RTX Corporation

We continue to see strong global demand for innovative solutions, illustrated by our book-to-bill ratio of almost 1.2 for the full year. And for the third time in 2018, we achieved record backlog, which rose to $42.4 billion at the end of the year. This drove an increase in backlog of more than $4 billion year over year and positions us for a strong 2019. Sales were up. 8.5% in the fourth quarter, and 6.7% for the full year. And in 2018, we accelerated our sales growth for the fourth time since 2015. This resulted in a new company record for annual sales of $27 billion. Cash flow was better than we expected, and we achieved a new company record for operating cash flow for the full year. Toby will review additional details about the fourth quarter and our 2019 guidance in a few minutes. Given the success we saw in 2018, I wanted to take a few minutes to share some of the RaceBeyond's key milestones across our company during the year. First, I'd like to highlight the strength of our classified business. In 2018, we had record classified bookings that were up over 45% year over year. Classified bookings for the full year were almost $7 billion, and we saw strong classified bookings across the businesses, including $2.6 billion at IIS, $2.4 billion at SAS, and $1.6 billion at missiles. Raytheon also had record classified sales, which grew 19% versus 2017 and represented 19% of company sales. Classified bookings and sales exceeded our plans for the year. Our strength in classified is driven in large part by the need of our domestic customers to address advanced threats as outlined in the national defense strategy. As a reminder, classified business is crucial for Raytheon's growth and success. It funds next generation technology development that is integral to the long-term growth of our future franchises and production awards. Second, We saw strong growth in many of our businesses in 2018, including at our IIS business, which grew 9%. Although we expect to see the Warfighter Focus program ramp down in 2019, we continue to see meaningful expansion in IIS's core markets, including cyber and space. IIS's innovative solutions are well aligned with our customers' current mission needs and long-term strategy. We saw this in 2018 with cyber and space programs at IIS achieving double-digit growth. Next, I wanted to highlight the progress we made in 2018 on one of our existing franchises, our Advanced Patriot Air and Missile Defense System. In December, we were awarded nearly $700 million for Sweden Patriot. And during 2018, we booked four major production awards for our Patriot system, totaling almost $4 billion in bookings. Three of the four major Patriot Awards were from new countries, Romania, Poland, and Sweden, and we now have 16 nations that depend on Patriot to protect their citizens and armed forces. All of these countries pool money to fund sustainment, support, and new development of Patriot, which keeps our system ready for the evolving threat for years to come. And with our current Patriot backlog, we have production visibility until at least 2023. In terms of future Patriot Awards, we still expect our next booking of $500 million for Romania Patriot in 2019, with additional follow-on awards to complete program in 2020 and 2021. We continue to see the total Raytheon Romania Patriot opportunity to be around $2 billion. For a Poland Patriot opportunity, our Phase II booking is still expected in 2020, with the total Raytheon Poland Patriot opportunity to be around $5 billion. There is also the potential for additional Patriot production awards, including the possibility of adding yet another new European country to the Patriot partnership. Another 2018 highlight was the new franchises Raytheon won across our businesses. And missiles, in addition to the new classified programs, we also won a new missile franchise, the Naval Strike Missile for the U.S. Navy. versus the prior system. And we have been developing this technology over the past few years, which will be applicable to other aircraft, including the rotorcraft market. We look forward to some of our new franchises that we have won over the last few years, transitioning from the development to full-rate production. These franchises include AMDR, Eacer, 3Dealer, Next Generation Jammer, Fab T, and Stormbreaker. During 2018, we also achieved testing milestones on some of our programs, such as the next generation Standard Missile 3 Block IIA. This interceptor defeats missile threats outside the Earth's atmosphere and is being developed and produced in cooperation with Japan. A test in December marked three significant achievements for the SM-3 Block IIA missile, including intercept from a land-based launch intercept of an intermediate range ballistic missile target, and intercept using tracking data from remote sensors. Additionally, this test supports a critical initial production acquisition milestone. Our SM-3 missiles are the only ballistic missile interceptors that can be launched both at sea and on land and have achieved over 30 intercepts in space. And we continue to see opportunities across our standard missile family of products, including the potential for multi-year awards for SM-3 Block 1B and SM-6, which will provide production visibility until at least 2026. Many of our innovative solutions, including the SM-3 Block 2A interceptor, were noted as critical products outlined in the Missile Defense Review, which was released earlier this month. We are encouraged by the MDR and how closely our customers' needs in these critical areas align with the capabilities we are developing, including interceptors, space-based sensors, high energy lasers, hypersonics, and counter hypersonics. As we start 2019, we feel very optimistic about the future and our ability to continue to grow both domestically and internationally. It's worth noting that we started the government fiscal year 2019 with the Department of Defense budget already in place, avoiding a continuing resolution for the first time in a decade. This timely bill passage is providing valuable stability and predictability, which is beneficial for both our customers and our shareholders. In closing, our very successful 2018 would not have been possible without the strong commitment and performance of our 67,000 employees around the world. I want to thank them for all they did for our customers, company, and shareholders during the year. We look forward to 2019 being another successful year for Raytheon, and it has certainly started on the right note. Earlier this month, Fortune magazine ranked Raytheon first for innovation within the aerospace and defense sector on their most admired companies list. That's great recognition of the investments we've made and the talent we have to drive our future success. We are clearly ready to take this great company to new heights in the year ahead and beyond. Now let me turn the call over to Toby.

