Good day, ladies and gentlemen and welcome to the Raytheon Q2 2015 Earnings Conference Call. My name is Mark and I will be your operator for today. At this time all participants are in listen-only mode. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to Todd Ernst, Vice President of...

Investor relations. Thank you, Mark. Good morning, everyone. Thank you for joining us today on our second 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 Web site at raytheon.com. Following this morning’s call, an archive of both the audio replay and a printable version of the slides will be available in the investor relations section of our Web site. With me today are Tom Kennedy, our Chairman and Chief Executive Officer; and Toby O’Brien, our Chief Financial Officer. We’ll start with some brief remarks by Tom and Toby and then we’ll move on to questions. Before I turn the call over to Tom, I’d like to caution regarding our forward-looking statements. Any matters discussed today that are not historical facts, particularly comments regarding the company’s future plans, objectives and 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 are discussed in detail in our SEC filings. With that, I’ll turn the call over to Tom. Tom?

Thank you, Todd. Good morning, everyone. This morning Raytheon reported solid second quarter operating results. Sales exceeded our guidance increasing by 3% over second quarter 2014. This was driven by IDS and missiles and was primarily organic. With this solid revenue performance, we now see an opportunity for top line growth in 2015. EPS and cash flow also exceeded our expectations in the quarter. This performance demonstrates that our focus on global growth is succeeding. As a result, we have updated our financial outlook to reflect our solid year to date performance and the acquisition of Websense in late May. Toby will walk you through those details in a few minutes. Global demand for advanced technologies drove an 11.9% increase in bookings in the quarter compared to the second quarter 2014. International bookings were particularly strong representing 46% of total bookings, led by the $2 billion Saudi Patriot award as well as a number of missile awards. Domestic bookings were also solid with awards from across our portfolio including Standard Missile 3, Evolved Seasparrow Missile, next generation radars for P-8 maritime aircraft as well as $626 million in classified awards at both SAS and IIS. Given the strength of our overall bookings year to date, we now expect full-year 2015 bookings to be approximately $24.5 billion, plus or minus $500 million. The Raytheon team and I had the opportunity to meet with many of our global customers last month at the Paris Air Show. The feedback reinforced what we have been seeing over the last year. That is many of them are investing in strong defense to deter evolving threats. I would note that compared to the Farnborough Air Show last year, the demand to strengthen the deterrence has increased, particularly from our customers in Eastern Europe, the Middle East…

[Operator Instructions] Your first question comes from the line of Robert Spingarn from Credit Suisse. Please proceed.

Tom, just a question on Websense and the overall commercial cyber strategy. Could you may be put into context what you are seeing there with your expansion into that market just as some of your competitors apparently are exiting.

I am not going to comment on the strategies of other companies but I can tell you that we are very excited about our Websense acquisition and our expansion into the commercial cyber market. The reasons we decided to do this are still solid and sound. We have been doing a very heavy integration effort for the last two months. And several of the reasons, and number one as you can see from reading the paper every day, the cyber threat continues relative to commercial companies as a new company that comes online everyday of having some type of a breach. And so we are continuing to get input and demand signals from commercial companies across the board and their demand is, they are looking for higher end, I would call defense-grade cyber solutions that will continue to -- and we see that increasing in the foreseeable future. So we see a strong demand, strong growth opportunities. But the combination of Raytheon and Websense is what's helping us deliver that high-end defense grade cyber capability.

Okay. And then just as a follow-up to that. Just really on what you just spoke of. Is the thrust of this then really to sell Raytheon's product to Websense or through Websense's organization into the commercial market or also to sell the Websense product. And then what scale do you need to achieve with this segment for this strategy to work for investors?

So first of all this is a two way, I would say winning side in terms of sales. One is, we are working to our sales channels which were initially in the government related world and international government related world. We are opening up those channels to the TRITON product, which is the Websense main platform. It's also allowing us, the commercial channels to go into the commercial world with our SureView product. And we believe we now have scale you will see and as Toby showed you, it's approximately $500 million a year in revenue, and now we have access to the commercial channels that we are going after. And a plus for the TRITON product is now they have access into the defense and also government channels that we had.

Which side of the two way would be the larger opportunity?

I think it goes both ways. We are seeing a pent up demand on the government side for the TRITON platform and we are also seeing a pent up demand on the commercial side for the elements of the SureView product, four main products that dropped into the TRITON platform for up sell. And we are seeing a benefit both ways and we anticipated those synergies and we are seeing those synergies come to fruition.

Your next question comes from Carter Copeland from Barclays. Please proceed.

