Good day, ladies and gentlemen. And welcome to the Raytheon First Quarter 2019 Earnings Conference Call. My name is Shanon, and I will be your operator for today. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Ms. Kelsey DeBriyn, Vice President of Investor Relations. Please proceed.

Thank you, Shanon. Good morning, everyone. Thank you for joining us today on our first 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 website 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 will start with some brief remarks by Tom and Toby and then move on to questions. Before I turn the call over to Tom, I would like to caution you 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 will turn the call over to Tom.

Thank you, Kelsey. Good morning, everyone. Raytheon delivered strong operating performance in the first quarter. Sales increased 7.4% and our bookings, sales, EPS and operating cash flow were all better than expected. We had backlog of over $41 billion, which is up almost $3 billion versus the same period last year. Our trailing four quarter book-to-bill ratio is strong at 1.13, and our growth strategy continues to be aligned with the needs of our global customers. Overall, I was pleased with our results in the first quarter, including strong performance at IIS and SAS, which more than offset missile's performance, which was below our expectations. Toby will review additional details about the quarter in a few minutes. Given the constantly evolving threat environment, I'd like to take a few minutes to discuss some of the innovative solutions we are developing consistent with Raytheon's long history of pushing the bounds of what is possible. Today, we are at the forefront providing advanced technology solutions for customers the most complex challenges. And we are seeing strong future opportunities in our core capabilities, such as in radars and missiles. And a great accomplishment for the company and our customer for the first time in March, The U.S. Missile-Defense Agency, in partnership with the industry team, launched two Raytheon exoatmospheric kill vehicle in back-to-back tests. One EKV successfully destroyed a complex threat representative intercontinental ballistic missile outside of the Earth's atmosphere, while the other EKV gathering test data in what is now known as a two-shot salvo engagement. This was a critical milestone for the ground-based midcourse defense system, and it also relied on Raytheon's advanced sensing capabilities, such as the Sea-Based X-Band Radar, 52 radar and multispectral targeting system on unmanned aerial vehicles to provide EKV with tracking and targeting data of the…

Thanks, Tom. I have the opening remarks, starting with the first quarter highlights and then we'll move on to questions. During my remarks, I'll be referring to the web slides that we issued earlier this morning. So everyone return to Page 3. We are pleased with the strong performance the team delivered in the first quarter with bookings, sales, EPS and operating cash flow better than our expectations. We had bookings in the first quarter, resulting in a strong trailing four quarter book-to-bill ratio of 1.13 and a backlog of over $41 billion. This positions us for continued growth throughout 2019 and beyond. Our sales in the quarter were $6.7 billion, up 7.4% with growth across all of our businesses. Our EPS from continuing operations was $2.77, better than our guidance and an increase of 25.9% year-over-year. I'll give a little more color on this in just a moment. We had an operating cash outflow of $411 million in the first quarter, better than the guidance we provided in January. And as expected, operating cash flow was lower than last year's first quarter, primarily due to higher net cash taxes and the timing of payments. During the quarter, the company repurchased 2.8 shares of common stock for $500 million. And I would add that last month, we announced an 8.6% increase in our dividend. This marks the 15th consecutive year of increasing dividends at Raytheon. Turning now to Page 4. Let me start by providing some detail on our first quarter results. Company bookings for the first quarter were $5.4 billion, resulting in backlog at the end of the first quarter of $41.1 billion. This represents an increase of approximately $3 billion or 8% compared to the first quarter 2018. It's worth noting that around 38% of our backlog is…

Thank you [Operator Instructions]. The first question will come from the line of Sheila Kahyaoglu with Jefferies and Company. Your line is open.

On missiles, how do we think about the franchise programs? Tom, you mentioned in your prepared remarks and how they develop longer-term as growth drivers and maybe just the return on sales of those assets. And then as a follow-up, you both mentioned actions have been placed for MS. Can you maybe describe that a little bit more? Thank you.

