Todd B. Ernst - Former Vice President of Investor Relations Thomas A. Kennedy - Chief Executive Officer, Director and Member of Executive Committee David C. Wajsgras - Chief Financial Officer and Senior Vice President.

Robert Spingarn - Crédit Suisse AG, Research Division Jason M. Gursky - Citigroup Inc, Research Division Cai Von Rumohr - Cowen and Company, LLC, Research Division Joseph B. Nadol - JP Morgan Chase & Co, Research Division Douglas S. Harned - Sanford C. Bernstein & Co., LLC., Research Division John D. Godyn - Morgan Stanley, Research Division Samuel J.

Pearlstein - Wells Fargo Securities, LLC, Research Division Peter J. Skibitski - Drexel Hamilton, LLC, Research Division David E. Strauss - UBS Investment Bank, Research Division.

Good day, ladies and gentlemen, and welcome to the Raytheon Second Quarter 2014 Earnings Conference Call. My name is Glenn, and I will be your operator for today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr.

Todd Ernst, Vice President of Investor Relations. Please proceed, sir..

Thank you, Glenn. 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 the 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 website. With me today are Tom Kennedy, our Chief Executive Officer; and Dave Wajsgras, our Chief Financial Officer.

We'll start with some brief remarks by Tom and Dave, and then move on to questions. Before I turn the call over to Tom, I'd 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'll turn the call over to Tom.

Tom?.

Thank you, Todd. Good morning, everyone. Earlier this morning, we reported solid second quarter results, with company sales, margins, EPS and cash flow higher than our expectations. Bookings were strong, driving a book-to-bill ratio of 1.19 in the quarter, with exceptionally strong bookings in the domestic business.

Our bookings in the second quarter increased by approximately $1.4 billion over the second quarter 2013. Looking to the balance of the year, we have a significant pipeline of opportunities, including several large international programs.

Over the past couple of months, I've traveled to meet a number of our international customers, including 2 trips to the Middle East, as well as to the Farnborough Airshow last week. Overall, at the Farnborough this year, the company hosted delegations from over 30 countries, totaling 700 meetings, with 1,200 customers and partners.

Based on these meetings, I can say with confidence that our global customers continue to look to Raytheon to provide advanced solutions to meet their evolving requirements. And demand remains strong, especially in the areas of integrated air and missile defense, C4ISR, cyber, critical infrastructure protection, and training.

As always, the timing of international awards can be difficult to predict, but demand is clearly there. In the second quarter, international sales comprised 29% of Raytheon's total sales. International bookings were 24% of total bookings and were up 21% year-over-year.

These bookings were primarily driven by the international TOW and the Canadian North Warning System opportunities we mentioned on the last call, as well as other missile and training awards. We continue to make progress on several international air and missile defense opportunities, which we've discussed on prior calls.

After the close of the quarter, Qatar signed a letter of agreement with the U.S. government for the Patriot system, and we expect a booking later this year. Qatar was -- will become the 13th nation to have chosen the Patriot integrated air and missile defense system to defend their country.

In addition, we expect Qatar to move forward on an air defense operating center for approximately $300 million, which we anticipate will result in a booking at the end of the year. During the quarter, we made progress on another international Patriot opportunity.

This approximately $2 billion opportunity continues to move forward and is now at the final stages of the approval process. We expect the booking in the second half of the year. We have recently received good news about 2 other large potential international opportunities.

In late June, Poland announced that Raytheon had been down selected for the next competitive phase of its medium-range missile defense system. We are now the sole U.S. competitor for the contract and believe we have a strong offering, with world-class technology that provide significant value to Poland.

Patriot is fielded and is being continuously upgraded with leading-edge technologies, which is a key competitive discriminator in this competition. A final decision on the Poland award is expected in 2015. And just after the close of the quarter, we booked $160 million for upgraded Patriot missiles for South Korea.

This is the first step of a 2-step process. The next step is a systems upgrade to Configuration-3 plus for South Korea's firing units for several hundred million dollars, which also is planned for next year. Overall, our international business remains strong. We are expanding into new markets, and broadening our presence in existing markets.

As we do this, we are continuously enhancing how we do business internationally so we can create and capitalize on even more opportunities. One of my top priorities is to foster this focus on global growth. To achieve this, we are taking a different approach in certain countries.

We are increasing our direct engagement, utilizing more local resources and expanding our global supply chain. We believe this commitment will provide us with the ability to create more international opportunities and increase our competitive advantage.

Looking now at the domestic environment, we saw strong bookings in the quarter, which increased nearly 30% year-over-year and resulted in a domestic book-to-bill of 1.27. This bookings achievement was driven by various sensor, training, missile and classified bookings.

