are annual planning objectives, they are really 3/5 year planning objectives. And that is where Bill and I take the board through, and we look at the trades of the best place to put the cash to work and if it is repurchases, we may do more repurchases. If it is acquisitions, we may do more in acquisitions. If it is dividends, we may do more in dividends. But it is a balance, and that is really the way we look at it.
Unidentified Participant
Okay. With that I think we have hit the clock and I want to thank you both for spending time with us today. We really appreciate it.
- Read more current RTX analysis and news
- View all earnings call transcripts