Just a couple of them. Toby on the AWD program, I wondered if you could just clarify if there is any risk of further financial impact there. Basically you have got that scrubbed to zero. And then the pre-contract revenue recognition, I wondered if you might size that for us? Toby O’Brien: Yes. So first with AWD, the answer is yes, that's scrubbed to zero as you say. The adjustment that we took in the quarter of the $33 million eliminated all of the remaining incentive fees where we were tied to the shipbuilder performance. So we do not anticipate any additional write-offs there relative to AWD. And then related to the pre-contract it was in the $100 million to $150 million range.

Okay. And then just as a follow-up. Obviously, I know you have been talking about IDS margin progression but the guidance implies a pretty big step up in the back half of the year. How should we think about how much of that is trend line to look at going forward and how much might be temporary related to either performance adjustments you expect to see as you hit milestones? Any color you can give us on that would be helpful. Toby O’Brien: Sure. Sure. So I think when you step back from it and we go back to the end of January then again in April, we talked about how at the company level we saw a couple of things driving margins down this year. The unfavorable mix and the higher level of investment. IDS of all the businesses followed by SAS was most impacted by the unfavorable mix. So what we are seeing is consistent with what we had expected to see for the year. That said, the margin in Q2 was in line with our expectations. So even though we had the unfavorable adjustment on AWD, we did see some other performance improvements in the quarter that essentially offset that. That again is consistent with lower margins in the first half of the year. We still expect to ramp up on IDS margins, particularly in Q4 as the overall business mix improved due to the ramp-up of the international awards that we saw at the end of last year and into the early part of this year.

Your next question comes from Peter Arment from Sterne Agee.

Tom, could you give us an update on Germany's decision to go with MEADS. Maybe just, is that is more looked at as a one-off or changes anything on the competitive landscape? How you are thinking about future Patriot awards?

First of all, we continue to work with the German customer. We already have the Patriot system in there and it is going through some upgrades relative to our Configuration-3 Plus. They are upgrading some of the -- all their systems. And they have decided to keep the patriot system operational till 2025. We have, obviously, heard their decision on MEADS but at the same time we continue to work with that customer as we proceed forward. We have not seen any changes relative to any of the competitions we are in or are perceived to be in in the near future that would impact any Patriot opportunities.

Okay. Thank you for that. And, Toby, just quickly. Just on the domestic growth versus international. I think previously you kind of guided to low single-digit down for domestic and up for international. Is that still intact for as we look for 2015? Toby O’Brien: Yes. So for our total year now for domestic, the way to think of it, Peter, is to be flat to down in the low-single digits and for international for the year to be up in the mid-single digits.

Your next question comes from the line of Robert Stallard from Royal Bank of Canada. Please proceed.

Tom, you mentioned the TRITON product at Websense earlier on. I was wondering if you could give us an idea of how the organic growth on that product has been tracking, year to date?

Well, the organic growth has been tracking about in the double-digits on that product. And as we mentioned before on the prior calls, they have two major products. One product is, I would call web filtering, that is declining and being replace by the TRITON platform. So if you look at the TRITION platform itself, it's in double-digit growth year-over-year. Toby O’Brien: Yes, Robert. As we talked about, we only have the month of June in the quarter post-acquisition. But if we look at the full quarter for Websense, TRITON, their bookings would have grown by about 10% on a quarter-over-quarter basis.

Okay. And then, Tom, maybe a bigger picture question. I was wondering if you could comment on what you think the impact to this Iran nuclear deal could be on your customers in the Middle East.

I am not going to get tied up in the politics of it but I can take you back to my statements earlier, that we are seeing an increased demand signal across the board. And it's not just in the Middle East which is what we are seeing in Eastern Europe and also in the Asia Pacific region and it's really for different regions. But it is -- any uncertainty in the geopolitical aspects of those regions, we are seeing an almost immediate reaction from these countries to want to beef up their defense. And I think if you look at this quarter, you will see the results of that in our bookings. And if you also, I did mention it, I know it was one quick line in my opening remarks but we hit an all time high in the company this year and that all time high was in the amount of international backlog and that was 44%. And we didn’t break open any champagne bottles and throw any glasses into the fireplace or anything like that but it is monumental for us to be able to have achieved that. And I think the correlation goes right to this, back that the threat is not going away it's increasing. And we are seeing it across three major regions of the world.

Your next question comes from the line of Jason Gursky from Citi. Please proceed.