I've had the opportunity to meet with numerous representatives from Congress and the Department of Defense over the past several months, and the feedback regarding the important capabilities that Raytheon products bring to the Warfighter continues to be positive.

In the defense bills making their way to through Congress, Raytheon programs are faring well despite continued budget pressure. Congress is proposing increases for several programs, including Tomahawk, SM-3 and EKV, and most other Raytheon programs are funded at or near the President's request.

Another issue of significant interest to Congress is homeland defense. In June, we achieved a successful test to the Exoatmospheric Kill Vehicle, which incorporates the latest hardware and software upgrades. This successful test keeps the United States on track to significantly increase its ground-based interceptor inventory.

And also in June, Raytheon won a nearly $300 million production competition for the FAB-T program. This program allows a short communication between military aircraft, ground sites and the new higher data rate Advanced EHF satellites. Our secure communications position with the U.S. Air Force is enhanced by this win.

It also builds on our leading position in the protective SATCOM market, where we provide a Navy Multiband Terminal for the U.S. Navy and SMART-T for the Army. The bulk of this award will be booked next year.

The FAB-T win underscores the value of our continued investment in advanced technology to strengthen our competitive advantage across multiple products. During the quarter, we also marked several milestones related to corporate responsibility, which reflects our values and strong company culture.

We released our new Corporate Responsibility Report, highlighting our efforts, investments and accomplishments in the many areas that define corporate responsibility at Raytheon.

We were recognized by the EPA with our seventh consecutive ENERGY STAR Sustained Excellence Award for continued leadership and protecting our environment through superior energy efficiency. We were, again, ranked on Corporate Responsibility Magazine's 100 Best Corporate Citizens list, illustrating our strong commitment to corporate citizenship.

In summary, we had a solid overall performance in the quarter. Bookings were strong, and we have a number of large opportunities included in the Qatar Patriot in the remainder of the year. I'd like to thank the Raytheon team for their continued dedication and focus on delivering value for our customers and shareholders.

With that, let me turn it over to Dave..

Okay. Thanks, Tom, and good morning, everyone. I have a few opening remarks starting with the second quarter highlights, and then we'll move on to questions. During my remarks, I'll be referring to the web slides that were issued earlier this morning. So if everyone would please turn to Page 3.

We're pleased with the solid performance the team delivered in the second quarter, with sales, EPS, margins and operating cash flow all better than our expectations. We had strong bookings in the second quarter at $6.8 billion and sales of $5.7 billion, resulting in a book-to-bill ratio of 1.19.

Operating margin was solid at 13.3% and on an adjusted basis was 11.8%. And our EPS from continuing operations was $1.59. On an adjusted basis, EPS was $1.41. Operating cash flow of $153 million was better than our prior guidance, driven by the timing of collections that were previously expected in the third quarter.

During the quarter, the company repurchased 2.6 million shares of common stock for $250 million, bringing the year-to-date share repurchase to 4.6 million shares for $450 million. We ended the second quarter with $560 million of net debt.

I'd like to point out that on May 12, Standard & Poor's Ratings Service upgraded our long-term senior unsecured credit rating from A- to A, reflecting our strong financial position. If you turn to Page 4, let me start by providing some detail on our second quarter results.

Our total company bookings for the quarter were $6.8 billion, an increase of about $1.4 billion compared to the second quarter 2013, and on a year-to-date basis were $11.1 billion, an increase of approximately $2.1 billion over the same period last year. It's worth noting that on a trailing 4-quarter basis, our book-to-bill ratio was 1.06x.

For the quarter, international was 24% of our total company bookings and on a year-to-date basis was 30%. For the year, we continue to expect international to be in the range of 35% to 40% of total bookings.

And as we mentioned on the April call, our full year 2014 bookings are expected to be $23.5 billion plus or minus $500 million for a book-to-bill ratio of between 1 and 1.05x. And as Tom just mentioned, we have several significant international opportunities that we expect to book in the back half of this year.

Now notable awards in the second quarter included $764 million of Missile Systems for TOW missiles for the U.S. Army, U.S. Marines and international customers.

Missile Systems also booked $289 million for Standard Missile-6, $259 million for AIM-9X Sidewinders, $179 million for AMRAAM, $130 million for Phalanx Weapon System, $81 million on MALD, $79 million on Rolling Airframe Missiles, and $75 million for SM-3. Additionally, MS booked $140 million on a classified program.

IIS booked $515 million on domestic training programs and $160 million on foreign training programs in support of Warfighter FOCUS activities. IIS also booked $521 million for a U.S. Air Force program and approximately $160 million to provide operations and maintenance services on an international radar system.

And Space and Airborne Systems booked $129 million to provide radar subsystems for the U.S. Navy. In addition, IIS and SAS booked $379 million and $431 million, respectively, on a number of classified programs.

