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Raytheon (NYSE:RTN)
Q4 2018 Earnings Conference Call
Jan. 31, 2019 9:00 a.m. ET


Prepared Remarks:


Good day, ladies and gentlemen, and welcome to the Raytheon's fourth-quarter 2018 earnings conference call. My name is Sonia, and I'll be your operator for today. As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Ms.

Kelsey DeBriyn, vice president of investor relations. Please proceed.

Kelsey DeBriyn -- Vice President of Investor Relations

Thank you, Sonia. Good morning, everyone. Thank you for joining us today on our fourth-quarter conference call. The results that we announced this morning, the audio feed of this call and the slides that we'll reference are available on our website at Raytheon.com.

Following this morning's call, an archive of both the audio replay and a printable version of the slide will be available in the investor relations section of our website. With me today are Tom Kennedy, our chairman and chief executive officer; and Toby O'Brien, our chief financial officer. We'll start with some brief remarks by Tom and Toby and then 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 Kennedy -- Chairman and Chief Executive Officer

Thank you, Kelsey. Good morning, everyone. Raytheon had a very successful year in 2018, and our growth strategy continued to deliver results for our shareholders and customers. There were many highlights in 2018 for Raytheon, and let me start by touching on some of our financial results.

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 Raytheon'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 a 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' core markets, including cyber and space, IIS' 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 in 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 remaining at Patriot opportunity to be around $2 billion. For our Poland Patriot opportunity, our Phase 2 booking is still expected in 2020, with a 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.

At missiles, in addition to the new classified programs, we also won a new missile franchise, the naval strike missile for the U.S. Navy. The missile is offered by Raytheon in partnership with Kongsberg. And because it's already a proven operational system, NSM saves the U.S.

billions of dollars in developmental cost. Our goal with NSM is to replace the existing domestic and international inventory of Harpoon and other international surface-to-surface missiles, making this another multibillion franchise opportunity for the company. New franchises we won at SAS during the year included classified work as well as our selection to develop and deliver the next-generation Distributed Aperture System or DAS for the F-35. Our DAS system enhances capability and reliability 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, EASR, 3DELRR, 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 our critical initial production acquisition milestone. Our SM-3 missiles are the only ballistic missile interceptors that could 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 IB and SM-6, which will provide production visibility until at least 2026. Many of our innovative solutions, including the SM-3 Block IIA 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're 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 on the investments we have 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.

Toby O'Brien -- Chief Financial Officer

OK. 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 3. 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% 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 pre-tax 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 4. 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% and 33% respectively over the prior year. And all of our businesses had a book-to-bill ratio over one in 2018. International orders represented 31% of our total company bookings for both the quarter and the full year.

At the end of 2018, approximately 40% of our total backlog was international. Turning now to Page 5. 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 continued 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 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 Forcepoint, we saw 10% sales growth in the quarter.

For the full year, total company sales were up $27.1 billion, up 6.7% over full-year 2017. Moving ahead to Page 6. 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 7. 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 8, 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 billion and $29.1 billion, up 6% to 8% 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 business. As for pension, we see the 2019 FAS/CAS operating adjustment at approximately $1.5 billion of income and the retirement benefits, nonservice expense and nonoperating at $726 million. We expect net interest expense to be between $153 million and $158 million, in line with 2018. We see our average diluted shares outstanding to be between 279 million 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%. 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 billion 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 billion 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% range. This is up about 20 basis points over 2018 at the midpoint.

At IDS, we see margins in the 16% to 16.2% 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%, in line with 2018. We see missiles margins in the 12.1% to 12.3% range, up 50 basis points at the midpoint versus 2018. SAS margins are expected to be in the 12.9% to 13.1% range, in line with 2018. At Forcepoint, we expect margins to be in that 3% to 5% range.

For 2019, at a total company level, our margins are expected to be in the 16.5% to 16.7% 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 pre-tax 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 billion 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 model. As I mentioned earlier, we see the 2019 FAS/CAS operating adjustment at approximately $1.5 billion of income and the retirement benefits, nonservice expense and non-operating at $726 million, which reflects our investment returns in 2018 of minus 4% on our U.S. pension assets, the December 31 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 our 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.