Let me start-off with the franchises. I think what’s unique about missiles is the fact that they have a strong -- first of all, a very strong stable of existing franchises that have gone to a syndicated refresh here over the last five years. In other words, new technology being inserted into them, essentially give them legs for another two decades. And the other one is that the success we've had in extending those franchises in international marketplace. And what's special now is that we have an opportunity for some, brining some new franchises on-board. We just brought one on-board NSM. I mentioned, how just within a matter of six months, we've extended that franchise into two other mission areas, so essentially doing three mission areas right off the bat. The other items are the ones where we're in a competition for one is the PrSM, which is a precision strike missile for the United States Army. And that program there it's just had very successful test that had CDR I mentioned and it just had a very successful motor test. So we're very keen that that we're in a very good position to potentially win that new franchise. And that will replace all of the Army's that comes out in the field today and give us the Army number one in a great significant capability, but also a brand new franchise for Raytheon. And we're also working on the next generation nuclear weapon for the LRSO program that is in competition that has down select out in the 2022 period. And that’s also the next generation weapon for the United States Air Force, and with about over a thousand weapons that will be procured over a period of time. So I feel very strongly about, number one, we call it the competitiveness of our existing franchises and our ability to extend them over a couple decades and then also provide them international legs and the new opportunities we have at missile. So bottom line is missiles has a lot of upside in terms of growth and we're supporting that. In fact the action plan that we're taking at missiles, this is the -- for us, so we have a new leader that has come on board that’s Wes Kramer. Wes was President of IDS, did a great job for us at IDS. He has also been at missiles support. He ran their largest business area, which was a standard missile business. So he knows the business. He knows the levers to pull to drive I think both continued growth and also margin expansion there. And we know we've been putting in some of the very detailed action plans to go drive margin expansion in the business. We're very certain for the margin range we have for this year's set, but we're also very positive on growing margins incrementally in '20 and then '21, and that sets our main focus at missiles.

And Sheila, I'll just add a little bit on the details of the things that we're doing out there. So there's already been some changes that have been made. There were some modifications to the word structure. Some product lines were consolidated, which obviously reduces management costs. There were some other leadership changes made on the staff. The team out there continues to review the cost structure, looking for opportunities to get benefit of the leverage that we have given the growth we've seen. We're reviewing the factory operations for incremental efficiencies and Wes, as Tom mentioned, will leverage his prior experiences at missiles and will be clearly focused on improving execution. And there'll be some other things we make, other changes we make along the way. But bottom line, the team is very focused on growing the business, improving program execution and as Tom mentioned, expanding margins.

Thank you. Our next question comes from Jon Raviv with Citi. Your line is open.

Tom, you had mentioned an era of rapid technological change. And it's maybe for both of you. Can you talk about the earnings algorithm in that era where we're seeing obviously this trade-off between growth in margin, which should maybe reverse in a couple years? And then also you mentioned that customer in that era want more integrated solutions. So how do they balance that desire for integration with them wanting more open architectures and maintaining competition? Perhaps in that answer you can also address the LTAM's competition. Thank you.

Well, first of all, we are having an explosion in technology. I mean essentially people talk about the fact that there's an exponential change in technology that is occurring now with things like machine learning, nanotechnology, quantum computing coming onboard out of the manufacturing. And we're heavily involved in all of those areas. I think our customer realizes that they need to take advantage of those new technologies to be able to generate the next generation of capability to put the United States in a premier position from a defense perspective. And so we're seeing a lot of activity in R&D on the government side to bring those new technologies to fruition. And what we're doing at Raytheon, our strategy is to take those technologies and again upgrade our existing franchises, whether they be radars or missiles, ground stations, ground systems and then also generate the next generation ones. And so we're playing both extending our existing franchises and then also working to take these new technologies to win new franchises. So we're -- the fact that we're all over that and the prime example, and you brought it up is the U.S. Army's Lower Tier Air Missile Defense Sensor, we call it LTAM. We are in a competition on that and we'll be proceeding here in May to something called the U.S. Army sense-off. What we're doing there is we're taking brand new technology and then start to coming up with the new 360 degree active electronically scanned array radar using our high-end GaN technology that we produced here at the Raytheon company. We expect the sense of this taking place in May and June of this year. And at some point, we believe the Army will complete their analysis. There is an RFP that's out there. So sometime late '19 early 2020, we expect to down select there.

