By Calvin Biesecker
Buoyed by a favorable tax settlement, tax gains from discontinued operations and strong operating performance, Raytheon [RTN] yesterday posted a hefty increase in its third quarter earnings, overcoming higher pension expense and weak sales.
The strong operating performance contributed to better overall margins, leading Raytheon to raise its earnings guidance for the year.
Net income was $728 million, $1.94 earnings per share (EPS), up 48 percent against $490 million ($1.25 EPS) a year ago. Excluding the tax settlement, which added $170 million (45 cents EPS) to earnings and another $88 million (23 cents EPS) to discontinued operations, adjusted income from continuing operations was $737 million ($1.26 EPS), well ahead of the $1.13 EPS estimated by analysts.
The improved operating results were driven mainly by better performance at the Space and Airborne Systems (SAS), Technical Services and Missile Systems segments, as the company continues to focus on process improvements and shedding costs. All three segments boosted margins, which contributed to each posting double-digit gains in operating income. SAS also benefited from a favorable business mix, Dave Wajsgras, Raytheon’s chief financial officer, said during yesterday’s earnings call.
Excluding pension adjustments, Raytheon’s operating margins were 12.9 percent, a 60 basis point improvement from a year ago.
Sales in the quarter were $6.3 billion, up 1 percent versus $6.2 billion a year ago, with growth at its Technical Services, SAS and Network Centric Systems segments nearly wiped out by declines at its Intelligence and Information Systems and Integrated Defense Systems segments. Sales at Missile Systems were flat.
Sales were below expectations due to delays in contract awards, which is due in part to the new affordability initiatives being implemented by the Defense Department. Additionally, cost cutting efforts also led to the lower sales as efficiencies gained in cost-type contracts result in savings that are passed along to the customer and also result in reduced revenues, Wajsgras said. However, those efficiencies transfer to fixed-price contracts, which helped drive margin improvement in the quarter, he noted.
Sales drivers in the quarter were domestic and foreign military training programs at Technical Services, and classified programs and an international tactical radar program at SAS.
The company continues to benefit from growth in its classified and international business. Foreign sales expanded 11 percent in the quarter and accounted for 24 percent of overall revenues, William Swanson, Raytheon’s chairman and CEO, said during the call.
Revenues from classified programs were up 14 percent in the quarter and are expected to be up that much for the full year with further growth next year, Swanson said.
“It’s a strength for the company,” he said.
The ongoing contract delays, coupled with the efficiencies Raytheon is gaining in its cost-type contracts, led it to reduce its sales guidance for 2010 to between $25.3 billion and $25.6 billion, down from between $25.6 billion and $26.1 billion previously. Wajsgras said delays account for about two-thirds of the reduction and the cost cutting efforts about one-third.
However, the improved operating efficiencies, combined with the tax benefit and a lower share count, enabled Raytheon to raise its expected EPS from continuing operations to between $4.45 and $4.55 versus $4 to $4.15 previously.
The company refrained from providing detailed guidance for next year due to uncertainty with how the Pentagon’s affordability initiatives will be implemented, the ongoing continuing resolution to fund FY ’11 federal budgets, continued difficulties in the domestic and international economies, as well as coming changes with the mid-term congressional elections next week, Swanson said.
“It’s the timing, really,” he said. “It’s not the if. That’s not my concern. My concern is can I predict what’s going to happen here; and we’ve got some unknowns and I’m not concerned about that because I think the company will continue to do well.”
Still, Swanson provided a rough outline of what to expect next year, projecting sales to be up 2 to 4 percent and margins in line with 2010. Raytheon will provide more details about 2011 expectation with its fourth quarter earnings.
Backlog at the end of the quarter was $35.7 billion, down $1.2 billion since the start of the year.
Free cash was a negative $223 million, which included $425 million and $141 million in share repurchases and dividend payments respectively.