[Operator instructions] The first question will come from Joseph DeNardi of Stifel. Your line is now open.

Joseph DeNardi -- Stifel Financial Corp. -- Analyst

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

Tom Kennedy -- Chairman and Chief Executive Officer

Yes. Good to hear from you, Joe, and I'll cover that. The -- I think two elements. I'll -- initially, I'll talk about missile defense in the Middle East that we still see a strong demand signals from 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 TPY-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 Abe cabinet did approve their 5-year plan, which was a 10% increase over the prior 10-year -- 5-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 the key weapon system that's in their procurement horizon.

So we're -- we feel very happy about the Asia Pacific region. And then back home, last year, the -- late last year, the missile defense actually came out earlier this year in the missile defense review. And if you go through that 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 -- out of that increasing existing capabilities, such as the ground-based interceptors, more of those, which has our EKV, Exoatmospheric Kill Vehicle, on top of that.

There are also more work in 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. We also called out the use of the SPY-6, what we call the AMDR radar for the navy, and also the use of SM-3 block IIA as an important element out of the missile defense review. And in -- beyond that, we're left of launch, it did call out the use of advanced sensors on the F-35.

And we -- I mentioned in my script that last year, one of the major franchises that we won was the EO-DAS, Distributed Aperture System, that will 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, some demand signals, all the way from the Asia Pacific region, the Middle East. And I mentioned that several of -- 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 areas of integrated air missile defense. 

Questions and Answers:


And our next question comes from Jon Raviv of Citi. Your line is now open.

Jon Raviv -- Citi -- Analyst

Hey, good morning, everyone.

Tom Kennedy -- Chairman and Chief Executive Officer

Yes, good morning.

Kelsey DeBriyn -- Vice President of Investor Relations

Good morning.

Jon Raviv -- Citi -- Analyst

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 related to IDS and MS this year, we certainly appreciate there are always a lot of moving pieces and complexities with new stuff ramping. Missile systems seems to have missed again and there was a lowered bar through 2018, and IDS also seemed to miss some 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 12.3% 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?

Toby O'Brien -- Chief Financial Officer

Yes, Jon. Let me start maybe high level, right at the company level around the guidance. And then I'll give you a little color on both of the businesses, missiles and IDS that you talked about. So we're very comfortable and we're pleased with the guidance that we put out there.

At the top line, it's showing 6% to 8% growth if you just take the midpoint. It would be the 5th year in a row of accelerating growth for the company. The other thing to keep in mind and I alluded to, but I quantified in my opening remarks and I'll quantify it now, not new news, but the headwinds at IIS, they're still growing and we expect them to still grow in '19. But they do have about a $0.5 billion headwind from the ramp down, which we knew about, of the Warfighter FOCUS program.

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. 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. And as I mentioned, we beat our expectations by $600 million at the midpoint. And it wasn't just timing, right? We didn't drop '19 by $600 million. We actually increased it by $100 million, which was $300 million operationally, offset by a couple hundred million dollars in additional cash taxes, right? 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, right? There were some higher levels of investments in the business from an R&D point of view, I 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 net productivity compared to what we were expecting. But overall, we're pleased with where IDS' performance is.

If I think about '19 for IDS and again, it's a little bit repetitive to what I said earlier, we -- they're performing well, they've got some mature production programs that are ramping down that have already been through the risk retirement phase, if you will. And Tom alluded to in his comments the strong bookings for Patriot with three new countries, four new major Patriot awards for $4 billion -- roughly $4 billion last year. Those are just in the early stages. Patriot's closer to a 5-year program compared to maybe -- the company on average is $3 billion.

So we've kind of got a mix almost within production programs and even within international production programs at IDS because it will be a couple of years before those programs ramp up and retire their risk. But I think we're very pleased with IDS' performance and the track that they're on. From a missiles point of view, I think there's a couple of 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, right, relative to the increase in classified work that they were getting. And even at a company level, if I take it 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 generate those new franchises and margin expansion opportunities when programs move into production. So I think specifically for missiles, we do expect them to improve their margins versus '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. Their bookings in that area grew 50% from $1 billion to $1.5 billion.