Jon, let me maybe just add a little bit on the part of the question related to the earnings algorithm or exactly how you put that, just a couple things to remember right. So we've talked before a lot last year about the mix we're seeing, the change in the mix, driven by the National Defense Strategy and obviously the changing technology plays into that as well. And just as a reminder, the segment margin that we guided to this year, it has about 20 basis points of margin headwind that we see because of that mix and we're offsetting that in a little bit more with about 40 basis points of productivity. We're clearly in an era or a time when we are winning many of these new developing classified programs. And as Tom said, we see them as future franchises that ultimately transition and lead to production over time. And as I mentioned, near term margin pressure but it should be tailwinds to margin in the future. These awards strengthen our portfolio right. We're all about franchises. And the more franchise that we can get, help and we expand those internationally at a point in time as well. So while we've seen some puts and takes as a result of this, especially in our 2019 guidance by business, we continue to see margin expansion going forward. And again, don't forget about our international content. About 30% of our business is international. It's on the higher end of our margin scale that we have to have the benefit of working to leverage when looking at the earnings equation also.

Thank you. Our next question comes from Doug Harnett with Bernstein. Your line is open.

I’d like to go back to missiles, because I just want to understand what's been the evolution here. We've really seen margin guidance reduced for four quarters in a row now essentially. I understand that some of last year that was attributed to a mix shift to more development. But now when you look at Q1, we actually see the backlog drop by more than $1 billion in missiles, and you made a leadership change. Can you talk about how you've looked at this unit over the last three to four quarters? And what you've seen is the issues there and when did you come to the decision that there had to be some significant changes.

Let me start off and then Toby will follow. The first thing is in terms of the leadership change the prior leader, prior president, Taylor did informed the company that he was plans to retire. So that president change was based on that retirement request. And so we were able to at the time bring on a very strong player that's Wes Kremer, and I'd say he's a strong player, because right now he is running the IDS business and he's doing quite well. And it's a similar type of business to missile. They do have in strong franchises there, lot of production, and also a lot of growth opportunity at IDS. And so we're taking that to the missile company, applying some of the techniques that Wes put in place and we have in place and we have in place at IDS at the missile company. But I think in the end game, first, it was originally as a initially relative to mix. We were winning and have one quite a few contracts in missiles and in development area and essentially it’s the R&D area for the government, which put pressure on us from a mix perspective. The other issue we were seeing is that we do have quite a bit of production programs going on here. And we weren't seeing as much pick-up on the production programs that we have seen in the past. And this started about probably about three quarters ago. And so we are putting much emphasis on essentially on the leaning out the factory, really working on our supply-chain and really driving productivity across all the production programs. The mix is a mix. But what we can do is we can drive essentially significant improvement in the factories and in our supply chain to drive margin expansion on that part. And I'll let Toby to answer some of this too.

So Dough, just to your questions about what’s happened overtime with the guidance, a lot of that last year was around the mix. And we did get hit with a lot more of the lower margin development classified work. We believe the guidance for this year going back to what we provided in January properly size that relative to missiles, the mix effect. We still feel that's the case today. The change that you're seeing here in the quarter is as we said around performance and execution. There were a couple of program adjustments in the quarter at missiles. We did have one that was about $15 million. But when you step back from it, they are growing the effects of mix, I think are well understood, we think that's right. And it was all performance related. So as I said before, we took that into account, relook at the year and made the adjustments. I think Tom said in his opening remarks the fundamentals there remain strong and we believe that. Our comment to your comment about the backlog. So I think it's important, you can't take one quarter and think of that as trend, either good or bad. I'd take you back to the fact that missiles has been leading growth in the company going back the last four or so years. As a reminder, last year they had a book-to-bill of 1.09, it was 1.26 in 2017. The book-to-bill was low in the quarter, which is what drove the backlog down. It's all timing related. I would tell you, we expect north of $9 billion of bookings at missiles this year, a book-to-bill of 1.05 or greater. Again, I think we've talked about it before. We expect two multiyear production awards in the back half of this year out at missiles that is part of what is going drive that. So I wouldn't read anything into the change in the backlog in the quarter, other than just timing related to some large bookings.

Thank you. And our next question comes from Robert Stallard with Vertical Research. Your line is open.