Okay. Thanks, Tom. I have a few opening remarks, starting with the fourth quarter and full year results. Then I'll discuss our outlook for 2019. After that, we'll open up the call for questions. During my remarks, I'll be referring to the web slides that we issued earlier this morning, which are posted on our website. Would everyone please move to page three? We are pleased with the strong performance the team delivered in both the fourth quarter and the full year. Bookings, sales, EPS, and operating cash flow all met or exceeded our expectations. We had strong bookings in the fourth quarter at $8.4 billion, resulting in a book-to-bill ratio of 1.15, and for the year, We had record bookings of $32.2 billion, resulting in a book-to-bill ratio of 1.19. This sets the stage for continued growth in 2019, which I'll discuss in more detail in just a few minutes. Sales were $7.4 billion in the quarter, up 8.5 percent from the same period last year. We saw strong growth across all of our businesses. For the year, sales were up 6.7%, reaching a new company record of $27.1 billion. Our EPS from continuing operations was $2.93 for the quarter and $10.15 for the full year. I will give a little more color on EPS in a few minutes. We also generated strong operating cash flow of $2.4 billion for the quarter and $3.4 billion for the full year. It's worth noting that we exceeded our operating cash flow guidance by approximately $600 million at the midpoint and achieved a new company record for operating cash flow. The increase was driven by operations and improved working capital. And as a reminder, we made a $1.25 billion pretax discretionary pension contribution in the third quarter of 2018. Additionally, during the quarter, the company repurchased approximately 2.3 million shares of common stock for $400 million, bringing the full-year 2018 repurchases to 6.7 million shares for about $1.3 billion. We reduced our share count in 2018, and we continue to see value in our share price. The company ended the year with a solid balance sheet and net debt of approximately $1.4 billion, which provides us financial flexibility for the future. Turning now to page four, let me go through some of the details of our fourth quarter and full year results. As I mentioned earlier, we had strong bookings of $8.4 billion in the quarter and $32.2 billion for the full year. resulting in a record backlog of $42.4 billion. This is an increase to backlog of $4.2 billion over year-end 2017 and provides us with a strong foundation for 2019. It's worth noting that both IDS and SAS had strong bookings performance for the full year 2018, up 76 percent and 33 percent, respectively, over the prior year. And all of our businesses had a book-to-bill ratio over one in 2018. International orders represented 31 percent of our total company bookings for both the quarter and the full year. At the end of 2018, approximately 40 percent of our total backlog was international. Turning now to page five. We had fourth quarter sales of $7.4 billion, an increase of 8.5% compared with the fourth quarter of 2017, and in line with our expectations. International sales continue to be strong, representing 30% of our total sales for both the fourth quarter and full year of 2018. So looking at the businesses, IDS had net sales of $1.7 billion in the quarter, up 8% from the same period last year, primarily due to higher net sales on two international Patriot programs awarded in 2018. IIS had net sales of $1.7 billion in Q4. The 9% increase compared with Q4 2017 was primarily due to higher net sales on cyber and space classified programs and on the Domino cyber program. Net sales of missile systems in the fourth quarter were $2.3 billion, up 6% compared with the same period last year. The increase was primarily driven by higher net sales on classified programs. In the fourth quarter 2018, SAS had net sales of $1.9 billion. The 13% increase from the fourth quarter 2017 was primarily driven by higher net sales on classified programs. And at force point, we saw 10% sales growth in the quarter. For the full year, total company sales were $27.1 billion, up 6.7% over full year 2017. Moving ahead to page six. Our operating margin in the quarter was 16.5% for the total company and 12% on a business segment basis and lower than last year's fourth quarter, primarily due to mix. Overall, the company continues to perform well. Turning to page seven, we had solid operating margin performance for the year. Our operating margin was 16.8% for the total company and 12% on a business segment basis. On page eight, you'll see both the fourth quarter and full year EPS. In the fourth quarter 2018, Our EPS was $2.93, and for the full year was $10.15. Both the quarter and full year were higher than the comparable periods in 2017, primarily driven by operational improvements from higher sales volume and lower taxes that were primarily associated with tax reform. Overall, we had strong operating performance for both the quarter and full year. Now, looking at our 2019 guidance on page 9, we see sales in the range of between $28.6 and $29.1 billion, up 6 to 8 percent from 2018, which is consistent with our initial outlook that we provided in October. The increase is driven by growth in both our domestic and international businesses. As for pension, We see the 2019 FAS-CAS operating adjustment at approximately $1.5 billion of income and the retirement benefits non-service expense and non-operating at $726 million. We expect net interest expense to be between $153 and $158 million in line with 2018. We see our average diluted shares outstanding to be between $279 and $281 million