That's probably rough numbers, close to about a 30 basis points impact, that they're dealing with. And we are continuing to focus on 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 they're -- the -- going forward, we feel we've significantly reduced the risk profile on that program -- the missiles business going forward.


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

Robert Spingarn -- Credit Suisse -- Analyst

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 of 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, 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 and then 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.

Tom Kennedy -- Chairman and Chief Executive Officer

Some good questions there. Let me -- 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 the missile business, if you're going to buy some AMRAAMs, it's about a three -- we get a contract, it spreads out over three years, ramping up the first year, kind of doing at least over -- probably maybe closer to 40% of work the second year and then ramping down the -- on the third year.

Then you get into some of our 5-year business, which would be like a Patriot System, that's -- you need a Patriot contract to go to deliver fire units. That probably works out to about a 5-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 3-year and kind of 5-year cycle.

Toby O'Brien -- Chief Financial Officer

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. 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 on 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 that's between the two years, 7% round numbers.

It's starting to get close to -- with the levels of increase that we saw in the '18 and '19 spending that gets then converted to sales over a roughly three year -- maybe a little bit longer than some of the IDS programs. From -- 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. The way to think of that this year, we expect our R&D investments expenditures to be about 3% of revenue, where they have been for the last couple of 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. We -- I think we said back in October, 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 of 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.

Beyond that, we are committed to returning, as a target, 80% of free cash flow to shareholders. I mentioned 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 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 to through the year and 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, 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 a little bit differently than kind of how I just described.

Tom Kennedy -- Chairman and Chief Executive Officer

And just one last element that is part of your question is we do not see any evidence of that 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 Cai Von Rumohr from Cowen and Company. Your line is now open.

Cai Von Rumohr -- Cowen and Company -- Analyst

Yes, thank you. Two questions. So your R&D was up 48% in the fourth quarter. Did that -- 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 can give us some color as to how you get to that very strong number.

Toby O'Brien -- Chief Financial Officer

Sure, let -- Cai, 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 in next-generation radar and radar-related technologies. So certainly, in part relative to 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.

The cash taxes may be slightly lower in 2020, partially offset by some lower net pension. So really, it's some puts and takes outside of operations. And I think given the significant size of some of our international programs, the payment terms were 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 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 Harned of Bernstein. Your line is now open.

Doug Harned -- Sanford C. Bernstein -- Analyst

Yes, thank you. Good morning.

Tom Kennedy -- Chairman and Chief Executive Officer

Good morning, Doug.

Doug Harned -- Sanford C. Bernstein -- Analyst

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. But then you, Lockheed, 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 in development. And so what I'm trying to understand is how much of what you're doing, sort of on the production side, could almost be maybe a built-in 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?

Toby O'Brien -- Chief Financial Officer

Yes, Doug. Hopefully, we'll hit all those points here. I'll start off, and then I'll let Tom jump in. So your first question about the mix between production and development work, I'll kind of put it in absolute terms, but then also contrast it back a couple of years.

So for 2019, think of it, rough number is 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, OK? So there has been a pretty significant shift at missiles specifically -- heavily or weighted toward the development, and it ties in to the classified business we're seeing. And on top of that, I kind of -- you made the point, but I'll quantify it, our missiles business grew 8% in '16, 10% in '17, 7% last year and another 7% to 10% for 2019. So you're seeing that higher mix toward development but on a much higher base as well.

As far as the production goes, from time to time, we'll built 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, right? So 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, it's 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, it splits about 50-50. And 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 TPY -- the THAAD LOA and the TPY-2 component of that for the -- Saudi's that it was signed at the end of last year and we expect to be under contract for this year.

So we've only got 2.5% of the company revenue tied to that. We continue to monitor the situation and working with all parties involved. And we're optimistic that over time, we will get to a point here where things move forward. And again, I think the 2.5%, it's another feature -- or it shows you again the breadth of our portfolio 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 JPMorgan. Your line is now open.