Backlog at the end of the second quarter was $33 billion, and funded backlog was $23.6 billion, up $1.4 billion compared to the same period last year. It's worth noting that approximately 38% of our backlog is comprised of international programs.

If you now move to Page 5, for the second quarter 2014, sales exceeded the high end of the guidance we set in April, primarily due to timing at both IIS and SAS. For the second quarter, our international sales were approximately 29% of total sales, and all of our businesses were at or above our expectations.

IDS had second quarter 2014 net sales of $1.5 billion. The change from Q2 2013 was primarily due to the completion of production phases on a couple of international Patriot programs and lower sales on a combat tactical radar program.

There was also an unfavorable $38 million impact from the Australian Air Warfare Destroyer program, which I'll address in a little more detail in just a moment. In the second quarter 2014, IIS had net sales of $1.5 billion.

Compared with the same quarter last year, the change was primarily due to lower volume on our training and mission support programs, partially offset by higher volume on domestic and international classified programs. Missile Systems had second quarter 2014 net sales of $1.5 billion. We saw lower sales for U.S.

Army programs in this year's second quarter compared with Q2 2013. And SAS had net sales of $1.5 billion. Lower volume on intersegment sales related to a combat tactical radar program for IDS and classified programs drove the change versus last year.

It's worth pointing out that excluding the reduced intersegment sales of approximately $50 million, SAS would have been down about 4%. Moving on to Page 6, our overall company margins were solid. Our reported operating margin was 13.3% and on an adjusted basis was 11.8%.

On a year-to-date basis, our operating margin was 13.8% and on an adjusted basis was 12.2%. As a reminder, our second quarter 2014 adjusted margin excludes the favorable FAS/CAS adjustment, which was worth about 150 basis points, or $0.18 per share.

So looking at the business margins, at IIS, missiles and SAS, margins were relatively consistent with the same period last year. And at IDS, the change was primarily driven by a decrease in estimated incentive fees on the Australian Air Warfare Destroyer program.

This program is structured as an alliance made up of Raytheon, an Australian government-owned naval shipbuilder, and the Commonwealth of Australia. It's a cost-type contract and our fee has a guaranteed amount, but also a variable portion that's contingent upon the aggregate cost performance of the alliance.

Now although Raytheon's performance continues on plan from both a cost and schedule standpoint, the shipbuilder is now estimating an increase in their cost to complete the program, which drove the decrease in the estimated incentive fees. Excluding this impact, IDS' margins would have been 16.2% on the quarter.

So overall, the company continues to perform well. Turning now to Page 7. Second quarter 2014 EPS was $1.59 and on an adjusted basis was $1.41. EPS for the second quarter 2014 was better than expected, primarily driven by the timing of sales and program performance improvements that were previously expected in the third quarter.

On Page 8, we are reaffirming the company's financial outlook for 2014 that we provided in April for net sales, EPS and operating cash flow. We continue to expect our full year 2014 net sales to be in the range of between $22.5 billion and $23 billion.

Our full year 2014 EPS is expected to be in the range of between $6.74 and $6.89, and on an adjusted basis, within a range of between $5.76 and $5.91. We have not included in our 2014 guidance either the potential extension of the R&D tax credit or the potential enactment of pension stabilization as part of the extension of the Highway Trust Fund.

These would be essentially offsetting if both were enacted. We repurchased 2.6 million shares of common stock for $250 million in the quarter and continue to see our diluted share count in the range of between 312 million and 314 million shares for 2014, which would be a 3% reduction at the midpoint.

As I mentioned earlier, operating cash flow in the quarter was strong due to the timing of collections previously expected in the third quarter. We continue to see our 2014 guidance for operating cash flow to be between $2.3 billion and $2.5 billion. And as you can see on Page 9, we've adjusted the margin guidance for 3 of our businesses.

We've lowered IDS' margins to reflect the adjustment for the Air Warfare Destroyer program and the timing of international awards, which is offset by improvements at missiles and IIS. For the company, we continue to see adjusted operating margin to be in the range of between 12.6% and 12.8% for the full year.

On Page 10, we provided some directional guidance on how we currently see the quarterly cadence for sales, EPS and operating cash flow from continuing operations for the balance of 2014. For the third quarter, we now expect sales to be in the range of $5.5 billion to $5.6 billion.

Further, we expect margins in the third quarter to be in line with year-to-date performance, in the low 12% range on an adjusted basis. This drives our third quarter EPS guidance of $1.53 to $1.60.

We continue to see a ramp in sales in the fourth quarter, which is being driven by awards we were expecting both this quarter and next, including Qatar Patriot and another significant international Patriot award. This increased volume, combined with favorable program mix, drive EPS to a range of $1.75 to $1.83 in the fourth quarter of this year.