on a full-year basis, driven by the continuation of our share repurchase program. We expect our effective tax rate to be between 17 and 17.5 percent. Our estimated tax rate in 2019 is higher than 2018, primarily due to the increase in pre-tax income and the absence of benefits recorded in 2018 for the discretionary pension contribution and certain tax planning initiatives. In 2019, we see our EPS to be in the range of $11.40 to $11.60 up year over year. Our operating cash flow from continuing operations for 2019 is expected to be between 3.9 and $4.1 billion. I will discuss operating cash flow more in a few minutes. Before moving on to page 10, I would like to mention that we expect our 2019 bookings to be between $29.5 and $30.5 billion, driven by demand from a broad base of domestic and international customers. And we expect stronger bookings in the second half of the year similar to prior years. So, if you move to page 10, here we have provided our initial 2019 guidance by business. We expect to see growth in all our businesses in 2019. At the midpoint of the sales range, we expect IIS sales in 2019 to be up slightly over 2018. As we've discussed before, this is driven by the planned ramp down on the Warfighter Focus Program. Excluding Warfighter Focus, we expect IIS to grow in the high single-digit range, driven by Mission Support and the Domino Program, as well as classified programs, primarily in cyber and space. With respect to segment margins, we expect 2019 margins to continue to be solid in the 12.1 to 12.3 percent range. This is up about 20 basis points over 2018 at the midpoint. At IDS, we see margins in the 16 to 16.2 percent range. And as we have discussed previously, this is driven by a change in program mix as we ramp up on some recently awarded programs. We traditionally see lower margins in the early phases of programs until we retire certain risks. We also expect lower volume year over year on some higher margin production programs that are nearing completion. We expect IIS margins of 7.8 to 8 percent in line with 2018. We see missiles margins in the 12.1 to 12.3 percent range up 50 basis points at the midpoint versus 2018. SAS margins are expected to be in the 12.9 to 13.1 percent range in line with 2018. At force point, we expect margins to be in the 3 to 5 percent range. For 2019, at a total company level, our margins are expected to be in the 16.5 to 16.7 percent range. If you now turn to page 11, we've provided you with our outlook for the first quarter of 2019. Please note, the first quarter of 2019 has one less workday than the first quarter of 2018, and this equates to about $100 million in sales overall. We expect the cadence for the balance of 2019 to play out similar to 2018 with sales, EPS, and operating cash flow ramping up in the second half of the year, as usual. Turning to page 12, we've provided you with an updated view of how we see our operating cash flow outlook over the next few years. We are pleased with our strong cash flow going forward, which is better than our prior expectations. As I mentioned earlier, in 2018, we had record operating cash flow that was $600 million better than our prior guidance at the midpoint, driven by operations and working capital improvements. As a reminder, we made a $1.25 billion pretax discretionary pension contribution in the third quarter of 2018. As we sit here today, no discretionary pension contributions are contemplated in our 2019 guidance. For 2019, we brought our operating cash flow guidance up to a range of $3.9 to $4.1 billion. Also, it's important to point out that we expect to pay approximately $900 million more in cash taxes in 2019, which is $200 million higher than our prior outlook. Also, on page 12, we provided operating cash flow guidance for 2020 of around $4.6 billion. And on page 13, as we've done in the past, we've provided a summary of the financial impact from pension in 2018, as well as the projected impact for the next five years, holding all assumptions constant. You'll note that this year we have provided you with two additional years of pension outlook to help you with your modeling. As I mentioned earlier, we see the 2019 FAS-CAS operating adjustment at approximately $1.5 billion of income and the retirement benefits non-service expense in non-operating at $726 million, which reflects our investment returns in 2018 of minus 4% on our U.S. pension assets, the December 31st discount rate of 4.3%, and a long-term return on asset assumption of 7.5%. Before concluding, I wanted to touch on our capital deployment strategy. As I just mentioned, we expect to continue to generate strong cash flow and maintain a strong balance sheet that provides us with financial flexibility. We remain focused on deploying capital in ways that create value for our shareholders and customers. This includes internal investments to support our growth, paying a sustainable and competitive dividend, reducing our share count, making targeted acquisitions that fit our technology and global growth needs, and making discretionary contributions to the pension from time to time. Let me conclude by saying that 2018 was a very successful year for Raytheon, where we once again delivered strong financial results. We set many new company records in 2018, including record operating cash flow, backlog and bookings, and both sales and bookings in the classified and international areas. We have a solid balance sheet, which gives us flexibility and options to continue to drive shareholder value and a strong outlook for cash. We are well positioned to grow in 2019 and beyond. So with that, we'll open up the call for questions.