Seth Seifman -- J.P. Morgan -- Analyst

Great. Thanks very much. Good morning.

Tom Kennedy -- Chairman and Chief Executive Officer

Good morning.

Seth Seifman -- J.P. Morgan -- Analyst

Tom, I wonder if you could talk a little bit about the preparation that 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?

Tom Kennedy -- Chairman and Chief Executive Officer

So yes, we are working with the U.S. Army to develop these advanced capabilities, which, in one of those capabilities for Patriot is an advancement to radar capability, 360-degree capability, utilizing our advanced, again, 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 at -- during this sense-off, which is expected in kind of toward the end of the second quarter of this year. Again, we have been developing this technology over many years.

It's a key technology that helped us win the AMDR, the EASR and several other radar programs, including the 3DELRR 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 customers, as I mentioned in -- during my script. We have now a cadre of 16 countries that are Patriot members, that are buying -- either buying Patriot or have Patriot and in some cases, have been buying spares, buying support and contributing to the overall continued evolution of the Patriot System.

This will be another element to bring in to those 16 countries and to future countries that 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 got the whole company focused on winning this.


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

Myles Walton -- UBS -- Analyst

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?

Toby O'Brien -- Chief Financial Officer

So on the -- 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, EASR and IDS, Next Gen Jammer, SAS, etc.

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 are 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.

Tom Kennedy -- Chairman and Chief Executive Officer

And let me take your question on relative to whether the missile defense review will just wind up with study contracts or are there real development type program efforts that's going to occur, and then also will there be an increase on production contracts. 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 into 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 on -- relative to the replacement kill vehicle, which will eventually then go into production. And also, the -- bringing in new 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 the -- in terms of some new technology, we are on board for that new technology that actually call us out using the F-35 for boost-phase intercept capabilities and the new sensor that we want on that, the EO-DAS, Distributed Aperture System, will be 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 highly involved in that, so we see more money going into the development for the high-energy lasers. It also calls out some of the -- called the space sensor layer.

There'll 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 are heavily involved in, in hypersonic defense. In fact, we believe the hypersonic defense market is larger than the hypersonic market, which we also significantly participated in. The reason for being it larger, the hypersonic defense market, it 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.

Kelsey DeBriyn -- Vice President of Investor Relations

Sonia, we have time for one more question please.


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

Robert Stallard -- Vertical Research Partners -- Analyst

Thanks so much. Good morning.

Toby O'Brien -- Chief Financial Officer

Hey, Rob.

Robert Stallard -- Vertical Research Partners -- Analyst

Toby, I hate to do this at 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?

Toby O'Brien -- Chief Financial Officer

Yes. So Rob, I'll take it back to the -- I guess, it's Slide 12, right, our -- and I know it doesn't go up to '21, but our cash outlook, the 3-year cash outlook here. And we're one year in when we provided this 3-year look, going back to this time last year. We've already compared to what we had said originally, kind of pushed things up.

However you want to look at it, at least $0.5 billion, if not more, toward the high end of that 3-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, specifically around asset returns, discount rates, discretionary contributions, etc.

And then operationally, as I mentioned, I think it was Cai's question, these large international programs, right, they present great opportunity for us to drive cash flow. And 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 DeBriyn for any closing remarks.

Kelsey DeBriyn -- Vice President of Investor Relations

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


[Operator signoff]

Duration: 61 minutes

Call Participants:

Kelsey DeBriyn -- Vice President of Investor Relations

Tom Kennedy -- Chairman and Chief Executive Officer

Toby O'Brien -- Chief Financial Officer

Joseph DeNardi -- Stifel Financial Corp. -- Analyst

Jon Raviv -- Citi -- Analyst

Robert Spingarn -- Credit Suisse -- Analyst

Cai Von Rumohr -- Cowen and Company -- Analyst

Doug Harned -- Sanford C. Bernstein -- Analyst

Seth Seifman -- J.P. Morgan -- Analyst

Myles Walton -- UBS -- Analyst

Robert Stallard -- Vertical Research Partners -- Analyst

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