Just on the missile theme, unfortunately. If you sort out the performance issues, what sort of benefit could you have to the operating margin in this business going forward? So ignoring mix just the productivity.

So Rob, I think the way to think of it, and I'll maybe start with this year and move forward for you here. So first of all, again, as Tom said, we believe we sized it. We've adjusted their range downwards, it's 11.7% at the midpoint, which is in line with where they ended last year. And we think we've seen -- see that appropriately. We would expect the cadence of margin to improve quarter-to-quarter throughout this year with a little bit of a bias towards the second half. And then when you think about 2020 and beyond, if I were to take it back to the 2016 timeframe, 2017 even 2015. Missiles was generating margins in the 13% range before we started to see this higher influx of the development in the classified work, and I believe that's still attainable, albeit out in time, because it's going to take time, both for these development programs to transition into production and to implement some of the actions that we talked about and refocus on the program execution. So we're not going to peg a number, but we would say improvements, incremental improvements in 2020 and beyond, driven by both the combination as that mix shifts a little bit more favorably, the production, the two big multiyear awards get into a strong production cadence out in the future and we execute better. It's going to be a combination of all that. But clearly, the business has demonstrated in the past, especially when the mix is different how they can perform.

Thank you. Our next question comes from George Shapiro with Shapiro Research. Your line is open.

You wound up beating the high-end of your EPS guidance by $0.25. You beat the high-end of your sales guidance by $150 million. I mean, a lot of this is due to IIS. But you didn't raise the guidance or the sales guidance. And usually, when you beat it by this much, you raise it by something. So is it all IIS where Warfighter sales didn't come down this quarter, aren’t expected to come down? And then also, was there any benefit to IIS sales from the consolidation that you did in the quarter? And any other color you might provide. Thanks.

I'll address the couple of IIS things, and then I'll tell you how we're thinking about the year from a company level. So the Warfighter sales came down in the quarter like we expected, but year-over-year we're looking at about $0.5 billion reduction. Most of that's in the back half of the year. So there is there is an imbalance first half, second half relative to how Warfighter is going to impact the revenue cadence at IIS. I would tell you even with that decline the rest of the IIS business is strong. You saw some of that in the first quarter in the cyber and space areas. And ex-Warfighter IIS is growing around 10% for the year. The consolidation of the entity that you referred that you asked about did have about $38 million impact in the quarter on revenue. So that's IIS. At a total company level, as we said, we're pleased with the first quarter results. They did exceed our expectations at the company level. Some of the higher sales volume we saw was timing related, driven by timing. And it clearly gives us confidence in our outlook of our 6% to 8% growth for the year. We mentioned the favorable performance at IIS and SAS, and we improved their total-year guidance. But those improvements were offset by the decrease in the missiles margin for the quarter that we flowed through to the year. So in total, as we said, the range stayed the same for segment margins, 12.1 to 12.3. Bringing it down to EPS, we were $0.35 higher than the high-end of our guidance range as you mentioned. Roughly half of that driven by the timing of sales and margins within the year, the other half driven by the timing of some corporate and non-operational items within the year that would now be expected to have a impact, a negative impact in the back half. So the change in margin guidance at the two businesses that improved IIS and SAS that flowed through and offset missiles. It's early in the year. We continue to be focused on growing the top line and improving margins. And then I'd just add for completeness. I think I mentioned in my opening remarks. We were pleased with the cash performance for the quarter, about $140 million better than the high-end of our guidance. It was timing related. It's early. The $3.9 billion to $4.1 billion that we have out there for the year would be on top of the, or is on top of the record performance we saw last year. Bottom line, we will keep an eye on all this, but we're confident in the outlook for the year.

Thank you. Our next question comes from David Strauss, Barclays. Your line is open.

Last one on missiles and then also one other question. Toby, I think you said you highlighted, maybe a $15 million negative to EAC. What were the total negative EACs in missiles in the quarter? And then on cash deployment, I think the $500 million share repo number, that’s a biggest I've seen on a quarterly basis that you guys done. How you're thinking about share repo from here? And then also the potential to potentially pull forward some of the future pension contribution needs into this year? Thanks.