Thank you. Ladies and gentlemen, if you have a question at this time, please press star then 1 on your touch-tone telephone. If your question has been answered or you wish to move yourself in the queue, please press the pound key. To prevent any background noise, we ask that you please place your line on mute once your question has been stated. In the interest of time and to allow for broader participation, you are asked to limit yourself to one question. The first question will come from Joseph Donardi of Stiefel. Your line is now open.

Yes, thanks very much. I'm wondering if you could just speak kind of longer term to, you know, the demand signals that you're seeing just broadly for missile defense in the Middle East, Asia, you know, and maybe how that's evolved over the past 12 months just given kind of changes in the threat environment. Thank you.

Yeah, good to hear from you, Joe, and I'll cover that. I think two elements. Initially, I'll talk about the missile defense in the Middle East that we still see a strong impact demand signals for multiple countries. The major concern there is Iran. And so we are seeing continued demand. We saw the, for example, the LOA signing of the THAAD system for the kingdom of Saudi Arabia that occurred last year. Raytheon has a major part of that procurement based on our TIPI-2 radars. We're also continuing to see a demand signal in the Asia Pacific region. especially relative to Japan. I think a big note here on Japan is in 2018, the ABI cabinet did approve their five-year plan, which was a 10% increase over the prior five-year plan. So in that plan, there is a significant effort relative to missile defense. I did mention in my script that we are working with Japan in the development of the SM-3 Block IIA, and that is a key weapon system that's in their procurement horizon. So we feel very happy about the Asia-Pacific region. And then back home, late last year, the missile defense actually came out earlier this year on the Missile Defense Review. And if you go through the Missile Defense Review, we're very encouraged here at Raytheon because many of our systems are called out. The Missile Defense Review will be increasing existing capabilities, such as the ground-based interceptors, more of those, which has our EKV, exo-atmospheric kill vehicle, on top of that. There are also more work on the area of homeland defense, but in terms of improvements that the Missile Defense Review called out, significant support for our replacement kill vehicle, so additional funding for that. It also called out the use of the SPY-6, what we call the AMDR radar for the Navy, and also the use of the SM-3 Block IIA as an important element out of the Missile Defense Review. And beyond that, for left of launch, it did call out the use of advanced sensors on the F-35, and I mentioned in my script that last year one of the major franchises that we won was the EODAS, Distributed Aperture System, that'll go on the F-35, which provides significant sensor capability here. So we, all around, I think the missile defense review was great for us, and then also the international demand signals, all the way from the Asia-Pacific region, the Middle East, and then I mentioned that several closing several deals in Europe here just last year, and then also the significant opportunity here for some more deals here coming in 2019. So we're very optimistic, especially in the area of integrated air and missile defense.

Thank you. And our next question comes from John Ravis of Citi. Your line is now open.

Hey, good morning, everyone.

Good morning.

Sorry to sort of go in this direction a little bit, but just can you talk a little bit about the idea of cushion in the guidance? And just specifically really to IDS and MS this year, we certainly appreciate there are always a lot of moving pieces and complexities with new stuff ramping. But, you know, missile systems seems to have missed again, and it was a lowered bar through 2018. And IDS also seemed to miss on margin. So I don't want to focus too much on the past, but just sort of as you lay out the 12-1 to 12, three segment margin guidance for 19. How much cushion is in there and how do we sort of get over the idea that things can change and perhaps underperform through the year?

