Raytheon [RTN] on Thursday posted lower sales but higher earnings with the bottom line benefiting by a swing to pension income and a handsome return from a business that was discontinued a decade ago.
Net income rose 12 percent to $551 million, $1.76 earnings per share (EPS), from $493 million ($1.50 EPS), driven by a favorable pension adjustment that added 18 cents to per share earnings versus a 14 cents EPS hit a year ago. The earnings also benefited from a $52 million (17 cents EPS) contribution from a settled claim related to a former business operation that was shed 10 years ago.
Excluding the discontinued operation, earnings from continuing operations were $499 million ($1.59 EPS), 2 percent higher than the $488 million ($1.50 EPS) reported a year ago and in line with consensus estimates for per share results. The company’s earnings were also helped by ongoing share repurchases that lowered the overall share count to further boost EPS results.
Sales in the quarter fell 7 percent to $5.7 billion from $6.1 billion as each of Raytheon’s four operating segments turned in lower top and bottom lines. International business accounted for 29 percent of revenue and the company is resetting expectations to raise the bar on the amount of future sales it expects to achieve from foreign customers.
In the long-term, getting the international component of Raytheon’s business to 40 percent of sales is “absolutely realistic,” Dave Wajsgras, the company’s chief financial officer, said on Thursday’s earnings call. He pointed out that by the end of 2014, the company’s backlog will consist of around 40 percent international orders.
“I would say longer term you should be thinking about the company as a 40-plus percent international company and view us more from a global perspective than just a domestic exporter,” Wajsgras said.
Thomas Kennedy, Raytheon’s CEO, said the company has made “some major changes in our international structure” and is looking at “each country as a market” that needs solutions that Raytheon can provide. The company is increasing its personnel presences in these countries, “doing much more localization,” and “we’ve significantly increased our global supply chain…the last several years,” he said.
“We reset the game,” Kennedy said. “We’ve reset it back to the first inning,” adding that the strategy is paying off and is “filling the pipeline for the future” with “a lot of upside potential in the international marketplace.”
Operating margins, including the benefit from the pension tailwind, increased 80 basis points in the quarter to 13.3 percent. At the segment level, only the Integrated Defense Systems (IDS) business was a significant weight on margins as its operating income fell more than 30 percent and margins dropped nearly 5 percent.
Operating earnings and margins at IDS suffered from lower sales and a $38 million decrease in estimated incentive fees on an Australian Naval shipbuilding program. Raytheon said that its fees were impacted on the Australian Air Warfare Destroyer (AWD) because the government-owned shipbuilder’s expected cost to complete its portion of the program has increased.
Raytheon has received $80 million in incentive fees on the program so far, excluding the $38 million write-off, leaving about $40 million in downside exposure remaining, Wajsgras said.
Raytheon officials said the three-ship AWD program is an alliance with Raytheon, the government-owned shipbuilder and the Australian government, adding that the contract arrangement is unique for the company. Wajsgras said Raytheon’s performance on the program has been to plan in terms of cost and schedule and its good performance has been recognized by the customer.
Wajsgras said the AWD program is important strategically, giving Raytheon the chance to “expand its naval combat systems expertise and capabilities to a new customer.” He added that the program has positioned “us well for future mission systems work on both surface and subsurface platforms with literally multi-billions of dollars of opportunity over time.”
Bookings in the quarter were $6.8 billion, 24 percent of which was international. In the second half of the year, the company expects a big step-up in international bookings to achieve its overall target for 2014 of between 35 and 40 percent of orders from foreign customers.
Total backlog at the end of the quarter was $33 billion, of which $23.6 billion was funded. At the end of 2013, backlog stood at $33.7 billion, with $23 billion funded. Free cash flow in the quarter was $77 million.
Kennedy said that the company is focused on organic growth while continuing to look for potential acquisition targets. Wajsgras said the company’s strong balance sheet positions it well to be able to return cash to shareholders in multiple ways.