I just wanted to follow up on the line of questioning of the last couple of callers there and have you discuss a little bit more about the longer term outlook as you move out into 2020, the back half of the decade here. I know you've talked about this before but it would be, I think, helpful to get some updated thoughts from you on how you view both the domestic and international market playing out over the next couple of years. When do you see a return to growth in your domestic business? And then as you look out into that, as far as 2020, the pipeline that you have on the international side and how you're going to be able to, or if you're going to be able to, sustain the types of growth that you are seeing today as we move out into the latter years of this decade?

So Jess, let me and then I will turn it over to Toby and he can put some numbers behind what I say. Right off the bat, I will just go back to the discussions we have had at, I think in the last call. And we have won some major domestic programs that were in development on right now. One is air missile defense radar the other one is next-generation jammer, FAB-T. We've also won a couple that are still on protest. But the ones we are finishing up, we will be finishing up on development will be in about the '18,'19 timeframe, which then will start going into LRIP and then by '20 going into full rate production. So on the domestic side, we are going to start to see an uptick relative to more production programs coming on line. So I think that’s good on to the domestic front. You are also seeing, based on the budget drills this year, that both the administration and also Congress are aligned with the fact that they believe that the budget needs to increase over the Budget Control Act of 2011 caps. The issue that they are having is how to go off and achieve that increase. But the bottom line is that they are both aligned, the administration and Congress, on the need for the increase. So we feel very positive about some breakthrough here in the next, hopefully next year, relative to '16s budget increasing over the Budget Control Act caps. However, we do have planned to the Budget Control Act caps which are about 1% increase over the fiscal year 2015. So we do see the domestic budget increasing over time. On the international, we talked about some major awards. We were down selected by Poland. That…

It’s a very, I think, a very good picture moving forward.

Yes, it sounds great. Just a quick follow-up question. On margins, Toby, can you talk a little bit about what's going to happen specifically in IDS in the back half that allows you to achieve the full-year guidance? And then, Tom, on the longer term outlook you just talked about with these ramping programs. What did that do to margins for the overall company if you are ramping development and early stage production on those things that you just talked about? Does that put you [indiscernible]?

What I think I will do is, Toby, he just went over on this actually on his discussion before. He will hit the IDS details and then I will kind of give you the bigger picture relative to where we see margins going in the future. Toby O’Brien: Yes. So, Jason, for IDS as we said before, the results so far have been consistent with our expectation given the impact of mix that we have seen there. In the second half, primarily in the fourth quarter is where we expect the uptick and there is really two things that are driving that. The mix, the business mix is going to start to improve with the large international programs, again, that we booked late last year and through the first half of this year, as they continue to move and ramp up through the production cycle. Additionally, we would also expect in the fourth quarter to see more program efficiencies flowing through to the bottom line. And overall we still see the margin outlook for the total year at IDS in the range of 15.1% to 15.3%.

Then relative to margins on the domestic side, we talked about some major development programs we had won and they are now obviously in development. When they start switching into production, we normally see a margin increase due to the fact that we are taking on more risk on the production side on firm type proposals. I mean firm fixed price contracts. We will see an uptick there in the margins but on the international side, as Toby mentioned, we have had some significant bookings here in the last year and a half. The area we are working right now and I think it's a great sign here is we are bringing on more suppliers. We are increasing the number of shifts we have in the factory, adding on days. So we are seeing, essentially getting quite a bit of synergy across these different wins that we had internationally and we do see a margin expansion across those programs as we go into 2016 and beyond. Toby O’Brien: And I think Jason just, if you are looking for a little more color or detail from an IDS perspective, the reason we see that our program efficiency towards the end of the year is the effects of things like strategic sourcing, automation in our factories that are driving efficiencies, again tied to the ramp up of those major production programs that we have referred to before.

Your next question comes from the line of Myles Walton from Deutsche Bank. Please proceed.

Just a quick follow-up on that one. Maybe, Toby, the run rate in the second half of '15, obviously, pretty great if you can get there on IDS. Is that the appropriate way to think about the mix as it's going to look into '16 or is there just a healthy performance in the second half that we should not think about that as a run rate? Toby O’Brien: So let met talk a little bit about IDS, right. So I mentioned in the second quarter they had strong sales growth and part of that was driven by the recognition of the pre-contract work that we talked about earlier. As far as the second half goes for a Q3 perspective, we do expect sales at IDS to be up high single digits in Q3. However, when we get to Q4, we will look to see sales on a quarter-over-quarter basis to be essentially flat compared to last year. Because in the fourth quarter of last year we did have a buildup of inventory that did convert into sales, that makes the comparison a little bit different. I wouldn’t take that as a run rate going into '16, however, but I would expect directionally '16 to be better than '15.