Now before we open it up for Q&A, let me summarize. We had solid second quarter performance. Our book-to-bill was 1.19 in the quarter and on a trailing 4-quarter basis was 1.06. As we look to the balance of the year, the pipeline of international and domestic opportunities is strong.

Our balance sheet position gives us continued flexibility to drive shareholder value in the future, and we remain confident in our outlook for the year. So with that, Tom and I will open up the call for questions..

[Operator Instructions] And your first question comes from the line of Robert Spingarn with Crédit Suisse..

I wanted to ask about margins. Dave, you just talked about this, and you alluded to the orders in the quarter that are going to drive sales, the international orders in the second half. I wanted to ask about pricing on these orders and pricing in general, because we have seen segment margins come down here now.

I think it's 3 quarters in a row sequentially. And I'm wondering -- you talked about a couple of the puts and takes at IDS.

But I'm wondering if just in general, are we seeing lower pricing come into the backlog?.

So it's a fair question, but we have not seen any pressure on fees or margins from a backlog perspective. We still have a healthy book of business with respect to our international profile. We're continuing to perform well for our domestic and international customers.

I think it's probably fair to point out that the second half margin profile is higher than the first half margin profile on -- at the company level. And we do see improvement in the overall margin guidance for both IIS and missiles. And SAS continues to perform quite well, frankly, as does IDS.

If you were to exclude the AWD situation that I just explained, margins in Q2 for IDS would've been about 16.2%..

So if pricing's locked in for the second half, should we see -- is there any execution risk that might be higher than normal? I just want to get a sense that we don't see a repeat, really, of the first half..

Rob, let me just jump in here. Right now, we do not see any issues relative to execution moving forward. In fact, we've a full-court press on getting more efficiencies out of the business, where you have the second half of the year, significant work in taking out square footage.

We're also working our strategic sourcing across the second half of the year as we've done in the first. So we actually see, actually, I would say a stronger foundation relative to margins in the second half with the activities we've put in place. So bottom line is we do not see that pressure that you're talking about..

And just quickly, Tom, your latest view on M&A versus buybacks?.

Well, first of all, and we talked about this before, it's -- first priority remains in growing the company organically. And then we, on the domestic side, we're focused on the hot spots, that includes missile defense, C4ISR, also heavy involvement in cyber.

And then we're addressing the international markets, as we discussed in both my script and also in Dave's script. So we're seeing a very large pipeline of organic growth opportunities, both on the domestic side and on the international side. At the same time, we do always look continually for value-added investments outside the company.

We continue to look at them in the cyber area and several other areas in our business domain. And as we go forward, we are looking at it in a disciplined approach way. And I can tell you that we, as part of that evaluation, we are looking at what adds value to the shareholders. And if it is a good fit, we will move forward.

And as time goes on, we'll let you know as we progress..

So let me just add 1 or 2 things to what Tom just went over. I mentioned earlier, and I think everyone's well aware of our strong balance sheet position, especially with respect to cash and liquidity and the strong cash flow performance we've had historically and the strong cash flow performance that we see going forward.

So we have, as one of our priorities, returning cash to shareholders, but it's one of multiple priorities. I think we're in such a strong position that one doesn't necessarily preclude the other. We don't see fundamental changes in our capital deployment plans going forward.

We do see a continued focus on growing the company, as Tom just mentioned, but that will not preclude us from continuing to have, what I would term, a shareholder-friendly capital deployment plan..

And your next question comes from the line of Jason Gursky with Citi..

Dave, I wonder if you would just walk us through the various opportunities and risks to the guidance for the rest of the year.

Where might we see upside if things go well, and where might we see some downside if things don't go well?.

Right. So again, it's a good question. On balance, we're very comfortable with the range of guidance that we put out there that incorporates what we would consider all the known risks and opportunities. From an international perspective, these are factored bookings.

So I would suggest that if these were to play out as we anticipate, at a full value, we would see some upside from a bookings perspective, which could translate into some other positives from a sales and earnings standpoint. The risk of -- we talked about the CR before. We've built that into our guidance in the fourth quarter.

We would expect a short-term CR toward the end of this year. But even if it were to continue into the first part of next year, I wouldn't see that having a major impact on our results. Those are the ones that are sort of top of mind..

Yes, I'll jump in on one, and this is -- there are some potential opportunities in the first quarter of 2015 that could pull into the year. As always, we're always working to pull those opportunities in as soon as possible so we can convert. And I would say that the team is doing a good job on those.

And so we look at those as upside potential that we're trying to harvest..

Your next question comes from the line of Cai Von Rumohr with Cowen & Company..

Dave, how much fee is still at risk on AWD, I mean, if it goes to 0?.