Thank you. Yeah, John, let me start maybe high level right at the company level around the guidance and then give you a little color on both of the businesses, missiles and IDS that you talked about. So You know, we're very comfortable and we're pleased with the guidance that we put out there. You know, at the top line, it's showing, you know, 6% to 8% growth. If you just take the midpoint, it would be the fifth year in a row of accelerating growth for the company. The other thing to keep in mind, and I, you know, alluded to it, but I'll quantify it in my opening remarks, and I'll quantify it now, you know, not new news, but the headwinds that IIS, they're still growing, and we expect them to still grow in 2019. but they do have about a half-a-billion-dollar headwind from the ramp down, you know, which we knew about of the Warfighter Focus Program. You know, normalized for that, you'd add about 200 basis points to the range, and we'd be looking at 8% to 10% growth at the company level. We think the guidance we've provided at this point, when you look kind of up and down the metrics, is balanced. You know, we're just starting the year out. We always look, whether it be this year or into the future, for ways to improve and do better, and that hasn't changed. I'd point out on the operating cash flow, we had an exceptional year in 2018. As I mentioned, we beat our expectations by $600 million at the midpoint, and it wasn't just timing. We didn't drop $19 by $600 million. We actually increased it by $100 million. which was 300 operationally offset by a couple hundred million dollars in additional cash taxes. So over that period, very strong performance. So we're very comfortable with it. We're pleased with it. And as usual, we'll always look to do better. Now, for the two businesses that you referred to, and in particular, their margins. So from an IDS point of view, I think First and foremost, if I step back, I'll look at the total year. They generated really strong margins, 16.6% for the total year. They were up 50 basis points over 2017, and we continue to see their margins in 2019 in that 16% range. Now, in the fourth quarter, there were two things that went on at IDS. There were some higher levels of investments in the business from an R&D point of view. Think next generation advanced radar technology. And we did see on a couple of development programs some cost growth that net-net resulted in a little bit lower cost. net productivity compared to what we were expecting. But overall, we're pleased with where IDS's performance is. If I think about 19 for IDS, and again, it's a little bit repetitive to what I said earlier, you know, they're performing well. They've got some mature production programs that are ramping down that have already been through the, you know, risk retirement phase, if you will. Tom alluded to in his comments the strong bookings for Patriot with three new countries, four new major Patriot awards for roughly $4 billion last year. Those are just in the early stages. Patriot's closer to a five-year program compared to maybe the company on average is three. We've kind of got a mix almost within production programs, even within international production programs at IDS. because it'll be a couple years before those programs ramp up and retire their risk. But I think we're very pleased with IDS's performance and the track that they're on. From a MISLS point of view, I think there's a couple things to point out there. Through last year, we've been talking about the increased level of development work, primarily classified development work that we've been getting Three of our businesses had significant new orders this year. Missiles kept exceeding our expectations relative to the increase in classified work that they were getting. Even at a company level, if I take you back to the start of the year and our original revenue guidance, and I think at the midpoint of that compared to where we ended up, we were about 170 basis points higher, that was effectively all classified work, right? And as we've talked about, it's a margin headwind in the near term. But over the long term, it's positive because it does, you know, it does generate those new franchises and margin expansion opportunities when programs move into production. So I think, you know, specifically for missiles, You know, we do expect them to improve their margins versus, you know, 18 and 19, as I said, to a range of 12.1 to 12.3. They clearly have been hit with the higher level of development classified programs. You know, their bookings in that area grew 50 percent, you know, from a billion to a billion and a half. That's probably, you know, rough numbers, close to about a 30 basis points impact. that they're dealing with, and we, you know, are continuing to focus on, you know, margin expansion there. They did in the quarter, in addition, have an impact in the quarter from a negative adjustment on an early stage production program that impacted their margin. But there, you know, going forward, we feel we've significantly reduced the risk profile on that program in the missiles business going forward.

Thank you. And our next question comes from Robert Spingard of Credit Suisse. Your line is now open.

Good morning. I wanted to ask a question, Tom, and then a clarification from Toby. So, Tom, your book-to-bill has been excellent last year, almost 1.2. It was good a couple years before, but it does outpace the sales growth. And I'm just wondering if there's a rule of thumb or a curve here that we should be using to model the conversion of bookings to sales and something like, I don't know, 40% year one, 20% year two, that kind of thing? Or is there an average duration we should be assigning to bookings? Or is this a trend of DOD simply locking in money in an accommodating political environment and then spreading the spending? And then for Toby, I just wanted you to clarify your cash deployment comments, given that you guys have the lowest net leverage among peers. Thanks. Thanks.