Okay. No, that's really helpful. And then, Tom, at a high level, lot of companies have been looking at their services blend with hardware. Do the two cost structures support themselves from a competitive perspective? And I'm sure you've gone through this exercise and not looking to layer other peoples strategies upon you. But how do you look at that equation where the services market becomes more and more competitive relative to the cost structure that's somewhat required for your hardware sensitive businesses?

No, actually that’s a great question. So first thing to just kind of set the stage. Raytheon never went down the path of getting into Fed IT business. I don’t know if you realize that. So we recognized a long time ago that that was not a business that we wanted to be in, really, because we saw that would eventually get commoditized. So we don’t have any of that effort going on within the company. The services that we do, most of it is associated with our products. So that helps us in maintaining our products, the logistics associated with our products. For example we do a lot of performance-based logistics relative to our products and that’s essentially comes under the umbrella of the services. Then in IIS where most of the traditional services are located, they are leaders in advanced solutions and capabilities and providing cyber services, intelligence, mission support and I would call high consequence training in key markets. And it's not just for the U.S. government, it's also for governments worldwide. So it's a pretty strong business for us. Again, we are not in the Fed IT, never were. So that’s an area that I think it's hard to compare us against some of these other companies that are shedding their services because a lot of that shedding is associated with the Fed IT.

Your next question comes from Howard Rubel from Jefferies. Please proceed.

Toby, I want to know if in some of your other forecasts going forward you're always going to basically understate acquisitions by about 50% of the cost? Because originally, as you indicated, it was going to be $0.48, and here we are looking at about half that. Can you elaborate on what has changed? And as we go forward and look at Websense, the deferred revenue number seems relatively modest versus the balance. What happened? Toby O’Brien: Yes. So just as a reminder, Howard, back in April when we gave the initial estimates, they were preliminary and subject to our final purchase accounting valuation. Part of our process, we had looked at other transactions and there were a range of potentials relative to percentage of assets etcetera. Percentage of purchase price that would be potentially characterized as intangible or the deferred revenue. So we had a range. We didn’t want to come back here and increase the dilution, for lack of a better way to say it. And in the quarter, as we do after, we close on all our acquisitions, we embarked upon the formal fair value analysis. We finalized that here at the end of June and what you see now is the update to reflect that. So it was really nothing more than that.

All right. I am going to talk about Patriot for one second. Tom, you sort of created a Patriot users group with all of your different customers around the world. Could you talk a little bit more about the ideas that you are getting from them that are, I will call it, leading to an ongoing upgrade in the system? And how do you see that playing out?

Well, let me just -- on a baseline element we are proceeding on upgrades of what's called Configuration-3 Plus. That was the upgrade to the Patriot system that was funded by the UAE several years back. We still have 72 fire units out there as opportunities to upgrade to Configuration-3 Plus. So we are off pursuing that element of it. In addition to that and as the user group is looking for us to provide a 360 AESA radar and we have been off working that for several years now and done some significant testing and believe we are in a position to take on contracts for that development of the 360 AESA radar. Right now there is an opportunity to replace 220 Patriot radars with the 360 AESA radar. So significant upgrades there. The other area that we are doing and it's on the international side is, and it's in Qatar, it's a contract to provide an air defense operating center which integrates all air defense systems. I think that will be the next thing that we are seeing with some of these other customers who have other air defense assets. They want them integrated with one common operating picture so that they can get the synergy of having everything together in one place and operated by one operator. So those are the type of upgrades we are pursuing. In many of the cases we already have contracts to start those systems, so we already have the initial customers. And then in some cases we are getting ready to get or first initial customer to move forward with them.

Your next question comes from the line of Hunter Keay from Wolfe Research. Please proceed.

Two questions on content. Can you remind us of your exposures to Sikorsky, however you want to quantify that? I think it's small but just to verify. And how should we think about Raytheon's potential role on long range strike? Haven't really heard a lot about that. Any color on that? Maybe it's too early, maybe not. Anything you want to provide would be great.

Relative to Sikorsky, you are right. We don’t have much content on the Sikorsky products. We have worked a lot with them. I have personally worked with Sikorsky on programs in the past. But right now it's not a significant of our revenue stream. Relative to long range strike, we really can't comment at this time.

Okay. I got you. All right, thanks. And then I think you guys made the comment last quarter, you've made, I think, dozens of cyber acquisitions over the last couple of years. I'm curious to hear what some of the lessons learned would be in terms of the pitfalls? Not necessarily what went right but what went wrong? And what can you take from that, as we look at Websense, in terms of things to avoid in the past that can be applied here at least?