No, Cai, I'm glad you asked that. So let me just talk about AWD very briefly, okay? So we're a top-tier contractor in Australia to the Australian government. The alliance-based contracting approach for this program was the Commonwealth's preferred method of contracting for the 3-ship AWD program, the Air Warfare Destroyer program.

This award provided Raytheon with an opportunity to expand our naval combat system expertise and capabilities to a new customer. So strategically, it's positioned us well for future mission systems work on both surface and subsurface platforms with literarily multi-billions of dollars of opportunity over time.

Now first, the customer recognizes Raytheon's good performance on our portion of the work. The Australian government's committed to working collaboratively and constructively with Raytheon and other stakeholders to implement a reform strategy to stop the program's growing cost and schedule overruns, again, from the shipbuilder.

And while it's difficult to predict the exact timing of when this ultimately plays out, we don't expect the process to conclude until sometime in 2015. Now with all of that said, inception to date, we've recorded incentive fee of about $80 million. We wrote off about $38 million in the second quarter.

So the exposure, the upside, the -- kind of the worst-case exposure at this stage would be about $40 million..

Cai, let me jump in on that to kind of explain that contract versus one of our DoD contracts. It's essentially, it's a cost-plus-fixed-fee contract with an incentive fee on top. So as Dave was saying, our maximum exposure is just the incentive fee. I don't know if that helps or not, but that's....

Yes, no, no, no. That's very clear. That was terrific. Your bookings plan is unchanged and you said 35% to 40% international, and you're clearly under-running that. So even to get to the lower end, it looks like you need like $5.2 billion close to what, $5.8 billion, something like that, in international bookings in the second half.

How do you expect that to kind of phase between Q3 and Q4? Because you got a lot of Mid-East customers. And usually, with Ramadan, they don't get around to doing things toward the end of the year..

So, Cai, the quarterly cadence, as you know, is very difficult to predict. We are very confident with our back-half outlook relative to international bookings. We can't get specific as to exactly where we are in the various stages of completion. Qatar, for example, that was -- recently, the LOA was executed, could be the end of Q3, maybe early Q4.

I don't want to get into much more detail on the other large Patriot program that we've been talking about, because it's the customer's request that we don't get into much detail at this point. There's other opportunities as well out of our missiles business and out of our SAS business.

But in total, we're looking at about 40% to 50% of our bookings in the second half from international. And I'll repeat it again, we're quite comfortable in our outlook..

And so, Cai, let me just jump in there. Let me add on the Qatar. When you add in the Patriot and the A dock, that covers over half, half of that value you discussed. And there's several other opportunities that will fill in the rest. They're factored.

So we feel very confident that we'll be able to achieve that number of about $5.5 billion of the international in the second half..

Terrific. And the last one, your pattern of the Q3 and Q4 is really something of a hockey stick. As you pointed out, low 12s margins and then a strong ramp in the fourth quarter.

Could you give us some color on like what -- why is it that low? Why does it move up in the fourth quarter, just in a general sense? Is it sort of overhead pressure from bidding this stuff, not getting the contracts? What are the key issues?.

Yes, so, Cai, a lot of it has to do with the cadence of the bookings. We had a very strong quarter in missiles, like we said before. We have strong bookings in the back half of the year, particularly international. There's really nothing too remarkable relative to the margin cadence.

It's, frankly, not very different than what we were anticipating when we gave guidance on the January call. The performance improvements that were pulled from Q3 into Q2 probably -- are probably worth noting. But again, there's nothing too remarkable with respect to the cadence.

The fourth quarter is going to be strong, similar to what we've seen in prior years, and that's just the nature of the business..

Your next question comes from the line of Joe Nadol with JPMorgan..

Dave, could you give the positives and negatives EAC adjustments gross?.

Yes, sure.

You mean for the second quarter?.

Yes, please..

Yes. The -- well, the net change was $88 million favorable, and that was about 1.5%. But if you exclude the AWD situation, it was about 2.2% overall. So -- and again, we provide some of the details much...

I'm sorry?.

Yes, just in -- I'm sorry, just in dollars, the positives as you give them in every 10-Q..

The gross favorable was in line with -- actually, it was a little bit better with respect to comparing to the first quarter. It was about $20 million better, just under $270 million..

Okay. I'm just -- what I'm trying to get at is you've called out the Australian radar last quarter. You called out a little bit this Patriot item, the refurb, I guess. I'm just trying to get a sense as to whether these truly are, particularly this quarter, one-offs that stand out.

Or every quarter, you guys have positives and negatives, just like every other defense company.

And how much of this is really unusual versus you're calling it out because it's the biggest negative you have?.

