Raytheon [RTN] on Thursday reported higher sales and earnings in its third quarter with the company benefiting in large part from international and classified work, lower taxes and improved operational performance, and the company raised its top and bottom line guidance for 2018.

Net income rose 19 percent to $644 million, $2.25 earnings per share (EPS), from $542 million ($1.97 EPS) a year ago, handily topping consensus estimates by 28 cents a share.

Sales increased 8 percent to $6.8 billion from $6.3 billion a year ago.

Raytheon Chairman and CEO Tom Kennedy. Photo: Raytheon
Raytheon Chairman and CEO Tom Kennedy. Photo: Raytheon

All five of Raytheon’s operating segments contributed to the top line gain, with the primary drivers being an international contract in the first quarter for a Patriot air and missile defense system, classified work for cyber, space and missile programs, a cyber security program for the Department of Homeland Security, surveillance and targeting systems, and work on an Army program to consolidate support for training and simulation.

The primary driver for the bottom line improvement was a lower tax rate associated with a new tax law that went into effect on Jan. 1, followed by operational improvements, a reduced share count, and a slight pension tailwind, all of which combined to more than offset a previously disclosed non-operating expense from a pension plan annuity transaction that chopped 80 cents a share from earnings.

At the operating level, the Intelligence, Information and Services (IIS), Integrated Defense Systems, and Space and Airborne Systems segments contributed to the higher profits due to stronger sales, favorable program mix, and increased program efficiencies.

Orders were exceptionally strong in the quarter at $8.7 billion, and combined with the opportunities in the fourth quarter, led the company to raise its guidance for bookings this year by $1 billion to between $29.5 billion and $30.5 billion. Strong order flow helped fuel backlog to a record $41.6 billion, up from $36.7 billion a year ago.

For the year, Raytheon raised its sales guidance to between $27 billion and $27.3 billion from the prior outlook of between $26.7 billion and $27.2 billion, with the increase being driven by work at IIS. Earnings guidance was increased to between $10.01 and $10.11 from between $9.77 and $9.97 due to pension tailwinds and lower interest expenses. Total business segment margin is expected to be 12.3 to 12.4 percent, down from prior guidance of 12.5 to 12.7 percent to reflect a change in sales mix toward lower margin programs.

Raytheon provided a rough initial outlook for 2019, with sales forecast to be up between 6 and 8 percent based on the strong order flow and backlog. Segment operating margin is expected to be similar to 2018 levels and the tax rate is expected to be between 17 and 19 percent.

On Thursday’s earnings call, Anthony “Toby” O’Brien, Raytheon’s chief financial officer, said that while sales will be higher in 2019, he reminded investors the company is still in the planning stages of determining detailed guidance for next year and that factors that will determine profitability include the ability to retire risk on programs and the sales mix between higher and lower margin programs.

Amid talk that the Defense Department, and other federal departments, may face a five percent budget cut in fiscal year 2020, or possibly a 2.5 percent reduction when separate war-related funding is added in, Raytheon Chairman and CEO Thomas Kennedy said a 2.5 percent drop would still be in line with the 2018 budget, which was 19 percent higher than fiscal year 2017. That’s still a “healthy” defense budget, he said, adding that awards the company has received this year and expects to in 2019 put Raytheon “in really great shape for fiscal year ’20.”

Asked about Raytheon’s exposure to business in Saudi Arabia, O’Brien said that nearly five percent of the company’s sales so far this year, which are $19.7 billion for nine months, are to the Kingdom and in 2019 sales to the country will remain “flattish.” He said the company expects two follow-on support contracts with Saudi Arabia in the fourth quarter and next year a “major award” for the TPY-2 air and missile defense system radar.

Some investors are concerned that the murder by a Saudi hit squad earlier this month of Saudi dissident journalist Jamal Khashoggi, who was living in the U.S., at a Saudi consulate in Turkey could end up costing U.S. defense contractors business in the Kingdom. The Trump administration so far has said the billions of dollars in defense sales are not at risk.

Kennedy said the company aligns with U.S. policies and positions but that he is “pretty confident we’ll weather this complexity.” He also said Raytheon is a global company with multiple franchises and isn’t reliant on one customer.

Kennedy was also asked about the discussion of program bids that erupted this week in earlier contractor earnings calls where Lockheed Martin [LMT] said it would have lost $5 billion if it had offered the same price on several major defense contracts won by low bidder Boeing [BA] during the third quarter. Kennedy replied that Raytheon isn’t a “platform company” and that its technology solutions are applied across multiple platforms.

“So we have not really seen those kinds of impacts relative to our competitions so it hasn’t really been meaningful to us,” Kennedy said. He said Raytheon’s win rates are in the 70 percent range, demonstrating its ability to win new business.

Still, Kennedy said Raytheon is attuned to its customers’ demands for affordability and is working to bring down costs and provide technology solutions that improve performance and reduce costs.

“So we’ve been looking at costs on day one of every one of these competitions to figure out our overall strategy, who we’re going to go team with, what type of technologies we’re going to bring to the game, what we’re going to have to do in our factories to get cost out, and I think the work that we have been doing seems to be paying off,” he said.