Hey, Rob, some good questions there. I'll tackle the ones you gave me. Our business has kind of two cycle periods, three years and five years. So, for example, in our missile business, if you're going to go buy some AMRAAMs, it's about a three – you know, we get a contract that spreads out over three years, ramping up the first year, kind of doing, you know, at least over – probably closer to 40% of work the second year and then ramping down on the third year. And then you get into some of our five-year business, which would be like a Patriot system. You get a Patriot contract to go deliver fire units. That probably works out to about a five-year program. There obviously is a ramp up and then the ramp down on delivery. And then the three years are kind of constant between those ramps. And that's essentially our business. And then we model it that way. It's executed that way. We don't have a lot of book and turn type business in one year outside of IIS. The IIS business does have contracts where they can book and complete in one year. But outside of that, the rest of the company is really based on this three-year and kind of five-year cycle.

And I think I'll just add on a little bit to what Tom said there, and I'll give you a comment on the balance sheet and the capital deployment. You know, That's a general rule of thumb, not to get too down in the weeds on this. Obviously, it matters when programs start within a year, right? I mean, a program on January 1 versus September 1, you're going to get a different answer. And that curve over the three to five years gets pushed out accordingly. Just to reinforce, if you think about it, we grew 6.7% last year, 6% to 8% this year. Just real simplistically, right, and every year is a little different, right? But, you know, that's between the two years, 7%, 7% round numbers. You know, it's starting to get close to the levels of the increase that we saw in the, you know, the 18 and the 19 spending that gets then converted to sales over a, you know, roughly three-year, maybe a little bit longer than some of the IDS programs. On the balance sheet and our leverage here, we continue to believe our philosophy and approach of utilizing a balanced capital deployment strategy makes sense. To reiterate, our first priority is investing in ourselves to support growth. You know, the way to think of that this year, we expect our R&D investments expenditures to be about 3% of revenue. You know, where they have been for the last couple years, obviously a little bit higher in dollars given the higher revenue. We've talked about last year how we ramped up a bit on our CapEx expenditures really to support programs both through demonstration hardware, facilities, and infrastructure capability. I think we said back in October to think of that as around 4% of our revenue, and we're in that ballpark there, but that is a significant step up over the last couple years as to where we've been before, but we're doing it because we do believe we align very well with our customers' needs, with our existing and future capabilities, and it ties all back to the NDS. You know, beyond that, we are committed to returning, you know, as a target 80% of free cash flow to shareholders. I mentioned, you know, the philosophy around a competitive and sustainable dividend, the continuation of the buyback program. We do think there is incremental value in the share price, and we do also look to augment that growth with, you know, key acquisitions that help with technology and growth. But again, those are more the smaller size type of deals. And lastly, we will consider pension contributions on a discretionary basis as we go through the year, look at what's happening in the market and our overall cash flow as well. I think the last point there, just as a reminder, and I think everybody knows this, You know, the balanced approach is the philosophy, but we obviously have the ability to flex up and down across the elements of that balanced approach if we feel it's going to do more good and create more value to allocate capital, you know, a little bit differently than kind of how I just described.

And just one last element as part of your question is we do not see any evidence of of the department parking money on contracts that won't be used. So we have not seen any evidence of that.

Thank you. And our next question comes from Kayvon Remore of Cowan & Company. Your line is now open.

Yes. Thank you. Two questions. So your R&D was up 48% in the fourth quarter. Is that one of the reasons that the margins were light, that you basically got paid for that, but you didn't have as much margin? And secondly, you have the tantalizing number on cash flow in 2020, which is up, but NAs in terms of the factors. Maybe you could give us some color as to how you get to that very strong number. Thank you.

Sure. Kai, let me start with the question on R&D. So the answer is in part, right? And in particular, at IDS, it was one of the reasons that I mentioned where their margins were impacted, and it was in the fourth quarter, and it was related to investments, you know, in next-generation radar and radar-related technology. So certainly in part relative to the – R&D it was. I think if on the cash flow for 2020, the $4.6 billion, I think the way to think of that is growth in operating cash during that period will be driven by operations, including some international collections. You know, the cash taxes may be slightly lower in 2020, partially offset by some lower net pension. So really it's, you know, some puts and takes outside of operations. And I think, you know, given the significant size of some of our international programs, the payment terms where, you know, oftentimes, more often than not, we'll get an advance, we'll kind of work that off, and then we'll have milestones or deliveries, you know, where we collect the balance of the cash. That's what you're seeing play out in support of the 2020 cash outlook.

Thank you. And our next question comes from Doug Harney of Bernstein. Your line is now open.