Well, I would say the -- clearly, the AWD Destroyer situation is unique. There's no other contract like that within the company. But again, it's worth reiterating. It's a tremendous growth opportunity and something that plays to our strengths. So I would say that is unique, a unique situation.

We talked a little bit on the first quarter call about an international Patriot program. It was a refurbishment program. I think we are continuing to see meaningful improvement in that program. And we believe, going to the back half of the year, that the major issues are behind us..

Okay, and then just over on the Patriot program, could you describe a little bit what you're doing from an industrial standpoint? My sense is that you've had some international programs that are kind of completing and running off, and you were expecting to get some of these 2 big orders that you're just obtaining in the second half earlier.

So is there a line break? Are there people that are -- are there layoffs there or people being moved to other areas temporarily? What are you doing? And how much work are you doing in anticipation of these 2 contracts that you're inventorying right now?.

Let me take that, Joe. Number one, as you can remember, in the first half -- early first half of the year, we did book a Kuwait deal. So the Kuwait deal is our bridge into the Qatar and then this other opportunity, international opportunity that we talked about. So I think we -- right now, we have the factory level loaded. We continue to perform well.

And it is a strong, I would say, producer and supporter of our margins moving forward on the Patriot line, especially on the production aspects of Patriot..

. Your next question comes from the line of Doug Harned with Sanford Bernstein..

Your Missile Systems backlog was very strong. And if you look over the last 3 years, we've seen very strong missile demand for Raytheon, for Lockheed, for MBDA.

What do you see driving this high level of demand, and where do you see it heading from here?.

Well, Doug, I mentioned that I just got back after 2 trips to the Middle East and spending some time at the Farnborough Airshow talking to quite a few of not only our international customers, but also our domestic customers.

One of the themes that we -- I heard consistently from leaders of countries across the Middle East, Europe and the Asia-Pacific region was the following, and it's because of all the uncertainty that is out there. They used the same words, slightly differently, but it was the same across. And that was a strong defense is a strong deterrence.

So what we're seeing is across all these nations is that they're looking to build up their defenses. They're looking at the weapons they need. And they're making sure they have the right stockpiles to support this deterrence capability so that they can defend their nations. And it's -- so the uncertainty in the world is driving that demand cycle..

But -- do you see this focused perhaps more on missile demand than maybe in other areas? Because it really does stand out, I think, in terms of growth..

Yes, missile demand, and it's also the overall Patriot systems and the air defense systems. If you remember last year, we booked a system, our NASAM system, in Oman. That, again, is a defensive-type system and, by the way, also happens to use AMRAAMs.

But that's the end game here, is that these countries are strengthening their defenses to provide a deterrence against the situations they're seeing in the regions they're located. And that's where the uptick's coming from..

And I think what you're seeing is a strong pull demand for both the tactical missiles as well as our strategic programs.

And when those come together, it bodes quite well for our Tucson operation, which, as you well know, we are the largest missile maker in the world and there is a lot of demand, both domestically and internationally, for the full spectrum of products that we're offering out there..

And we're seeing strong demand for air-to-air. We're seeing strong demand for air-to-surface. And strong demand for surface-to-surface and surface-to-air across the board. But when you roll it all up, it's all about these nations wanting to provide strong defense for their country.

And the reason they want that strong defense is they want to make anyone out there think twice before they do anything. And that's driving the demand, and it's just based on personal contact with the heads of the militaries of these countries..

Okay. And then before, you talked a little bit about the importance of organic investment. And if I have this right, I mean, your intent is to increase that investment, as many of your peers are, in, presumably, both R&D and CapEx.

But can you talk a little bit about the scale of organic investment you're looking at and the time frame over which you determine the business case when you make these investment decisions?.

So let me just start out briefly and then we'll add some -- Tom will add some color. But I do want to remind everyone that back in January when we gave our initial guidance, we talked about strategic investments that we were going to embark on for the company both in 2014 and beyond.

I think we talked at that point about 20 basis points' worth of investment to strategically and organically grow the company. We're continuing down that path and have been. We see that as a critical tool to grow the company organically. And again, it's part of our overall thinking on the best way to deploy our capital..

So I'll jump in on that. A key element to our win on FAB-T and, last year, on Next Generation Jammer and AMDR, was our investments in technology to bring the best possible capabilities to our customers. So we continue to invest to achieve a competitive advantage in the marketplace, both on the domestic side and also on the international marketplace..

And is there any time frame that you tend to focus on when you make these decisions in terms of when the returns would likely come?.

We break it up into almost 3 areas. I mean, there is -- we look as far out as 10 years out in terms of where we think technology is moving. We want to make sure that we're in the right spot at that time. And I'll -- then my example to that is the GaN technology we have talked about in the past.

It was about a 10-year investment process in that to set us up to win some major programs like AMDR and also Next Generation Jammer.