I will tell you what, the lessons learnt led to the acquisition of Websense. And so the lessons were, if we did very well in buying these companies on the government side but we were not achieving any upside relative to the commercial side. And so when we went back and reevaluated the reason why it turned out that we didn’t have the commercial channels. And it takes quite a bit of effort to establish channels to be able to reach out to 30,000 customers versus 20 government customers. That’s the different game. Is wasn’t the technology, an underlying technology, it wasn’t the products, it wasn’t the personnel. It was essentially not having access to the market channels that’s required in the commercial business. And so that was the lesson learnt. And so we took that lesson learned and we went out and we started in 2013 looking at what was the best company out there that we could potentially acquire that would enable us to unlock the capabilities we had from the other acquisitions but into the commercial marketplace. And someone that already had a strong position, already had a new product, a new platform, allowing us to move forward. And so essentially it was the structure of how we implemented those companies. And we right now have -- everything we are seeing, we think we have taken that lesson learned to heart and are making the right inroads into that commercial marketplace.

Your next question comes from David Strauss from UBS. Please proceed.

Toby, did I hear you right where you said Websense would be at high teens margins ex the cost to develop the commercial cyber product and then restructuring it? And if so, how long does it take until you are kind of through that spend to actually report high teens margins at Websense? Toby O’Brien: Yes. So the answer to the first part is, you hear it correct. Without those two items we would be, we said 17% to 18%, part 1. Part 2, relative to the timing of that, so we are always going to be looking to make investments in technology and make sure we are keeping up with the threat there. But if we were to look out over time without that, probably in the '17 timeframe.

And how long are you running on the restructuring side? I mean how much restructuring is there to do here?

The majority of it will be completed this year. There could be a little bit of a tail into early part of next year.

Okay. And then a follow-up. So you've talked about $7 billion, roughly, in Patriot orders. A little bit surprised. I would have thought a fair amount of those orders would come with advanced payments, yet we haven't really seen -- we've actually seen the advanced payment balance go down. Can you just comment on that?

So a couple of those orders were FMS, right, which do not have the advanced payments. What you have really seen here is a timing issue, right. And if I take it back up to a higher level not specific to those orders, we have seen the advance account on the balance sheet, to your point David, fluctuate over time, driven by the timing of those advances and then when they are subsequently liquidated. On average, historically we have run at a rate of about 9% to 10% of sales, okay. At the end of the first quarter, the balance was about $2 billion, to your point as well. Slightly below our five-year average which has been around $2.2 billion. And really the main driver on that was timing. Back last year in the first quarter we had received a significant advance from a customer and we had full liquidated that here to the first quarter of '15. On some of the new awards, we have milestone payments as well that are more weighted towards the back half of the year. That all said, from an overall point of view, we would expect our advances to remain in the range of about 9% of sales this year which is pretty much in line with prior periods in that $2 billion range.

Your next question comes from the line of Richard Safran from Buckingham Research. Please proceed.

A lot has been asked. I just wanted to ask you about some upcoming programs. There's this JSTARS recapitalization program out there. You announced some recent teaming with Bombardier and Lockheed. Northrop recently announced with Boeing. I just want to know, from your perspective, is this indicative that the program is more near term? If you could give us any sense of the timing of the opportunity and some sense of the size? Any color here on this would be helpful because I tend to think this is a rather substantial opportunity for you.

No, we agree with you. You are right. We are teamed with Lockheed and Bombardier on one of the teams for work including sensors and some additional work. We are also providing a radar as a kind of a merchant supplier for the other teams, if they so desire. So we are kind of, have been spending quite a bit of time on this program in ensuring that we wind up with a piece of it moving forward.

Okay. And then just as a follow-up here also. So on your 3-D printing technology, just wanted to get a sense here. Is this applicable to current and future missile programs? Is this technology applicable across the board? Because I know there has been things like trying to get an upgrade here of the Tomahawk etcetera. Or is this more something that you are gearing towards like next generation missile programs, like the next generation land attack weapon?

Let met first tell you why it's important and what it's bringing to the industry. The 3-D printing allows you to essentially build up these very complex assemblies. Multi-part assemblies as one part, one continuous part and therefore improving cost. But it also does something else. In areas where heat is a major issue, it allows the heat transfer capabilities to be significantly enhanced. When you have an assembly with multiple parts that are tied together, you have heat issues at the intersection of those pieces. So by being able to build one continuous, very complex part and you can solve a lot of the heat transfer problems which is very important as we move into the hypersonics area of our missiles.

Okay. We are going to have to leave it there this morning. Thank you for joining us. We look forward to speaking with you again on our third quarter call in October. Mark?

Ladies and gentlemen, thank you for your participation. This concludes your call. You may now disconnect. Have a great day.