Yes. Thank you. Good morning. Good morning, Doug. I'd like to turn back to missiles because I look at what's going on right now in the world with respect to missiles. I mean, you – Blockheed, MBDA, everyone has very strong demand and has rising backlogs. But if I think of those, if I split them into two types, some are production just being flat out on producing on certain programs, and certainly I would say Paveway is probably one of those for you. And others are development. And so what I'm trying to understand is how much of what you're doing sort of on the production side can almost be... maybe a build to inventory in a sense, as opposed to the development side, which can, you're explaining that related to margins, which is something that may have a longer term growth rate associated with it. So could you give us a sense, what is the mix sort of on a percentage basis in missiles between production and development? And if I can throw one more thing in there, have you done anything with respect to concerns about possible Saudi sanctions when you look at that outlook?

Doug, hopefully we'll hit all those points here. I'll start off and then I'll let Tom jump in. Your first question about the mix between production and development work, I'll put it in absolute terms, but then also contrast it back a couple of years. For 2019, think of it, you know, rough numbers, about 70% production, 30% development. But if you were to go back a couple years, it would have been more in the 80-20 range. Okay, so there has been a pretty significant shift at missiles specifically, heavily weighted towards the development, and it ties into the classified business we're seeing. And on top of that, you made the point, but I'll quantify it. Our missiles business grew 8% in 2016, 10% in 2017, 7% last year, and another 7% to 10% for 2019. So you're seeing that higher mix towards development, but on a much higher base as well. As far as the production goes, from time to time we'll build to inventory when we think it makes economic sense, not just in missiles but in other of our businesses. But it's not something that we do as a general rule of thumb across all of our programs. And then lastly, from my perspective, on Saudi Arabia, I think here's how you should think about it. Last call in October, we talked about just under around 5% of our revenue from Saudi. That's where 2018 ended up. It was 5%. 2019 is the same. It's about 5% of revenue. But when you peel that back and you look at it in two buckets, the component that's related to offensive weapon sales versus defensive sales, it splits about 50-50. And, you know, to this point, relative to the defensive weapon sales, we've seen no indication, if anything, just the opposite of continued support for defensive sales to Saudi Arabia. And I won't repeat it, Tom alluded to the THAAD LOA and the TIPI-Y2 component of that for the Saudis that was signed at the end of last year and we expect to be under contract for this year. So we've only got, you know, 2.5% of the company revenue tied to that. We continue to monitor the situation, you know, and working with all parties involved. And, you know, we're optimistic that over time we will get to a point here where things move forward. And, again, I think, you know, the 2.5%, it's another feature or shows you, again, the breadth of our portfolio here. At the company level, how balanced it is, no one country, no one program necessarily is a 20%, 30% contributor to the company's results.

Thank you. And our next question comes from Seth Seifman of J.P. Morgan. Your line is now open.

Great. Thanks very much, and good morning.

Good morning, Seth.

Tom, I wonder if you could talk a little bit about the preparations you guys are making for the lower-tier AMD competition and how the Army's efforts in that area are evolving and what's coming up for this year as you focus on trying to keep that business.

So, yeah, we are working with the U.S. Army to develop these advanced capabilities, which in one of those capabilities for Patriot is an advanced radar system. capability, 360-degree capability, utilizing our advanced GAN technologies. Later this year, there is going to be what they call a sense-off. Raytheon will be participating in that. We have made investments over the years to provide a capability that we think is a capability that the U.S. Army needs and wants. We will get an opportunity to demonstrate that capability to the United States Army during the sense-off which is expected kind of towards the end of the second quarter of this year. Again, we have been developing this technology over many years. It's key technology that helped us win the AMDR, the Acer, and several other radar programs, including the three-dealer for the Air Force. So we feel very well positioned to provide this new capability to the U.S. Army, but also to all our international partners. As I mentioned during my script, we have now a cadre of 16 countries that are Patriot members that are either buying Patriot or have Patriot, and in some cases, buying spares, buying support, and contributing to the overall continued evolution of the Patriot system. This will be another element to bring into those 16 countries and to future countries that are would like to enhance their Patriot systems. Then also, obviously, to the U.S. Department of Defense and the Army in buying those systems. Bottom line is we feel very well positioned for the competition. We're taking it seriously. We love radars. It's a major capability of the company, and we've got the whole company focused on winning this.

Thank you. And our next question comes from Miles Walton of EBS. Your line is now open.

Thanks. Good morning. Beyond, maybe Toby first, beyond 2019, in Doug's question, you talked about margin mix dynamics for 19. But beyond 19, if you can comment on kind of margin profiles beyond there, if that's possible. And then maybe for Tom, do you expect real direct budget fall through on the back of the missile defense review in the 2020 plan? Or is this something more that kicks off studies versus real programs with real money? Thanks.