We also look out about the 5-year period in terms of what's changed and making sure that we're focused in that area in terms of what investments we need to make to be prepared to win business in that area, or keep our products relevant.

For example, on Patriot, we continue to invest in Patriot to make it relevant in the latest technologies so that we're competitive in the global marketplace.

And then we also look in the near term, the 1 to 2 years, to see what tweaks we need to make in terms of our technology investments to ensure that we're competitive on, I guess, the relevant competitions that are going on in that time period. Hopefully, that helps. But it's not just tomorrow.

It really is kind of broken down into these 3 major time chunks..

Your next question comes from the line of John Godyn with Morgan Stanley..

Guys, Raytheon has done a great job positioning itself for a lot of these international opportunities, and we can see that in international sales as a percentage of revenue and what you said about bookings.

I'm just curious, what inning do you think we're in, in terms of this pretty significant international growth cycle?.

I really appreciate the question. So let me tell you why. We reset the game. So we're back -- we've reset it back to the first inning, and let me explain that. We've recently made some major changes in our international structure and focusing on a set of countries and looking at countries in a different way, international countries.

And the way we're looking at them is each country as a market and understanding what elements of that country need solutions that Raytheon can provide and can provide in a better way than our competitors. And that's starting to pay off and it's filling the pipeline for the future.

And I would say we have a lot of upside potential in the international marketplace because of this focus and this strategy we have. We've been, for example, in the Middle East for 48 years, I may have talked about this on a phone call before, but we give out something called a service award pin.

And a couple of years back, I was in Saudi and gave out the 2 40-year service pins to 2 Saudi nationals. So we're heavily engaged in the Middle East. We've been in Japan, for example, for over 50 years. And we have a very strong brand internationally.

And I think that all together our time in these places, the fact that we have operated successfully on programs -- in many cases, you can check our records on some of these international programs we have. We've taken over from our competitors who have not been able to complete the programs. So we have the solid reputation and brand.

We are leveraging that into essentially set the clock back to the first inning and putting more folks on the ground. We're also doing much more work in localization. And we've significantly increased our global supply chain here over the last several years.

The bottom line is we're essentially repositioning the company to move beyond our 30% revenue for this year in terms of international. I don't know if that helps, but you -- we just can't let -- keep going inning -- inning to inning. You got to reset the game every now and then. And this is -- in the last 6 months, we've been off resetting the game..

That's very helpful.

And when we think about the company big picture, could we get to 40% international sales as a percentage of revenue? Are those types of targets realistic long term?.

Yes. I would say that they're absolutely realistic long term. I'd rather not give a specific time frame. But if you just simply look at where we will likely end up from a backlog perspective at the end of this year, we will be in the 40% range plus or minus, depending on how exactly things play out.

But I would say longer term, you should be thinking about the company as a 40-plus percent international company and view us more from a global perspective than just a domestic exporter..

Your next question comes from the line of Sam Pearlstein with Wells Fargo..

Dave, I was wondering if you could help me with this. And I know somebody asked somewhat earlier. But if I look at the first quarter, which was higher, the second quarter was comfortably ahead of the 21.5% of the year's earnings that you projected. You're buying back at a higher rate year-to-date than you had been running.

I guess, why aren't you in a position to be talking about a higher guidance? What's the risks in the second half that maybe I'm not seeing?.

We do see a strong second half of this year..

Okay.

And then just looking on the P&L, why was G&A up in dollars as a percentage of sales in the second quarter? Is there something unusual, or is this the right level to be thinking about?.

Well, there's a couple of things going on, and we had some public disclosure on this. There's a new stock compensation program. And the accounting was such that we recorded that in the second quarter, and that's in G&A. The CAS harmonization that we've been talking about for a while is also part of the G&A line.

We are awaiting -- there's a timing, with respect to an insurance recovery for some property damage that we had that shifted into the fourth quarter and came out of the second quarter. So by and large, I would say, again, there's nothing too remarkable.

But with the CAS harmonization and some of the other things that we've talked about, G&A will likely be higher than what it's been in the past. But I do want to point out that when you stand back and look at the overall cost structure of the company, that is continuing to improve.

It's just where these expenses and expense reductions are taking place..

Okay, and last question for Tom is just, I don't know if you addressed Turkey in terms of the Patriot, but it's been quite a turnaround for that opportunity. And recently, I get there was a down select.

How should we size that opportunity to think about where that goes from here?.

On Turkey or Poland? Which one do you want?.

Turkey was what I was thinking, because you talked about Poland..

So on Turkey, I mean, there's -- they're in discussions with the Chinese. There was lot of press out there. They have not concluded the negotiations. They have asked us to extend the validity of our proposal, which we have done. As you may know, the U.S.

government and NATO have significant concerns relative to a Chinese solution for Turkey and being able to tie that Chinese solution into the NATO system. So they've -- both the U.S. government and NATO, have raised this issue to the highest levels of Turkey's government, and that is being worked in the background.