So on missiles, just to put in perspective, the net EAC adjustments in the quarter were $4 million, and they were above $69 million -- a little over $60 million of negatives. And again, if you just kind of think of the 9.5% margin. If the performance had been more, the EAC adjustments had been more aligned with our expectation, we would've been in a plus or minus 11% margin range for the quarter. Again, the issues we're dealing with here in missiles in the quarter are related to their performance. On the share repo, we continue to see value in our shares. We are committed to the share repurchase program. The outlook for the year, similar from a dollar value point you give or take to next year -- to last year about $1.3 billion and the 2 plus percent reduction. And we will continue to evaluate that. As far as the pension goes, we will, per our normal practice, we're looking at that all the time. But we'll have a clearer view of that as we get towards the back half of the year. We obviously want to see what's going on from an overall cash generation, allocation of capital and certainly what's happening in the market and how the plans are performing. Last year, just as a reminder, the reason we did something a little bit earlier was we got the benefit with the change in the tax laws to make the deduction at the prior tax rate of the 35%. So we were a little bit ahead of when we would normally look at discretionary contributions.

Thank you. Our next question comes from Cai von Rumohr with Cowen and Company. Your line is open.

So your guidance for the second quarter, 250 to 255 in earnings, looks like we get a fair amount of margin compression given your revenue guide. Could you walk us through maybe some of the puts and takes on margins, particularly missiles? Do we have some more pain to get things under control in the second quarter? And is that the reason for what looks like a light margin guide? Thanks.

So typically for the company, our segment margins do ramp up in the second half. And obviously, therefore, start a bit lower in first half. We did see some Q1 margins, about 50 basis points higher than our expectations, so that we were ahead of our guidance, ahead of our expectations on the segment margins in Q1. A decent portion of this improvement was driven by the timing of some profit previously expected in Q2, primarily at both IIS and SAS and therefore, taking that all into account does result in a lower margin in Q2. If I look at the businesses, specifically for Q2, we do see lower IDS and IIS margins compared to Q1. And also just as a bit of a reminder, Forcepoint traditionally or typically does have a loss in both Q1 and Q2 due to the seasonality of their business. So although the Q2 margin expectations, they are a little bit lower, we do feel good about our guidance for the total year of the 12.1 to 12.3. And I can tell you we have had years in the past where the cadence was similar. And part of that is driven, as I mentioned, by Forcepoint given that they are in a loss for the first half of the year and a profit in the back half as their volume increases.

Thank you. Our next question comes from Rob Spingarn with Credit Suisse. Your line is open.

So Tom, I wanted to go to hypersonics and think about Raytheon's positioning in offensive hypersonics. So you talked about the TBG, and I think you want something -- I'll hop a few years. But it seems like one of your competitors has been winning a lot of the hypersonic work lately. Where do you stand and what are the opportunities, can you catch up or is this the wrong way to think about it?

Let me start off with what we are doing right now. So on the offensive, and I think I mentioned on our prior call that the defensive hypersonics is actually a bigger market than the offensive. But on the offensive, we are heavily involved in multiple programs. One of them is the air breathing hypersonics weapons program, and that's with the DARPA program. And then we are working on that program. We are also on a hypersonic boost glide weapons program, one of them is the tactical boost glide program that I mentioned on my -- during my discussion upfront. So that's essentially the two big programs that we are engaged in from a hypersonic perspective on the offensive side. We are also working several other arrangements in hypersonic area that I can't really get into on the phone here. But we feel we're in a very strong position relative to where we want to be on offensive hypersonics. On defensive side, we are heavily involved in that several activities involved in that, but it also moves on beyond just the missile part also moves into the sensor part, both on land and in space. So the overall area of hypersonics is a big opportunity for Raytheon where we believe we're engaged in the right elements of that and we're proceeding forward.

Thank you. Our next question comes from Seth Seifman with JPMorgan. Your line is open.

I wanted to ask briefly another question about IIS, where excluding any Warfighter headwind as the performance has been consistently good for several quarters now both sales and margins. I mean, if we look just specifically at the margin and we exclude the one timers from the quarter. It's been consistently mid-80s for the past three quarters now? I mean is this mid-8 business going forward, and if not why not? And you're obviously growing nicely, the end markets are growing and it seems like you're taking some share to. How do you think about the growth potential in the out years?

