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Raytheon Company (RTN - Analyst Report) reported second quarter 2012 earnings from continuing operations of $1.41 per share, beating the Zacks Consensus Estimate of $1.21. The result was also higher than the year-ago quarterly earnings of $1.20 per share. The increase was driven by operational improvements and capital deployment actions.

Operational Performance

Revenue was $5.99 billion, down 3.4% from $6.20 billion in the year-ago period. It also missed the Zacks Consensus Estimate by $30 million. The company reported net income of $471 million, higher than $438 million in the prior-year period.

Total backlog at the end of the reported period was $33.9 billion, down from $34.5 billion in the year-ago period.

Segment Performance

Integrated Defense Systems (IDS): Segment revenue decreased 4% to $1.22 billion year over year. The change in net sales was primarily due to lower sales on a U.S. Navy program. Segment operating income rose 16% to $236 million. The change in operating income was primarily due to favorable contract mix and improved program performance.

During the quarter, IDS booked $134 million to provide advanced Patriot air and missile defense capability for an international customer.

Intelligence and Information Systems (IIS): Segment revenue remained flat year over year at $751 million. Segment operating income rose 11% to $61 million. During the quarter, the segment booked $458 million on a number of classified contracts.

Missile Systems (MS): Segment revenue decreased 1% year over year to $1.36 billion. Segment operating income rose 12% to $169 million. The increase in operating income was primarily due to improved program performance. During the quarter, MS booked $687 million for an Exoatmospheric Kill Vehicle (EKV) contract for the Missile Defense Agency (MDA); $348 million for Tomahawk for the U.S. Navy and international customers; and $302 million for the production of Standard Missile-6 (SM-6) for the U.S. Navy.

Network Centric Systems (NCS): Segment revenue decreased 15% year over year to $962 million in the quarter, largely due to lower sales in U.S. Army programs. The segment operating income was $123 million, down 28% year over year. The decline in operating income was primarily due to a change in contract mix and lower volume in the second quarter 2012.

During the quarter, NCS booked $90 million on the Standard Terminal Automation Replacement System (STARS) program for the Federal Aviation Administration (FAA) and $82 million on the Advanced Field Artillery Tactical Data System (AFATDS) program for the U.S. Army.

Space and Airborne Systems (SAS): Revenue in the quarter increased 2% year over year to $1.38 billion. The increase in net sales was primarily attributable to higher net sales on an international tactical radar program. SAS recorded $204 million in operating income, up 16% from the previous-year period. The increase in operating income was primarily attributable to improved program performance.

During the quarter, SAS booked $205 million to provide multi-spectral targeting systems (MTS) for Unmanned Aerial Vehicles to the U.S. Air Force. SAS also booked $462 million on a number of classified contracts.

Technical Services (TS): Revenue fell 4% year over year to $821 million. The decline in net sales was primarily due to lower net sales on a National Science Foundation (NSF) Polar contract, which was completed in the first quarter of 2012. TS recorded operating income of $75 million, up 4% year over year. The increase in operating income came on the back of improved program performance.

During the quarter, TS booked $568 million on domestic training programs and $90 million on foreign training programs in support of Warfighter FOCUS activities.

Financial Update

Raytheon ended the reported period with cash and cash equivalents of $2.35 billion versus $4.00 billion at the end of 2011. Long-term debt remained flat at $4.61 billion versus year-end 2011. The company ended the second quarter 2012 with $1.7 billion of net debt.

Operating cash flow from continuing operations for the second quarter 2012 was an outflow of $259 million compared with an outflow of $89 million in the second quarter of 2011. Year-to-date operating cash flow from continuing operations was an outflow of $148 million versus an outflow of $29 million in the comparable period in 2011. The change in operating cash from continuing operations for both the quarter and year-to-date were primarily due to the timing of collections. I

n the reported quarter, the company repurchased 4 million shares for $200 million. Year-to-date, the company repurchased 11.9 million shares of common stock for $600 million.

Guidance

Raytheon maintained its sales guidance in the range of $24.5 billion to $25 billion for 2012. However, it raised its EPS guidance range to $5.70–$5.85 for 2012 versus its previous expectation of $5.55 – $5.70.

Outlook

Given the declining trend in U.S. defense spending, Raytheon is one of the best-positioned companies among the large-cap defense players given its non-platform-centric focus. This insulates the company from program specific risk related to cancellation or deferral of any specific program.

Going forward, revenue and earnings growth would continue to be driven by its strong presence in the areas of Intelligence, Surveillance and Reconnaissance (ISR); air & missile defense systems; border security; air traffic management; training and homeland security; and cyber security.

Almost a quarter of Raytheon’s business is generated outside the U.S. in sharp contrast to the large cap defense primes like L-3 Communications Holdings Inc. (LLL - Analyst Report). Incremental dependence on foreign sales is evident with sales rising in recent years.

Foreign sales-to-total sales ratio was 26% in 2011, 24% in 2010 and 23% in 2009. This helps Raytheon to shield itself from the risks associated with the U.S. DoD budgets owing to the incoming effect of sequestration currently required under the Budget Control Act effective from January 2, 2013.

Raytheon is actively involved in a number of classified U.S. Government programs, principally through its IIS and SAS business segments. Total classified sales were 15%, 14% and 13% of total net sales in fiscals 2011, 2010 and 2009, respectively.

In a time when big-ticket platform programs are increasingly coming under the scanner for cutbacks, Raytheon’s substantial exposure to the classified programs of the U.S. government will add substantial layer of protection for the company. We have a long-term Outperform recommendation on the stock.

Currently, it holds a short-term Zacks #3 Rank (Hold), primarily due to the high-level of current valuation of Raytheon. Year-to-date the stock rose almost 14% and is now hovering around its 52 week high.

Based in Waltham, Massachusetts, Raytheon Company is a leader in technology and innovation, specializing in defense, homeland security and other government markets throughout the world. It provides state-of-the-art electronics, mission systems integration and other capabilities in the areas of sensing; effects and command, control, communications and intelligence systems, as well as a broad range of mission support services.

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