But we continue to stand ready with our Patriot offering. We believe we have a solid offering that includes coproduction and some co-development in Turkey to enable the Turkish government to essentially increase their integrated air and missile defense capabilities for their nation. So we stand ready for the next steps..

Your next question comes from the line of Pete Skibitski with Drexel Hamilton..

Maybe one for Dave. I just wanted to kind of get a little more color on CapEx. Last year, you were about $330 million in CapEx spend, which was below guidance. This year, I think between PP&E and software, your guidance is about $450 million according to the last Q.

I was just wondering, are you still tracking to that number? And then directionally, as you think about footprint reductions, should we think CapEx is headed up, down, flat as we go forward? Just some color on that area, please?.

Sure. So we've talked about investing in ourselves, and we're continuing to do that. Tom spoke before about strategic and technology investments. Some of that is part of what you're seeing in our increasing capital this year. We are continuing to make good progress on utilization improvements. We're tracking to about a 2% reduction this year.

We talked about a goal of a 10% utilization improvement over the next 3 to 5 years, and we have plans in place and are moving towards those objectives. So I would say from a -- if you stand back and look at what's going on from a capital spend perspective, I think we are driving value the right way through those type of investments..

Okay.

So, Dave, is this kind of like new tooling to [indiscernible] system?.

I'm sorry.

This is like new -- say it again?.

So these type of investments is an example of sort of new tooling for [ph] better utilization? I'm just trying to understand why -- what was really driving the need for the investment..

Okay. So we talked about the R&D-type investments, right? The technology and strategic investments. Some of these may be building prototypes and things like that going forward. With respect to real estate, when we're consolidating facilities, we have to build out new space with skips and additional sort of special things that we use at our business.

So some of that is built into the capital. But again, I would say that these are all things that we're doing today to improve the business going forward..

Okay. I understand much better.

And are you approaching peak, or is there still more to go?.

I would -- I'll talk a little more about that probably on the third quarter call. At this stage, you probably want to think about it as flattish as we go into 2015. This isn't formal guidance, but kind of an early perspective is we're going to continue to do the type of things that we've embarked on in '14.

So I would say to think about it as flattish, that's probably the best path forward here..

. Your last question comes from the line of David Strauss with UBS..

International versus domestic sales growth that you've got baked in for the second half of the year, how does that break out?.

Okay. So in the second half of this year, we're seeing domestic sales growth probably down maybe 1% to 5% or 6%. From an international perspective, we're seeing sales growth of maybe 2% to 5-plus percent on the back half of the year. And then if you take in combination, we're essentially in line with where we were in 2013..

Okay. And then, Dave, I have to ask you on pension..

No pension questions today. It's a sensitive subject [ph]..

Yes. I know you have your annual update in Q3. The last couple of years that's been a positive upper for you.

Can you talk about that? And then everything else pension-related, CAS and mortality and all of that, what's kind of changed relative to 3 months ago?.

So you're right, we'll talk about it in a little more detail in the third quarter. And it's very difficult to forecast how that's going to play out with respect to truing up actuarial assumptions.

With respect to the new mortality tables that are going to be used in the future, I mentioned on the last call that we have already taken that into account in our earlier assumptions and started to do that next year. So we don't see a -- any kind of significant impact from a pension standpoint on that or from that.

We mentioned a little earlier about the legislation with respect to pension interest rate stabilization. It was first enacted in 2012. And there's a bill that's, right now, in the Senate, not enacted yet, but it could be going forward. Now there's a lot of moving parts here with respect to stabilization.

Initially, it affects funding, CAS expense and taxes, and then going forward also impacts that FAS expense. So we're evaluating our funding strategy under the legislation. And we also have to take into account the discount rate environment, demographics, return on assets.

I did mention in my earlier remarks that if the House bill were enacted in its current form, it could impact us by about $0.10. But we see that being offset by the R&D tax credit, which is also worth about $0.10 assuming that's enacted. Again, we'll provide further guidance on the Q3 call and give a little more detail then..

Okay.

And last one on the international side, the bookings strength that you're talking about in the second half of the year, you're anticipating in the second half of the year, what would that do from the perspective of bringing in advances in the back half of the year?.

It would be a plus from an advance standpoint..

Any sort of quantification?.

No. I'd not rather not get too specific on that at this point. I appreciate the question, but we can't get too specific. Again, these are factored, and the advances are also factored..

All right. Thank you all for joining us this morning. We look forward to speaking with you again on our third quarter conference call in October.

Glenn?.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect, and have a great day..