Let me jump in there and obviously Tom can add any color if he wants and hopefully I get it all you broke up a little bit on the question, but I'll go back to Q1 performance right and kind of, to your question about the margins. If we exclude the couple items that we talked about in the comments in the release around the consolidation of the entity that we planned on, in the material sales, right. IIS would have about 8.5% margin in the quarter and there see a real strong execution. That was largely driven by their net program efficiencies compared to where they perhaps perform to the last year in their prior guidance. So, we expect them to continue to perform at a strong level going forward I think I have said before this business can certainly get a north of 8% on a consistent basis from a margin point of view. I think they have got the execution side of it down really well based upon how they performed last year and certainly into the first quarter this year. I think as everybody knows they are the one business right that from their business model has the structure that drives the margins to be a little suppress right to have the least amount of fixed price and the least amount of international work, but I know Dave and the team are working hard to improve that especially in the area of cyber and various international opportunities. So I expect they are going to continue to grow even with the headwinds of Warfighter that they will be through this year between cyber and space and international. And I would expect that over time they will continue to incrementally improve the margins and that they clearly have the ability to get this business to operate in the very high single-digit margins, albeit over time especially as that mix transitions and becomes a little bit more international biased.

Thank you. Our next question comes from Pete Skibitski with Alembic Global. Your line is open.

One more question on missiles but more from a revenue standpoint. Tom, I know you guys kind of organized each of your segment by product area and I'm wondering which of the product areas within MS is going to grow the fastest this year to get it to your guidance? And just how dependent is the guidance on signing the two multi-year on the SM this year?

So, I think a big player this year for missiles and actually for their segment that has the two multi-year in it, the SM-3, Block 1B multi-year and the SM-6 multi-year. And those are combined that's about four over little bit over $4 billion booking. And so the ramping up the latter half of this year and obviously into 2020 and beyond. I think they're going to get significant because they are multi-year -- its five-year multi-year will give them significant base improvements and their factories moving forward. We are seeing across all elements all the business areas within missiles significant growth and also significant international demand signals. So I think it's maybe Toby, give you the exact numbers here but we are very positive on the growth side of missiles and so again we want to leverage the fact that we are growing not just on the development programs but now with these two multi-years on the production programs; when we want to leverage that to drive productivity and efficiency improvements to essentially drive the inter-margin expansion going in the right direction also.

The only thing I would add, Pete. As Tom, hit it right on. I mean they have got such a broad portfolio there isn't a single program or program area that were dependent upon here in the near term certainly this year and into the future to drive the growth that's coming from some of the classified work, some of our air-to-air business, the missile defense business that SM-3, participates in. So I think that's a key feature they have got the largest amount of franchises in the company. And while they are all at various stages they are all contributing or most all are contributing to the growth this year.

Shannon, we have time for one more question, please.

Our last question is from Carter Copeland with Melius Research. Your line is open.

I wondered you called out in missiles in the K, a charge on a next-gen precision strike weapon. And then in your earlier remarks you mentioned a couple of charges. Can you tell us a bit if that's the same program if we added another program, if we're talking about an expansion of loss making or zero margin work there. And then just in general with respect to the mix at missiles with respect to the 2019 plan versus 2018? How much more of the cost type of work do you have as a percentage this year than say you'd had last year? Thanks.

Let me start with the last one first. At missiles in particular the cost type mix and directionally is, think of it as maybe five to seven points -- 500 to 700 basis points higher or more biased toward cost type versus fixed price on a year-over-year basis. On your first question, I mentioned, I figured who asked the question earlier but when I was talking about the performance and I mentioned in the quarter we had a one adjustment that was about $15 million. It is not the same program that you referenced from the K, this was an international test range upgrade program that we saw some growth driven by design related issues in the early phases and we are now moving into the production in the integration phase. So, it's not the same program that was driving the negative adjustments that I referred to here in Q1.

That's all the time we have today. Thank you for joining us this morning. We look forward to speaking with you again on our second quarter conference call in July.

Ladies and gentlemen this concludes today's conference. Thank you for your participation. Have a wonderful day.