So, on the post beyond 2019 margins, obviously we're not going to give a specific number, but we are confident that we have the opportunities to continue to improve the margin beyond 19. I think because of the mix of business, we would see incremental, I'll think of it that way, the opportunity for incremental improvements on a year-over-year basis. not necessarily step functions. And the reason I say that are kind of two or threefold, right? One, maybe not so much with the more recent classified work, but some of the development programs that we had won a few years back, like AMDR, EESER, at IDS, NextGen, JAMR, at SAS, et cetera, as those transition out of development into low rate, full rate production, all else equal, that provides margin opportunity as we move from cost type to fixed price type of work. And then we're also, as a company, we're always looking for other areas to drive margin improvement and offset the headwinds from things like mix, right? So we've talked a lot about the automation investments we've made, working to lean out our factories, trying to enhance more the scope of work that's in our global business or shared services organization to get the benefits of scale there. We're always looking at our indirect costs, both at the corporate level and across the businesses. to drive those down, and so on and so forth, supply chains and other big areas. So I am confident that the opportunities are there, and we will be able to incrementally improve on our segment margins going forward.

And let me take your question relative to whether the Missile Defense Review will just wind up with study contracts or the real development-type program efforts that's going to occur? And then also, will there be an increase on production contracts? And the answer is really the latter. There will be development programs that will be funded, and there will be production elements. For example, again, it breaks down in three major areas. The one is essentially to increase what they have today. and that's in the area of the ground-based interceptors. We provide the kill vehicle for those ground-based interceptors, so they will be production-type contracts. They also want to improve what they have today. And on the improvement, we're already involved in that on what's called the replacement kill vehicle, or RKV. So that will be an increase in the development program relative to the replacement kill vehicle, which will eventually then go into production. And also, you know, the bringing in more advanced radars like the AMDR SPY-6 on the naval ships and utilizing those. And then also our SM-3 Block IIA, which is now ready for production and is going into production. So we'll be buying more of those production assets there. And then in terms of some new technology, we are on board for that new technology that actually calls out using the F-35. for boost phase intercept capabilities, and the new sensor that we want on that, the EOI-DAS, distributed aperture system, will be a key element of that. That's a little bit of a development program, but geared for production. We also talked about high-energy lasers. We're heavily involved in that, so we see more money going into development for the high-energy lasers. It also calls out something called the space sensor layer. There will be initially studies to do architectures for that, but that will eventually go into a major development program. And then there's the whole area, a big area, an area that we're heavily involved in, is hypersonic defense. In fact, we believe the hypersonic defense market is larger than the hypersonic market, which we also significantly participate in. And the reason for it being larger, the hypersonic defense market, also includes the sensors and the trackers to be able to track these hypersonic threats, but then also being able to go off and defeat them. So it's a very important market for Raytheon. We're heavily engaged in it, and we know that there's real money going into that.

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

Thank you. And our last question comes from Robert Ballard of Vertical Research. Your line is now open.

Thanks so much. Good morning.

Hey, Rob.

Toby, I hate to do this with the last question, but I'm going to ask about pension. Slide 13. If I'm reading this right, you have a big step up in your cash pension contribution in 2021 on a net basis. Do you see other opportunities within the business, maybe working capital or other things, to offset that headwind as we get to 2021?

Yeah, so Rob, I'll take you back to the, you know, I guess it's slide 12, right? And I know it doesn't go out to 21, but our cash outlook, the three-year cash outlook here. And, you know, we're one year into when we provided this three-year look, you know, going back to this time last year. We've already, you know, compared to what we had said originally, kind of pushed things up, you know, however you want to look at it, at least half a billion in if not more towards the high end of that three-year window. And I think we've got opportunity to continue to have that happen going forward. So we are confident in our ability to continue to generate strong cash flow to offset headwinds, including specifically the pension there. Obviously, a lot can happen between now and then, whether it be related to pension or specifically around asset returns, discount rates, you know, discretionary contributions, et cetera. And then operationally, as I mentioned, I think it was Kai's question, these large international programs, right, they present great opportunity for us to, you know, drive cash flow. And, you know, you got some puts and takes on those too, right, when you're working off advances. So things can get lumpy at a point in time, and as we get closer to 21, things will be clearer. But sitting here today, I'd say we'd have the ability to offset that pension headwind.

Thank you. And ladies and gentlemen, this does conclude our question and answer session. I would now like to turn the call back over to Ms. Kelsey DeBrien for any closing remarks.

Thank you for joining us this morning. We will look forward to speaking with you again on our first quarter conference call in April.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.